Facts of the Case

Samsung India Electronics Pvt. Ltd. (STI), a wholly owned subsidiary of Samsung Electronics Co. Ltd., Korea, was engaged in manufacturing and selling mobile phones in India and overseas markets. Under a Technology License Agreement, STI paid royalty and technical assistance fees to Samsung Korea for use of proprietary technology and know-how.

For Assessment Year 2008-09, the Transfer Pricing Officer (TPO) determined the Arm’s Length Price (ALP) of royalty paid on exports to associated enterprises (AEs) as NIL, resulting in a transfer pricing adjustment of ₹1.99 crore. The Dispute Resolution Panel (DRP) upheld this adjustment, leading to a final assessment order against the assessee.

The Income Tax Appellate Tribunal (ITAT) later deleted the adjustment, following its earlier decision for AY 2007-08 in the assessee’s own case. The Revenue challenged the ITAT order before the Delhi High Court.

Issues Involved

  1. Whether royalty paid by an Indian subsidiary to its foreign parent for technical know-how can be determined at NIL under transfer pricing provisions.
  2. Whether the assessee functioned as a contract manufacturer, thereby negating the need for royalty payment.
  3. Scope of TPO’s authority in evaluating commercial transactions and determining ALP.
  4. Applicability of OECD Transfer Pricing Guidelines and the arm’s length principle.

Petitioner’s (Revenue’s) Arguments

The Revenue argued that STI operated as a contract manufacturer for Samsung Korea, purchasing raw materials from group entities, manufacturing products, and exporting them to AEs. It contended that royalty paid on such exports amounted to payment “to itself,” as all entities were part of the same multinational group.

The Revenue further asserted that STI charged higher prices to independent parties than to AEs, suggesting that the value of intangibles was already embedded in sale prices, thereby making separate royalty payments unwarranted.

Respondent’s (Assessee’s) Arguments

The assessee contended that it was a full-fledged licensed manufacturer, not a contract manufacturer. It emphasized that manufacturing activities required access to proprietary technology owned by Samsung Korea, for which royalty was payable.

It was further submitted that STI independently negotiated sales terms, bore business risks, and sold products both to group entities and unrelated parties under market conditions. Therefore, royalty payments were legitimate and at arm’s length.

Court Order / Findings

  • STI operated as an independent licensed manufacturer and not as a contract manufacturer.
  • Payment of royalty was intrinsically linked to the receipt of technology and expertise necessary for manufacturing.
  • There was no evidence that Samsung Korea dictated production quantity, pricing, or sales terms.
  • The existence of a parent-subsidiary relationship does not imply that royalty payments are to “self.”
  • TPO cannot disregard a genuine commercial transaction without demonstrating that it deviates from arm’s length conditions.
  • OECD Guidelines indicate that contract manufacturing typically involves extensive instructions, low risk, and assured purchase of output—conditions not present in this case.
  • Intellectual property owners are entitled to arm’s length compensation for use of their technology.

Important Clarification

  • Royalty payments between associated enterprises are permissible if supported by genuine licensing of technology or intangibles.
  • Determination of ALP at NIL requires strong evidence that no independent party would pay for such services.
  • Being a wholly owned subsidiary does not eliminate the need for compensation to the parent for intellectual property.
  • TPO’s role is limited to pricing analysis and does not extend to questioning commercial wisdom.

Link to download the order –  https://www.mytaxexpert.co.in/uploads/1772176417_PRINCIPALCOMMISSIONERIFINCOMETAX8VsSAMSUNGINDIAELECTRONICSPVT.LTD..pdf 

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