Tally Solutions Pvt Ltd vs. DCIT (ITAT Bangalore)

Transfer Pricing & Sale of IPRs: Important Principles of Law Explained

The assessee sold its Intellectual Property Rights (IPRs) (patents, copyrights and trade marks) to its AE for a consideration of Rs. 38.50 crores. The sale price was justified on the basis that there were “inherent flaws” in the IPRs and “intense development inputs” were required to be done by the buyer. The TPO adopted the “Excess Earning Method” (as prescribed by the “International Valuation Standard Council“) and determined the value of the IPR at Rs.260.63 crores which was upheld by the DRP. In appeal before the Tribunal, the assessee raised the following contentions: (a) that the AO had made a reference to the TPO without forming a “considered opinion” on the issues under reference; (b) the “Excess Earning Method” adopted by the TPO was not a prescribed method under the Act or Rules; (c) as there was no appropriate method for determination of ALP of IPR, the value declared by the assessee had to be accepted as ALP; (d) on merits, the TPO had relied on estimates and surmises in projecting the future cash flows while disregarding evidence in the form of audited financial statements. HELD by the Tribunal:

(i) There is nothing in s.92CA that requires the AO to first form a “considered opinion” before making a reference to the TPO. It is sufficient if he forms a prima facie opinion that it is necessary and expedient to make such a reference. The making of the reference is a step in the collection of material for making the assessment and does not visit the assessee with civil consequences. There is a safeguard of seeking prior approval of the CIT. Moreover, by virtue of CBDT’s Instruction No.3 of 2003 dated 20.5.2003 it is mandatory for the AO to refer cases with aggregate value of international transactions more than Rs.5 crores to the TPO (Sony India 288 ITR 52 (Del) & Ranbaxy Laboratories 299 ITR 175 (AT) (Del) followed);

(ii) The argument that the “Excess Earning Method” adopted by the TPO is not a prescribed method is not acceptable. A sale of IPR is not a routine transaction involving regular purchase and sale. There are no comparables available. The “Excess Earning Method” is an established method of valuation which is upheld by the U.S Courts in the context of software products. The “Excess Earning Method” method supplements the CUP method and is used to arrive at the CUP price i.e. the price at which the assessee would have sold in an uncontrolled condition (method explained, Intel Asia Electronics Inc followed);

(iii) On merits, the “Excess Earning Method” has to be applied using the projected sales (and not actual sales) because when an intangible is sold, the risk of future income potential lies with the buyer. However, in determining the projected sales and profits, the TPO committed several errors such as not excluding the sales-returns (detailed directions given on how to apply the EEM).