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Kirby Building Systems India Ltd., Pashmylaram, Medak Dist. 502 307 Vs. Addl. CIT, Range-8 Hyderabad.
July, 21st 2014
         IN THE INCOME TAX APPELLATE TRIBUNAL
           HYDERABAD BENCHES "B" : HYDERABAD

 BEFORE SHRI B. RAMAKOTAIAH, ACCOUNTANT MEMBER
                       AND
       SHRI SAKTIJIT DEY, JUDICIAL MEMBER

                   ITA.No.1651/Hyd/2010
                 Assessment Year 2006-2007

Kirby Building Systems
India Ltd., Pashmylaram,      vs. Addl. CIT, Range-8
Medak Dist. 502 307               Hyderabad.
PAN AABCK-0239-M
(Appellant)                       (Respondent)

                   ITA.No.1975/Hyd/2011
                 Assessment Year 2007-2008

Kirby Building Systems
India Ltd., Pashmylaram,      vs. JCIT, Range-8
Medak Dist. 502 307               Hyderabad.
PAN AABCK-0239-M
(Appellant)                       (Respondent)

                  For Assessee Mr. Farrokh V. Irani &
                               Mr. Pankaj Jain
                  For Revenue Mr. D. Sudhakar Rao

               Date of Hearing 11.06.2014
       Date of pronouncement 18.07.2014

                            ORDER

PER B. RAMAKOTAIAH, A.M.

            These two appeals are by assessee against the
respective orders of A.O. passed under section 143(3) read with
section 144C(1) of the I.T. Act, 1961 making additions under
section 92CA of the I.T. Act. In A.Y. 2006-07 there is one more
issue of disallowance of sales tax deferred under section 43B of
the I.T. Act, 1961. Since, common issues are involved in these
assessment years, these are heard together and decided by
                                 2
                         ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                   Kirby Building Systems India Ltd.,
                                      Pashamylaram, Medak District.

this order. For the sake of reference, the facts in appeal for
A.Y. 2006-07 are discussed elaborately.

2.           We have heard the Ld. Counsel and learned D.R.
in detail and perused paper books containing pages 445. Ld.
Counsel also placed on record a separate case law paper book
and also brochure containing activities of the assessee
company for explaining various technical activities of the
assessee.

ITA.No.1651/Hyd/2010 ­ A.Y. 2006-07 :

3.           The assessee has raised 11 grounds in this appeal
out of which, ground Nos.1 to 8 pertain to T.P. adjustments.
Ground No.9 pertains to disallowance of an amount of
Rs.13,45,52,755/- under section 43B. Ground No.10 is on levy
of interest under section 234B and 234D and ground No.11 is
on initiation of penalty proceedings under section 271(1)(c).
Ground No.10 is consequential in nature and Ground No.11 is
premature    in nature    and    therefore, they     need not be
adjudicated and accordingly, ground Nos. 10 and 11 are
dismissed.

4.           Ground Nos. 1 to 8 pertain to the disallowance of
payment of royalty and technical service fee to M/s. Kirby
Building Systems, Kuwait analysed under the provisions of
transfer pricing. Briefly stated, assessee M/s. Kirby Building
Systems India Ltd., is engaged in the business of manufacture
of Pre-Engineered Steel Building System (PEB) Products. For
the year under consideration, assessee filed return of income
declaring total income of Rs.6,82,39,910/-. A.O. noticed that it
had international transactions with its AE to an extent of
                                 3
                         ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                   Kirby Building Systems India Ltd.,
                                      Pashamylaram, Medak District.

Rs.15,96,89,713/-.      The   following    are    the   details    of
international transactions entered into by and between the
taxpayer and the AE :

Name of the AE     International           Value in INR
                   transaction
Kirby Kuwait       1. Payment of royalty     1) 137,037,502
                   and technical services
                   fee.
                   2. Payment of interest    2)    1,473,502
                   (ECB in Kuwait Dinar)
                   3. Payments towards       3)      657,120
                   reimbursement        of
                   expenses
KIMMCO             Purchase of insulating        19,429,932
                   material
Alghanim           Payment of interest on          1,031,517
Mauritius          (EC8 in USD)

5.           The TPO vide order dated 30.10.2009 accepted the
operating transactions consisting of purchase of         insulating
material and of payment of interest, reimbursement expenses
as at arm's length price. However, payment of royalty and
technical services fee of Rs.13,70,97,902/- were considered as
not at arm's length. After giving opportunity to the assessee,
the TPO was of the opinion that there was no need to pay any
royalty and technical service fee to the AE. His order vide para
10.2 to 10.4 on the issue is as under :


     "10.2.Royalty/technical services fee paid to Kirby
     Kuwait (AE)

     During the Financial Year under consideration, the tax payer
     has debited an amount of Rs.17,71,37,206/- towards
     royalty at the rate of 7.5% on sales. During F.Y. 2004-05, the
     taxpayer has paid royalty at Rs.6,77,67,700/- to Kirby,
     Kuwait (AE) at the rate of 3.5% on sales.
                            4
                    ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                              Kirby Building Systems India Ltd.,
                                 Pashamylaram, Medak District.

As per the agreement entered by and between the taxpayer
and it's AE at clause-4, the rates for payment of royalty are
given. Except that, nothing is mentioned. What is the basis
for which royalty is paid by the taxpayer remained
unsubstantiated. In its reply dated 10.03.2009, the taxpayer
in response to query no.10 has replied as under :

"Kirby India has technology collaboration with Kirby Kuwait.
In this regard, Kirby India has entered into a TSA with Kirby
Kuwait. The initial term of the agreement was for 7 years
starting from 1st April, 2000 to 31st March, 2007. However,
owing to business exigencies, the TSA was amended
intermittently to provide for waiver of the royalty during the
years 2000 to 2004. The amendments have resulted in
deferring the payment of royalty to subsequent years.
However, the amendment in the royalty rates and the
payments terms are subject to the condition that the royalty
payments will not exceed the potential outflow as agreed in
the original TSA. Further, in respect of the lump sun
technical fee, the sum of USD 2,000,000 which was agreed
as per the original TSA, has not been revised but the
payment terms have been amended to defer the payment
over a certain number of years up to 2017."

Taxpayer failed to furnish any FAR analysis in respect of
royalty payment. It is pertinent to note that no royalty was
paid by the taxpayer from year 2000 to 2004. Just because
RBI fixed the limits of royalty rates, the same is taken as
bench mark for payment of royalty. However, one has to
understand that the RBI limits is nothing to do with
determination of arms length price under the provision
contained under section 92 of I.T. Act, 1961. RBI limits are
meant to regulate foreign exchange as part of forex
management. The reason give for not paying royalty by the
taxpayer between the years 2000 to 2004 is that there were
no profits made during the said financial years. This is not
correct. In fact, for F.Y. 2003-04, the taxpayer has earned a
net profit margin of 6.67%. The claim of the taxpayer that
there is a substantial expansion of the manufacturing facility
during the F.Y. 2003-04 is also not correct. No significant
expansion took place during that year. Plant machinery
valued at Rs.2,64,35,261 is only added. A net profit of
Rs.6,71,10,235 was made on sale of Rs.108,38,57,968.
These are not valid reasons for paying royalty in some years
and not paying in some other years. When the taxpayer did
not paid royalty from year 2000 to 2004 (4 years), there is
                             5
                     ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                               Kirby Building Systems India Ltd.,
                                  Pashamylaram, Medak District.

no reason/basis as to why the royalty should be paid in
subsequent years, more so, based on an agreement, which
is never implemented. Also, the amount paid towards
technical     services   at     Rs.59,20,536/-      remained
unsubstantiated by the taxpayer with reference to the
benefits derived and services rendered. The taxpayer failed
to bring out any evidence in support of the technical services
actually received.




Hon'ble Supreme Court in the case of Union of India vs.
Gosalia Shipping P. Ltd., 113 ITR 307 (SC) held that :

"It is true that one cannot place over reliance on the farm
which the parties give to their agreements or on the label
which they attach to the payment due from one to other. One
must have regard to the substance of the matter and if
necessary, tear the veil in order to see whether the true
character of a payment is some thing other than what by a
clever devide of drafting it is made to appear."

10.3. Shifting of profits to no tax jurisdiction :

Rule of substance over form is the key in examining the
agreements entered by and between the taxpayer and it's
A.E. in respect of payment made towards royalty and
technical fees as these transactions are controlled. After
examining the available information/evidence on record and
analysis thereon, the only inference that can be drawn is
that these two transactions that is payment towards royalty
and technical services is that they are not at arms length. In
the guise of these payments, the taxpayer is shifting profits
to no tax jurisdictions like Kuwait and Mauritius, thereby
enriching themselves without paying taxes that are due in
the country where the taxpayer operates. The profits
declared by the taxpayer are not comensurating with the
functions performed and risk assumed in the country of
operations.

10.4. Brand value :

The taxpayer has also taken brand value as one of the
factors   for   payment      of   the     so-called    technical
services/royalty. Kirby, India sets its footprint in the country
in the year 2000. What brand value Kirby, Kuwait
commands in a country like India where the usage of pre-
engineered steel buildings are at a nascent stage. Only after
                                 6
                         ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                   Kirby Building Systems India Ltd.,
                                      Pashamylaram, Medak District.

     year 2000, the infrastructure sector has opened up which
     started accepting these pre-engineered steel structures in
     industrial sector. PESBs are not consumer products which
     can be bought off the shelf from any store. Also it is
     important to note that brand value is developed from the
     contributions made by all the group entities of MNEs.
     Therefore, Kirby, India has developed its own brand value
     by spending huge amounts on marketing, development and
     advertisements as discussed in the earlier part of this order.
     Significant costs have been incurred by Kirby, India in
     marketing of its product in the country. Also, the PESBs are
     customized to the needs of the customers with reference to
     locations and functionality of the business. The PESBs
     which are prevalent in Kuwait cannot be simply replicated
     here in India. Kirby, India has spent huge amounts in
     marketing development and business promotion to
     familiarize their products. Developed in-house expertise and
     most of the works are also outsourced on job work basis.
     Therefore, creation of brand value is from all sides and from
     all entities of a multinational group. No payment on account
     of brand value by the taxpayer to its AE is not justified.

     In view of the above discussion, it is concluded that the
     payment made by the taxpayer to its A.E. on account of
     technical services is excessive as already huge payments
     were made in the past several years. Neither taxpayer nor
     its AE could substantiate the actual technical services
     rendered, costs incurred/contributed, benefits derived. The
     arms length price of the payment made towards technical
     services is at Rs.59,20,536/- is taken as NIL under CUP
     method. As the payment of royalty on sales is without any
     basis and hence the transaction is treated as sham and no
     method is adopted. The arms length price of the royalty paid
     at Rs.17,71,37,206/- is taken at NIL."

Accordingly, he has suggested disallowance of the entire
amount pertaining to technical services and royalty to an
extent of Rs.18.30 crores.

6.           Assessee filed its objections before the DRP. The
DRP after analyzing the transactions of the AE and various
agreements entered by the assessee with AE with reference to
                                7
                        ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                  Kirby Building Systems India Ltd.,
                                     Pashamylaram, Medak District.

payment of technical fee and royalty gave partial relief by
stating as under :

   "8.3     After going through the entire material provided by
   the taxpayer and after extensive discussion of the TPO, we
   are of the view that Kirby India has established a plant In
   the outskirts of Hyderabad with technical assistance from
   its AE. Definitely, the AE has to be paid in terms of royalty
   and technical knowhow fee for the same. The main question
   here is whether the technical fee/royalty paid vis-a-vis the
   profit earned by the taxpayer and the services rendered by
   the AE are adequate or whether they are within the ALP. The
   following table gives the fee for technical services debited
   into the Profit & Loss Account by the taxpayer during the
   last so many years as under :

                Financial Year Technical Fees
                               paid in Rs.
                2005-06              59,20,536
                2004-05           1,90,05,260
                2003-04           1,02,87,965
                2002-03              63,84,953
                2001-02              10,74,145
                2000-01               2,43,259
                Total             4,29,16,118

   8.4.     As seen from the above table, the taxpayer during
   the last six years has debited to the Profit & Loss Account to
   the tune of Rs. 4,29,16,118/- on account of technical
   services. The benefit derived by the taxpayer from the above
   technical services, we are of the view is adequately
   compensated and hence further technical fee payment in
   this year is not necessary. The action of the TPO in taking
   technical fee payable for this year as "nil" is upheld. In
   respect of royalty, during the financial year under
   consideration the taxpayer was paying the royalty @7.5% on
   sales and debited an amount of Rs. 17.71 crores. As one
   could see, the AE is declaring 15% profit and the taxpayer
   has declared nearly 6% profit, whereas the royalty payment
   is @7.5% of the sales. Besides, this makes us to infer that
   there is a shifting of profit from India to its AE. We also tend
   to believe that since shifting of profits to its AE in countries
   non taxable, there would be a tendency to shift the profit
   from the taxpayer to its parent companies. Now the question
                                 8
                         ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                   Kirby Building Systems India Ltd.,
                                      Pashamylaram, Medak District.

     is how to quantify them. During the FY 2004-05, the
     taxpayer has paid the royalty @ 3.5% on sales of Rs.
     6,77,67,700/-. We are of the view that during this year also
     the royalty payment of 3.5% on sales would meet the
     requirement of ALP. To this extent, the TPO's report is
     modified i.e. ALP in respect of royalty payment is calculated
     as under :

     Price Received vis-a-vis the Arms Length Price:

     The price charged by the tax payer to its Associated
     Enterprises is compared to the Arms Length Price as under :

Arms Length Price of payment made towards          NIL
technical services
Price shown in the international transactions      Rs.59,20,536/-
Shortfall being adjustment u/s.92CA.               Rs.59,20,536/-

Arms Length Price of payment made               Rs.17,71,37,206/-
towards royalty
Price shown in the international                Rs. 8,26,64,030/-
transactions
Shortfall being adjustment u/s.92CA.            Rs.9,44,73,176/-

Summary of adjustments u/s.92CA:

(1) In respect of payment              made         Rs.59,20,536
towards technical services.
(2) In respect of payment              made      Rs.9,44,73,176
towards royalty
Total                                           Rs.10,03,93,712

7.           Thus the assessee has got partial relief from the
DRP. Therefore, it has raised various grounds on the denial of
claim of payment of       technical services and restriction of
royalty to the AE in its grounds 1 to 8.

8.           Ld. Counsel drew our attention to the activities of
the assessee company, reliance on technical expertise of Kirby
Building Systems, Kuwait and the sequence of events to
submit that originally assessee has entered into an agreement
for technical assistance and technical services with Kirby
                               9
                       ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                 Kirby Building Systems India Ltd.,
                                    Pashamylaram, Medak District.

Building Systems Kuwait on 1st April, 2000 in which it
undertook to pay an amount of 2 Million US Dollars as
technical service fee. This amount was to be paid, 1/3rd on
approval of collaboration agreement from Reserve Bank of
India, 1/3rd on delivery of knowhow documentation and
balance in 4 years after the proposal was approved by the RBI.
However, vide amended agreement dated 07.09.2001 it was
understood that lump sum amount of 2 Million USD would be
paid in 5 equal installments beginning           from the     year
December, 2002 with modified terms of payment of Royalty
and Technical fee. Since the assessee company was incurring
losses and was in requirement of working capital, there was
further amendment on November 12, 2002 with further
modifications. Since assessee paid only an amount of 0.4
Million US dollars as on that date, the technical fee was to be
paid at 2,67,000 USD in the year 2003 and 1,00,000 USD each
from 2004 to 2016 and balance 33000 US Dollars in the year
2017. It was submitted that lump sum technical fee payable at
the time of initial operations of the company was in fact
deferred so as to suit the assessee company in its working
capital requirement. Accordingly, it was submitted that
assessee paid US $1,00,000 as technical fee in the year under
consideration.

9.          With reference to royalty, it was submitted that in
the original agreement dated 01.04.2000 royalty was payable
on domestic sales at 2.5% in the first year and 5% from second
year i.e., 2002 onwards up to 31.03.2007. However, assessee
has not paid any royalty in the year 2000-2001 and vide
agreement dated 07.09.2001, the terms were changed to pay
royalty at 5% on domestic sales and 5% on export sales from
                               10
                       ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                 Kirby Building Systems India Ltd.,
                                    Pashamylaram, Medak District.

the year 2002 to March, 2007. In spite of that, assessee did
not pay any royalty in the years 2002 and 2003. Therefore,
vide agreement dated 12.11.2002, this was changed to no
royalty up to March 2003 and 7.5% on domestic sales and 8%
on export sales for 3 years up to March, 2007. This was
however, further modified vide agreement dated 17.12.2005 to
nil royalty up to 2004 and 7.5% on domestic sales for 3 years
and 8% of export sales for 3 years, that too up to March, 2007.
All the agreements were approved by RBI as well as Industries
Department, Government of India. It was submitted that
assessee in the impugned year has claimed the royalty at 7.5%
on domestic sales and 8% on export sales.

10.         It was submitted that assessee has never paid any
royalty at 3.5% on domestic sales and to that extent both TPO
and DRP wrongly considered the payment at 3.5% and allowed
the amount at that rate. It was submitted that royalty in A.Y.
2005-06 was paid at 7.5% on domestic sales which was
allowed. As far as the technical knowhow is concerned, this
amount was payable in a lump sum amount initially which was
deferred and only USD 1,00,000 was paid in the year.

11.         With reference to the total denial of technical
knowhow fees and partial denial of royalty by the DRP, it was
submitted that either the TPO or the DRP has no jurisdiction
to deny the claim in its entirety as they have only power to
examine the arm's length price of the payments made to AE. It
was further submitted that in case of T.P. adjustments, the
A.O. disallowed the entire claim invoking the provisions of
section 37(1), whereas DRP partially allowed the amount of
Royalty without any comparative study under various methods
                               11
                       ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                 Kirby Building Systems India Ltd.,
                                    Pashamylaram, Medak District.

prescribed under the provisions for examining the arm's length
price of the transactions entered into by the assessee with its
AE. Since the TPO has no jurisdiction to examine the
allowability of royalty claim, action of the TPO/DRP is not
sustainable. For this proposition, the Ld. Counsel relied upon
the decisions of the Hon'ble High Court of Delhi in the case of
CIT vs. EKL Appliances Ltd. 1068 of 2011 dated 29.03.2012
which in turn, was followed by Coordinate Benches of ITAT,
Mumbai in SC Enviro Agro India Ltd. vs. DCIT ITA.Nos. 2057,
2058/Mum/2009 dt.07-11-2012 and in the case of Thyssen
Krupp    Industries    India     P    ltd   vs.   ACIT,    Mumbai
ITA.No.7032/Mum/2011 dated 27.11.2012 and also by the
Coordinate Bench at Hyderabad in the case of DCIT vs. Air
Liquide Engineering India P. Ltd., in ITA.No.1040/Hyd/ 2011
and others dated 13.02.2014. It was the submission that A.O.
cannot disallow the amount in its entirety without examining
the arms length price of the transaction.

12.         Coming to the observations of the TPO that there
was shifting of profits to no tax jurisdiction, it was submitted
that this argument cannot be accepted in view of the
provisions of T.P. and also on further fact that assessee has
paid the taxes on the amounts in India. It was submitted that
the royalty and technical fee payable are on net basis.
Therefore, assessee has grossed-up the amounts and to an
extent of about 32% assessee has paid taxes including service
tax, cess and other taxes. The Ld. Counsel referred to the
detailed submissions made before the DRP on this issue.

13.         It   was   further       contended    that    assessee's
agreements with AE were approved by RBI and also by the
                                12
                        ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                  Kirby Building Systems India Ltd.,
                                     Pashamylaram, Medak District.

Department of Industries and therefore, the TPO/DRP has no
role to deny the claim which was approved by other
Government Authorities. Ld. Counsel on a clarification about
the working of royalty clarified that even though the rate
agreed/approved stood at 7.5% of domestic sales or 8% of
export sales, as per the policy of the RBI there are various
exclusions in considering the turnover. Therefore, the effective
date of royalty was much less whereas, the DRP has approved
the rate at 3.5% on the gross domestic sales. Therefore, there
is a little variation in the amounts taken.

14.         Summarising      the    arguments,      Ld.    Counsel
submitted that DRP/TPO has no jurisdiction to restrict the
amount to NIL. Ld. Counsel made various propositions as
under and as supported by various decisions of the Coordinate
Benches/High Court.

      i.    That TPO has to apply method while considering
            the adjustments to the international transactions.
            For this he relied on

            (i)     Merck Ltd., Mumbai vs. DCIT, Circle 6(3),
                    Mumbai      ITA.No.925/Mum/2007         dt.
                    19.07.2013.
            (ii)    Johnson & Johnson Ltd., Mumbai vs. CIT-
                    LTU, Mumbai ITA.No.83/Mum/2011 dated
                    05.02.2014.
            (iii)   Kodak India P. Ltd., Mumbai vs. ACIT 10(1),
                    Mumbai ITA.No.7349/Mum/2012 dated
                    30.04.2013
            (iv)    Reebok India Co. vs. ACIT, New Delhi
                    ITA.No.5857/Del/2012 dt. 14.06.2013


      ii.   The TPO has no jurisdiction to question the
            business prudence of the assessee in paying
            various royalties/technical knowhow fee.
                                13
                        ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                  Kirby Building Systems India Ltd.,
                                     Pashamylaram, Medak District.

             (i)    Johnson & Johnson Ltd., Mumbai vs. CIT-
                    LTU, Mumbai ITA.No.83/Mum/2011 dated
                    05.02.2014.
             (ii)   Reebok India Co. vs. ACIT, New Delhi
                    ITA.No.5857/Del/2012 dt. 14.06.2013


      iii.   The TPO has no jurisdiction to disallow the entire
             amount without determining the ALP

             (i)    SC ENVIRO Agro India Ltd., Mumbai vs.
                    DCIT 3(3), Mumbai ITA.Nos.2057 &
                    2058/Mum/2009 dated 07.11.2012
             (ii)   M/s. Thyssen Krupp Industries India P.
                    Ltd., Mumbai vs. ACIT, C.C.3(3), Mumbai
                    ITA.No.7032/Mum/2011 dt. 27.11.2012


      iv.    The TPO has no jurisdiction to disallow or differ
             from the agreements which are approved by other
             Government Authorities like Department of
             Industries or by Reserve Bank of India.

             (i)    SC ENVIRO Agro India Ltd., Mumbai vs.
                    DCIT 3(3), Mumbai ITA.Nos.2057 &
                    2058/Mum/2009 dated 07.11.2012

      v.     The benefit derived by the assessee is also not
             relevant for considering the payment of royalty and
             technical knowhow fee and relied on the following
             case laws

             (i)    DCIT, Circle1(1), Hyderabad vs. M/s. Air
                    Liquide    Engineering    India   P.   Ltd.,
                    Hyderabad ITA.No.1040/Hyd/2011 etc., dt.
                    13.02.2014
             (ii)   ACIT, Cir.4, Ahmedabad vs. Hitachi Home &
                    Life Solutions (India) Ltd., ITA.No.2361 &
                    2362/Ahd/2008 etc., dated 24.09.2013.

15.          Learned D.R. however, relied on the detailed
orders of the TPO and DRP to submit that there is no necessity
to pay royalty at higher amount and so the authorities are
within the jurisdiction to restrict the amount at NIL on
                                14
                        ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                  Kirby Building Systems India Ltd.,
                                     Pashamylaram, Medak District.

technical services fee and 3.5% on gross sales as far as royalty
is concerned. He relied on the orders of the authorities.


16.         Ld. Counsel, in reply, also clarified various issues
raised and placed on record a cumulative payment of royalty
and technical services fee by the assessee over a period to
submit that effective rate of royalty is very much less. It was
submitted that the assessee has paid cumulative royalty as
percentage of cumulative sales at 3.75% up to A.Y. 2009-2010.
It was submitted that the payment of technical knowhow and
royalty should be allowed in full.

17.         We have considered the rival contentions and
examined the orders of the authorities, documents placed on
record and relevant case law relied upon. Kirby Building
Systems India P. Ltd., is a wholly owned subsidiary of
Alghanim     Industries,      a        Kuwait    based    Multi-Billion
Conglomerate. It is one of the world's largest producers of Pre-
Engineered Steel Buildings (in short "PEB") and has been
operational for more than 38 years since 1976. To pioneer the
PEB concept, it has set up a plant in India in the year 1999
with a manufacturing facility with a capacity of 60,000 MT per
annum at Hyderabad. It was submitted that Kirby Kuwait has
extremely   talented   pool       of   skilled   structural   engineers,
designers   and    detailers       conversant      with   Indian    and
Internationally acclaimed codes and engineering practices. All
the buildings designed by Kirby are custom designed using
latest domestic/international codes and standards such as IS,
MBMA, AISC, AISI and AWS. PEB technology has various
advantages being flexibility in expansion, faster installation,
energy efficient and practically maintenance free with superb
                                15
                        ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                  Kirby Building Systems India Ltd.,
                                     Pashamylaram, Medak District.

quality and also earthquake resistant. It has applications
starting from factories and warehouse to air-craft hangers,
stations, ship yards, work-shops, Stadiums etc. Assessee
indeed pioneered a new concept of Pre-Engineering Steel
Building with the technical help of its AE.

18.         There is no dispute with reference to the fact that
assessee was promoted by the Kirby Building Systems, Kuwait
and its original technical service agreement for payment of
lump sum amount of $ 2 million dollars as technical knowhow
fee and royalty of 2.5% in the first year and 5% from second
year onwards up to March 31, 2007 was approved by the RBI
and Ministry of Industries. It is also a fact that assessee did
not remit any of those amounts in those years and the
agreement was amended periodically. As stated above in the
facts of the case, in the impugned year assessee has paid $ 1
lakh dollars as technical knowhow fee and royalty at 7.5% on
domestic sales as per the agreements entered into and
approved by the authorities.

19.         In the guise of examining the payments under T.P.
provisions, it is noticed that the TPO has not analysed these
payments either under TNMM method or under any other
method which require to be analysed as per the provisions.
However, the TPO has examined the business necessity of
payment of technical knowhow fee and royalty under the
provisions of section 37(1) rather than under the provisions of
T.P. His decision of not allowing any royalty payment or
technical knowhow payment and determining the ALP at NIL
cannot be sustained in view of the fact that this technical
knowhow fee and royalty were agreed upon when the assessee
has originally entered into agreement as on 01.04.2000 much
                                  16
                          ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                    Kirby Building Systems India Ltd.,
                                       Pashamylaram, Medak District.

before the T.P. provisions came on statute. It may be another
reason that assessee has revised the agreement and paid
subsequently, partly in the impugned year, but that does not
prevent assessee claiming expenditure which was necessary for
its business operations in view of the agreement entered at the
time of establishing the unit in India. Had there been no
revision of the agreement, the payment of technical knowhow
fee would have been over by the year 2002 itself. Assessee paid
in a sense belatedly the same amount which was payble
originally due to rescheduling in payment period. No extra
amount was required to be paid. Moreover, on the entire
turnover in the intervening years, assessee also would have
paid royalty. However, due to business requirements, both the
parties agreed to revise the royalties.     TP provisions does not
empower the TPO to decide about the commercial decisions
and determining the ALP at NIL thereby, denying the entire
claim instead of allowing the amount on the basis of ALP to be
determined under the provisions.

20.            The Hon'ble Delhi High Court in the case of CIT vs.
EKL Appliances ITA.No.1068 of 2011 and 1070 of 2011 dated
29th March, 2012 considered similar issue whether the TPO
has power to restrict in determining the ALP at NIL under the
provisions of T.P. when he was supposed to have determined
the arms length price of the international transaction. The
Hon'ble Delhi High Court after examining the facts of the case
held under :

      "19.    There is no reason why the OECD guidelines should
      not be taken as a valid input in the present case in judging
      the action of the TPO. In fact, the CIT (Appeals) has referred
      to and applied them and his decision has been affirmed by
      the Tribunal. These guidelines, in a different form, have
                           17
                   ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                             Kirby Building Systems India Ltd.,
                                Pashamylaram, Medak District.

been recognized in the tax jurisprudence of our country
earlier. It has been held by our courts that it is not for the
revenue authorities to dictate to the assessee as to how he
should conduct his business and it is not for them to tell the
assessee as to what expenditure the assessee can incur.
We may refer to a few of these authorities to elucidate the
point. In Eastern Investment Ltd. v. CIT, (1951) 20 ITR 1, it
was held by the Supreme Court that "there are usually
many ways in which a given thing can be brought about in
business circles but it is not for the Court to decide which of
them should have been employed when the Court is
deciding a question under Section 12(2) of the Income Tax
Act". It was further held in this case that "it is not
necessary to show that the expenditure was a profitable
one or that in fact any profit was earned". In CIT v.
Walchand & Co. etc., (1967) 65 ITR 381, it was held by the
Supreme Court that in applying the test of commercial
expediency for determining whether the expenditure was
wholly and exclusively laid out for the purpose of business,
reasonableness of the expenditure has to be judged from
the point of view of the businessman and not of the
Revenue. It was further observed that the rule that
expenditure can only be justified if there is corresponding
increase in the profits was erroneous. It has been
classically observed by Lord Thankerton in Hughes v. Bank
of New Zealand, (1938) 6 ITR 636 that "expenditure in the
course of the trade which is unremunerative is none the
less a proper deduction if wholly and exclusively made for
the purposes of trade. It does not require the presence of a
receipt on the credit side to justify the deduction of an
expense". The question whether an expenditure can be
allowed as a deduction only if it has resulted in any income
or profits came to be considered by the Supreme Court
again in CIT v. Rajendra Prasad Moody, (1978) 115 ITR
519, and it was observed as under: -

 "We fail to appreciate how expenditure which is otherwise
 a proper expenditure can cease to be such merely because
 there is no receipt of income. Whatever is a proper
 outgoing by way of expenditure must be debited
 irrespective of whether there is receipt of income or not.
 That is the plain requirement of proper accounting and the
 interpretation of Section 57(iii) cannot be different. The
 deduction of the expenditure cannot, in the circumstances,
 be held to be conditional upon the making or earning of
 the income."
                            18
                    ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                              Kirby Building Systems India Ltd.,
                                 Pashamylaram, Medak District.

It is noteworthy that the above observations were made in
the context of Section 57(iii) of the Act where the language
is somewhat narrower than the language employed in
Section 37(1) of the Act. This fact is recognised in the
judgment itself. The fact that the language employed in
Section 37(1) of the Act is broader than Section 57(iii) of the
Act makes the position stronger.




20.      In the case of Sassoon J. David & Co. Pvt. Ltd. v.
CIT, (1979) 118 ITR 261 (SC), the Supreme Court referred to
the legislative history and noted that when the Income Tax
Bill of 1961 was introduced, Section 37(1) required that the
expenditure should have been incurred "wholly,
necessarily and exclusively" for the purposes of business in
order to merit deduction. Pursuant to public protest, the
word "necessarily" was omitted from the section.

21.     The position emerging from the above decisions is
that it is not necessary for assessee to show that any
legitimate expenditure incurred by him was also incurred
out of necessity. It is also not necessary for assessee to
show that any expenditure incurred by him for the purpose
of business carried on by him has actually resulted in profit
or income either in the same year or in any of the
subsequent years. The only condition is that the
expenditure should have been incurred "wholly and
exclusively" for the purpose of business and nothing more.
It is this principle that inter alia finds expression in the
OECD guidelines, in the paragraphs which we have quoted
above.

22.     Even Rule IOB(l)(a) does not authorise disallowance
of any expenditure on the ground that it was not necessary
or prudent for assessee to have incurred the same or that
in the view of the Revenue the expenditure was un-
remunerative or that in view of the continued losses
suffered by assessee in his business, he could have fared
better had he not incurred such expenditure. These are
irrelevant considerations for the purpose of Rule 10B.
Whether or not to enter into the transaction is for assessee
to decide. The quantum of expenditure can no doubt be
examined by the TPO as per law but in judging the
allowability thereof as business expenditure, he has no
authority to disallow the entire expenditure or a part
thereof on the ground that assessee has suffered
continuous losses. The financial health of assessee can
                          19
                  ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                            Kirby Building Systems India Ltd.,
                               Pashamylaram, Medak District.

never be a criterion to judge allowability of an expense;
there is certainly no authority for that. What the TPO has
done in the present case is to hold that assessee ought not
to have entered into the agreement to pay royalty/brand
fee, because it has been suffering losses continuously. So
long as the expenditure or payment has been demonstrated
to have been incurred or laid out for the purposes of
business, it is no concern of the TPO to disallow the same
on any extraneous reasoning. As provided in the OECD
guidelines, he is expected to examine the international
transaction as he actually finds the same and then make
suitable adjustment but a wholesale disallowance of the
expenditure, particularly on the grounds which have been
given by the TPO is not contemplated or authorised.

23.     Apart from the legal position stated above, even on
merits the disallowance of the entire brand fee / royalty
payment was not warranted. Assessee has furnished
copious material and valid reasons as to why it was
suffering losses continuously and these have been referred
to by us earlier. Full justification supported by facts and
figures have been given to demonstrate that the increase in
the employees cost, finance charges, administrative
expenses, depreciation cost and capacity increase have
contributed to the continuous losses. The comparative
position over a period of 5 years from 1998 to 2003 with
relevant figures have been given before the CIT (Appeals)
and they are referred to in a tabular form in his order in
paragraph 5.5.1. In fact there are four tabular statements
furnished by assessee before the CIT (Appeals) in support
of the reasons for the continuous losses. There is no
material brought by the revenue either before the CIT
(Appeals) or before the Tribunal or even before us to show
that these are incorrect figures or that even on merits the
reasons for the losses are not genuine.

24.    We are, therefore, unable to hold that the Tribunal
committed any error in confirming the order of the CIT
(Appeals) for both the years deleting the disallowance of
the brand fee l royalty payment while determining the ALP.
Accordingly, the substantial questions of law are answered
in the affirmative and in favour of assessee and against
the Revenue. The appeals are accordingly dismissed with
no order as to costs".
                                             20
                                     ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                               Kirby Building Systems India Ltd.,
                                                  Pashamylaram, Medak District.

20.1.             The Principles laid down by the Hon'ble Delhi High
Court in the above said case equally applies to the facts of the
case. What TPO has done in the present case is to hold that
assessee need not pay any royalty or technical knowhow fee to
the AE. Even though DRP has partly modified the payment of
royalty, what we noticed is that they also made a mistake in
allowing only 3.5% of royalty when in fact, there is no such
claim in any of the earlier years. As submitted by the Ld.
Counsel in the course of arguments/presentation before us
assessee claimed at 7.5% in earlier year which was also
allowed.

20.2.             Moreover, the payment of royalty over the period
up     to    A.Y.     2009-10          and     technical         knowhow     fee    was
summarized by the assessee in the following table which was
filed during the course of hearing before us in order to
substantiate the arguments that the cumulative royalty as
percentage of cumulative sales is much less at 3.08% up to the
impugned year which is still less than what the DRP allowed.

A.Y.        Net sales of   PBIT ­      Royalty       Technical    Royalty    Cumulative
            PEBs           Rs. Cr.     payment ­     fee          (as % of   Royalty as %
            (excluding                 Rs. Cr.       payment      sales)     of cumulative
            excise duty)                             Rs. Cr.                 sales.
            Rs. Cr.

2001-02           47.15       -1.69            ---         0.02      0.05%          0.05%


2002-03           76.32        5.66            ---         0.11      0.14%          0.11%


2003-04           85.81        6.17            ---         0.64      0.74%          0.37%


2004-05          100.68        8.78            ---         1.03      1.02%          0.58%


2005-06          193.34       17.46           5.36         1.78      3.69%          1.78%


2006-07          231.69       13.05          13.26         0.45      5.92%          3.08%


2007-08          292.78       23.01          15.82         0.44      5.56%          3.79%
                                   21
                           ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                     Kirby Building Systems India Ltd.,
                                        Pashamylaram, Medak District.


2008-09    390.54     29.33       15.75       0.39    4.14%        3.88%


2009-10    816.69     54.08       33.06       0.49    4.11%        3.96%




20.3.       Further as there was a mismatch of percentages in
the royalty claimed, clarification was sought in the course of
argument and Ld. Counsel explained that even though royalty
had a fixed percentage of 7.5% agreed, it was not on gross
sales but on net sales, as RBI has excluded various amounts.
It was also submitted that DRP without studying the terms
and conditions of payment of royalty as approved, allowed
royalty at 3.5% on gross sales which technically is also almost
equivalent to the royalty claimed by the assessee on net sales
basis. It was submitted that as percentage of sales, royalty
payment in the impugned year was only 5.92%. Be that as it
may, we are not in a position to approve the action of the A.O.
/ DRP in restricting the royalty and total denial of Technical
services fee without any basis at NIL under the guise of T.P.
provisions. In view of this, we are not in agreement with the
action of the TPO / DRP.

20.4.       In the course of arguments, Ld. Counsel made
various propositions on payments of Royalty and technical
services fee and cited the decisions of the Coordinate Benches
of the Tribunal in the case of SC ENVIRO Agro India Ltd.,
Mumbai     vs.      DCIT      3(3),       Mumbai     ITA.No.2057      &
2058/Mum/2009 dated 07.11.2012, M/s. Thyssen Krupp
Industries India P. Ltd., Mumbai vs. ACIT, CC 3(3),m Mumbai
in ITA.No.7032/Mum/2011 dt. 27.11.2012, Air Liquid India P.
Ltd., vs. DCIT, Circle 1(1), Hyderabad ITA.No.1159/Hyd/2011
etc., dt. 13.02.2014 and host of other decisions as stated in
                                22
                        ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                  Kirby Building Systems India Ltd.,
                                     Pashamylaram, Medak District.

the submissions above to substantiate various propositions.
Suffice to say that we have considered various legal principles
on the issue. We are of the opinion that apart from legal
position, even on merits the disallowance of entire technical
knowhow payment and part disallowance of royalty payment to
AE was not warranted.

21.          There is one more aspect to the above issue. The
agreements were periodically approved by RBI and by Ministry
of Industry and assessee was paying the amounts as per the
agreements. Even though approval by the other Governmental
authorities does not prevent TPO in examining the ALP as per
the provisions of the Act, what we noticed was that TPO did
not examine the issue under the T.P. provisions at all but took
upon the role of an A.O. in analyzing the commercial
expediency of payment of royalty and technical knowhow
under the provisions of section 37(1). Since the agreements
were approved by the authorities and considering the facts of
the case, we are of the opinion that the royalty fee and
technical knowhow are at arm's length and that assessee's
claim should be allowed as such. There is no information
brought on record by the TPO that the payment at 7.5% on the
net sales is not at arm's length as there was no other
comparable    case   brought     on    record.    Generally,    the
Government of India is approving the royalty payments at 7.5%
of the sales and this approval given by the RBI and Ministry of
Industry is at par with similar agreements being approved in
other contracts/agreements. Considering these aspects, we are
of the opinion that royalty and technical knowhow payments
made by the assessee to its AE are considered at arm's length
                                23
                        ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                  Kirby Building Systems India Ltd.,
                                     Pashamylaram, Medak District.

and thereby, the grounds raised by the assessee on this issue
are allowed. A.O. is directed to allow the amounts as claimed.

CORPORATE TAX MATTERS:

22.         Ground No.9 pertain to disallowance of amount of
Rs.3,45,52,755/- pertaining to sales tax deferment under the
provisions of A.P. VAT Act, 2005. A.O. disallowed the amount
invoking the provisions of section 43B on the reason that
assessee did not furnish any information with reference to
deferment and the ITAT in the case of Krebs Bio-Chemical
Industries in A.Ys. 2002-03 and 2003-04 in ITA.Nos. 1035 and
1036/Hyd/2006 dated 29.01.2008 supported the case of the
Revenue.

22.1.       Assessee contested before the DRP that A.O. did
not issue any show cause notice while disallowing the amount
and the judgment of Krebs Bio-Chemical Industries (supra)
does not apply to the assessee. It also contended that decision
of Hon'ble Supreme Court in the case of Gujarat Polycrete P ltd
vs. CIT is also not applicable. Assessee placed number of
documents supporting the amount into a deferred loan but the
DRP was of the view that the documents were not complete.
Accordingly, it confirmed the order of the A.O.

23.         Before us, Ld. Counsel contended that assessee
has placed all the documents before the A.O. as well as before
the DRP and referred to the order of the DRP in later year A.Y.
2007-08 wherein clear findings were given by DRP about this
and allowed the objection raised by the assessee in that year.

24.         After considering the rival contentions, we agree
with assessee's objection with reference to disallowance of the
                                  24
                          ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                    Kirby Building Systems India Ltd.,
                                       Pashamylaram, Medak District.

amount. As seen from the order of the DRP in A.Y. 2007-08,
the DRP on the basis of the evidences furnished before it,
allowed the amount by stating as under:

      "10.      Last ground of objection relates to the disallowance
      of sales tax under 43B of the Income Tax Act. The A.O.
      disallowed the claim of the assessee stating that it failed to
      produce a copy of the agreement with the Sales Tax
      department on conversion of deferment into interest free
      loan. The A.O. also cited the decision of the ITAT in the case
      of Krebs Bio-chemicals Industries Limited dated 29.01.2008
      that such agreement is a necessary condition to prevent
      addition u/s. 43B. however, it is argued that such
      stipulation is not there in the order of the ITAT according to
      the AR. The AR Sri M.P. Lohia clearly pointed out that para-9
      of the Hon'ble ITAT is in favour of the assessee. However,
      the AR placed before us the agreement in document No.
      28414, dated 06.04.2001 wherein agreement is concluded
      between DCCT, Charminar Division and assessee company
      on the determent of the sales tax and conversion of the same
      into loan. As per this document, which the photocopy is
      enclosed herewith, Rs.321,05,458/- is the benefit availed
      under sales tax deferment scheme. They have also produced
      the letter of Asst. Commissioner, Large tax payers Unit,
      Charminar Division in their favour. Further, the final
      assessment order for the year 2006-07 under CST Act, 56
      dated 25.11.2009 is also produced in support of their stand
      that the impugned sum is covered by deferment. Considering
      all the evidences produced and the agreement copy of which
      is enclosed herewith, relief is granted to the assessee. On
      this ground, the objection is allowed."



24.1.         Since the facts are similar and the claim also being
similar, we direct the A.O. to allow the amount in this year as
well. Ground No.9 is accordingly allowed.

25.           In   the   result,   ITA.No.1651/Hyd/2010       of   the
assessee is allowed.
                                      25
                              ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                        Kirby Building Systems India Ltd.,
                                           Pashamylaram, Medak District.

ITA.No.1975/Hyd/2011 ­ A.Y. 2007-08

26.             In this appeal, assessee has raised 14 grounds.
Ground Nos. 1 to 12 on the issue of T.P. adjustments made.
Ground No.13 is levy of interest under section 234B which is
statutory in nature. Ground No.14 is initiation of penalty
proceedings. The grounds 13 and 14 are academic in nature
and need not be adjudicated. Accordingly, they are dismissed.

27.             Now coming to Ground Nos. 1 to 12 pertains to
T.P. adjustments. Even though DRP in earlier year allowed the
royalty payment at 3.5%, DRP in this year differed from that
and upheld the TPO's action of disallowing the entire technical
services      fee    of   Rs.58,22,935/-      and    royalty   payment    of
Rs.20,81,35,663/-. For the detailed reasons given in earlier
appeal on similar issue, we do not approve the disallowance of
entire amount invoking the provisions of T.P. For the reasons
stated therein, we modify the order of DRP and direct the A.O.
to    allow    the    amounts       as    claimed.   These     grounds   are
considered as allowed.

28.             In    the   result,      ITA.No.1975/Hyd/2011       of   the
assessee is allowed.

29.             To        sum-up,         ITA.No.1651/Hyd/2010           and
ITA.No.1975/Hyd/2011 of the assessee are allowed.

        Order pronounced in the open Court on 18.07.2014.

  Sd/-                                           Sd/-
 (SAKTIJIT DEY)                                 (B.RAMAKOTAIAH)
JUDICIAL MEMBER                               ACCOUNTANT MEMBER

Hyderabad, Dated 18th July, 2014

VBP/-
                               26
                       ITA.No.1651/Hyd/2010 & 1975/Hyd/2011
                                 Kirby Building Systems India Ltd.,
                                    Pashamylaram, Medak District.


Copy to

1. Kirby Building Systems India Ltd., Plot No.8-15, IDA,
   Phase-III, Pashmylaram, Medak District ­ 502 307.
   C/o. Mr. Farrokh V. Irani, Advocate, 305B, Churchgate
   Chambers, V.T. Marg, Mumbai ­ 400 020.
2. Addl.CIT, Range-8, I.T. Towers, Masab Tank, Hyderabad.
3. Disputes Resolution Panel, 4A, I.T. Towers, A.C. Guards,
   Hyderabad ­ 500 004.
4. Addl. CIT (Transfer Pricing), Hyderabad
5. D.R. "B" Bench, ITAT, Hyderabad.

 
 
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