Delhi High Court
Commissioner Of Income Tax vs M/S Nestle India Ltd. on 11 May, 2011
Author: A.K.Sikri
REPORTABLE
* IN THE HIGH COURT OF DELHI AT NEW DELHI
+ ITA 662/2005, 288/2011, 294/2008,
96/2008,1202/2005
RESERVED ON: 15.02.2011
% PRONOUNCED ON: 11.5.2011
(1) ITA 662/2005
COMMISSIONER OF INCOME TAX . . . APPELLANT
Through : Mr. Sanjeev Sabharwal & Ms.
Rashmi Chopra, Sr. Standing
Counsel.
VERSUS
M/S NESTLE INDIA LTD. . . . RESPONDENT
Through:. Mr. Dinesh Vyas, Sr. Advocate
with Mr. Rupesh Jain, Ms. Kavita
Jha and Mr. Somnath Shukla,
Advocates.
(2) ITA 288/2011
COMMISSIONER OF INCOME TAX . . . APPELLANT
Through : Mr. Sanjeev Sabharwal & Ms.
Rashmi Chopra, Sr. Standing
Counsel.
VERSUS
M/S NESTLE INDIA LTD. ...RESPONDENT
Through: Mr. Dinesh Vyas, Sr. Advocate
with Mr. Rupesh Jain, Ms. Kavita
Jha and Mr. Somnath Shukla,
Advocates
(3) ITA 1202/2005
COMMISSIONER OF INCOME TAX . . . APPELLANT
Through : Mr. Sanjeev Sabharwal & Ms.
Rashmi Chopra, Sr. Standing
Counsel.
ITA 662/2005,288/2011, 1202/2005,294/08,96/08 & 288/11 Page 1 of 31
VERSUS
M/S NESTLE INDIA LTD. ...RESPONDENT
Through: Mr. Dinesh Vyas, Sr. Advocate
with Mr. Rupesh Jain, Ms. Kavita
Jha and Mr. Somnath Shukla,
Advocates.
RESERVED ON: 15.02.2011
PRONOUNCED ON:11.5.2011
(4) ITA 288 OF 2011
COMMISSIONER OF INCOME TAX . . . APPELLANT
Through : Mr. Sanjeev Sabharwal & Ms.
Rashmi Chopra, Sr. Standing
Counsel.
VERSUS
M/S NESTLE INDIA LTD. ...RESPONDENT
Through: Mr. Dinesh Vyas, Sr. Advocate
with Mr. Rupesh Jain, Ms. Kavita
Jha and Mr. Somnath Shukla,
Advocates.
(5) ITA 96 OF 2008
COMMISSIONER OF INCOME TAX . . . APPELLANT
Through : Mr. Sanjeev Sabharwal & Ms.
Rashmi Chopra, Sr. Standing
Counsel.
VERSUS
M/S NESTLE INDIA LTD. ...RESPONDENT
ITA 662/2005,288/2011, 1202/2005,294/08,96/08 & 288/11 Page 2 of 31
Through: Mr. Dinesh Vyas, Sr. Advocate
with Mr. Rupesh Jain, Ms. Kavita
Jha and Mr. Somnath Shukla,
Advocates.
(6) ITA 294 OF 2008
COMMISSIONER OF INCOME TAX . . . APPELLANT
Through : Mr. Sanjeev Sabharwal & Ms.
Rashmi Chopra, Sr. Standing
Counsel.
VERSUS
M/S NESTLE INDIA LTD. ...RESPONDENT
Through: Mr. Dinesh Vyas, Sr. Advocate
with Mr. Rupesh Jain, Ms. Kavita
Jha and Mr. Somnath Shukla,
Advocates.
CORAM :-
HON'BLE MR. JUSTICE A.K. SIKRI
HON'BLE MR. JUSTICE M.L. MEHTA
1. Whether Reporters of Local newspapers may be
allowed to see the Judgment?
2. To be referred to the Reporter or not?
3. Whether the Judgment should be reported in the
Digest?
A.K. SIKRI, J.
1. The questions of law which arise for consideration in these
appeals are common. These appeals concern with the same
assessee though it pertain to different assessment years. The
issue is with regard to deduction claimed by the assessee in
respect of remuneration/royalty paid by it to other subsidiaries and
the assessee‟s holding companies. Only the amount of royalty paid
in two years is different. To recapitulate briefly the circumstances
under which the aforesaid payments of royalties are claimed, the
assessee company is involved in the business of manufacturing
and marketing of various food products and beverages. In the
Income Tax Return filed for the assessment year 1997-98 it had
declared total income of ` 17,99,29,538/-under Section 115 JA of
the Income-Tax Act (hereinafter referred to as „the Act‟). The case
was selected for scrutiny and in the assessment made by the
Assessing Officer, several additions/disallowances were made.
Here we are concerned with only one disallowance which was
made, as aforesaid, i.e. qua the royalty payment made by the
assessee.
The Assessing Officer noticed that the assessee had debited
the amount of ` 47,00,41,000/- on account royalty payable to two
overseas companies namely Nestec S.A. and Societe Des Produits
Nestle S.A., Switzerland. These payments were claimed as
business expenditure on account of technical assistance rendered
by the two companies to the assessee. The Assessing Officer took
this payment of royalty as huge when the book profit of the
assessee after pay in that assessment years were ` 53.43 crores.
The AO asked for various details with supporting evidence and
documents about the nature of technical assistance and the basis
on which the assessee had entered into agreement to pay the
aforesaid amounts. The AO also noticed that the two foreign
companies were 100% subsidiaries of the assessee‟s holding
company and therefore the agreement/transactions were not at
arm‟s length. The AO referred to Sections 40A (2) (b) and Section
92 of the Act and held that he was entitled to go into the question
of reasonableness of the said payments and find out whether the
said expenditures were wholly and exclusively for the purpose of
carrying out business. He also referred to Article 9 of the DTAA
wherein it is specifically provided that when management, control
or capital of an enterprise in a contracting state, directly or
indirectly controls management of an enterprise in another
contracting state, then profit of that enterprise can be calculated
after excluding conditions different from those, which would have
been incorporated in a contract made between two independent
entity. The AO noticed that there were eight agreements entered
into between the assessee and the aforesaid two companies and
only two agreements were specifically approved by the
Government of India. He was of the view that even this approval
did not prevent him to go into the question as to whether or not
alleged expenditure should be allowed as a deduction. After
examining the issue he formed the view that the payment made
by way of commission/royalty was highly excessive in nature and
there was no justification for making payment of this magnitude
which was 40% of the gross profits. The Assessing Officer wanted
the assessee to furnish details regarding valuation of technical
service received, impact of such technical service and working
profits of each product which according to the AO the assessee
failed to produce. Thus, the Assessing Officer formed an opinion
that the assessee was not able to justify such a huge payment. He
specifically referred to the payment of ` 20.72 crores made on the
product Coffee which the company had started manufacturing in
the year 1964 and disallowed an amount of Rs 10 Crores out of
this payment. With regard to other products, a similar
disallowance of ` 5 crores was made. In this manner, out of ` 47
crores paid by the assessee to the aforesaid two overseas
companies, by way of commission/royalty, a sum of ` 15 crores
was disallowed.
2. The assessee felt aggrieved by this order of the Assessing
Officer and went in appeal. In this appeal, the assessee triumphed
as the CIT (A) accepted the contention of the assessee and
allowed the entire amount of royalty. In this manner,
disallowance of ` 15 crores made by the AO was deleted by the CIT
(A). It was inter alia, held by the CIT (A) that royalty payment in
terms of sales at 3.5% to 5% as against the Government norms of
5-8% was reasonable. It was further held that the royalty
payments for technical know-how are linked to sales and not to
profit which is a derived figure that can vary from year to year. It
would be relevant to state here that for the assessment year 1998-
99, the Assessing Officer had made a similar disallowance of ` 17
crores. However, the appeal preferred by the assessee against
that order was dismissed by the CIT (A) sustaining the
disallowance made by the Assessing Officer.
3. In so far as the assessment year 1997-98 is concerned, the
CIT (A) had allowed the appeal of the assessee. The Revenue
approached the Tribunal challenging the order of the CIT (A). The
assessee, on the other hand, filed appeal in so far as order of CIT
(A) in respect of assessment year 1998-99 is concerned. These
appeals have been decided by the Tribunal in favour of the
assessee. Thus, the order of CIT (A) in respect of assessment year
1997-98 was affirmed dismissing the appeal of the Revenue.
Likewise, the appeal of the assessee in respect of assessment year
1998-99 has been allowed. Effect is that the Tribunal has held that
the payment of commission was not huge or unreasonable and
since it was a business expenditure the entire expenditure
incurred by the assessee in both these years by way of payment of
royalty/commission to the aforesaid two overseas companies is
entitled for deduction.
4. Though, we shall take note of the order of the Tribunal in
detail immediately hereafter, three significant aspects which
influenced the Tribunal in arriving at the aforesaid decision are as
follows:-
(i) Royalty was paid on the basis of turn-over
of the assessee/Indian company and the rate
fixed was 3.5% of the turnover. The two
overseas companies had given similar know-how
to various companies world-wide with similar
clause for payment of royalty and the average
was 3.55%. Thus from the Indian companies,
the royalty was fixed at lesser rate than the rate
at which these two overseas companies were
claiming royalty from other companies in other
countries.
(ii) The two agreements out of eight which
were approved by the Reserve Bank of India
provided stipulation as per which the Reserve
Bank of India had authorized the assessee to
pay royalty upto 5%. Thus, the Reserve Bank
had, under the given circumstances, found
even 5% of the turn over as royalty to be
reasonable. (we may observe that it may not be
a relevant ground).
(iii) The royalty was paid for giving technical
know-how by the said companies to the
assessee. But for the said technical know-how,
there could not even be production of any of the
food and beverage items undertaken by the
assessee here in India. Furthermore, the two
overseas companies had been in continuous
research and development activity whereby
they were improving upon the products. All
such improvements which were the result of R &
D was provided to the assessee on continuous
basis. The assessee had thus received the
services from the said two companies and as a
consideration thereof, paid the aforesaid royalty.
This was, therefore, clearly a business
expenditure allowable.
(iv) Even the Assessing Officer did not dispute
this position and he joined the issue only on the
quantum of the royalty paid which according to
the AO was unreasonably high. The Tribunal on
the facts of the case found that the amount of
royalty was neither unreasonable nor exorbitant.
5. These appeals are against the order of the Tribunal which
were admitted on the following substantial question of law:-
"Whether the Income Tax Appellate Tribunal in
law in deleting the addition of ` 15 crores made
by the Assessing Officer on account of alleged
remuneration/royalty paid by the Assessee top
100% subsidiaries of the Assessee‟s holding
companies by relying upon Section 40A (2) (b)
and Section 92 of the Income Tax Act, 1961 and
Article 9 of the Double Taxation Avoidance
Agreement?"
"(2) Whether the Income Tax Appellate
Tribunal was correct in law in holding that the
Assessing Officer could not have examined
reasonableness and genuineness of the
alleged expenses/ payments made by the
Assessee to 100% subsidiaries of the
Assessee‟s holding companies in view of the
permission given by the Reserve Bank of
India?"
6. The aforesaid questions were formulated in respect of
assessment year 1997-98 as mentioned above. In so far as
assessment year 1998-99 is concerned, there is only a difference
in amount which is ` 17 crores instead of ` 15 crores in this year.
The perusal of question no.1 would demonstrate that the AO had
invoked the provisions of Section 40A (2) (b) of the Act to deny
the deduction in respect of entire amount of royalty and
disallowing part thereof as noticed above. The reasons given by
the AO for invoking this provisions was that the two overseas
companies to whom the payments were made are the companies
in which the assessee has substantial interest as they are 100%
subsidiaries of the assessee‟s parent company and, therefore, as
per the aforesaid provision, it was open to the Assessing Officer to
form an opinion as to whether the expenditure was excessive or
unreasonable having regard to the fair market value of the good,
services or facilities for which the payment was made.
7. Section 91 of the Act deals with the arms length price. The
reason for invoking this provision was again the same namely
close relation between the assessee and the two overseas
companies to whom the payment was made.
8. We may point out at this stage that Nestec S.A. is the parent
company with its headquarter at Switzerland. It has various
subsidiary companies. Nestec S.A. and Societe Des Produits
Nestle S.A. Switzerland, are the 100% subsidiary company of the
said company. Likewise, the assessee is the subsidiary company
of the aforesaid parent company. In this manner, though there is
no direct inter-se link between the assessee and the aforesaid two
companies to whom the royalty is paid, at the same time, the
assessee as well as the two companies are the subsidiary of the
same parent company. In that manner, we can say, these
assessee and recipients of royalty are the siblings and this kind of
co-relation exists between the assessee and the aforesaid two
companies with whom agreements have been signed and royalty
paid.
9. In so far as Article 9 of the DTAA is concerned, it is brought
into focus because of the reason that the royalty is paid to the
foreign companies and there is a Double Tax Avoidance
Agreement between the Indian Government and the Switzerland
Government. Before discussing as to how these three aspects are
dealt with by the Tribunal in the impugned order, it would be
advisable to take note of the nature of agreements signed
between the assessee and the aforesaid licensor specifying the
kind of technical know-how which has been given by those licensor
to the assessee and the nature of technical know-how provided to
the assessee under these agreements.
10. Nine agreements which are signed between the parties
relate to different products, like coffee, pasta, noodles, dry mix
infant foods, chocolates, infant weaning foods, dairy whitener etc.
By virtue of these agreements, the assessee is permitted to
manufacture and sell in India, the Nestle S.A. branded products
under the same brand name, logo and packing etc. These
agreements have various parts, part-A relates to "Manufacturing
Licence". As per the provisions contained in this part, the
assessee is granted licence during the term of the agreement to
use the know- how for the manufacture of the products. The
said know-how which the assessee is allowed to use, remains the
property of the parent company. Not only the existing know-how
but any improvement or development thereto are also to be given
and communicated to the assessee. Part-B of the agreement
deals with "duties and obligation of SPN". Under this part clause
relating to "Scope of Assistance" is provided as per which
technical assistance to be given to the assessee is all pervasive in
the operations of the assessee company. It includes oral advice or
supply of documents or samples, manuals, plans, papers and/or
other material. The recipient companies have undertaken to
supply the complete technical documentation to the assessee.
The technical assistant is to be provided from Switzerland in India
by way of spot assistance as well as training of personnel of the
assessee companies. Part-C of the agreement pertains to
"Duties and Obligation" of the assessee. Part-D deals with
"Consideration" and it is under this part it is agreed that royalty
to be paid by the assessee to the recipient companies would be
3.5 percent of the turnover. Part -E stipulates "Terms and
Termination" and Part -F includes "Miscellaneous Provisions".
Clause 32 of the agreement under the caption "Confidentiality"
binds the assessee to keep secret and confidential all information
and documentation and, in particular, the compliance of this
provision by the assessee‟s staff, employees and workers. All the
nine agreements are on same terms. The Tribunal in its detailed
order took into consideration the aforesaid aspects and
particularly the nature of know-how and services provided by the
recipient companies to the assessee. Various documents and
material supplied to the assessee in this behalf discuss in minute
detail the services rendered and the benefit which accrued to the
assessee as a result thereof. The remuneration which the
assessee got was not for any single purpose but a bundle of
benefits were accrued to the assessee namely; brand, know-how,
technical upgradation, technical supervision, collaboration and
assistance. The Tribunal also noticed that the assessee had
supplied plethora of documents before the lower authorities in
respect of both the assessment years and tabulated those
documents in the impugned order and found that the Assessing
Officer had not discussed or referred to even those documents. So
much so, even a suggestion was given to the AO to visit the
factory premises of the assessee in order to enable him to have a
spot observation of the technical know-how which was received by
the assessee enabling it to produce the aforesaid products. He
was even invited to have a meeting for a full and comprehensive
presentation on technical assistance.
11. In addition, the Tribunal took note of the following significant
features/aspects:-
(i) The assessee was a widely held Public
Limited Company and had more than 60,000
shareholders. About 2500 shareholders attended
the Annual General Meeting of the Company
every year where the annual accounts and major
issues of the company were placed and
approved. The local shareholders of the
company benefited tremendously. A person
who held 100 shares in 1970 had received
dividend of ` 2,66,563/- and the value of his
holding as a result of bonus shares and attractive
right shares was nearly ` 19 lakhs.
(ii) The parent company had been in this line of
business for the last 135 years. Nescafe as a
product grew and developed over a period of 60
years. In the beginning, it was 12 minutes coffee
brew; today it is instant coffee with improved
test profile. It was necessary for the assessee to
receive continuous technical assistance. The
Assessing Officer however, did not appreciate
the need of continuous assistance from the
collaborator.
(iii) During the year 1997, the assessee had
achieved the record level of exports and had
established itself as a leading exporter of Value
Added Instant coffee. The company‟s products
were available in 600000 outlets in 3000 towns
throughout the country, serviced by 3900
distributors. The assessee exported instant
coffee from India to Russia, Hungary, Poland,
Taiwan and instant tea to the USA and Japan.
During the year 1997, the company‟s export was
over ` 330 crores.
(iv) Emphasising the tremendous value of
nutrition in the foods that form our daily diets
The science and technology of food was being
given high priority and nowhere that was more
true than at Nestle who had been in the food
business for 125 years. Through constant
Research and Development , Nestle sought to
improve the quality of food and thereby quality
of life itself. The learned counsel took us through
the report of the Directors‟ of the assessee
company relating to structure of Nestle
Research; Technological Development; Quality
Assurance, Nestle India Access to Global
Technology Bank. Referring to these reports, the
learned counsel highlighted some examples of
technology advancement directly relating to the
business of the assessee company. For example,
in 1992 weaning food manufacturing technology
was enhanced through the introduction of "Z
line" manufacturing process. This process was
developed by NESTEC to meet the specific needs
of overseas market and was found to meet the
requirements of the Indian scenario. As a result,
Nestle India was able to introduce weaning foods
that ensured improved bioavailability of
carbohydrates through the process of
Enzymation, providing higher nutrition per meal
and enhanced digestibility. It was clearly visible
achievement of the global Nestle R & D. The
learned counsel pointed out that coffee-
manufacturing facility of the assessee-company
at Nanjangud was comparable with the best in
the world; as a result agglomerated instant
coffee was introduced in India for the first time.
The introduction of Maggi Noodles revolutionized
the eating habits in the country and added a new
dimension to convenience foods. The Noodle
plant was feasible only because of the know-how
and expertise received from NESTEC. The
learned counsel for the assessee pointed out that
quality assurance aspect of the assessee-
company's product could never be over
emphasized. For this purpose, vitamins, and
amino-acid analyses were carried to ensure
correct proportions in the finished product,
Contaminants like affatoxins and pesticide
residues were regularly monitored on sensitive
raw materials and finished products. Additionally
intensive on-going microbiological analyses were
conducted to search for pathogens like
salmonella and staph aureus. In the field of
packaging, Nestle India introduced for the first
time in the country polyester/low density
polyethylene. 2 Minute Noodles sachet with
reduced oxygen permeability enables consumers
to get a fresher product on the shelf. Nestle India
also brought about successful shift from
traditional rigid tin containers to flexible packs in
regard to its milk products, instant foods and
weaning foods not only resulted in significant
reduction in foreign exchange outflow through
imported tinplate but also resulted in cost
savings in excess of 35 per cent. Reading from
the annual report for the year 1996, the leaned
counsel referred to continuous Business
Excellence & Common Application (BEGA)
Initiative. He pointed out that in a country as
diverse as India, supply chain management was
critical to rapid growth. The BECA concentrated
heavily on streamlining and improving supply
chain management. The major benefits included
reduction in working capital through lower
inventories of finished goods and material, better
stock availability, reduction in obsolescence of
materials. Further, the Moga Factory was chosen
as a pilot plant and the Moga Improvement Team
(MIT) was put in place. The team members
comprising international experts from Nestle
Technical Services (NESTEC) and local staff
embarked on a programme in 1996 with the
single-minded objective of optimizing production
cost while enhancing product quality so as to
make Nestle product even more competitive in
the market place. The team identified the
following areas for detailed study :
-Process improvement to ensure optimal
usage of resources;
-Improvement of operational efficiency;
-Cost optimization.
A series of small but critically important
initiatives ranging from redesigning of
laboratories to palletisation of raw
materials and improvements in on-line
analyses led to significant reduction in
raw and packing material utilization,
manufacturing and filling losses and
labour manhours resulting in substantial
savings and improved productivity and
machine utilization. The pilot project in
Moga having proved successful, the
company intended to implement key
learnings of the MIT in other factories.
During later part of 1996, an
international Sales and Marketing
Improvement Team (SMIT) undertook a 4
months' SMIT exercise in India as a part
of major global initiative of Nestle to
enhance sales and marketing
productivity on a worldwide basis.
Following three critical areas were
identified from the point of view of the
growth objectives of the sales :
- Ensure direct coverage of all urban
towns in India;
- Expand distribution to reach one million
retail outlets on a regular basis;
- Work in partnership with the
distributors.
The aim was to access and evaluate
various operations with a view to
optimize the company's secondary sales
from distributor to the retailer. SMIT took
step-by-step approach, the team
continued to focus solely on actionable
solutions that were not only achievable
but also sustainable over the long-term.
The pilot project having been successful
in Chennai, the company intended to
implement key learning all over India.
(v) It took note of the detailed technical
instructions provided to the assessee, the
detailed manufacturing instructions, the material
relating to control procedure, technical manuals,
lab instructions, drawing and R &D aspects of
technical assistance agreements. The Tribunal
also noted the quality assurance aspects of the
products of the assessee company which it could
achieve because of the nature of technical know-
how as well as the advancements made in the
field of technology.
(vi) The Tribunal also noted that training was
an integral and indispensable part of Nestle. It
was a major investment in the future of the
company and imperative because it was an
investment in people. To this end, Nestle India
benefited greatly from the training programme
offered at the Rive Reine International Training
Centre at Vevey, Switzerland. These programme
were an irreplaceable part of Nestle India‟s
overall training plan. In addition to Rive Reine
courses, in-house Training & Development
programme within the country received
considerable support from the international
exports who visited India.
(vii) The Tribunal also took note of the
argument of the learned counsel for the assessee
and found substance therein namely providing
this technical know-how for the first time to the
assessee company was not possible without such
rigorous and continuous R& D activities
undertaken by the recipient companies/parent
company. It was noticed that R & D budget of
Nestle, SA, Switzerland was over ` 2000 crores.
The assessee participated in a scheme to reap
benefits of the same on payment of a very small
amount. R& D achievements mostly were
invisible but were of paramount importance.
Specialists at the Headquarters in Switzerland or
at Product Technology Research Centres wrote
technical know-how documents. The documents
were validated through industrial usage and
were continuously updated. With a strong
centralized research, 7 development s and the
very long experience in setting up and operation
of factories, Nestle had been able to develop a
vast knowledge base, which was essentially
proprietary. To be able to impart this knowledge
to the Nestle organizations entitled to receive it,
Nestle had created the Technical Instruction
system that guided the creation, distribution and
management of "know-how" flow. These
instructions covered product specific information,
like Recipes and Manufacturing Instructions,
Operational Aspects of factory operations as well
as Safety, Environment Protection and Quality
Assurance.
12. Taking note of all these aspects, the Tribunal came to the
conclusion that the Assessing Officer was not correct in his
observation that information and material asked by him was not
provided by the assessee. On the contrary, by and large, the
assessee furnished entire information, material and evidence as
was asked for by the AO having regard to the nature of the
technical know-how and other services provided by the recipient
companies, the Tribunal went into the question of quantum of
remuneration and arrived at a finding that this remuneration was
not unreasonable or excessive but was justified. We may
reproduce below:-
"94.We now come to the question as to
whether the quantum of remuneration as
agreed upon in the agreements in question
and actually paid during the course of the
assessment years before us is justified on the
facts and in the circumstances of the case. In
other words, whether both the AO in the
assessment order for asst. yr. 1997-98 and
the learned CIT(A) in the appellate order for
asst, yr. 1998-99 are justified their conclusion
that the assessee in collusion with parent
company in Switzerland adopted a colourable
device whereby the profits of Indian company
were siphoned away to be aggrandized by
the Swiss company. The learned AO has
argued in the assessment order for asst. yr.
1997-98 that from the very fact that no
evaluation and analysis of technical
assistance had been made at the time of
entering into agreements and subsequently
to determine the impact of technical
assistance on the business of the company, it
was clear that these agreements had been
entered into with the sole object of diverting
profit of the assessee-company. In this
context, the learned AO even asked the
assessee to produce a certificate from an
independent technical agency that the
payments were commensurate to actual
services received. Besides, both the learned
AO in the assessment proceedings for the
asst. yr. 1997-98 and the learned CIT(A) in
the order for the asst. yr. 1998-99
emphasised that the assessee was already
well established and well versed in the
business of products in question, and was not
new to the business of manufacture and sale
of those products and, therefore, the
assessee could not by any stretch of
imagination be considered to need further
technical assistance of the magnitude so as
to part with a substantial chunk of its
business profit.
95. The authorities below in their orders and
the learned CIT (Departmental
Representative) in his arguments before us
have relied upon certain charts indicating
78.37 per cent and 49.95 per cent of the
profit had been paid off by the assessee-
company under the agreements in relation to
the asst. yrs. 1997-98 and 1998-99
respectively. During the course of hearing
before us, the learned counsel for the
assessee has attacked the very rationale of
the exercise done in these charts by the IT
authorities. According to him, the quantum of
remuneration could not, in any case, be
linked with the profit. The profit was a
derivative figure depending on various
factors outside the direct and reasonable
control of the technical assistance providers.
Contracting for a fixed amount of royalty
could be disastrous if the product did not
click in the market. In the sale-linked
agreement, the technical assistance
providers interest in the success of the
product was highest and ensured maximum
assistance was received. Moreover,
intangible benefit of technical assistance
could not be gauged by the performance of
the same year in which the investment in
technology was made. The benefit could be
gauged only over sufficiently long-term
allowing the technical initiative to bear fruits.
That apart, the learned counsel for the
assessee pointed out that the working done
by the Department was highly unreasonable
inasmuch as the payments were compared
with the profit of the company after payment
of remuneration in question. The learned
counsel, therefore, furnished a separate chart
to show that even on imperfect and irrational
basis of comparison with the profit adopted
by the assessing authority, the payments in
question constituted only 34.89 per cent and
26.59 per cent of the profits for asst. yrs.
1997-98 and 1998-99, respectively. The
learned counsel further argued that the
percentage was higher during asst. yrs. 1997-
98 and 1998-99 because the net profit as
percentage of turnover itself was lower in
those assessment years. As to the question
that no independent evaluation of the value
and utility of technical services were carried
out, the learned counsel argued that such
was never a practice in a case where highly
specialized and restricted technology was
imparted. Technology provided to the
assessee by the parent company and its
subsidiary had always been and was intended
to always remain the property of the parent
company and its subsidiaries. The assessee
had been given a right to use only that
technology for manufacture and sale of
products under the parent company's brand
name. The technology was highly sensitive
and confidential and, therefore, in every
agreement, the assessee was bound by
confidentiality clause. In such circumstances,
to invite an independent agency for
evaluation and certification as desired by the
AO was unthinkable. As to the basis on which,
the quantum of remuneration for technology
assistance was fixed, the learned counsel
argued that at the time of entering into the
agreement, it was not possible to predict
accurately the amount of remuneration to be
paid to technical assistance providers. That
depended on the success of the product
launched and actual working of the project in
India and subject to several imponderables. It
was for that reason that there was no specific
working made at the time of entering into
agreements in question and insistence of the
learned AO on production of the same was
not justified. The assessee as well as the
technical assistance providers were in the
line of business and had experience for a long
time and based on their experience and
perception, by mutual discussion, the rate of
remuneration was fixed. It was not possible
to physically demonstrate that intangible
exercise. The fact of the matter was that the
remuneration was fixed at a very reasonable
rate in spite of the Government regulations
having permitted payment of remuneration
at much higher rate. The justification of
remuneration paid was to be seen in the
voluminous material and evidence filed by
the assessee during the course of the
assessment proceedings and the proceedings
before us. It was totally inappropriate to test
the reasonableness of the remuneration on
the yardstick of profit of the year in which the
payment was made. This issue required a
long-term view to be taken. On careful
consideration of the detailed submissions
made by the assessee in this behalf and
briefly enumerated by us in paras 37 to 65 of
this order, we find ourselves in substantial
agreement with the assessee. In the first
instance, the assessee only had license to
use the technology and, therefore, the
assessee could not have continued the
manufacture of any Nestle brand product
without the consent of the parent company.
We do not subscribe to the argument of the
learned CIT (Departmental Representative)
that as intellectual property rights were not
recognized in India, the assessee could have
snapped ties with the foreign company and
carry on its business as before. We also find
that the technical assistance provided by the
parent company was all pervasive in the
operations of the assessee-company and
permeated into almost every detail. The
assessee-company in India was reaping
harvest of fine production technology evolved
by the parent company over 125 years by
virtue of presence in more than 70 countries.
For continuing to harvest the benefit, it was
essential for the assessee to have a perennial
source of supply of all the technological
innovation, advancement and upgrade. It
would not be an exaggeration to say that in
modern times, no businessman can afford to
be oblivious of the fast moving technology
related to his business on the ground of
contented with the knowledge and
experience already gathered. The assessee
did not contribute a single penny to R&D cost
of Nestle SA stated to be over Rs. 2,000
crores per year. Nestle India received tested
technology and therefore, did not have to
suffer loss of any failed technology or project.
The assessee had access to all the required
technology available with the parent
company not only in respect of
manufacturing but also in various other fields
like quality control, personnel, staff
management, marketing, storage and so on.
The kind of technical assistance received by
the assessee was of such nature as to sustain
its position as number one manufacturer in
India in respect of the products being
manufactured by it. During the course of
hearing before us, the learned counsel for the
assessee has given several examples of
major technological advancements that had
taken place in the area of the assessee's
products. He explained to us in detail the
major changes that took place in the field of
coffee manufacturing and state of art
technology that allowed to capture the aroma
of fresh coffee in the products of the
assessee. The learned counsel dwelt at
length on the unique technology in relation to
extraction process called MUCH process
resulting into better-finished product from the
same coffee beans. He made reference to the
changes in the manufacturing process of
weaning foods that ensured bio availability of
carbohydrates through the process of
Enzymation to provide higher nutrition in
meals and enhanced digestibility. These were
just a few examples from out of the many
advancements and changes taking place
every year. The learned counsel pointed out
that during the period under consideration,
more products were launched by Nestle than
in the immediately preceding two decades.
He also emphasized with considerable
justification that several thousand Indian
shareholders of the assessee-company were
tremendously benefited. An investor who
purchased 100 shares in 1970 had grown into
shareholding of 3700 shares of the market
Value of Rs. 19 lakhs after having received
the dividend totaling to Rs. 2,66,653. The
learned counsel argued that these aspects
were required to be appreciated rather than
merely suspecting that the remuneration for
technical assistance was nothing but a
camouflage to siphon away and repatriate
the profits of Indian operations. On careful
consideration, we see considerable force and
justification in these arguments of the
assessee."
13. The Tribunal also considered the question of applicability of
Section 40 A( 2) and Section 92 of the Act and held that these
provisions were not applicable. The matter was required to be
looked into having regard to the provisions of Section 37 (1) of the
Act and once it was found that it was a business expenditure, the
same was allowable under the aforesaid provision.
14. In so far as nature of services provided against the
consideration in the form of royalty paid by the assessee, the
findings are recorded by the Tribunal on the analysis of the
relevant documents and material and we do not find any
perversity in the same. In fact, once it is found that having
regard to the nature, quantum and quality assurance, the
technical know-how and other services provided to the assessee,
the compensation paid in the form of royalty/consideration is not
excessive but reasonable and justified, question formulated need
not even be gone into. However, we would like to answer these
questions as the appeal was admitted on the same.
15. We take up question of law no.2 in the first instance. We are
of the view that the Tribunal is not correct in observing that since
the permission is given by the Reserve Bank of India, the
reasonableness and genuineness of the expenditure could not
have been gone into by the AO. The purpose for which such
permission is given by the RBI is totally different. The RBI is only
concerned with the foreign exchange and, therefore, would look
into the matter from that point of view. The RBI, at the time of
giving such permission would not keep in mind the provisions of
the Income Tax Act and that is the function of the income tax
authorities and, therefore, they can validly go into such an issue.
Thus, we answer question of law no.2 in favour of the Revenue
and against the assessee but hasten to add that it has no bearing
on the outcome of the case as the payment is found to be
reasonable and genuine, even otherwise.
16. Coming to first question of law, it is an inter-play of section
40-A (2), Section 92 and Article 9 of the DTAA. These provisions
are reproduced below:-
Section 40 A (2)
"(2) Where the assessee incurs any
expenditure in respect of which payment has
been or is to be made to any person
referred to in clause 9b) of this sub-section,
and the Assessing Officer is of opinion that
such expenditure is excessive or
unreasonable having regard to the fair
market value of the goods, services or
facilities for which the payment is made or
the legitimate needs of the business or
profession of the assessee or the benefit
derived by or accruing to him therefrom, so
much of the expenditure as is so considered
by him to be excessive or unreasonable shall
not be allowed as a deduction..."
Section 92
"Income from Transaction with the
nonresidents, how computed in certain
cases:-
Where a business is carried on between a
resident and a non-resident and it appears to
the Assessing Officer that, owing to the close
connection between them, the course of
business is so arranged that the business
transacted between them produces to the
resident either no profits or less than ordinary
profits, which might be expected to arise in
that business, the Assessing Officer shall
determine the amount of profits, which may
reasonably be deemed to have been derived
therefrom and include such amount in the
total income of the resident."
"Article 9: Associated Enterprises
1 Where-
(a) An enterprise of a Contracting State
participates directly or indirectly in the
management, control or capital of an
enterprise of the other Contracting State, or
(b) The same persons participate directly
or indirectly in the management control or
capital of an enterprise of a Contracting State
and an enterprise of the other Contracting
State,
And in either case conditions are made or
imposed between the two enterprises in their
commercial or financial relations which differ
from those which would be made between
independent enterprises, then any profits
which would, but for those conditions, have
accrued to one of the enterprises, but, by
reason of those conditions, have not so
accrued, may be included in the profits of
that enterprise and taxed accordingly"
17. Submissions of the learned counsel for the Revenue was that
the profits earned by the assessee company are/were diverted to
the recipient foreign companies in the name of
remuneration/royalty and, therefore, as per Article 9 of DTAA, this
diverted amount is allowable to tax in India in the case of the
assessee company. This submission has to be negatived in view
of our aforesaid discussion. We may also observe that Article 9
(1) of the DTAA is relevant for the purpose of bringing back to
India the income of the non-resident and as no obligation for
disallowing expenditure in the hands of the Indian Resident there.
This becomes abundantly clear from the language of the aforesaid
Article. Insofar as Section 40A (2) of the Act is concerned, no
doubt, the Assessing Officer can disallow such expenditure which
is found to be excessive and unreasonable. This is a question of
fact and as held so in the following cases:-
(i) Upper India Steel Manufacturing & Engg.
Co. Pvt. Ltd. Vs. CIT, 117 ITR 569 (SC)
(ii) CIT Vs. Northern India Iron & Steel Co.
Ltd. 179 ITR 599 (Del)
(iii) CIT Vs. Sriram Piston & Rings Ltd, 181
ITR 230 (Del)
(iv) CIT Vs. Padmini Packaging Pvt. Ltd. 155
Taxman 268 (Del)
18. Since on facts of this case, it is held that expenditure was
neither excessive nor unreasonable, the same could not be
disallowed under Section 40 A (2) of the Act. It is stated at the cost
of repetition that the AO did not question the genuineness of the
payment namely that the payment was in fact made by the
assessee to the recipient foreign company/parent company. The
assessee has been able to discharge its burden namely it was a
justifiable and reasonable business expenditure and thus should
be allowed under Section 37 of the Act. We may recapitulate the
following findings of the Tribunal in this behalf:-
(i) That the assessee has successfully discharged
this burden;
(ii) That the assessee has furnished almost entire
information asked for;
(iii) That technical assistance received by it was
essential for its business purposes;
(iv) That the assessee highly benefited from this
know-how and technical assistance;
(v) That the quantum of remuneration was
justified;
(vi) That the technical assistance was all pervasive
in the operation of the assessee;
(vii) That there was no camouflage to siphon away
Indian profits abroad; and hence disallowance
of remuneration is not called for;
19. The Tribunal has held that the assessee having discharged
the initial onus, burden shifted to the Revenue to show that the
payment of royalty was excessive or unreasonable having
regard to the legitimate needs of business or that the assessee
has made less than ordinary profits and the Revenue has not
discharged the said onus. The Tribunal has in general recorded
clearly its findings of facts:-
That no material or evidence has been brought
on record by Revenue to substantiate
applicability of above provisions;
That the Revenue has not specified as to how
much ordinary profit was supposed to be and
basis of its determination, before treating
royalty payment as excessive and
unreasonable.
20. Coming to Section 92 of the Act, the CBDT has itself clarified
in its Circular No. 14 dated 27.11.2001 that Section 92 of the Act
does not apply in respect of „payment of royalty etc‟ which are
not the part of regular business carried on between a resident and
a non- resident.
21. This aspect is suitably dealt with by the Tribunal and we
agree with its reasoning. In view of the above, we answer the
question no.1 in favour of the assessee and against the revenue.
As a result, these appeals fail and hereby dismissed.
(A.K. SIKRI)
JUDGE
(M.L. MEHTA)
JUDGE
MAY 11, 2011
Skb
