B.R. Baskaran, A.M.

1. This appeal filed by the Assessee is directed against the assessment order dated 29.10.2010 passed by the Assessing Officer under Section 143(3) of the Act in pursuance of directions given by Dispute Resolution Panel under Section 144(C) of the Act and it related to the assessment year 2006-07.

2. The grounds raised by the Assessee give rise to the following issues:

(a) Determination of arms length price in respect of royalty amount of `1,27,27,343/- paid to an associated enterprise of the Assessee.

(b) Disallowance of claim of usance interest expense of `2,48,47,396/-

(c) Disallowance of 10% of expenses claimed under the head "Staff Welfare" on adhoc basis.

(d) Charging of interest under Section 234B of the Act

(e) Initiation of penalty proceedings under Section 271(1)(c) of the Act.

3. The facts relating to the case are stated in brief. The Assessee herein is engaged in business of manufacture of polystyrene and expandable polystyrene. It is wholly owned subsidiary of M/s LG Chemicals India Pvt.Ltd (Holding Company). The said holding company is 100% subsidiary of another company named M/s LG Chemicals Ltd., Korea. The transfer officer has depicted the ownership details of the impugned companies in the form of a chart as under:

LG International Corpn. Korea

(Associate Company)



LG Corporation



LG Chemical India Pvt. Ltd. (100%)



LG Polymers India Pvt. Ltd (100%)

(Assessee).

During the year under consideration, the Assessee company entered into an agreement titled as "Trade Mark Sub License Agreement" in the month of October, 2005 with M/s LG Chem Ltd Korea, as per which the Assessee herein was given non exclusive sub license for the use of "LG" Trade Marks for its business. It is to be noted here that the right to use the "LG" trade mark was granted by M/s LG Corporation to M/s LG Chem Ltd Korea, vide an agreement entered between the two companies in December, 2004 and according to the said agreement, M/s LG Chem Ltd Korea is entitled to sublicense the Trade marks to certain entities. Accordingly, M/s LG Chem Ltd Korea entered into the above said trade mark sub license agreement with the Assessee company. As per the terms of the sub license agreement cited above, the Assessee company paid the royalty amount of LG Chem Ltd. Korea (39.20%) `1,27,27,343/- during the year under consideration for the use of the trade mark cited above, which was calculated in the following formula.

Royalty = (Revenue (-) Advertising expenses) x 0.20%.

3.1 During the course of assessment proceeding, the assessing officer made a reference to the Transfer Pricing Officer (TPO) for estimation of arms length price (ALP) for the impugned royalty payment made by the Assessee. There is No. dispute with regard to the fact that M/s LG Chem Ltd, to whom the impugned royalty amount was paid, is an Associated Enterprise of the Assessee company. The TPO, vide his order dated 30.10.2008, passed Under Section 92CA(3) of the Act, determined the ALP of the impugned royalty payment at NIL value. Accordingly the Assessing Officer disallowed the entire amount of `1,27,27,343/- claimed by the Assessee. The "Dispute Resolution Panel" (DRP) also upheld the view of the TPO. The assessing officer also proposed to disallow the amount claimed under the head "Usance Interest expenses" and 10% of the amount claimed under the head "Staff Welfare expenses". Both the disallowances proposed by the Assessing Officer were also approved by the DRP. Accordingly the Assessing Officer completed the assessment by making the three types of disallowances discussed above. Aggrieved by the order of the Assessing Officer, the Assessee is in appeal before us.

4. The first issue relates to the determination of ALP in respect of the royalty amount paid by the Assessee to its AE. The TPO has come to the conclusion that the impugned royalty payment transaction is a sham one and the motive behind the same is to shift the profits of the Assessee company out of the country. The reasons cited by the TPO for arriving at such a conclusion are narrated below:

(a) Though the trade mark sub license agreement was entered in October-2005, the Assessee company started making payments from January, 2005. It is to be noted that the Assessee company did not make any such payment in the earlier years even though it was using the said LG brand.

Hence the reasons for making the impugned royalty payment remain unsubstantiated.

(b) Apart from the agreement, the Assessee could not furnish any other evidence to justify the impugned payment. In order to determine the arms length price of any royalty payment towards any intangible, following are the factors that are to be taken into consideration:

1) The expected profits attributable to the trademark;

2) The cost of developing the brand name or trademark

3) The uniqueness of the trademark

4) Compensation charged by the taxpayer for the costs incurred in brand building activity for its AE.

The Assessee could not substantiate on any of the above factors/ attributes of trademark license to justify the payment made.

(c) The Assessee could not establish with any evidence as to what value added by the trade mark in terms of consumer acceptability, geographical significance, market share, sales volume and other relevant factOrs.

(d) The trade mark has not gained any value in the market as there is a decline in the turnover and profits of the Assessee vis--vis the preceding year.

(e) The Assessee could not furnish details of royalty charged by the AE from other related/unrelated parties.

(f) The Assessee has failed to substantiate the benefits derived by it from the said payment.

(g) As per the information furnished by the Assessee from its study for benchmarking on 28.08.2009, the Supreme Petrochem Ltd, another company which also manufactures a similar product i.e. polystyrene in India, has recorded operating margin i.e. operating profit over total cost at 4.48; in the year under consideration as against negligible profit margin earned by the Assessee.

(h) M/s Supreme Petrochem Ltd was promoted by M/s Supreme Industries Ltd., M/s R. Raheja Investment (P) Ltd., and M/s S.H. Chemical Company Ltd., Korea. As per the annual report of M/s Supreme Petrochem Ltd, it has not paid any amount towards any intangible to any of its related parties. Further it has been stated therein that there is an impressive growth of over 15% in domestic demand of polystyrene during the year under review. However, the turnover of the Assessee has come down during the year under consideration, which means the trade mark of its AE, LG Chem Ltd, Korea did not help the Assessee to improve its turnover. Hence the impugned payment made to the AE is not justified.

(i) The Honble Supreme Court in the case of Union of India v. Gosalia Shipping P Ltd. 113 ITR 307 (SC) held that:

It is true that one cannot place over reliance on the form 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 device of drafting it is made to appear".

The transaction entered into by and between the Assessee and its AE is treated as a sham transaction as the motive behind the transaction is to shift the profits out of the country. The arms length price of these transactions is taken at nil, thereby enhancing total income of the Assessee to that extent.

Accordingly the TPO determine the ALP of royalty payment at Nil amount and considered the entire payment of `1,27,27,343/- made by the Assessee as short fall requiring adjustment under Section 92CA of the Act.

5. The dispute resolution panel also approved the views of the TPO by making following additional observations:

(a) "LG" trade mark has brand value for consumer durables (white goods) only and it was not recognized for polystyrene chemicals.

(b) The impugned trade mark was registered only in the year 2008 in India and hence there is No. registered trade mark during the year under consideration. In the absence of proper registration, the said trade logo can be used by any concern.

6. We have heard the rival contentions on this issue. Both the counsel argued at length for and against the observations of the TPO/DRP discussed above. However, on a careful perusal of the observations of TPO, we find that the TPO has directed himself to examine the genuineness of the transaction, necessity of making the impugned payment and also the viability of the same. There should not be any doubt that these aspects are normally considered by the management of the company while making business decisions. Nevertheless, the Assessee has made detailed submissions in respect of each of the observations made by the TPO and we highlight some of them below:

(A) It is purely a business decision:

(1) LG trade mark is owned by M/s LG Corporation and the LG group of companies has been using the same over the years.

(2) In Dec.2004, M/s LG Chem Ltd and M/s LG Corporation entered into a trade mark license agreement for use of the said trade mark by M/s LG Chem and its overseas affiliates, according to which M/s LG Chem was constrained to make payment of royalty calculated @

0.20% of the (consolidated revenue less advertisement expenditure), i.e. consolidated sales of LG Chem and its overseas affiliates.

(3) Both M/s LG Corporation and M/s LG Chem Ltd are listed in Korean Stock Exchange and the majority of the equity capital in those companies is held by independent share holders. All such arrangements are open for share holders scrutiny and are subject to corporate governance.

(4) Consequently, M/s LG Chem Ltd entered into an agreement with the Assessee company on identical terms in the month of October, 2005 with a specific clause that the royalty amount shall be paid with retrospective effect from January, 2005.

(5) The rate of royalty between M/s LG Corporation and LG Chem Ltd and also between M/s LG Chem Ltd and the Assessee company is the same i.e. 0.20% of revenue less advertisement expenditure, i.e., there is No. mark up made by M/s LG Chem Ltd, Korea.

(B) There is a value attached to the trade mark:

(a) The LG brand is created over a period of 62 years and has tremendous brand value, being one of the top global brands recognized across the world. The LG group is having an annual turnover of about US $100 billion.

(b) During the calendar year 2006, LG Corp has incurred a cost of KRW 89,797 million (approx. $78.08 million) on maintenance, administration and enhancement of the LG brand.

(c) The royalty amount paid by the Assessee company is 0.5879% of the Total royalty income of LG Corporation.

(C) Benefits attached to the Trade Mark:

(a) LG Brand is an international brand and is having market goodwill and recognition, which will help the Assessee company in the long run.

(b) The use of said trade mark allows the Assessee company to distinguish its products from others and allows enjoying the commercial benefits attached to the established brands.

(c) Trademark is a promise to the customer that a stipulated quality will be maintained and hence the customer can purchase a branded product believing in its quality which reduces his burden in matters such as, time in searching, examining for ensuring quality etc.

(d) It has helped the Assessee company to achieve a formidable position in the chemical business.

(D) Economic Viability:

(a) As per the press note No. 9 (2000 series) issued by the Ministry of Commerce & Industry, Govt. of India, payment of royalty up to 2% for exports and 1% for domestic sales is allowed under automatic route on use of trade marks and brand name of the foreign collaborator without technology transfer. However, the Assessee company has paid royalty only @ 0.20% of (revenue - advertisement), which is very much lower vis-a-vis the rate mentioned in the above said press note of the government.

(b) The impugned payment has not affected the profitability of the company significantly.

(c) There are various factors that can be considered to evaluate the value of brand of an organization. These factors could be a combination of increased sales or increased price, and/or reduced cost of goods sold, and/or reduced or more efficient marketing investment.

It would be important to note that brand certainly adds value to a business house but this is not a single factor determining the profitability. There are many more aspects that go into which impact the earnings of a company such as market conditions, availability of raw material, supply and demand and other external factOrs.

(d) The comparison of working results of M/s Supreme Petrochem Ltd is also not appropriate as the said company did not get any "brand name" from M/s SH Chemicals, Korea. Further the said company is the largest manufacturer of polystyrene with more than 50% of market share.

(e) In spite of the fact that LG Polymers, being less than half the size of Supreme, it has earned similar margins, illustrating the benefits derived by the brand in terms of sales and higher prices.

(E) Reply to DRPs observations regarding registration of trademark:

(a) The application for the registration of LG trademark was made by Lucky Ltd., Korea in India before "The Registrar of Trade Marks, Office of the Trade Marks Registry, Calcutta on 30th January, 1995.

(b) As per Section 23 of the Trademarks Act, 1999, the trade mark when registered shall be registered as of the date of the making of the said application.

(c) Copy of the extract from correspondences with the Registrar of Trade Marks evidencing the change of name of Lucky Ltd to LG Corp is produced herewith.

(d) Reliance was placed on the following judgment:

P.L. Anwar Basha v. M. Natarajan (: AIR 1980 Mad 56 )

7. The necessity and purpose of using a brand name or logo was discussed by the Honble High Court of Delhi in the case of Maruti Suzuki Ltd v. Additional CIT/TPO (2010) 233 CTR (Del) 105 and the observations made in Para 61 are extracted below:

61. I a domestic entity irrespective of whether it is an independent entity or an AE of a foreign entity, feels that the use of a foreign brand name and/or its logo it likely to be beneficial to it, by enabling it to ward off the competition from other players, garner a larger market share or maintain its existing market share despite increase in competition on account of entry of foreign players, there can be No. dispute about the domestic entity taking a business decision to use a foreign brand and/or logo on its products, on payment of royalty to the owner of the foreign brand/logo. The exposure to the foreign brand/logo, on account of its use on the produces of the domestic entity, is only incidental in such cases, the primary objective being to bring benefit to the domestic entity by using a reputed brand name/logo on its products. In that case, it cannot be said that since the foreign brand and/or logo will be used by the domestic entity, the owner of the brand/logo should also make payment to the domestic entity for carrying the foreign brand/logo on its products. What is important to note is that it is the domestic entity which wants the use of foreign branch/logo on its products as well as on their promotion, marketing and development, so that it may cash upon the reputation associated with the foreign brand/logo, by selling its products under that name/logo. So long as the payment of royalty for use of the foreign brand/logo by a domestic entity is within the limits, if any, prescribed by law in this regard, there can be No. reasonable objection to such a payment and it is not open to the IT authorities to claim payment to the domestic entity merely for using the foreign brand/logo on the domestic products".

Thus, a company may use the foreign brand/logo for not only increasing its market share, but also for maintaining its existing market share. Thus, it is always not necessary that the use of brand name will increase the business profits. Further, as contended by Learned A.R, the profitability of an enterprise is the result of cumulative effect of various aspects, in which the brand value is one of the aspects. Accordingly the same cannot be taken as the sole criteria for determining the performance of an enterprise.

8. In the case of DCIT v. M/s Ekla Appliances (2011-TII-37-ITAT-DELTP), the TPO determined the ALP for the royalty payment to be Nil, primarily on the ground that the Assessee has not been benefited from the technical Know how and the Assessee was incurring losses continuously.

The Honble ITAT approved the observations made by the learned CIT (A) in that case in the following lines:

14.2 In this regard, learned Commissioner of Income Tax (Appeals) further mentioned that it is an acknowledged fact that transfer pricing has more to do with economic principles and business conditions that prevail in an uncontrolled situation. He further referred to certain OECD guidelines issued in this regard. He observed that TPO has completely disregarded the business and commercial strategy/realities behind the transaction and acted in a completely mechanical manner without giving regard to the economic circumstances surrounding the transaction and the business decision taken by the Assessee. Further learned Commissioner of Income Tax (Appeals) opined that TPO cannot question the judgment of the Assessee as to when it is necessary and expedient to expand its business, when and from whom or from which sources the technology or technical know how is to be taken and at what cost etc., or what steps should be taken to meet the needs of the market forces and to face the competitors etc. Learned Commissioner of Income Tax (Appeals) held that royalty payment was incurred for genuine business purpose and the disallowance were uncalled for and unjustified

9. The above discussions show that there was a business necessity for the Assessee to make the impugned royalty payment to its AE. Hence we do not find any merit in the decisions of TPO/DRP in holding that the impugned royalty payment transaction is a sham transaction.

10. As per Section 92 of the Act, the income arising from an international transaction, shall be computed having regard to the arms length price. Under Section 92F (ii) the term "arms length price" is defined as under:

arms length price" means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions.

However, in the instant case, the TPO did not examine the arms length price of the impugned royalty payment in accordance with the provisions of Section 92C of the Act. It is also the contention of the Assessee that the TPO did not indicate to the Assessee that he proposes to treat the impugned transaction as a sham one nor did he call for any objection from the Assessee in that regard. The Learned A.R also relied up on host of case law in connection with this issue. Further the observation of DRP with regard to the trade mark registration, though defended before us by the Assessee, requires examination at the end of the Assessing Officer/TPO. Accordingly we are of the view that the ALP of the impugned royalty payment and the issue relating to the trademark registration need to be examined afresh. Accordingly we set aside the order of Assessing Officer/TPO/DRP on this issue and restore the same to his file for examination of the same afresh in accordance with the law, after affording necessary opportunity of being heard.

11. The next issue relates to the disallowance of `2,48,47,396/- claimed under the head "Usance interest expenses". The Assessee incurred the expenditure cited above, on the borrowing made by it from the banks for importing raw materials. The Assessing Officer felt that there is No. necessity for the Assessee for availing loan from banks, when the supplier of raw materials himself is giving a time for making the payment within 90 days. The Assessing Officer has also observed that the Assessee did not furnish the details of Letters of Credit, terms and conditions governing the payment of said interest etc. He has also observed that the Assessee is investing surplus funds in shares and securities, which could have been utilized to make payments in time thus avoiding payment of impugned interest. Accordingly the Assessing Officer has concluded that the Assessee did not make out any case in support of allowing the impugned interest payment. The said views of the Assessing Officer were approved by the DRP.

12. The Learned A.R submitted that it is the prerogative of the company to decide about the manner of managing its working capital requirements. He relied upon the decision of Honble Supreme Court in the case of Dhanrajgirji Raja Narasingirji (: 91 ITR 544) in this regard. He further submitted that the suppliers, in the instant case, charge interest after the period of credit allowed by them and the interest so charged are usually higher than the rate of interest charged by the banks. Hence the Assessee has decided to avail bank credit facilities.

13. We agree with the views of the Learned A.R on this issue. As submitted by him, it is the prerogative of the Assessee to regulate its business affairs and it is not open for the department to question the same.

Similar views have been expressed by the Honble Supreme Court in the case of Dhanrajgiriji Raja Narasingirji, referred (Supra). However, the Assessing Officer has also observed that the Assessee has failed to submit the necessary documents such as Letter of credit copies, the terms and conditions etc. in support of the said claim. There cannot be any dispute that it is the responsibility of the Assessee to substantiate the claim made by it. Hence, in the interest of natural justice, we are of the view that the Assessee may be provided with one more opportunity to substantiate its claim with necessary documents. Accordingly, we set aside the order of Assessing Officer on this issue and restore the same to his file with a direction to examine the issue afresh in accordance with law. The Assessee is also directed to furnish the documents/evidences in support of its claim and that may be called for by the Assessing Officer.

14. The next issue relates to the adhoc disallowance made in the expenditure claimed under the head "Staff welfare". The Assessee had claimed a sum of `96,07,553/- under this head. The Assessing Officer has observed that the Assessee did not furnish complete details to substantiate the said claim and accordingly he disallowed 10% of the same by following the decision of Special bench of ITAT, Kolkata in the case of JCIT v. ITC Ltd (: 299 ITR 341). It is the contention of the learned A.R that the Assessee has given break up details before the Assessing Officer. However, it is the case of the Assessing Officer that though the Assessee has given the break up details of the impugned expenditure, yet it has failed to furnish the complete details and further it was not shown that the same was incurred only for the welfare of its employees alone. We notice that the Assessing Officer is not clear as to the nature of details he is expecting from the Assessee. Though the Assessee has placed a copy of break up details in page 157 of its paper book, the nature of expenses incurred in each of the head is not given. Accordingly, in our view, this issue also requires re-examination at the end of the Assessing Officer. Accordingly, we set aside the order of the Assessing Officer on this issue and restore the same to his file for examination afresh in accordance with the law. While examining the said issue, the Assessing Officer should see that the queries raised by him/ the details called for by him are specific, clearly pointing out his requirement. The Assessee is also directed to furnish the details that may be called for by the Assessing Officer in this regard.

15. The next issue relates to the charging of interest under Section 234B of the Act. Since all the issues are set aside to the file of the Assessing Officer, this issue is also set aside to the file of the Assessing Officer. The Assessee may advance his arguments before the Assessing Officer.

16. The Assessee has also raised a ground with regard to the initiation of penalty proceeding under Section 271(1)(c) of the Act. In our view, there is No. bar on the Assessing Officer on initiating the penalty proceeding after the completion of the assessment. It is the requirement of law to hear the Assessee before levying penalty and hence the Assessee is free to defend his case before the Assessing Officer at that point of time. Accordingly, this ground is rejected.

17. In the result, the appeal of the Assessee is treated as partly allowed for statistical purposes.