$~16
* IN THE HIGH COURT OF DELHI AT NEW DELHI
+ ITA 923/2015
COMMISSIONER OF INCOME TAX-IV ..... Appellant
Through Mr. Raghvendra Singh, Advocate
versus
HERO MOTOCORP LIMITED. ..... Respondent
Through Mr. Ajay Vohra, Sr.Advocate with
Ms. Kavita Jha and Ms. Rupali Gupta,
Advocates
CORAM:
JUSTICE S. MURALIDHAR
JUSTICE ANIL KUMAR CHAWLA
ORDER
% 08.05.2017
Dr. S. Muralidhar, J.:
1. This is an appeal by the Revenue under Section 260A of the Income Tax
Act, 1961 (,,Act) directed against the order dated 23rd November, 2012
passed by the Income Tax Appellate Tribunal ('ITAT') in ITA No.
5130/Del/2010 for the Assessment Year ('AY') 2006-07.
2. By its order dated 14th January, 2016, the Court issued notice confined to
the following question (which incidentally was the fourth of the five
questions urged by the Revenue):
"Whether on the facts and circumstances, the ITAT was correct
in law in holding that by export of specified models to specified
countries, the Assessee company had benefited and therefore by
deleting addition of Rs. 12.19 crores made by AO on account of
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export commission without appreciating the fact that the
Assessee has to export motorcycles to underdeveloped countries
in very restrictive environment and on such terms and conditions
which were detrimental to the Assessee and were for the benefit
of the subsidiaries of the AE."
Background facts
3. The background facts relevant to the question projected are that the
Assessee is engaged in the business of manufacture and sale of motorcycles
using technology licensed by Honda Motor Co.Ltd., Japan (,,HMCL). The
Assessee set up its plant in the year 1984 to manufacture models of
motorcycles by using know-how of HMCL through a Technical
Collaboration Contract dated 24th January, 1984. Under the said agreement,
the Assessee was provided with technical assistance not only for
manufacture, assembly and service of the products but was also provided
with information, drawings and designs for the setting up of the plant. The
said agreement expired in 1994.
4. On 2nd June, 1995 a License and Technical Assistance Agreement
(,,LTAA) was entered into between HMCL and the Assessee on fresh terms
for a further period of ten years. By another LTAA dated 2nd June, 2004, the
earlier LTAA was extended for an additional period of ten years. By the said
LTAA, HMCL (described as Licensor) granted to the Assessee (described as
Licensee) an "indivisible, non-transferable and exclusive right and license,
without the right to grant sublicenses, to manufacture, assemble, sell and
distribute the products and parts" during the term of the LTAA "within the
Territory" (defined as India).
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5. On 21st June, 2004 a separate Export Agreement (,,EA) was entered into
between HMCL and the Assessee whereby HMCL accorded consent to the
Appellant to export specific models of two wheelers to certain countries on
payment of export commission @ 5% of the FOB value of such exports. The
Assessee explained that the payment of export commission was made by it
to HMCL as consideration for HMCL according consent to the Assessee to
export two wheelers in the specified overseas territories, which were earlier
being supplied only by HMCL or its other affiliates.
6. Today during the course of submissions, Mr. Raghvendra Singh, learned
counsel for the Revenue, submitted that there were two aspects to the
payment by the Assessee of export commission of Rs. 12.91 crores to its
Associated Enterprise (,,AE) i.e., HMCL (at the rate of 5%) during the AY
in question. One was to treat it as an international transaction thereby
entailing a transfer pricing (,,TP) adjustment. The alternative approach of
the Revenue was to disallow the payment of export commission under the
general provisions of the Act. This was by construing the export commission
as royalty which in turn would require the Assessee to deduct tax at source
under Section 195 of the Act. The failure to do so would lead to the
disallowance under Section 40 (a) (i) of the Act of the entire payment of the
export commission as a deduction.
Treatment of export commission as an international transaction
7. As it transpired, the question as projected in the present appeal by the
Revenue and on which notice was issued pertained to treating the payment
of export commission as an international transaction entailing a TP
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adjustment. In this context, it requires to be noted that the Transfer Pricing
Officer (,,TPO) held that the payment of export commission by the Assessee
to its AE i.e., HMCL was unnecessary; that it was detrimental to the
Assessee and only with a view to benefitting the AE's units/subsidiaries in
those countries to which the Assessee was permitted to export the vehicles.
On this basis, the TPO proceeded to hold that the Arm's Length Price
(,,ALP) of the said transaction i.e., the payment of export commission was
nil. He recommended a TP adjustment of the entire sum of Rs. 12.19 crores
paid by the Assessee to its AE as export commission during the AY in
question. After the DRP concurred with the TPO and the Assessing Officer
(,,AO) passed the final assessment order on that basis, the Assessee filed an
appeal before the ITAT.
8. By the impugned order, the ITAT reversed the above orders of the TPO,
the DRP and the assessment order by holding that there was no basis for
treating the payment of export commission as an international transaction.
The ITAT analysed the clauses of the Agreement dated 21st June, 2004 for
the payment of export commission and came to the conclusion that "the
allegation of the Revenue that export agreement between the assessee and
HMCL was not for the benefit of the assessee and by way of export, instead
of the assessee, the subsidiaries of the AEs have been benefited, is factually
incorrect." Based on the model-wise figures of export sales placed before it
by the Assessee, and which was unable to be controverted by the Revenue,
the ITAT held that the Assessee had in fact benefitted from the transaction
inasmuch as it had earned a profit of Rs. 13.05 crores through exports. The
ITAT factually found that "The export sale rate was more than the domestic
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sale rate even after considering the export commission." Consequently, the
ITAT set aside the disallowance by the AO of the payment of export
commission by way of a TP adjustment.
Question urged by the Revenue
9. Mr. Raghvendra Singh submitted that the Revenue might not be able to
contest the above factual finding as far as treating the payment of export
commission as an international transaction entailing a TP adjustment was
concerned. However, he urged that this Court should frame a question on the
alternative plea of the Revenue viz., that the payment of export commission
was in fact payment of royalty which required the Assessee to deduct tax at
source and the failure to do so led to disallowance of the deduction under
Section 40 (a) (i) of the Act.
10. He further submitted that this question was critical for the companion
appeals (i.e. ITA Nos. 312/2015, 538/2015 and 118/2017 CIT-4 v. Honda
Siel Power Products Ltd.) where notice was issued by this Court on this
very question. He pointed out that in those cases the ITAT had, in answering
the question against the Revenue and in favour of that Assessee, merely
followed its decision in the present matter of Hero Motocorp Ltd.
11. Consequently, although the question has in fact not been urged by the
Revenue as such in the memorandum of the present appeal, the Court
proceeds to examine if any question of law requires to be framed on the
issue of treating the payment of export commission as royalty for the
purposes of Section 9 (1) (vi) read with Section 40 (a) (i) of the Act.
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Submissions on behalf of the Revenue
12. The contention of the Revenue, as articulated before the ITAT and as
reiterated before this Court on its behalf by Mr. Raghvendra Singh is that
under Explanation 2 below sub-clause (vi) of Section 9 (1) of the Act,
'royalty' means consideration for the purposes specified thereunder in sub-
clauses (i) to (vi). The word 'consideration as defined in Section 2 the Indian
Contract Act, 1872 would include a payment to do or abstain from doing a
particular thing. He pointed out that under the LTAA dated 2nd June, 2004,
there was a specific bar (in the form of a negative covenant) that prevented
the Assessee from using the know-how to manufacture vehicles for export
outside India. Within a few days on 21st June, 2004, a separate EA was
entered into permitting export of the vehicles so manufactured to certain
countries. The EA was in fact nothing but an extension of the LTAA itself.
The preamble clauses of the EA expressly referred to the LTAA and also
described the parties thereto as the Licensor and the Licensee. It is submitted
that the consideration for the negative covenant under the LTAA i.e.,
abstaining from exporting the product outside India was monetised in the
EA in the form of the export commission and was therefore a payment of
royalty.
13. Mr. Singh submitted that in the absence of any principal-agent
relationship between HMCL and the Assessee in terms of the EA, the
payment of export commission thereunder was without consideration. It was
nothing but a payment of royalty for the use of the know-how to
manufacture vehicles for export to the countries specified. If at all any
payment had to be made, it had to be to the subsidiaries of the AE who were
ITA 923 of 2015 Page 6 of 10
selling vehicles in those territories. The EA was nothing but a device to
enable the AE to avoid paying taxes on the income earned as a result of the
use by the Assessee of the know-how. The actual royalty paid had to include
the payments both under the LTAA and the EA i.e., inclusive of the
component of the export commission. He placed reliance on the decision of
this Court in Commissioner of Income Tax v. Shiv Raj Gupta (2015) 372
ITR 337 (Del). He pointed out that the reliance placed by the ITAT on the
decision of the Authority for Advance Ruling in the case of SPAHI Project
P. Ltd. v. CIT-Central-III (2009) 315 ITR 374 (AAR) was misplaced as it
was distinguishable on facts.
Submissions on behalf of the Assessee
14. Mr. Ajay Vohra, learned Senior counsel for the Assessee contested the
above submissions. He referred in detail to the clauses of both the LTAA
and the EA and submitted that they were two separate agreements. He
pointed out that it was only after two decades of working out the technical
collaboration agreement that HMCL agreed to permit export by the Assessee
of the Hero Honda brand of vehicles to territories where HMCL and its
subsidiaries operated. He pointed out that Article 3 of the LTAA dated 2nd
June, 2004 anticipated a separate EA whereby the Assessee would be
permitted to sell the products outside India. The consideration was clearly
spelt out in the EA viz., the ceding of territories for the Assessee to sell and
use the existing distribution network of HMCL and its subsidiaries in those
territories without extra payment.
15. Mr. Vohra further submitted that the Assessee continued to pay the
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amounts under the LTAA in relation to the vehicles exported. This was
separate from the export commission. Further, HMCL could continue to
export Honda vehicles to those territories through its subsidiaries. The
Assessee was permitted to export the Hero Honda brand of vehicles. He
submitted that it was not permissible to re-characterise the transaction of
export commission as one involving payment of royalty. He finally
submitted that the impugned order of the ITAT called for no interference
and did not give rise to any substantial question of law on this issue.
Is export commission in fact 'royalty'?
16. The submissions on behalf of the Revenue hinge on having to treat the
LTAA and EA as forming part of the same scheme of agreements, one in
continuation of the other and which achieve the same result i.e., payments
by the Assessee to the AE i.e., HMCL. However, when the entire history of
the collaboration between the Assessee and HMCL is viewed, then the
picture becomes clear. As rightly noted by the ITAT, the technical know-
how was licensed by HMCL to the Assessee since 1984. This was continued
in 1995 and then in 2004 by the LTAA dated 2nd June, 2004. The EA which
was entered into on 21st June, 2004 could not therefore be said to be
contemporaneous.
17. Secondly, the specific clauses in the EA further bring out the nature of
the transaction involved therein. The payment of the export commission was
not without consideration. It permitted the Assessee to export specified two
wheelers manufactured under the Hero Honda brand to the specified
countries. Further, the Assessee did not have to pay for using the existing
ITA 923 of 2015 Page 8 of 10
distribution and sales networks in those territories. The attempt at re-
characterising the transaction as one involving payment of royalty overlooks
the fact that the payment under the LTAA is treated by the Assessee itself as
royalty. Such royalty is in effect paid even on the export consignments.
Also, to view this as only benefitting the AE is to overlook the fact that not
only has the Assessee benefitted in various ways as noted before, but it has
also earned during the AY in question profits of Rs. 13.05 crores from
exports.
18. In the above factual background and the specific wording of the clauses
of both the LTAA and the EA, it is not possible to accept the contention that
the export commission was in fact the monetisation of the negative covenant
of the LTAA viz., abstaining from exporting to territories outside India. This
argument at its best is ingenious but far removed from what the transaction
in fact is. The consideration for the EA is clearly spelt out. Consequently,
there was no question of there having to be an principal-agent relationship to
justify the payment of the export commission. The amount spent on that
score by the Assessee was for the benefit of its business and in fact resulted
in a benefit.
19. In Commissioner of Income Tax v. Shiv Raj Gupta (supra), two
agreements were entered into on the same day, one for the sale of shares for
around Rs. 55.83 lakhs and another a 'non-compete' agreement for a
consideration of over Rs. 6 crores. In the circumstances of that case, it was
held that the non-compete agreement was a colourable device and the
consideration received thereunder was brought to tax. The facts in the
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present case are different. As already noted, the two agreements i.e., the
LTAA and EA were distinct and independent. The Revenue has not been
able to show that the EA was a colourable device and that the export
commission was a disguised royalty payment. It was not a payment for
technical services either.
20. In this context, the Court concurs with the following findings of the
ITAT:
"Therefore, by export agreement, the assessee has not been
transferred or permitted to use any patent, invention, model, design or
secret formula. Similarly, HMCL, by way of export agreement, has
not rendered any managerial, technical or consultancy services . In
view of the above, we hold that export commission was neither
royalty nor fee for technical services and, therefore, the assessee was
not required to deduct tax at source on the payment of export fee.
Once the assessee was not required to deduct the tax at source, it
cannot be said that the assessee failed to deduct tax at source so as to
apply Section 40(a)(ia)."
Conclusion
21. For all of the above reasons, the Court concludes that the payment of
export commission by the Assessee to HMCL was not in the nature of
payment of royalty or fee for technical services attracting disallowance
under Section 40 (a) (i) of the Act. No substantial question of law arises
from the said issue. The appeal is, accordingly, dismissed.
S.MURALIDHAR, J
ANIL KUMAR CHAWLA, J
MAY 08, 2017
mw
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