Gemological Institute of America Inc (the taxpayer) is a US-based company and has an Associated Enterprise (AE) in India named GIA India Laboratory Pvt. Ltd. (GIA India). The taxpayer has received royalty income from the said AE for the Assessment Year (AY)s 2011-12 to 2016-17. The royalty income so received was duly offered to tax by the taxpayer under Article 12 of the India-US Double Taxation Avoidance Agreement at 15% on a gross basis.

The taxpayer had appealed before the Mumbai Income Tax Appellate Tribunal (ITAT) for the years AY 2014-15 to AY 2016-17 on various issues. The key issue from these was concerning the impact of the Advance Pricing Agreement (APA) signed by the taxpayer's Indian AE, i.e., GIA India, with the Central Board of Direct Taxes (CBDT), regarding which a part of the royalty received by the taxpayer company from its Indian AE had to be refunded to the Indian AE1.

About the APA

GIA India approached the CBDT for an APA, under Section 92CC of the Income-tax Act, 1961 (the Act). On 7 May 2018, the APA was concluded between GIA India and CBDT wherein the key points w.r.t the royalty transaction are as follows:

Sr. No. Particulars Comments
1. Term of APA 5 previous years starting from AY 2014-15 onwards along with a rollback period of 4 previous years starting from AY 2010-11 onwards.
2. Arm's Length Price (ALP) Royalty amount should not exceed 53.5% of the operating profit of the India Graded segment of GIA India for that relevant year
3. Invoicing and Credit Terms
  • Royalty payment made by GIA India in excess of the ALP determined shall be recovered from the taxpayer by raising an appropriate invoice; and
  • Excess royalty amount to be realized by GIA India within 60 days of the date of the issue of invoice
4. Disclosure GIA India to disclose the said excess royalty amount as additional income in the modified return of the respective years
5. Amount The amount of refund by the taxpayer to GIA India as determined in the APA from AY 2011-12 to AY 2016-17 is INR 3372.85 million (USD 45.90 million)

The net result of the above APA is that the royalty income received by the taxpayer from its Indian AE and offered to tax was required to be partially refunded to the Indian AE. Whatever was held to be in excess of the arm's length price arrived at under the aforesaid APA was required to be refunded.

Proceedings before the first appellate authority

Based on the above APA, the taxpayer claims that the amount so refunded to GIA India should be reduced from the computation of its taxable income from the royalty. The said claim was put forth before the first appellate authority, i.e., the Dispute Resolution Panel (DRP), for three years, i.e., AY 2014-15 to AY 2016-17. Key findings from the directions provided by DRP are as under:

  • As per Section 92(3) of the Act, if any adjustment has the effect of reducing the income chargeable to tax or increasing the loss with respect to any transaction, the Indian transfer pricing provisions shall not apply;
  • APA in the case of GIA India does not have a binding force on the computation of royalty in the hands of the taxpayer;
  • APA proceedings in the case of the GIA India are entirely independent and cannot be imported into the computation of taxable royalty of the taxpayer; and
  • The taxpayer is not a party to the Unilateral APA entered into between CBDT and GIA India and therefore cannot seek any relief based on the APA.

Thus, the DRP summarily rejected the claim and hence the taxpayer was in appeal before the Mumbai ITAT. In addition to the aforesaid years, the taxpayer also raised similar contentions for AY 2011-12 to AY 2014-15 by way of additional ground before the Mumbai ITAT.

The taxpayer's submissions, department's arguments and the observations of the ITAT w.r.t. royalty transaction are discussed hereunder.

Proceedings before the second appellate authority, i.e., Mumbai ITAT

Key contentions of the taxpayer

Real Income vs Notional Income: By virtue of the APA between GIA India and the CBDT, the fundamentals of the royalty transaction between GIA India and the taxpayer had undergone a change. Income can be said to accrue only when the taxpayer has an indefeasible right to receive the same. The fact that the refund was made in a subsequent year does not matter as it is admittedly on account of the royalty income booked in the respective assessment years. Therefore, the excess royalty amount refunded to its Indian AE cannot be treated as an income. Hence, it ought to be reduced from its taxable income of royalties for the respective years. Accordingly, it is contended that what can be brought to tax is the real income of the taxpayer and not hypothetical or the notional income. The taxpayer relied on the Hon'ble Supreme Court's judgment in the case of Bokaro Steel Ltd2 in this regard.

Provisions of Section 92C(4) of the Act are inapplicable: The taxpayer argued that the second proviso to Section 92C(4) of the Act prohibits the corresponding relief of an arm's length adjustments to the AE, is inapplicable in the instant case.

Second proviso to Section 92C(4): "where the total income of an associated enterprise (Indian entity) is computed under this sub-section (92C(4))on determination of the arm's length price paid to another associated enterprise (overseas AE) from which tax has been deducted or was deductible under the provisions of Chapter XVIIB, the income of the other associated enterprise (overseas AE) shall not be recomputed by reason of such determination of arm's length price in the case of the first mentioned enterprise(Indian entity)".

The taxpayer submitted that the prohibition applies only where the total income of an enterprise is computed under sub-section (4) of Section 92C on the determination of the Arm's Length Price (ALP).

Furthermore, in contrast, it is also pointed out that no corresponding prohibition is provided in Section 92CC to 92CE of the Act, which are the provisions governing the APA scheme, nor is there any such prohibition in the rules that govern the APA program in India.

On the other hand, APA is a voluntary agreement between a taxpayer and the CBDT. It is certainly not the process wherein the Assessing Officer (AO)/Transfer Pricing Officer (TPO) determines ALP during the course of assessment proceedings.

For non-applicability of the second proviso in the case, the taxpayer relied on the decision of the Bangalore Bench of ITAT in the case of ACIT vs. EYGBS India Pvt. Ltd.3 wherein it was held that the prohibition contained in the first proviso to Section 92C(4) would have no application to a case of APA.

Accordingly, it was submitted that only the net amount, i.e., originally billed royalty amount- as reduced by the refunds in terms of the APA arrangement, should be brought to tax in the hands of the taxpayer.

Secondary adjustment provisions are inapplicable: The taxpayer submitted that secondary adjustment provisions are applicable from AY 2018-19 onwards. Since the years under consideration are AY 2011-12 to AY 2016-17, the provisions of secondary adjustment are not applicable.

Income can not be taxed twice: The taxpayer contended that not excluding the royalties refunded by the taxpayer, and not giving a corresponding effect in the computation of income would result in double taxation and an unjust collection of tax twice over by the tax department, which can never be the intention of the legislature and any interpretation, which leads to such absurd result must be avoided. Reliance was placed on the Hon'ble Supreme Court's judgments in the cases of CIT vs J H Gotla4 and K P Varghese vs ITO5.

Key objections of the tax authorities

The taxpayer is not a party to the APA and thus, no relief can be sought by the taxpayer from the findings/conclusions in APA.

Similarly, as regards the provisions of Section 92C(4), the revenue reiterated its argument that the negotiations reached in the APA indeed get covered under the provisions of Section 92C(4).

The revenue also questions as to why the taxpayer did not choose to become party to the APA when it had the option to do so (i.e., Bilateral APA option).

The revenue argued that since the secondary adjustment provisions were not applicable to the period covered under the appeal, the act of claiming refund of the excessive royalty by GIA India from the taxpayer is a unilateral act. The revenue emphasized that the taxpayer always had the right to reject such a claim, the provisions of secondary adjustments did not obligate it.

The revenue also questioned, if, in a scenario, the payment made by GIA India to the taxpayer is less than ALP determined in the APA, whether the taxpayer would have offered the additional income as royalty? Perhaps, No!

Judgment of the Mumbai ITAT

Notional income vs Real Income: The Mumbai ITAT noted that the requirement of claiming the refund of excess royalty was one of the critical assumptions forming part of the APA between the CBDT and GIA India. Therefore, the APA would be rendered ineffective if the refund was not claimed by GIA India. Further, the corresponding refund to the GIA India has been shown as GIA India's income, and offered to tax as such by way of a modified return in consequence of the APA (again one of the critical assumptions of the APA).

Therefore, the Mumbai ITAT held that there could be no way in which a taxpayer can be taxed in respect of an income, which the taxpayer has bonafide refunded to the person from whom such an income was received. Income must be a real income, which the taxpayer has actually earned in reality, and not a mere hypothetical income!

Secondary adjustment provisions: The Mumbai ITAT observed that no secondary adjustment could be unilateral in nature. When GIA India is to raise an invoice on the taxpayer, that invoice is to be accounted for by the entity issuing the invoice as also by the entity receiving the invoice.

In any case, Section 92CE has nothing to do with the taxability of correct income in the hands of the foreign AE (i.e., taxpayer). The Mumbai ITAT, in their humble understanding, stated that there was no bar, even in respect of the period, prior to insertion of Section 92CE, on any secondary adjustments being made by parties to a transaction.

Whether the refund was voluntary or under a legal obligation, it does not really make any difference as long as the refund is bonafide, particularly when its commercial expediency is not, and rightly so, even called into question.

Furthermore, it stated that the observations made by the DRP w.r.t the fact that the taxpayer cannot benefit from the APA entered by GIA India with CBDT is all very superficial. It is not the content of the APA, but the impact of the APA that is relevant. The AE may not be party to the APA, yet the impact of APA's terms has to be taken into account when these terms affect the AE.

Thus, the Mumbai ITAT rejects the department's arguments and accepts the taxpayer's claim in principle subject to verification of the actual refund of royalties made by the taxpayer.

Other grounds of the taxpayer

In addition to the above, the taxpayer objected to the department's contention that the taxpayer has a Permanent Establishment (PE) or business connection in India. In this regard, the Mumbai ITAT held that this matter is covered by the decision of the coordinate bench in the taxpayer's own case for AY 2010-11, where it was held that the taxpayer does not have PE in India. The Mumbai ITAT agrees with the coordinate bench's decision which remains in agreement with the taxpayer on this issue.

Furthermore, the Mumbai ITAT held that, the fact that the taxpayer does not have a PE or business connection in India, the issues regarding attribution of profits or, charging of royalty under Section 44DA of the Act are infructuous and do not call for any adjudication.

Our Comments

In the instant case, the Mumbai ITAT appears to have adopted a reasonable interpretation of the relevant statutory provisions, thereby not leading to absurd results. Most importantly, the judgment focuses on the intent of the legislature rather than its literal interpretation.

Furthermore, the taxpayer's matter was pending disposal with the ITAT when the APA got signed and therefore it could cover additional ground on account of APA findings and finally get relief as well! However, it remains to be seen as to what will happen in cases which are not pending disposal or already disposed off. How will such taxpayers (aggrieved by double tax) approach the judiciary, in the absence of any specific provisions?

Interestingly, the CBDT report of November 2019 on APA programme in India suggests that Intra-group royaty transaction remains to be most contentious matter where the applicants are seeking certainty.

Given the complexity and also the quantum of appeal; a possibility that the CBDT may consider clarifying the position in the law to avoid further litigations, investment of time and effort on this matter, which is likely to travel all the way to the Apex Court for resolution, cannot be ruled out.

In the meantime, the taxpayers would be very pleased with the positive outcome of this judgment and may look to re-strategize their open tax matters.


1. Gemological Institute of America Inc. vs. Additional Commissioner of Income Tax International Tax Circle 2(3), Mumbai
2. CIT vs. Bokaro Steel Ltd. (236 ITR 315)

3. ITA No 2984/Bang/2018

4. 156 ITR 323

5. 131 ITR 597

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