The Bombay High Court has held that where, pursuant to an APA entered into by the Indian associated enterprise with the CBDT, excess royalty earlier received by the non-resident associated enterprise is refunded bona fide to the payer, only the amount ultimately retained by the non-resident constitutes royalty “paid” within the meaning of Article 12 of the India-US DTAA and only that amount can be brought to tax in India.
The Court clarified that transfer pricing provisions relied upon by the Revenue, i.e., Sections 92(3), 92C(4) and 92CE did not bar such reduction in the facts of the case, particularly because the ALP stood governed by the APA and the refunded amount did not represent real income of GIA US. On the PE issue, the Court held that the ITAT’s findings that GIA India was not a fixed place PE, service PE, or agency PE of GIA US under Article 5 of the India-US DTAA were factual findings based on the record.
The Division Bench comprising Justice B.P. Colabawalla and Justice Firdosh P. Pooniwalla observed that the ITAT had carefully examined the facts and found that GIA India was an independent separate legal entity rendering grading services to its own clients, bearing all service, client-facing, transit and related risks in relation to stones sent to GIA US, and that the arrangement with GIA US was akin to assignment or sub-contracting of grading services rather than a joint venture.
The Bench noted that GIA India did not have authority to conclude contracts on behalf of GIA US, had not secured orders for GIA US in India, and that no employees/personnel of GIA US had visited India so as to trigger service PE provisions. It therefore held that the findings that there was no fixed place PE, no service PE, and no agency PE were pure findings of fact and gave rise to no substantial question of law.
On the royalty issue, the Bench rejected the Revenue’s reliance on Sections 92(3), 92C(4) and 92CE. It held that Section 92(3) can apply only where computation of income is made under Section 92(1) in the case of the same person to whom Section 92(3) is sought to be applied, and cannot be invoked by relying on computation in the case of one person and applying the limitation to another.
The Bench further held that where ALP is determined on the basis of an APA, Section 92C(3) is not attracted, and consequently Section 92C(4) and its provisos, including the second proviso, do not apply. On Section 92CE, it observed that secondary adjustment is an obligation on the assessee undergoing the primary adjustment and does not determine taxability of the correct income in the hands of the foreign associated enterprise.
The Bench further applied the doctrine that only real income can be taxed, cases of deemed income apart. It held that under Article 12 of the India-US DTAA, royalty “paid” denotes the amount actually and eventually paid, i.e., the amount retained by GIA US after giving effect to the APA-mandated refund. The Bench considered the refund obligation to be one of the critical assumptions of the APA and held that the royalty refunds/recoveries could not be seen in isolation from the original receipts.
Since the excess royalty was refunded bona fide, did not eventually belong to GIA US, had already been offered to tax in GIA India’s hands through a modified return, and had been denied as deduction to GIA India, taxing the same amount again in GIA US’s hands would be incongruous.
Briefly, the dispute relates to the quantum of royalty paid by GIA India Laboratory Private Limited (GIA India) to Gemological Institute of America Inc. (GIA US) that could be taxed in India; and whether GIA India constituted a permanent establishment (PE) of GIA US in India under Article 5 of the India-US DTAA.
For A.Y. 2011-12, GIA US had filed its return offering royalty of Rs. 68.53 crores to tax. Separately, GIA India had entered into an Advance Pricing Agreement (APA) with the CBDT on 7 May 2018, including rollback years, under which the arm’s length price (ALP) of royalty for A.Y. 2011-12 was determined at Rs. 49.08 crores, and GIA US refunded the excess royalty of Rs. 19.44 crores to GIA India pursuant to an invoice raised under the APA. GIA US then claimed before the ITAT that the refunded amount could not be regarded as its income. The ITAT allowed reduction of the refunded royalty from GIA US’s taxable income and also held that GIA US did not have a PE in India.
