ITAT: Royalty Payments In Consonance with RBI Guidelines Exempt from TP Adjustments

Introduction

The Income Tax Appellate Tribunal, Ahmedabad (‘ITAT’), while dismissing the revenue’s appeal in the case of Deputy Commissioner of Income Tax v. Invida India (P) Ltd.[i]* *held that Invida India (‘Assessee’) had rightly determined the arm’s length price (‘ALP’) for payment of royalty using the external comparable uncontrolled price (‘CUP’) method. This determination was made in accordance with the Reserve Bank of India (‘RBI’) guidelines, with the Assessee having fulfilled all the necessary criteria and documentation requirements for applying the aforementioned method.

Brief Facts

• The Assessee was engaged in the business of trading pharmaceutical products on a wholesale basis with respect to phone products. The Assessee had entered into a 5-year ‘Brand Licencing Agreement’ (‘Licence Agreement’) with its Singapore-based associate enterprise (‘AE’). The License Agreement granted the Assessee the marketing, manufacturing and distribution rights for two products, against which the Assessee was liable to pay royalty @5% of their net sales.

• The Assessee determined the ALP for the aforementioned international transaction by applying the external CUP method. However, pursuant to the notices issued under ss. 143(2) and 142(1) of the Income-tax Act, 1961 (‘IT Act’), the Assessing officer (‘AO’), dissatisfied by the ALP determined by the Assessee, held the same to be incorrect and erroneous, and accordingly made transfer pricing (‘TP’) adjustments. The AO disputed that in addition to the royalty payments of the Assesses, its payment for management fees and IT allocation costs were not made at an ALP.

• The Assessee filed an appeal before the Commissioner (Appeals) [‘CIT(A)’], whereby the rate of 5% of net sales for royalty determination was allowed, and all additions made by the AO were deleted. Aggrieved by the order passed by the CIT(A), the revenue approached the ITAT.

Held

• The ITAT, while upholding the order passed by the CIT(A), observed that the payment of royalty was made keeping in mind the rate at which royalty payment is allowed by the Indian regulatory authorities, i.e., the RBI. The Assessee had furnished all relevant documents and duly fulfilled the criteria envisaged under r. 10D of the IT Rules, 1962.

• It was held that the use of the CUP method was most suited for calculating ALP in the present case, and considering that the AO had failed to establish the reason why the CUP method was not applicable in the Assessee’s case, the contention of the revenue was not justified. The ITAT noted that the Assessee had provided sufficient evidence to support its allocation of costs and to demonstrate that the markup of 15% was reasonable.

Our Analysis

In the aforementioned case, the order passed by the ITAT reaffirms the importance of meticulous compliance in matters concerning TP regulations, which can often help businesses uphold bases during tax scrutiny. Further, the ruling also establishes a higher burden of responsibility on the AO while conducting TP assessments. Instances where the AO fails to conclusively establish his case before the appellate authorities invariably result in the deletion of unsubstantiated adjustments. Additionally, this decision highlights the significance of proper documentation and benchmarking in TP cases and its importance in substantiating arm’s length transactions.

End Note

[i] (2024) 163 taxmann.com 510 (Ahmedabad)

Authored by Anshi Bhatia, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.