2025 (4) TMI 1436 - AT - Income Tax

TP Adjustment - payment of royalty/consideration for use of trademark and knowhow - HELD THAT - We find that the Tribunal for the immediately preceding AY i.e. 2017-18 2024 (8) TMI 277 - ITAT DELHI in so far as royalty addition is concerned decided the issue in favour of the assessee wherein the payment of royalty was held to be at arm s-length by coordinate benches of this Tribunal. Addition on account of consultancy services reimbursement of advertisement expenses and IT cost allocation - HELD THAT - On perusal of the Tribunal s order for the AY 2017-18 2024 (8) TMI 277 - ITAT DELHI assessee has availed consultancy services from an employee based out of Hong Kong and has reimbursed the salary and related expenses of this employee to its AE. Since this is similar to the issue of expatriate cost in previous years we find no reason to take a different view for this assessment year. While respectfully following the consistent view taken by the Tribunal in Assessee s own case for the AY 2007-08 2008-09 and 2009-10 we hold that the impugned addition cannot be sustained. We therefore direct the TPO/AO to delete the adjustment made on this issue. Thus Ground and sub-grounds are partly allowed in favour of the assessee. Not allowing deduction on account of reversal of provision for contingent Income tax liability credited to profit and loss account and disallowed earlier in the year of creation that the time it was debited to profit and loss account - HELD THAT - As Counsel submits that thus the provision which was created in AY 2016-17 was never claimed as deduction since it was added back in the computation of income. Since in the assessment year under consideration the provision was reversed in the books consequent adjustment was made in the tax computation otherwise it would have resulted in a double addition. We find considerable merit in the submissions of the Ld. Counsel for the assessee. Therefore the issues in ground nos. 5 6 are in principle allowed subject to verification by the Assessing Officer. The Assessing Officer while passing the consequential order may verify the contentions of the assessee before allowing claims of the Assessee.

Summary

The primary legal issues considered by the Tribunal in these appeals relate to the validity of directions issued by the Dispute Resolution Panel (DRP) under the Income Tax Act, 1961, and the correctness of Transfer Pricing (TP) adjustments made by the Assessing Officer (AO) in respect of royalty payments, consultancy services, reimbursement of advertisement expenses, IT cost allocation, and certain corporate tax provisions including reversal of contingent income tax liability and Local Body Tax (LBT) provisions.

One significant issue raised was whether the DRP's directions were invalid for non-compliance with CBDT Circular No. 19 of 2019, specifically regarding the absence of a computer-generated Document Identification Number (DIN) on the DRP order. However, this ground was not pressed by the Assessee and was dismissed accordingly.

The core Transfer Pricing issues centered on the arm's length nature of royalty payments and related adjustments made by the AO and upheld by the DRP. The Assessee challenged the AO's adoption of the Transactional Net Margin Method (TNMM) at the entity level instead of the Comparable Uncontrolled Price (CUP) method adopted by the Assessee. The AO also included third-party advertising and marketing expenses in the royalty base and applied an ad-hoc 10% mark-up, which was contested by the Assessee.

In respect of consultancy services, reimbursement of advertisement expenses, and IT cost allocation, the Assessee relied on consistent earlier Tribunal decisions in its own case, where similar adjustments were deleted. The Revenue defended the AO and DRP orders.

Further, corporate tax grounds involved the non-allowance of deductions on reversal of provisions for contingent income tax liability and LBT, which the Assessee argued should be allowed to avoid double taxation, relying on judicial precedents. The Revenue sought restoration of these issues to the AO for verification.

Lastly, a ground concerning rectification of differential disallowances reported in the tax audit report versus the income tax return was raised and directed to be examined by the AO.

Regarding the Transfer Pricing adjustment on royalty payments, the Tribunal analyzed the relevant legal framework under Section 92 of the Income Tax Act and the Transfer Pricing Rules, particularly Rule 10B. The Tribunal examined the License Agreement between the Assessee and its Associated Enterprise (AE), which mandated royalty payments based on sales and required the Assessee to undertake advertising campaigns approved by the AE to maintain a uniform worldwide image.

The Tribunal noted that the AO and DRP rejected the CUP method used by the Assessee and applied TNMM at the entity level, including third-party advertising expenses with a 10% mark-up, contending that marketing was the responsibility of the AE and thus should be factored into the royalty benchmarking. The Tribunal, however, relied on a series of its own earlier decisions spanning assessment years 2006-07 through 2017-18, where the CUP method was consistently upheld and TNMM rejected for similar royalty payments in the Assessee's case. It emphasized the principle that different international transactions with AEs must be benchmarked on a transaction-to-transaction basis considering the distinct functions, assets, and risks (FAR) involved, rather than aggregating all transactions at the entity level.

The Tribunal further observed that the inclusion of advertising expenses as part of the royalty payment was a new issue not previously considered and that the License Agreement's advertising clause required the Assessee to incur advertising expenses but did not transform such expenses into royalty payments. The Tribunal held that the AO's approach was contrary to the consistent judicial precedent and that the CUP method adopted by the Assessee was appropriate. Consequently, the royalty adjustment was deleted.

On consultancy services, reimbursement of advertisement expenses, and IT cost allocation, the Tribunal applied the principle of consistency by following its prior rulings in the Assessee's own case. It noted that the Assessee had reimbursed the AE on a cost-to-cost basis for consultancy services, advertisement expenses supported by third-party back-to-back invoices, and IT support services. The AO and DRP had disallowed these on grounds of lack of evidence of receipt of services or characterization as shareholder services. The Tribunal found that the AO and DRP had failed to appreciate the factual matrix and that the Assessee had provided sufficient documentary evidence of actual services rendered and that these were genuine business expenses. The Tribunal held that the AO's jurisdiction was limited to benchmarking the transactions under Section 92(1) and did not extend to questioning commercial expediency. It thus deleted the TP adjustments on these accounts.

Regarding the corporate tax grounds, the Tribunal considered the issue of reversal of a provision for contingent income tax liability created in an earlier assessment year and disallowed then, now reversed in the current year. The Assessee contended that denying deduction of this reversal would result in double taxation since the provision was not allowed as a deduction when created. The Tribunal noted that the provision was disallowed in the year of creation and the reversal in the current year should be allowed to avoid double addition, relying on several judicial precedents affirming that reversal of previously disallowed provisions can be allowed as deduction. Similar reasoning was applied to the reversal of provision for LBT, which was no longer payable due to the introduction of GST and related compensation mechanisms. The Tribunal allowed these grounds in principle but remanded them to the AO for verification of facts.

On the issue of rectification under Section 154 relating to differences in disallowances reported in the tax audit report and income tax return, the Tribunal directed the AO to examine the Assessee's rectification petition and dispose of it expeditiously.

In summary, the Tribunal's significant holdings include the following:

"The action of TPO in undertaking entity level benchmarking by TNM method combining of the international transactions is not justifiable. The TP analysis provided by assessee, based on transaction to transaction basis in respect of different segments should be adopted."

"The TPO did not appreciate the Assessee's transactions correctly and applied entity level benchmarking on TNMM method by combining Assessee's all international transactions with associated enterprise without justification."

"The TPO has no locus-standi to opine on the necessity or otherwise for the incurrence of expenditure. His jurisdiction extends only to benchmark the transaction in terms of mandate of Section 92(1) of the Act."

"The approach of the TPO, which has also been thereafter approved by the Ld. DRP is contrary to the legal as well as the factual position and the transfer pricing adjustment made thereupon, is unsustainable."

"The reversal of provision for contingent income tax liability which was disallowed in the year of creation should be allowed as deduction in the year of reversal to avoid double taxation."

On each of the contested Transfer Pricing issues, the Tribunal applied the established legal principles under the Income Tax Act and Transfer Pricing Regulations, emphasizing the importance of consistency with prior decisions and adherence to the transactional nature of benchmarking. It rejected the AO's entity-level TNMM approach in favor of the Assessee's CUP method, finding the latter to be the correct arm's length standard. The Tribunal also underscored the limited scope of the AO's jurisdiction to benchmarking rather than questioning commercial expediency or the necessity of expenses.

For the corporate tax issues, the Tribunal recognized the principle that reversal of provisions previously disallowed should be allowed to prevent double taxation, subject to factual verification by the AO.

Consequently, the Tribunal partly allowed the appeals for the assessment years 2018-19 and 2020-21, deleting the Transfer Pricing adjustments on royalty payments, consultancy services, advertisement expenses, and IT cost allocation, and remanding the corporate tax issues for verification and appropriate relief.