2024 (7) TMI 882 - AT - Income Tax

TP Adjustment - ALP of the royalty receipts - differences in the amounts reflected in Form 3CEB of the Assessee vis- -vis its group entities - as submitted TPO had not computed the ALP of the international transactions by following any of the prescribed methods u/s 92C but had proceeded to determine the ALP on the basis of differences in reporting amounts by the assessee and its AEs which is not prescribed under any method and hence amounts to an ad-hoc addition, which was not permissible under transfer pricing provisions HELD THAT - We observe that the assessee is earning royalty income for allowing the use of the Trade name. Assessee is registered in the USA and therefore follows accounting principles in accordance with the relevant US GAAP and follows calendar year of accounting. Therefore, there are bound to be some differences when it prepares its accounts and files return of income in India, as the method of revenue recognition for the USA entity and the provisioning of expenditure for the Indian entities are bound to be different. When we peruse the agreement in relation to the royalty it is evident from Article VI (A) of the agreement that the method of computation of royalty for the assessee is also different and is based on the financial year sales of the group entities that end within the calendar year. However, when the group entities compute their royalty payments, it would be based purely on financial year figures on a real time basis as they have complete visibility regarding their external sales on which they have to pay royalty. Further, the group entities would also need to record royalty expenses following the accounting principle of conservatism irrespective of whether the assessee has disclosed the said figures as income in its books of accounts. Also examined the reconciliation submitted by the Assessee before the lower authorities and it is borne from record that the Assessee has been able to reconcile substantially the impugned differences and the major reason for the differences was only on account of timing differences in recognition of revenue. Thus, TP additions on royalty receipts by the assessee made by the TPO only on account of timing differences are not sustainable in law, since the same does not affect the arm s length determination of a transaction and in any case, there is no or very minimal loss actually caused to the exchequer on account of such differences so as to warrant any income addition to the total income of the assessee. TPO has not determined the ALP of the international transactions by following any of the prescribed methods but has made the transfer pricing addition by determining the ALP of the royalty receipts merely on the basis of the differences in the amounts reflected in the Form 3CEB/financial statements of the assessee and the AEs. Such an approach of the TPO is quite alien to transfer pricing provisions and is nothing but ad-hoc in nature. Thus we hold that such an ad-hoc approach of the TPO, without appreciating the functions, assets and risks in relation to the international transactions and without following the methods prescribed under section 92C of the Act, is completely contrary to law and does not serve the purpose of the Legislature in introducing Chapter X under the Income-tax Act. TPO has to determine the ALP by following any one of the prescribed methods alone and the transfer pricing addition cannot be made on an ad-hoc basis. See Johnson and Johnson Limited 2017 (3) TMI 1520 - BOMBAY HIGH COURT and M/S. LEVER INDIA EXPORTS LTD. 2017 (2) TMI 120 - BOMBAY HIGH COURT - Assessee appeal allowed.

Issues Involved:
1. Adjustment of Rs. 7,94,80,630/- and enhancement of Rs. 1,15,97,802/- on account of international transaction of receipt of royalty.
2. Disregarding the transfer pricing analysis by the Appellant.
3. Referral to the TPO without satisfying criteria.
4. Applicability of Chapter X provisions.
5. Transfer pricing adjustment based on differences in reported amounts.
6. Inconsistent approach in granting credit for transactions with AEs.
7. Levying interest u/s. 234B.
8. Validity of final assessment order dated 31.07.2018.

Issue-Wise Detailed Analysis:

1. Adjustment and Enhancement on Account of Royalty:
The Tribunal considered whether the TPO was correct in making a transfer pricing addition of Rs. 7,94,80,630/- and further enhancement of Rs. 1,15,97,802/- to the total income of the Appellant on account of the value of the international transaction of receipt of royalty. The Tribunal noted that the TPO made adjustments based on differences between the amounts reported in Form 3CEB by the Assessee and its AEs. The Tribunal concluded that such an approach is not prescribed under any of the methods for benchmarking the ALP of an international transaction and is therefore unfounded in law.

2. Disregarding the Transfer Pricing Analysis by the Appellant:
The Tribunal observed that the Assessee had benchmarked the international transactions by adopting the CUP method, and substantial reconciliation was provided to the TPO. The Tribunal found that the TPO had not computed the ALP by following any prescribed methods under section 92C of the Act but had made an ad-hoc addition based on differences in reporting amounts, which is not permissible under transfer pricing provisions.

3. Referral to the TPO Without Satisfying Criteria:
The Tribunal did not specifically address the criteria for referral to the TPO but focused on the methodology adopted by the TPO in making the adjustments. The Tribunal emphasized that the TPO's approach was not aligned with the prescribed methods and was ad-hoc in nature.

4. Applicability of Chapter X Provisions:
The Tribunal noted that the provisions of Chapter X are not applicable as the international transactions of receipt of royalty do not result in tax avoidance by way of shifting of any profits from India. The Tribunal emphasized that the differences were primarily due to timing differences in recognition of revenue.

5. Transfer Pricing Adjustment Based on Differences in Reported Amounts:
The Tribunal held that the TPO's approach of making adjustments based on differences in reported amounts in Form 3CEB is not sustainable. The Tribunal highlighted that such differences were due to timing differences and did not affect the arm's length determination of the transaction. The Tribunal cited the decision of the Hon'ble Supreme Court in CIT v. Excel Industries Ltd. to support its view that timing differences should not lead to tax adjustments.

6. Inconsistent Approach in Granting Credit for Transactions with AEs:
The Tribunal noted that the TPO did not provide corresponding relief where the Assessee reported higher amounts than the group entity. The Tribunal found this approach to be inconsistent and not in line with the principles of transfer pricing regulations.

7. Levying Interest u/s. 234B:
The Tribunal did not specifically adjudicate on the issue of levying interest under section 234B, as it was deemed consequential and dependent on the primary issues related to transfer pricing adjustments.

8. Validity of Final Assessment Order Dated 31.07.2018:
The Tribunal did not specifically address the validity of the final assessment order dated 31.07.2018, as the primary focus was on the merits of the transfer pricing adjustments. The additional grounds raised by the Assessee were considered academic and left open for future consideration if necessary.

Conclusion:
The Tribunal concluded that the transfer pricing additions on royalty receipts made by the TPO based on timing differences are not sustainable in law. The Tribunal ordered the deletion of the addition of Rs. 9,10,78,432/- made in the final assessment order. The appeal of the Assessee was partly allowed, and the additional grounds were left open as academic.

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