Bombay High Court
Commissioner Of Income Tax It 3 Mumbai vs Gemological Institute Of America Inc Ay … on 16 June, 2026
Author: B. P. Colabawalla
Bench: B. P. Colabawalla
2026:BHC-OS:13178-DB
ITXA-2306-2022 and ORS (F).docx
IN THE HIGH COURT OF JUDICATURE AT BOMBAY
ORDINARY ORIGINAL CIVIL JURISDICTION
INCOME TAX APPEAL NO.945 OF 2022
Commissioner of Income-tax,
(IT)-2 .. Appellant
Versus
Gemological Institute of America Inc. .. Respondent
WITH
INCOME TAX APPEAL NO.2306 OF 2022
Commissioner of Income-tax,
(International Taxation)-2, Mumbai .. Appellant
Versus
Gemological Institute of America Inc. .. Respondent
WITH
INCOME TAX APPEAL NO.73 OF 2023
Commissioner of Income-tax,
(International Taxation)-2, Mumbai .. Appellant
Versus
Gemological Institute of America Inc. .. Respondent
WITH
INCOME TAX APPEAL NO.779 OF 2023
Commissioner of Income-tax,
(International Taxation)-2, Mumbai .. Appellant
Versus
Gemological Institute of America Inc. .. Respondent
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WITH
INCOME TAX APPEAL (L) NO.21874 OF 2022
Commissioner of Income-tax,
(International Taxation)-2, Mumbai .. Appellant
Versus
Gemological Institute of America Inc. .. Respondent
WITH
INCOME TAX APPEAL NO.72 OF 2023
Commissioner of Income-tax,
(International Taxation)-2, Mumbai .. Appellant
Versus
Gemological Institute of America Inc. .. Respondent
WITH
INCOME TAX APPEAL NO.2331 OF 2022
Commissioner of Income-tax,
(International Taxation)-2, Mumbai .. Appellant
Versus
Gemological Institute of America Inc. .. Respondent
WITH
INCOME TAX APPEAL NO.553 OF 2023
Commissioner of Income-tax,
(International Taxation)-2, Mumbai .. Appellant
Versus
Gemological Institute of America Inc. .. Respondent
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Senior Advocate N. Venkatraman, ASG, a/w Mr. Subir Kumar,
Mr. Akhileshwar Sharma, Ms. Ashita Aggarwal, Ms. Diksha Pandey,
for the Appellants.
Mr. J.D. Mistri, Senior Advocate, a/w Mr. Niraj Sheth, Mr.
Gunjan Kakkad, i/b Mr. Atul K. Jasani, for the Respondents.
CORAM: B. P. COLABAWALLA &
FIRDOSH P. POONIWALLA, JJ.
RESERVED ON : 24th April, 2026
PRONOUNCED ON : 16th June, 2026
JUDGMENT:
– [PER B. P. COLABAWALLA J.]
INTRODUCTION:
1. All the above Appeals are filed by the Revenue challenging the
orders of the Income Tax Appellate Tribunal (for short the “ITAT”) dated
21st June 2019, 30th April 2021 and 17th January 2022, respectively. The
order dated 21st June 2019 is with reference to the A.Y. 2010-2011. The order
dated 30th April 2021 is with reference to A.Y. 2011-2012 to A.Y. 2016-2017,
and the order dated 17th January 2022 is with reference to A.Y. 2017-2018.
2. The two basic issues raised in all these Appeals are:
(i) What is the quantum of royalty that can be brought to tax in
India, which was paid by the GIA India Laboratory Private
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ITXA-2306-2022 and ORS (F).docxLimited (for short “GIA India”) to the Respondent –
Gemological Institute of America Inc. (for short “GIA US”). It is
undisputed that GIA US (the Respondent – Assessee) is an
Associated Enterprise (for short “AE”) of GIA India. For the
sake of convenience, this issue is referred to as the royalty
issue.
(ii) Whether GIA India is a Permanent Establishment (for short
“PE”) of the Respondent – GIA US in India in terms of Article 5
of the India-US Double Taxation Avoidance Agreement (for
short the “India-US DTAA”). For the sake of convenience, this
issue is referred to as the PE issue.
3. Both the aforesaid issues arise in A.Y. 2011-2012 to A.Y. 2016-
2017. However, for A.Y. 2010-2011 and A.Y. 2017-2018, only the PE issue
arises for our consideration. It is in this light that the parties have referred to
and addressed us on the basis of the facts for the A.Y. 2011-2012 (ITXA No.
2306 of 2022). The parties have also stated that the questions that arise in
the Appeal for the A.Y. 2011-2012 (ITXA No. 2306 of 2022) be considered as
the questions of law. The parties further agreed that though questions in the
other Appeals may be differently worded, the questions of law in A.Y. 2011-
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2012 be treated as the questions to be decided in all the above-mentioned
Appeals. We have, therefore, proceeded on that basis.
4. The questions raised by the Revenue – Appellant in A.Y. 2011-
2012 (arising from the order of ITAT dated 30th April 2021) are as follows:-
(a) Whether on the facts of the case and in law, the Hon’ble
ITAT is justified in allowing reduction of returned income of
royalty in the hands of the assessee based on the APA entered into
in an earlier year by the Indian entity GIA India laboratory Ltd.
even while the assessee was not a party to the APA?
(b) Whether on the facts of the case and in law, the Hon’ble
ITAT is justified in allowing the claim of the assessee to revise its
income without appreciating that allowing such claim of the
assessee is beyond the purview of Section 253 of the Act?
(c) Whether on the facts of the case and in law, the Hon’ble
ITAT is justified in allowing adjustment of income of the assessee
as a consequence of the APA with the Indian entity GIA India
laboratory Ltd., thereby allowing a secondary adjustment, without
appreciating that the first proviso to Section 92CE(1) specifically
prohibits Secondary adjustment u/s 92CE?
(d) Whether on the facts of the case and in law, the Hon’ble
ITAT is justified in ignoring the expression of word “through”
which has been used in section 9(1)(i) of the Income-tax Act, 1961
in defining income deemed to accrue or arise in India which has
been further clarified in Explanation- 4 to Section 9(1)(i) of the
Income-tax Act, 1961?
(e) Whether on the facts of the case and in law, the Hon’ble
ITAT is justified in ignoring the fact that the assessee is doing its
business through its AE in India through GIA India Laboratory
Private Limited by restricting the AE to grade only low value
diamonds and also laying down fees to be charged for grading
high value diamonds, obtaining such diamonds from AE, thereby
doing its business through its AE in India and erred in ignoring
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the expression of word “through” which has been used while
defining the concept of “permanent establishment” and “business
profit” in article 5 and 7 of the India-USA DTAA?
(f) Whether on the facts of the case and in law, the Hon’ble
ITAT is justified in not considering that the assessee company was
supervising and having close control over the general as well as
day to day activities of GIA India Lab through its deputed
personnel in its employment or control which leads to the
conclusion that GIA India Lab is a PE of the assessee company?
(g) Whether on the facts of the case and in law, the Hon’ble
ITAT is justified in not considering that entire risk with respect to
diamonds received for grading is borne by the GIA India, cost of
shipping and delivery are also borne by the GIA India Lab and
therefore GIA India is a PE of the assessee?
5. We must mention that for A.Y. 2017-2018, an additional issue
was raised, namely, “Whether in the facts of the case and in law, the ITAT is
justified in deleting the addition made on attribution of profit and royalty
being effectively connected with PE under Section 44AD of the Income Tax
Act, 1961 stating that there is no PE in India.”
6. As can be seen from the above questions, questions (a) to (c) deal
with the royalty issue, whereas questions (d) to (g) [along with the additional
question for A.Y. 2017-2018] deal with the PE issue.
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FACTS:
7. Before we deal with these questions, it would be necessary to set
out some brief facts in relation to the A.Y. 2011-2012, and on the basis of
which parties have also proceeded before us.
8. The Respondent (GIA US) is a US-based company and a world
leader engaged in the business of gem grading/certification, which is a
critical function associated with cutting, polishing and sale of diamonds. A
large part of the world’s diamond cutting industry is located in India and
needs to avail the grading services. The GIA Group, therefore, incorporated a
wholly owned subsidiary in India, namely GIA India, on 26th September
2007, to grade diamonds. For this purpose, GIA US also provided it with the
required equipment, technical know-how, expertise, etc. Similar to the set up
in India, GIA US has also set up subsidiaries in Thailand and Botswana for
the same reason.
9. For the technical know-how and expertise, etc., royalty was
charged by GIA US (the Respondent) to GIA India for A.Y. 2011-2012. In the
earlier years, post commencement of business, due to technical and physical
constraints, diamonds of more than 1.99 carats, or those in excess of GIA
India’s grading capacity, were accepted for grading by GIA India and
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thereafter sent to GIA US or other subsidiaries of the group for grading. This
inter group grading services were charged/paid for by the group companies at
an agreed rate as per the GIA Gem Grading Services Agreement, which is
accepted by the Indian Tax Authorities to be at an Arm’s Length in case of
both GIA India as well as GIA US. It transpires that subsequently GIA India
progressively started grading diamonds of higher carats, and currently it can
grade diamonds of upto 3.99 carats.
10. For A.Y. 2011-2012, GIA US filed its Return of Income on 10th
November 2011, declaring a total income of Rs.68,53,46,239/-, which was
the royalty received from GIA India, and offered to tax. A revised Return of
Income was also filed on 6th September 2012, which also included the said
royalty income. The case of GIA US was selected for scrutiny, and the
transaction being an international transaction, initially, on 18 th February
2014, a reference was made by the Assistant Commissioner of Income Tax
(International Taxation), Circle-2(3)(2) [the Assessing Officer of GIA US] to
the Transfer Pricing Officer (“TPO”) for computation of the Arm’s Length
Price (“ALP”). On 29th January 2015, the TPO passed his order under section
92CA(3) proposing a NIL adjustment. Thereafter, the Assistant
Commissioner of Income Tax (International Taxation), Circle-2(3)(2), passed
a draft Assessment Order dated 23rd March 2015 under Section 144C(1) read
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with Section 143(3) of the Income Tax Act, 1961 (for short “IT Act“).
Aggrieved by the said draft Assessment Order, GIA US raised its objections
before the Dispute Resolution Panel (for short the “DRP”), which issued its
directions on 27th October 2015. Thereafter, the said Assistant Commissioner
of Income Tax passed a final Assessment Order dated 16th December 2015
and assessed GIA US’ total income at Rs.72,88,67,984/-. This was on the
basis that GIA US has a Permanent Establishment (PE) in India and
therefore, as per Article 7 of the India-US DTAA, assessed the entire income
of GIA US, including the aforementioned royalty income, at 42.23%.
11. Aggrieved by the final Assessment Order dated 16th December
2015, GIA US filed an Appeal before the ITAT on 25th January 2016, which
was lodged with the ITAT as Income Tax Appeal No. 386/Mum/2016. It is
undisputed that much before any reference was made to the Transfer Pricing
Officer either in the case of GIA US or GIA India (date of making reference to
the TPO in the case of GIA India was 16th December 2013), GIA India filed an
application dated 22nd March 2013 for entering into an Advance Pricing
Agreement (for short the “APA”) with the Central Board of Direct Taxes (for
short the “CBDT”) under Section 92CC of the IT Act for A.Ys. 2014-2015 to
2017-2019. This application was for the determination of the ALP of the
royalty paid by GIA India to GIA US. For the roll-back period of A.Y. 2010-
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2011 to 2013-2014, GIA India filed an application on 30th March 2015 under
Section 92CC(9A) of the IT Act. It appears that after a prolonged negotiation,
the CBDT entered into an APA dated 7th May 2018 with GIA India, inter
alia, determining the ALP (Arm’s Length Price) of royalty and also requiring
the excess royalty received by GIA US to be repaid to GIA India. As
mentioned earlier, for A.Y. 2011-2012, royalty paid by the GIA India to GIA
US was Rs.68,53,46,239/-. However, the ALP of royalty, as determined by
the APA, was Rs.49,08,99,461/-. Accordingly, as per the APA, GIA US was
liable to refund to GIA India the excess amount of Rs.19,44,46,788/- within a
stipulated period. The aforesaid exercise (with different figures) also applied
to A.Y. 2012-2013 to A.Y. 2017-2018.
12. To ensure that the excess amount of royalty paid by GIA India to
GIA US was refunded, the APA dated 7th May 2018, inter alia, required GIA
India to raise an invoice in respect of the excess royalty paid, and for income
tax purposes, to reduce the claim of royalty deduction made by it originally in
its Return of Income by filing a modified Return of Income for the
Assessment Year under consideration. Accordingly, the aforementioned
excess sums were invoiced by GIA India to GIA US, and GIA India filed its
modified Return of Income, reducing the deduction claimed on account of
payment of royalty. For the excess amount paid for A.Y. 2011-2012
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(Rs.19,44,46,788/-) an invoice dated 30th June 2018 was raised by the GIA
India on GIA US, and in terms of the said invoice, GIA US paid the aforesaid
amount to GIA India on 18th July 2018. Payments for the other Assessment
Years were also made within the time stipulated as per the APA.
13. Since the ALP was now determined as per the APA entered into
between the CBDT and GIA India, and the excess royalty amount paid was
also refunded by GIA US to GIA India, GIA US in its Appeal pending before
the ITAT (ITXA No. 386/Mum/2016), sought to raise an additional ground
by its letter dated 6th November 2018, claiming that the amount of
Rs.19,44,46,788/-, which was refunded back to GIA India as per APA dated
7th May 2018, could not be regarded as its income and GIA US should not be
assessed on the same. In the Appeals filed in relation to A.Y. 2012-2013 to
2013-2014, similar additional grounds were raised by GIA US before the
ITAT. For A.Y. 2014-2015 to 2016-2017, this issue was raised before the DRP,
and for A.Y. 2017-2018, the said claim was made by way of a revised Return
of Income filed on 30th November 2018. It is pertinent to note that the
revised Return of Income of GIA US for A.Y. 2017-2018 was accepted by the
Assistant Commissioner of Income Tax (International Taxation), Circle-2(3)
(2).
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14. The appeals for A.Y. 2011-2012 to A.Y. 2016-2017 were
consolidated and were decided by the ITAT by a common order dated 30th
April 2021. The additional grounds raised by GIA US in respect of the
reduction from its total income of the excess royalty paid back to GIA India
were allowed, and the amounts repaid by GIA US to GIA India were directed
to be reduced from the total income of GIA US, subject to verification of GIA
US having paid the amounts back to GIA India. The ITAT also held that GIA
US did not have a PE (Permanent Establishment) in India, and therefore,
royalty income was taxable at 10% in terms of Section 9 read with Section
115A of the IT Act, as opposed to the rate of 42.23% applied by the Assistant
Commissioner of Income Tax (International Taxation). Thus, by virtue of the
ITAT order dated 30th April 2021 passed for A.Y. 2011-2012 to 2016-2017, as
well as the Assessment Order dated 20th April 2021 passed by the Assistant
Commissioner of Income Tax (International Taxation) for A.Y. 2017-2018,
the position was that GIA India got a lesser deduction of royalty and
correspondingly, the GIA US’ income was reduced by the same amount. It is
aggrieved by this order of the ITAT that ITXA No. 2306 of 2022 (for A.Y.
2011-2012) has been filed.
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SUBMISSIONS OF THE APPELLANT:
15. Considering the aforesaid factual backdrop, Mr. Venkatraman,
the learned ASG appearing on behalf of the Revenue, submitted that the
ITAT completely misdirected itself by allowing the Appeal of GIA US and
reducing their income by Rs.19,44,46,788/-. He submitted that Chapter X of
the IT Act is a special anti-avoidance regime. Its object is to ensure that the
income arising from international transactions between Associated
Enterprises is computed having regard to the ALP (Arm’s Length Price), so as
to prevent erosion of the Indian tax base through profit shifting. According to
Mr. Venkatraman, the statutory scheme makes it clear that the determination
of the ALP under Chapter X is undertaken with reference to the international
transaction as a whole and not from the perspective of either party in
isolation. Section 92C, in referring to “the arm’s length price” in the singular
and to “such persons” in the plural, reflects a transaction-centric and
inherently bilateral framework. The ALP is thus an objective standard
emerging from the transaction itself and not a party-specific construct. The
statute does not contemplate multiple or divergent prices for the same
transaction depending on the perspective of the taxpayer or the Transfer
Pricing Officer examining either side.
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16. Mr. Venkatraman submitted that in this statutory setting,
Section 92 assumes central importance. It provides that income arising from
an international transaction shall be computed having regard to the ALP,
thereby constituting the statutory bridge between the machinery contained in
Chapter X and the general framework of charge and computation. Sections
92C and 92CA furnish the machinery for the determination of the ALP by the
Transfer Pricing Officer. Sections 92CC and 92CD, which deal with Advance
Pricing Agreements and their implementation, operate within the same
framework and are likewise confined to the determination and
implementation of the ALP. Section 92CC(1) expressly contemplates an
agreement only for determining the ALP in relation to an international
transaction.
17. Mr. Venkatraman submitted that there are specific statutory
prohibitions in the IT Act against a downward adjustment in the hands of a
non-APA Associated Enterprise (AE). In this regard, Mr. Venkatraman
submitted that Section 92(3) imposes an express limitation by providing that
the provisions of Section 92 shall not apply where computation having regard
to the ALP results in a reduction of income or increase of loss. This is a
substantive restriction consistent with the anti-avoidance character of
Chapter X, and ensures that transfer pricing provisions, including those
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relating to Advance Pricing Agreements, cannot be invoked to the detriment
of the Indian tax base. The only limited relaxation provided under the
Advance Pricing Agreement regime is contained in Section 92CC(3), which
permits departure from the methods otherwise referred to in Sections 92C
and 92CA. That relaxation is confined to the methodology of determining the
ALP. There is no corresponding relaxation or override in respect of Section
92, and in particular, no departure from Section 92(3).
18. Accordingly, the determination of the ALP cannot vary in law
depending on the perspective of the authority examining one side of the
transaction or the other. While the ALP remains uniform, its application in
computation operates asymmetrically by reason of Section 92(3). The
asymmetry reflected in the two orders dated 29th January 2015, passed by
the same Transfer Pricing Officer on the same date in the cases of GIA India
and GIA US, therefore, represents a consequence of a statutory compulsion in
view of Section 92(3) inherent in the anti-avoidance framework, and not any
divergence in the determination of the ALP itself. Further, the APA
mechanism cannot be used as a vehicle to achieve indirectly what the statute
prohibits directly. A non-resident AE could never, in law [in view of Section
92(3)] have entered into an APA for the purpose of seeking a downward
revision of its income. The absence of such a possibility flows from the design
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of the anti-avoidance framework itself. In the present case, however, the
impugned order effectively extends to GIA US the benefit of an APA entered
into by GIA India, and thereby permits a reduction of income which could
not have been achieved directly under the statute. It does so by giving effect
to a subsequent repayment beyond mere adjustment of books, and travels
back in time to undo a completed tax levy. Such an approach is legally
impermissible.
19. To buttress this argument, Mr. Venkatraman submitted that
there is no statutory mechanism for non-APA parties to seek any adjustment.
In this regard, Mr. Venkatraman relied upon Section 92CD and submitted
that the statutory framework provides a limited deeming fiction for giving
effect to an APA and that fiction is confined to the applicant alone (in the
present case, GIA India). Under Section 92CD, the Assessee entering into an
APA is permitted to furnish a modified Return which is deemed to be a
Return filed under Section 139(1). It is by virtue of this statutory fiction that
the ALP determined under the APA can be given retrospective effect in the
case of the signatory to the APA (in the present case, GIA India). Crucially,
there is no provision enabling the non-resident AE to revise its income or
reopen a completed tax position on account of an Advance Pricing Agreement
entered into by its Indian affiliate, and any subsequent legislative
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developments operate prospectively and cannot be invoked to retrospectively
undo a completed tax levy. This position stands further reinforced by the
subsequent legislative development introduced by the Finance Act, 2026,
which substitutes Section 169(1) of the Income-tax Act, 2025. By this
amendment, the statute, for the first time, extends the effect of the deeming
fiction associated with an Advance Pricing Agreement beyond the applicant
to “any other person being an associated enterprise”, by enabling such person
to furnish a return or a modified return where income is modified pursuant
to the agreement, within the prescribed time frame from the month in which
the Advance Pricing Agreement is entered into. The Explanatory
Memorandum to the Finance Bill, 2026 candidly acknowledges that under
the law as it previously stood, there was no provision enabling a non-
signatory Associated Enterprise to modify its return, claim a refund, or seek
consequential adjustment of taxes paid or withheld, on account of an
Advance Pricing Agreement entered into by another person. The
memorandum further clarifies that the amendment is to apply only to
Advance Pricing Agreements entered into on or after 1 st April 2026 and to
Assessment Years commencing from that date, with the provision itself
taking effect from 1st April 2026. In these circumstances, the subsequent
amendment cannot be invoked to retrospectively confer a right or mechanism
upon a non-signatory Associated Enterprise for the relevant Assessment
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Years. The statutory scheme, as it stood, lacked any enabling provision for the
reduction of income in the hands of such an entity. The repayment made by
GIA US pursuant to the APA does not alter this position. Such repayment is a
consequential adjustment flowing from the implementation of the APA in the
hands of GIA India and does not operate in law to retrospectively re-
characterise or reduce income that had already accrued and been received by
GIA US in the relevant assessment years. The Act contains no provision by
which such repayment can travel back in time to undo a completed tax levy.
20. Mr. Venkatraman then submitted that Section 92CE(3) further
reinforces the one-directional asymmetric framework. A “primary
adjustment” as defined, contemplates an adjustment to the total income of
the Assessee on account of transfer pricing provisions which results in an
increase in income or reduction in loss. It does not contemplate a decrease in
income. Correspondingly, the provisions relating to “secondary adjustment”
are confined to adjustments in the books of accounts of the Assessee, aimed
at aligning the cash position with the primary adjustment. These provisions
do not operate to recompute or reduce taxable income and are confined to
the Assessee who has undergone the primary adjustment. Thus, the statute
consistently proceeds on the basis of upward adjustment in the hands of the
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the counter-party.
21. Lastly, on the royalty issue, Mr. Venkatraman submitted that
Section 92C(4) read with its proviso forms a complete code governing the
consequences of the determination of the ALP. The structure of the provision
itself makes a clear and deliberate distinction between (i) limiting the relief
available to the Assessee undergoing the transfer pricing adjustment and (ii)
the express statutory bar against any corresponding adjustment in the hands
of the counter-party. In this regard, Mr. Venkatraman placed heavy reliance
on the second proviso to Section 92C(4). Mr. Venkatraman submitted that
this proviso expressly prohibited any re-computation of income in the hands
of the Associated Enterprise corresponding to the adjustment made in the
case of the Assessee. He submitted that legislative intent was unambiguous,
namely, once an upward adjustment was made in the hands of the tested
party (GIA India), there was an express prohibition against granting a mirror
downward adjustment to the counter-party (GIA US). Thus, far from
supporting the GIA US’ plea, the statutory text itself forecloses the very
argument of corresponding relief.
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22. To put it in a nutshell, Mr. Venkatraman submitted that when
one looks at the statutory framework as set out in Chapter X of the IT Act, it
was clear that once GIA US was paid the royalty by GIA India in the relevant
Assessment Year, it became taxable, and merely because GIA US had
refunded the excess royalty paid to it as per the terms of the APA, GIA US
could not claim a reduction of its income, and which was granted by ITAT in
the impugned order. Mr. Venkatraman submitted that this is more so in the
present case when one takes into consideration that the Advance Pricing
Agreement (APA) operates only in relation to the person who enters into the
agreement and the international transaction covered thereby. In terms of
Section 92CC(5), the binding effect of an APA is expressly confined to “the
person in whose case and in respect of the transaction in relation to which the
agreement has been entered into”. In other words, the rights and obligations
under the APA are limited to its signatory, and no benefit can be claimed by
or extended to a non-signatory Associated Enterprise (in the present case
GIA US).
23. Mr. Venkatraman then submitted that the argument canvassed
by GIA US, and which was accepted by the Tribunal, namely that only the
“real income” could be taxed and not by the statutory framework of transfer
pricing or the APA regime, is wholly misplaced and misconceived. Mr.
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Venkatraman submitted that the underlying premise is that the repayment is
made in the subsequent year out of commercial expediency, and can travel
back in time to undo a completed tax levy in earlier Assessment Years.
According to Mr. Venkatraman, even proceeding on this basis, and without
prejudice to the statutory position discussed earlier, the scheme is untenable
on first principles. The jurisprudence on accrual and “real income” operates
across three distinct and mutually exclusive categories, each addressing a
different stage in the emergence of income. They are: (a) completed accrual
and receipt, and subsequent reversal is wholly irrelevant and ineffective; (b)
Non-crystallization of accrual, namely adjustment at the stage of
determination; and (c) Extinguishment by operation of law or impossibility
within the same year. As far as categories (b) and (c) are concerned, they
operate at the stage of accrual itself, addressing situations where the income
either never comes into existence or stands extinguished before the close of
the previous year. They do not contemplate cases where income has fully
accrued, has been received and accepted as income, and is thereafter sought
to be altered by a subsequent voluntary act. A case like that would squarely
fall in category (a).
24. Once the case of GIA US falls within category (a), then it is
squarely covered by a decision of the Bombay High Court in the case of
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Kishinchand Chellaram and Others Vs. The Commissioner of
Income-Tax Central Bombay [1955 SCC OnLine Bom 134] and
which was confirmed by the Hon’ble Supreme Court in its decision in the case
of Kishinchand Chellaram Vs. Commissioner of Income-tax
[(1962) 46 ITR 640 (SC)].
25. Mr. Venkatraman submitted that in the facts of the present case
GIA US filed its original Return for A.Y. 2011-2012 on 10th November 2011,
and APA was executed only on 7th May 2018, and the refund was paid only
pursuant to the invoice raised by GIA India on 30th June 2018, a gap of 7
years. In these facts, the right to receive income fully crystalized, the income
was quantified, billed and received in terms of the contract between GIA
India and GIA US. GIA US accepted and returned it as its income, and there
was no dispute, contingency or legal infirmity affecting accrual within the
relevant previous year. The repayment occurred years after the close of the
previous year and after the Return was filed. This is therefore not a case of
non-accrual or extinguishment within the year falling within categories (b)
and (c) referred to above but one of voluntary repayment of income already
accrued and received, and hence, squarely falls within category (a) and is
covered by the decision of this Court as well as the Hon’ble Supreme Court in
Kishinchand Chellaram (supra).
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26. For all the aforesaid reasons, Mr. Venkatraman submitted that
the ITAT completely misdirected itself in allowing GIA US to reduce its
income by Rs.19,44,46,788/- for A.Y. 2011-2012 and also correspondingly for
A.Y. 2013-2014 to 2016-2017. He, accordingly, submitted that questions (a)
to (c) be answered in the negative and in favour of the Revenue and against
the Assessee.
27. As far as questions (d) to (g) are concerned, and which relate to
the PE issue, Mr. Venkatraman, the learned ASG appearing for the Revenue,
took us through the findings of the ITAT in the impugned order dated 30th
April 2021. Since this order of the ITAT only relies upon the order passed by
it in the case of GIA US for Assessment Year 2010-2011, Mr. Venkatraman
also took us through the order passed by the ITAT for A.Y. 2010-2011 dated
21st June 2019. After pointing out the relevant paragraphs [of the ITAT
order] on the PE issue, Mr. Venkatraman submitted that the ITAT completely
went wrong in holding that GIA India is not a PE of GIA US. He submitted
that the documents and facts would clearly establish that: (a) with expanding
business, the GIA group has set up many labs across the globe, including
India, and it is apparent that all units/labs are working under the control,
guidance and supervision of GIA US, including using the brand, logo,
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technology, process and expertise and utilising services of personnel deputed
by GIA US. Mr. Venkatraman submitted that GIA India is now operating in
India with the help of the lab directly set up by GIA US; (b) the technology,
expertise, design etc of the grading services is being provided to GIA India by
GIA US. According to Mr. Venkatraman, the client will approach the lab
situated in a specific country and may ask for grading services from GIA US
either through that office or through GIA’s direct office. In some cases, a
particular office will grade the diamonds, if it is capable of the same, or it will
utilise services of the lab of GIA US, Thailand or other affiliate entities. The
billing will be centralised by the particular office at the global rate fixed by
GIA US. The management expenses, advertisement, legal and similar
expenses would be incurred by GIA US, for which GIA India would reimburse
it. This operation of GIA US and GIA India is so overlapping, and the
demarcation between them is very blurred. There is no real difference in the
treatment accorded to clients either of GIA US or Thailand or India. From the
client’s perspective, he will be dealing with the GIA conglomerate which basic
structure has been formalised as a joint venture business spread across
multiple jurisdictions.
28. Mr. Venkatraman submitted that the Hon’ble Supreme Court in
the case of Hyatt International Southwest Asia Ltd. Vs. Additional
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Director of Income Tax [2025] 176 taxmann.com 783 (SC) ruled in
the context of a PE and what would constitute a “place of business”. Mr.
Venkatraman submitted that in paragraph 13, the Hon’ble Supreme Court
held that for a PE to exist, two essential conditions must be satisfied: (i) the
place must be at the disposal of the enterprise, and (ii) the business of the
enterprise must be carried on through that place. The disposal test is pivotal,
meaning thereby that the enterprise must have a right to use the premises in
such a way that enables it to carry on its business activities. According to Mr.
Venkatraman, in the facts of the present case, GIA India takes orders from
customers to carry out the grading services upto 1.99 carats and for 2 carats
and more, uses the services of GIA US. Further, GIA US exercises strategic,
operational and financial control over GIA India. Further, there is a
continuous business relationship between GIA US and GIA India to establish
the factum of a business connection. All these factors would clearly go to
show that GIA India is the PE of GIA US in India. Therefore, the ITAT
completely went wrong in coming to the conclusion that GIA US does not
have a PE in India. He, therefore, submitted that as far as questions (d) to (g)
are concerned, the same also be answered in the negative, and in favour of
the Revenue and against the Assessee.
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SUBMISSIONS OF THE RESPONDENT (GIA US):
29. On the other hand, Mr. Mistri, the learned Senior Counsel
appearing for the Respondent (GIA US) submitted that when one looks at the
facts of the present case, the issue is whether under the IT Act/India-US
DTAA, GIA US can be taxed on royalties as finally paid to it of
Rs.49,08,99,451/- (real income of the Assessee) or on the amount of
Rs.68,53,46,239/- which was the amount initially received by GIA US from
GIA India towards royalty for A.Y. 2011-2012. He submitted that admittedly,
out of the initial amount of Rs.68,53,46,239/- [received by the GIA US from
GIA India], a sum of Rs.19,44,46,788/- was undisputably refunded by it to
GIA India on 18th July 2018. Once this is the case, it is only the real income
of GIA US, namely the sum of Rs.49,08,99,451/- (Rs. 68,53,46,239 – Rs.
19,44,46,788) can be brought to tax in India. Mr. Mistri submitted that as per
the India-US DTAA, and more particularly in terms of Article 12 thereof,
what can be brought to tax in India are royalties “paid” to GIA US by GIA
India. He submitted that the word “paid” denotes only that amount which is
actually and eventually paid i.e. the amount that remains or is by agreement
with GIA India, retained by GIA US. The clear provisions of the India-US
DTAA and the well settled position under the IT Act provide that only the
retained amount that GIA US is entitled to, can be regarded as its income
chargeable to tax. What was received initially but thereafter returned cannot
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be regarded as “paid” to GIA US. By the plain common meaning of the word
and use of this terminology, the DTAA incorporates the doctrine of real
income. In support of the proposition that only the real income can be
brought to tax, Mr. Mistri placed reliance on the following decisions:-
(a) Godhra Electricity Co. Ltd. Vs. CIT (1997) 225 ITR 746
(SC)
(b) CIT Vs. Bokaro Steel Ltd. (1999) 236 ITR 315 (SC)
(c) CIT Vs. Lok Housing & Construction Ltd. (2015) 58
taxmann.com 179 (Bom)
(d) FGP Ltd. Vs. CIT (2010) 326 ITR 444 (Bom)
(e) CIT Vs. M.P. Audyogik Kendra Vikas Nigam (Raipur)
Ltd. (1997) 227 ITR 799 (MP)
(f) H.M. Kashiparekh & Co. Ltd. Vs. CIT (1960) 39 ITR 706
(Bom)
30. Mr. Mistri submitted that the ITAT has, in great detail, dealt
with the doctrine of real income in its impugned judgment and order dated
30th April 2021. After a detailed examination of the facts, the ITAT held that
there can be no way in which an Assessee can be taxed in respect of that part
of the receipt of income which the Assessee has bonafide refunded to the
payer. As far as bonafides of the Respondent (GIA US) are concerned, the
same can hardly be disputed, was the submission. The facts of the present
case clearly bear out that even before any transfer pricing reference was made
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either in the case of GIA India or GIA US, in order to ensure that there is
certainty and there are no disputes going forward with the Income-tax
Department, on 25th March 2013, GIA India filed an application under
Section 92CC to reach an agreement inter alia on the quantum of royalty to
be paid by GIA India to GIA US. Mr. Mistri submitted that it is important to
note that the provisions of Sections 92CC to 92CD (Advance Pricing
Agreement provisions) were introduced on 1st July 2012 and the application
was made by GIA India shortly thereafter on 25th March 2013. It is not as if
the transfer pricing provisions were already invoked, and with the fear of
getting caught, that GIA India made the application for entering into an APA.
In these circumstances, Mr. Mistri submitted that the finding of the ITAT
that the Assessee (GIA US) bonafide refunded the excess amount to GIA
India, in terms of the APA entered into between GIA India and the CBDT,
cannot be faulted or called into question. Mr. Mistri submitted that it is now
a well settled position that in order for income to be taxed in the hands of the
Assessee, it must be the real income which the Assessee has actually earned
in reality and not merely any hypothetical income which the Assessee could
have earned but in fact did not earn.
31. Mr. Mistri submitted that the Revenue has attempted to cloud
the issues with extraneous contentions regarding transfer pricing provisions.
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He submitted that the Revenue unfortunately, is of the view that (i) transfer
pricing provisions need to be considered and (ii) on consideration thereof,
GIA US’ claim be rejected. Mr. Mistri submitted that both these contentions
are utterly erroneous and completely misconceived, as more particularly held
by the ITAT in the impugned order.
32. Mr. Mistri submitted that the reliance placed by the Revenue on
Section 92(3) is wholly misplaced. The sine qua non for the application of
Section 92(3) is that a computation of income should be made under sub-
section (1) in the case of the same person to whom Section 92(3) is sought to
be applied. It is only if a person is subject to a computation under Section
92(1) that any question can arise as to whether such computation has the
effect of reducing the income chargeable to tax, nevertheless, in the case of
the same person. He submitted that the Revenue is completely confused
when it seeks to rely upon a Section 92(1) computation in the case of GIA
India and then applies Section 92(3) to GIA US. This is completely
unstateable and patently erroneous from a plain reading of Section 92(1). Mr.
Mistri submitted that Section 92 only proscribes a downward adjustment in a
case where a reduction in income is claimed without repayment of the excess.
Section 92(3) could have no application in the present case where the
differential royalty of Rs.19,44,46,788/- has been repaid by GIA US, and its
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claim is based solely on that factor. Mr. Mistri submitted that in the present
case, by the APA entered into with GIA India [which is approved/signed by
the Government of India], the royalty price now paid/received by and
between GIA US and GIA India is at a price which, by operation of law,
cannot be considered/questioned as being different from the Arm’s Length
Price (ALP). Accordingly, all transfer pricing provisions cannot be applied
once an APA has been entered into with the CBDT.
33. Mr. Mistri submitted that the reliance placed on the second
proviso to Section 92C(4) is also wholly misplaced. The second proviso to
Section 92C(4) applies only in case of a transfer pricing adjustment and not
where a variation/adjustment of any other type (such as pursuant to an APA)
is made. He submitted that this issue is no longer res integra and has been
clearly decided by the Hon’ble Karnataka High Court in the case of PCIT Vs.
EYGBS (India) (P) Ltd. [(2025) 180 taxmann.com 681]. Mr. Mistri
fairly pointed out that though this decision was dealing with the first proviso
to Section 92C(4), the ratio laid down therein would equally apply even to the
second proviso to Section 92C(4), and which was pressed into service by the
Revenue. Mr. Mistri submitted that the rationale for providing for an APA is
to remove any uncertainty as to the determination of income of an Assessee
engaged in international transactions with Associated Enterprises. Where the
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Assessee declares his income based on the ALP determined on the basis of an
APA, there is a statutory bar on the AO/TPO to enhance the income under
the transfer pricing provisions because the transaction price as per the APA
conforms to the ALP. In these circumstances, there can be no question of
Section 92C(4) or any of its provisos being made applicable.
34. Mr. Mistri submitted that where the ALP is determined by an
APA, no adjustment can be made contrary thereto, either for future years or
the roll back period. In other words, for all the Assessment Years that are
covered by the APA, the ALP would have to be determined on the basis of the
APA. In the present case, for all the Assessment Years in question, and since
in the present case we are referring to the A.Y. 2011-2012, the ALP
determined for the royalty to be paid by the GIA India to GIA US for this
Assessment Year, was Rs.49,08,99,451/-. Hence, what can be brought to tax
in India is only Rs.49,08,99,451/-, and not the amount initially received by
GIA US from GIA India of Rs.68,53,46,239/-, especially when the excess
amount of Rs.19,44,46,788/- was refunded back to GIA India.
35. As far as the decision relied upon by the Revenue in the case of
Kishinchand Chellaram (supra) is concerned, Mr. Mistri submitted that the
same is clearly distinguishable on the facts. He submitted that in this case,
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even though the shareholder was compelled to return the dividend, the fact of
payment of the dividend was not (and in view of Section 16 could not be)
obliterated, but there was a separate event of its repayment. It is in this light
the Hon’ble Supreme Court held that in view of the deeming provisions that
the dividend became income of the year in which it was declared/paid. He
submitted that the factual situation in the present case is completely different
and hence, the aforesaid decision can have no application. In any event, Mr.
Mistri submitted that much water has flown since the decision rendered in
Kishinchand Chellaram (supra), and now it is well settled that (i) only real
income can be taxed and (ii) claims can be made before the ITAT by raising
additional grounds, if proceedings are pending. This is clearly laid down by
the Hon’ble Supreme Court in the case of National Thermal Power Co.
Ltd. Vs. Commissioner of Income-tax [1998] 229 ITR 383 (SC).
36. Mr. Mistri lastly submitted that the argument regarding
“secondary adjustment” is wholly misplaced, as the question of making a
secondary adjustment can only arise in the case of GIA India and never in the
case of GIA US, as is sought to be argued. This is clear from the explicit
language of Section 92CE(1). The question of secondary adjustment would
only arise if the excess monies representing the primary adjustment are not
repatriated to India within the prescribed time. In the present case,
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admittedly, excess monies have been repatriated within the prescribed time
limit. In any event, the definition of the word “secondary adjustment” is
merely a description of what the secondary adjustment is, and the said
provision does not impose any obligation on GIA US to make any adjustment
in its books. However, since the amount of Rs.19,44,46,788/- was actually
paid by GIA US, an entry in its books maintained in the USA would certainly
have been made. Mr. Mistri submitted that the requirement of secondary
adjustment can only apply to a foreign enterprise which maintains books of
account in India, e.g. an enterprise having a PE or a fixed base in India. It
cannot be applicable to an entity like GIA US which does not have a PE in
India and is otherwise not required to maintain books of account in India.
Mr. Mistri pointed out that in fact on the issue of secondary adjustment, the
Tribunal has given its discussion and findings in paragraphs 18 to 20 thereof
and which Mr. Mistri once again reiterates before us. For all these reasons,
Mr. Mistri submitted that questions (a) to (c) to be answered in the
affirmative and in favour of the Assessee and against the Revenue.
37. As far as the PE issue [questions (d) to (g) and the additional
question for A.Y. 2017-2018] is concerned, Mr. Mistri submitted that the
same does not give rise to any substantial question of law. In this regard, Mr.
Mistri took us through the factual findings rendered by the ITAT in its order
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dated 21st June 2019 (for A.Y. 2010-2011) and submitted that the factual
findings rendered are in conformity with the facts placed before the ITAT. He
submitted that it is not even the case of the Revenue that these factual
findings are in any way perverse or contrary to the facts on record. In these
circumstances, he submitted that as far as the PE issue is concerned, the
same does not give rise to any substantial question of law and hence are not
required to be entertained at all.
FINDINGS:-
38. We have heard the learned counsel for the parties at length. We
have also perused the papers and proceedings in the above Appeals including
the written submissions tendered by the parties.
39. As mentioned earlier, in the present Appeals, there are two
issues that need to be decided. The first issue is regarding the quantum of
royalty that can be brought to tax in India in the hands of GIA US [questions
(a) to (c) reproduced earlier]. The second issue is whether GIA India is a PE
of GIA US in India in terms of Article 5 of the India-US DTAA [questions (d)
to (g) reproduced earlier as well as the additional question raised in
A.Y.2017-18 and reproduced earlier]. We will deal with these issues
independently.
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REASONING AND CONCLUSIONS ON THE PE ISSUE:
40. Since these are the two issues that need to be decided, we will
first focus our attention on the issue whether the GIA India is a PE of GIA US
in India, in terms of Article 5 of the India-US DTAA. For the Assessment Year
2011-2012 (and the other Assessment Years which we are considering), the
ITAT, on the PE issue, only followed its earlier order passed for A.Y. 2010-
2011. It would, therefore, be necessary to see the findings of the ITAT for A.Y.
2010-2011. The ITAT, in its order dated 21st June 2019 (for A.Y. 2010-2011),
carefully considered the submissions of the Department as well as those of
the Assessee (GIA US) in relation to whether GIA India was a PE of GIA US,
in India. The discussion of the ITAT on this aspect can be found in
paragraphs 9 to 18. To put it in a nutshell, the ITAT factually found that the
transaction of grading services between GIA US and GIA India could not be
considered to be in the nature of a joint venture since GIA India had its own
independent expertise. It was only due to its technology/capacity constraints
that GIA India forwarded stones to GIA US for grading purposes. The ITAT,
after examining the facts, came to the conclusion that the arrangement
between GIA India and GIA US was not one where each party contributes its
share in order to undertake the economic activity which is subject to joint
control. In fact, the arrangement was akin to an assignment or sub-
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contracting of grading services by GIA India to GIA US, whenever GIA India
did not have the requisite expertise, technology or capacity for carrying out
grading services. The ITAT further noted that the aforesaid arrangement was
also accepted as a mere rendering of grading services by the Transfer Pricing
Officer, both in the case of GIA India as well as GIA US.
41. With this background in mind, the ITAT first examined whether
GIA India can be termed as a “fixed place” PE of GIA US in terms of Article
5(1) of the India-US DTAA. As per Article 5(1), a fixed place PE arose when
the foreign entity had a fixed place through which its business was wholly or
partly carried on. The ITAT, being the last fact-finding authority, after
examining the facts, came to the conclusion that, in the present case, there
was no joint venture arrangement between GIA US and GIA India vis-à-vis
gem grading services rendered by GIA US to GIA India. To come to this
conclusion, ITAT found that GIA India, which enters into an agreement with
its client, bears all the risk, including credit risks, client-facing risks, etc., and
also GIA India bears the risk of loss or damage to articles while in transit to
and from GIA US and also during the time when the articles are at or in the
facilities of GIA US. Looking at these facts, the ITAT found that the economic
risks of gem grading services rendered by GIA US vis-à-vis stones/diamonds
of the customers of GIA India were borne by GIA India, and hence there was
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no joint venture arrangement between GIA US and GIA India. The ITAT also
took into consideration the provisions of Article 5(6) of India-US DTAA,
which provided that the mere fact that a company has a controlling interest
in the other company did not, by itself, without anything more, construe the
other company to be its PE. The ITAT therefore found that GIA US does not
have a “fixed place” PE in India. To come to this finding, the ITAT also took
support of a decision of the Delhi High Court in the case of DIT Vs. E-
Funds IT Solution [(2014) 364 ITR 256 (Delhi)], and which was
affirmed by the Hon’ble Supreme Court in (2017) 399 ITR 34 (SC), where
the facts were very similar to the facts in the case before the ITAT.
42. Thereafter, the ITAT also went on to examine whether under
Article 5(1) of the India-US DTAA, GIA India can be termed as a “service PE”
of GIA US. The ITAT found that a service PE arises only on the furnishing of
services in India by GIA US through employees or other personnel, but only if
the activities of that nature continue in India for periods aggregating to more
than 90 days within any twelve-month period or the services are performed
within India for a related enterprise. The ITAT, on examining the facts, came
to the conclusion that GIA US renders grading services and management
services to GIA India. In fact, two graders who were earlier employed with
GIA US, are now employed with GIA India and are on the payroll of GIA
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examining the facts, the ITAT found that no “service PE” is created in India in
terms of Article 5 of the India-US DTAA. In fact, the ITAT once again relied
upon the decision of the Delhi High Court in E-Funds IT Solution (supra)
where it was held that the two employees deputed to e-Fund India did not
create a service PE, as the entire salary cost was borne by e-Fund India, and
they were working under the control and supervision of e-Fund India. In the
instant case, since the grading services were rendered outside India and none
of the employees/personnel of GIA US had visited India, the service PE
provisions were not triggered in the present case, was the finding of the ITAT.
43. Thereafter, the ITAT also went on to examine whether an
“agency PE” was created in terms of Article 5(4) of the India-US DTAA. The
ITAT, after examining such provisions, came to the conclusion that an agency
PE is created where a person, other than an agent of an independent status to
whom paragraph 5 applies, is acting in India on behalf of an enterprise of the
US, then that enterprise shall be deemed to have a permanent establishment
in India if: (a) he has and habitually exercises in India an authority to
conclude on behalf of the enterprise, unless his activities are limited to those
mentioned in paragraph 3 which, if exercised through a fixed place of
business, would not make that fixed place of business a permanent
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establishment under the provisions of that paragraph; (b) he has no such
authority but habitually maintains in India a stock of goods or merchandise
from which he regularly delivers goods or merchandise on behalf of the
enterprise, and some additional activities conducted in the State on behalf of
the enterprise have contributed to the sale of goods or merchandise; or (c) he
habitually secures those orders in India wholly or almost wholly for the
enterprise. The Tribunal also noted the provisions of Article 5(5), which
stipulates that an agency PE excludes any business activity carried out
through a broker, general commission agent, or any other agent having an
independent status, if such broker, general commission agent, or any other
agent having independent status acts in the ordinary course of business.
Having examined the provisions of Articles 5(4) and 5(5), the ITAT thereafter
applied those provisions to the facts of the present case. The ITAT came to
the conclusion that GIA India is an independent and separate legal entity in
India, which is engaged in rendering grading services. Further, considering
the functions and the risks assumed by GIA India vis-à-vis its business
activities in India, the ITAT found that GIA India is an independent entity
which is rendering grading services to its clients in India and bears all the
service risks, as well as the client-facing risks vis-à-vis the stones sent to GIA
US for grading purposes. In these facts, the ITAT found that GIA India is not
acting in India on behalf of GIA US. Further, GIA India does not have any
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authority to conclude contracts on behalf of the GIA US, and neither has it
done so. Further, it has not secured any orders for GIA US in India. Looking
at these facts, and also taking into consideration the transfer pricing study
report and the fact that the Transfer Pricing Officer has also accepted the
functional and risk analysis in the case of GIA India and GIA US, the ITAT
came to the conclusion that GIA India cannot be regarded as an “agency PE”
of GIA US in India.
44. Before concluding on this issue, the ITAT also noted that a
similar query, i.e. why GIA India should not be construed as a PE of GIA US,
was raised for A.Y. 2009-2010. However, after considering the detailed
response furnished by GIA US (vide its reply dated 2nd November 2012), no
addition whatsoever was made, and which fact is evident from the
Assessment Order for A.Y. 2009-2010 dated 26th March 2013. The ITAT
therefore held that it was all the more incumbent upon the Revenue in A.Y.
2010-2011 to discharge its onus as to why a different stand was being
adopted, especially in the face of the facts that the nature and source of the
income in question remained the same. On this ground also, the ITAT was
not satisfied with the argument of the Revenue that GIA India is a PE of GIA
US in India.
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45. Having gone through this order in great detail, we find that the
ITAT [for A.Y. 2010-2011] has very carefully examined the facts and
thereafter come to the conclusion that GIA India is not a PE of GIA US in
India. When one looks at the factual finding rendered by the ITAT (which is
the last fact-finding authority), we are clearly of the view that in the facts of
the present case, GIA India could not be termed as a PE of GIA US in India,
as it clearly (a) did not have a fixed place of business in India; (b) was not a
service PE as contemplated under Article 5(1); and (c) was not an agency PE
as contemplated under Article 5(4) of the India-US DTAA. From the facts
narrated, it is clear that GIA India was an independent, separate legal entity
rendering grading services to its clients upto a particular capacity (at the
relevant time upto 1.99 carats). If the stones to be graded were of a higher
capacity (more than 1.99 carats), it is only in those circumstances that GIA
India would forward those stones for grading purposes to GIA US or to other
enterprises of the GIA Group, depending upon the service requirement.
These were independent and individual transactions and can never be termed
as one which could take the colour of a joint venture arrangement, a service
PE or an agency PE as contemplated under Article 5 of the India-US DTAA.
This is more so when one takes into consideration that the entire risk in
relation to the stones forwarded by GIA India to GIA US on behalf of its own
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customers was borne entirely by GIA India, and no risk was attached
whatsoever to GIA US.
46. Once these are the facts, and it has not even been contended
before us, and correctly so, that these factual findings are either perverse or
contrary to the record, we are clearly of the view that the questions raised by
the Revenue on the PE issue, namely questions (d) to (g), as well as the
additional question raised in A.Y. 2017-2018, do not give rise to any
substantial question of law requiring an answer by this Court. Hence,
questions (d) to (g) reproduced earlier, as well as the additional question
raised in A.Y. 2017-2018, also reproduced earlier, are not entertained.
REASONING AND CONCLUSIONS ON THE ROYALTY ISSUE:-
47. As mentioned earlier, the royalty issue is basically regarding the
quantum of royalty that can be brought to tax in India, which was paid by
GIA India to GIA US. On this issue, questions (a) to (c) have been framed by
the Revenue. We hereby admit the appeals for A.Y. 2011-12, A.Y. 2012-13,
A.Y. 2013-14, A.Y. 2014-15, A.Y. 2015-16, and A.Y. 2016-17 on questions (a) to
(c), and with the consent of the parties, the aforesaid appeals are heard finally
at the admission stage itself.
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48. It is the undisputed position before us that GIA US is an
Associated Enterprise of GIA India. To put it in a nutshell, it is the argument
of the Revenue that for A.Y. 2011-2012, GIA US filed its Return of Income
declaring a total income of Rs.68,53,46,239/-, which was the royalty received
from GIA India and which was offered to tax. Since the case of GIA US was
selected for scrutiny, and the transaction being an international transaction,
a reference was made by the Assessing Officer of GIA US to the Transfer
Pricing Officer for the computation of the Arm’s Length Price (ALP).
Thereafter, the Transfer Pricing Officer passed his order proposing a NIL
adjustment. Accordingly, the Assessing Officer of GIA US passed a draft
Assessment Order under Section 144C(1) read with Section 143(3), which was
initially objected to by GIA US before the DRP. Despite the objections, the
Dispute Resolution Panel (DRP) issued its directions on 27th October 2015.
Thereafter, in line with the directions issued by the DRP, the Assessing
Officer passed a final Assessment Order and assessed GIA US’ total income at
Rs.72,88,67,984/-. This was on the basis that GIA US has a Permanent
Establishment in India, and therefore, its entire income, including the royalty
received, was liable to be taxed in India at 42.23%. Aggrieved by this final
Assessment Order, GIA US filed an Appeal before the ITAT on 25th January
2016. Long before all this, GIA India had filed an application (dated 22nd
March 2013) for entering into an Advance Pricing Agreement (APA) with the
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Central Board of Direct Taxes (CBDT) under Section 92CC of the IT Act for
A.Y. 2014-2015 to 2018-2019. Thereafter, on 30 th March 2015, GIA India
filed another application for the rollback period, namely for A.Y. 2010-2011
to 2013-2014. As mentioned earlier, after a prolonged negotiation, an APA
was entered into on 7th May 2018 between GIA India and the CBDT inter
alia determining the ALP of the royalty payable by GIA India to GIA US, and
also requiring the excess royalty received by GIA US to be repaid back to GIA
India. It is on this basis that GIA US refunded to GIA India the excess
amount of royalty in the amount of Rs.19,44,46,788/-. Since the excess
amount was refunded, it was GIA US’ case that now what could be taxed in
India under Article 12 of the India-US DTAA (Article relating to royalty and
fees for technical services) was Rs.49,08,99,451/- [i.e. Rs.68,53,46,239 minus
Rs.19,44,46,788]. It therefore raised an additional ground in the Appeal filed
before the ITAT, which was pending. This was allowed by the ITAT in the
order dated 30th April 2021. According to the Revenue, this could not be
done for two reasons: (i) as elaborated earlier, the transfer pricing provisions
did not permit any downward adjustment in the income; and (ii) such a
ground could not be raised and relief sought in an Appeal that was filed prior
to the APA being entered into between GIA India and the CBDT.
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49. On the other hand, it was the argument of GIA US that under the
India-US DTAA, and more particularly in terms of Article 12 thereof, what
could be brought to tax in India are royalties “paid” to GIA US by GIA India.
This would effectively mean that only the amount that GIA US ultimately
retained, can be regarded as its income chargeable to tax. What was initially
received by GIA US but thereafter returned (partly), cannot be regarded as
“paid” to GIA US. Since, admittedly, the amount retained by GIA US is the
amount of Rs.49,08,99,451/-, it is only that figure that is “paid” and can be
brought to tax in India, and not the amount initially received by it of
Rs.68,53,46,239/-.
50. To understand these rival contentions, we will first examine
whether the reliance placed on the transfer pricing provisions by the Revenue
is of any assistance to them to contend that the amount that has to be
brought to tax in India is Rs.68,53,46,239/- and not Rs.49,08,99,451/-. The
Revenue placed heavy reliance on Sections 92, 92C, 92CC, 92CD and 92CE of
the IT Act to contend that what is to be brought to tax is the amount of
Rs.68,53,46,239/- and not Rs.49,08,99,451/-.
51. All the Sections referred to above fall under Chapter X of the IT
Act, which relates to “Special Provisions Relating to Avoidance of Tax”.
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Section 92 deals with the computation of income from international
transactions having regard to the ALP and reads as under:-
“92. (1) Any income arising from an international transaction
shall be computed having regard to the arm’s length price.
Explanation.-For the removal of doubts, it is hereby clarified that
the allowance for any expense or interest arising from an
international transaction shall also be determined having regard
to the arm’s length price.
(2) Where in an international transaction or specified domestic
transaction, two or more associated enterprises enter into a
mutual agreement or arrangement for the allocation or
apportionment of, or any contribution to, any cost or expense
incurred or to be incurred in connection with a benefit, service or
facility provided or to be provided to any one or more of such
enterprises, the cost or expense allocated or apportioned to, or, as
the case may be, contributed by, any such enterprise shall be
determined having regard to the arm’s length price of such
benefit, service or facility, as the case may be.
(2A) Any allowance for an expenditure or interest or allocation of
any cost or expense or any income in relation to the specified
domestic transaction shall be computed having regard to the
arm’s length price.
(3) The provisions of this section shall not apply in a case where
the computation of income under sub-section (1) or sub-section
(2A) or the determination of the allowance for any expense or
interest under sub-section (1) or sub-section (2A), or the
determination of any cost or expense allocated or apportioned, or,
as the case may be, contributed under sub-section (2) or sub-
section (2A), has the effect of reducing the income chargeable to
tax or increasing the loss, as the case may be, computed on the
basis of entries made in the books of account in respect of the
previous year in which the international transaction or specified
domestic transaction was entered into.”
(emphasis supplied)
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52. Section 92(1) stipulates that any income arising from an
international transaction shall be computed having regard to the ALP. The
determination of the ALP is to be done by the Transfer Pricing Officer under
Section 92CA on a reference being made to him by the Assessing Officer. Sub-
section (3) of Section 92 provides that the provisions of Section 92 shall not
apply in a case where the computation of income under sub-section (1) has
the effect of reducing the income chargeable to tax or increasing the loss, as
the case may be, computed on the basis of entries made in the books of
accounts in respect of the previous year in which the international
transaction was entered into. Heavy reliance was placed on sub-section (3) to
contend that it is because of this provision that GIA US could not now
contend that the income chargeable to tax was Rs.49,08,99,451/-, where it
had initially offered to tax the amount of Rs.68,53,46,239/-.
53. At the outset, we fail to understand how these provisions can be
of any assistance to the argument of the Revenue. On reading of the aforesaid
Section, we are clearly of the view that for Section 92(3) to apply,
computation of income should be made under sub-section (1) in the case of
the same person to whom Section 92(3) is sought to be applied. It is only if a
person is subject to the computation under Section 92(1) that any question
can arise as to whether such computation has the effect of reducing the
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income chargeable to tax, nevertheless, in the case of the same person.
Section 92(1) cannot be relied upon for computation in the case of one person
and then apply Section 92(3) to another person. This, according to us, is
patently erroneous from a plain reading of Section 92. Further, we find force
in the argument canvassed by Mr. Mistri that Section 92 only prohibits a
downward adjustment in a case where a reduction in income is claimed
without repayment of excess. Section 92(3) could have no application in the
present case, where the differential royalty of Rs.19,44,46,788/- has been
repaid by GIA US to GIA India, and its claim is based solely on that factor.
54. The next provision that was relied upon by the Revenue was
Section 92C, and more particularly, Section 92C(4). Section 92C deals with
the computation of the ALP. Sub-section (4) of Section 92C stipulates that
where the ALP (Arm’s Length Price) is determined by the Assessing Officer
under sub-section (3), the Assessing Officer may compute the total income of
the Assessee having regard to the ALP so determined. For the sake of
convenience, Section 92C(3) and (4) are reproduced hereunder:-
“(3) Where during the course of any proceeding for the
assessment of income, the Assessing Officer is, on the basis of
material or information or document in his possession, of the
opinion that-
(a) the price charged or paid in an international
transaction or specified domestic transaction has not been
determined in accordance with sub-sections (1) and (2);
or
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(b) any information and document relating to an
international transaction or specified domestic transaction
have not been kept and maintained by the assessee in
accordance with the provisions contained in sub-section
(1) of section 92D and the rules made in this behalf; or
(c) the information or data used in computation of the
arm’s length price is not reliable or correct; or
(d) the assessee has failed to furnish, within the specified
time, any information or document which he was required
to furnish by a notice issued under sub-section (3) of
section 92D,
the Assessing Officer may proceed to determine the arm’s length
price in relation to the said international transaction or specified
domestic transaction in accordance with sub-sections (1) and (2),
on the basis of such material or information or document
available with him:
Provided that an opportunity shall be given by the
Assessing Officer by serving a notice calling upon the
assessee to show cause, on a date and time to be specified
in the notice, why the arm’s length price should not be so
determined on the basis of material or information or
document in the possession of the Assessing Officer.
(4) Where an arm’s length price is determined by the Assessing
Officer under sub-section (3), the Assessing Officer may compute
the total income of the assessee having regard to the arm’s length
price so determined:
Provided that no deduction under section 10A or section
10AA or section 10B or under Chapter VI-A shall be
allowed in respect of the amount of income by which the
total income of the assessee is enhanced after computation
of income under this sub-section:
Provided further that where the total income of an
associated enterprise is computed under this sub-section
on determination of the arm’s length price paid to another
associated enterprise from which tax has been deducted or
was deductible under the provisions of Chapter XVIB, the
income of the other associated enterprise shall not bePage 49 of 99
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length price in the case of the first mentioned enterprise.”
(emphasis supplied)
55. As can be seen from the aforesaid provisions, sub-section (3)
stipulates that where during the course of any proceeding for the assessment
of income, the Assessing Officer is, on the basis of material or information or
document in his possession, of the opinion that (a) the price charged or paid
in an international transaction has not been determined in accordance with
sub-sections (1) and (2) of Section 92C; or (b) any information and document
relating to any international transaction have not been kept or maintained by
the Assessee in accordance with the provisions contained in sub-section (1) of
Section 92D or the rules made in that behalf; or (c) the information or data
used in the computation of the Arm’s Length Price is not reliable or correct;
or (d) the Assessee has failed to furnish, within the specified time, any
information or document which he was required to be furnished by a notice
issued under Section 92D(3); the Assessing Officer may proceed to determine
the ALP in relation to the said international transaction on the basis of such
material or information or document available with him.
56. Sub-section (4) stipulates that where the ALP is determined by
the Assessing Officer [under sub-section (3)], he may compute the total
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income of the Assessee having regard to the ALP. What is important for our
purposes, and on which much stress was laid by the Revenue, was the second
proviso to Section 92C(4). The second proviso to Section 92C(4) stipulates
that where the total income of an Associated Enterprise (GIA India) is
computed under this sub-section on determination of Arm’s Length Price
paid to another Associated Enterprise (GIA US) from which tax has been
deducted or was deductible under the provisions of Chapter XVIIB, the
income of the other Associated Enterprise (GIA US) shall not be recomputed
by reason of such determination of Arm’s Length Price in the case of the first-
mentioned Enterprise (GIA India).
57. On a plain reading of the second proviso of Section 92C(4), at
first blush, the argument canvassed by the Revenue appears to carry much
weight. However, we find that in the facts of the present case, Section 92C(4)
would not apply to GIA US. This is for the simple reason that in the present
case, there is already an Advance Pricing Agreement (APA) that has been
entered into between GIA India and CBDT. That APA now governs the
determination of the ALP (Arm’s Length Price) for all the years that form the
subject matter of the APA. Once an APA has been entered into, the ALP has
to be determined solely on the basis of the APA. The second proviso to
Section 92C(4) applies only in a case where a transfer pricing adjustment is
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made by the Assessing Officer, namely where the ALP is determined by the
Assessing Officer under Section 92C(3), and not where a variation or
adjustment is made pursuant to an APA.
58. In this regard, the reliance placed by Mr. Mistri on the decision
of the Karnataka High Court in the case of Principal Commissioner of
Income-tax Vs. EYGBS (India) (P.) Ltd. [2025] 180 taxmann.com
681 (Karnataka) is well founded. The question that was being considered
by the Karnataka High Court was whether the Tribunal’s order could be said
to be perverse in confirming the order of the first appellate authority holding
that the voluntary adjustment made to the Arm’s Length Price pursuant to
the APA is eligible for deduction under Section 10AA of the Act without
appreciating that the Assessee had declared TP adjustments pursuant to the
APA in its computation of income only in anticipation of TP adjustments by
the Transfer Pricing Officer and to avoid the rigors of Section 92C(4) of the
Act, and consequently, the enhanced benefits under Section 10AA of the Act.
From this question, it is clear that what the Karnataka High Court was
considering was the first proviso to Section 92C(4) and not the second
proviso to Section 92C(4). Whilst examining this aspect, the Karnataka High
Court held that the TP adjustments are made pursuant to the APA entered
into by the Assessee with the CBDT. Section 92CC of the Act empowers the
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CBDT to enter into an APA with any person for determining the Arm’s
Length Price or specify the manner in which the Arm’s Length Price is to be
determined, in relation to an international transaction to be entered into by
that person. After considering the provisions of Section 92CD, the Karnataka
High Court held that the scheme of providing for an APA is to remove any
uncertainty as to the determination of income of an Assessee engaged in
international transactions with its Associated Enterprises. The Assessee was
required to declare his income in accordance with the APA. Except in certain
cases, where there was a change in law and facts, or the agreement is
occasioned by fraud or misrepresentation, the APA would be binding.
Thereafter, the Karnataka High Court examined the provisions of Section
92C(1) as well as provisions of Section 92C(4) along with its two provisos and
came to the conclusion that it was apparent from a plain reading of sub-
section (4) of Section 92C that the same would be inapplicable. It held that
the said sub-section requires the Assessing Officer to compute the total
income, having regard to the ALP determined by the Assessing Officer under
sub-section (3) of Section 92C. In turn, Section 92C(3) provided that the
Assessing Officer can proceed to determine the Arm’s Length Price only in
cases where he is of the opinion that (a) the price charged or paid in an
international transaction, has not been determined in accordance with sub-
sections (1) and (2) of Section 92C; or (b) that information and
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documentation relating to the international transaction has not been
maintained as mandatorily required; or (c) that the information or data for
computing the ALP is unreliable; or there is failure on the part of the
Assessee to furnish any information or document required to be furnished
along with the notice. The Karnataka High Court held that in a case where the
Assessee voluntarily computes the Arm’s Length Price pursuant to an APA
entered into with CBDT, none of the conditions as set out in sub-section (3)
of Section 92C are attracted, and consequently, sub-section (4) of Section
92C is also not attracted. The relevant portion of the Karnataka High Court’s
decision reads thus:-
“14. The questions of law in the present appeals as projected by
the Revenue, are similarly worded. We consider it apposite to set
out the questions of law as projected in ITA No.106/2025. The
same are reproduced below:
“(1) “Whether on facts and circumstances of the case, the
Tribunal’s order can be said as perverse in nature in
confirming the order of first appellate authority holding
that voluntary adjustment made to ALP pursuant to APA is
eligible for deduction under section 10AA of the Act
without appreciating that the assessee has declared TP
adjustments pursuant to APA in its computation of income
only in anticipation of TP adjustments by the Transfer
Pricing Officer and to avoid rigors of Section 92C(4) of
the Act and consequently enhanced benefits under section
10AA of the Act”?
*****************
17. It is material to note that the TP adjustments are made
pursuant to the APA entered into by the Assessee with CBDT.
Section 92CC of the Act empowers the CBDT (Central Board of
Direct Taxes) to enter into an APA (Advance Pricing Agreement)
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with any person for determining an ALP or specify the manner in
which the ALP is to be determined, in relation to an international
transaction to be entered into by that person and income referred
to in Section 9(1)(i) of the Act or the manner in which said income
is to be determined as is reasonably attributable to the operations
carried out in India.
18. It is relevant to refer to Sub-sections (1) and (2) of Section
92CD of the Act. The same reads as under:
“92CD. (1) Notwithstanding anything to the contrary
contained in Section 139, where any person has entered
into an agreement and prior to the date of entering into
the agreement, any return of income has been furnished
under the provisions of Section 139 for any assessment
year relevant to a previous year to which such agreement
applies, such person shall furnish, within a period of three
months from the end of the month in which the said
agreement was entered into, a modified return in
accordance with and limited to the agreement.
(2) Save as otherwise provided in this section, all other
provisions of this Act shall apply accordingly as if the
modified return is a return furnished under Section 139.”
19. The provisions of Sections 92CD(1) of the Act are
unambiguous and even if a return has been filed prior to an
Assessee entering into an APA, he is entitled to furnish a modified
return declaring his income in accordance with the terms of the
APA. Subject to certain exceptions, the APA is binding both on the
Assessee and the Revenue.
20. It is clear that the scheme of providing for an APA is to
remove any uncertainty as to the determination of an income of
an Assessee engaged in international transactions with associated
enterprises. The Assessee is required to declare his income in
accordance with the APA. Except in certain cases, where there is
a change in law and facts or the agreement is occasioned by fraud
or misrepresentation, the APA would be binding. Subsections (5),
(6) and (7) of Section 92CC of the Act provide for the same in
unambiguous terms. The said Sub-sections are reproduced below:
“(5) The advance pricing agreement entered into shall be
binding–
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(a) on the person in whose case, and in respect of the
transaction in relation to which, the agreement has been
entered into; and
(b) on the Principal Commissioner or Commissioner, and
the income-tax authorities subordinate to him, in respect
of the said person and the said transaction.
(6) The agreement referred to in sub-section (1) shall not
be binding if there is a change in law or facts having
bearing on the agreement so entered.
(7) The Board may, with the approval of the Central
Government, by an order, declare an agreement to be void
ab initio, if it finds that the agreement has been obtained
by the person by fraud or misrepresentation of facts.”
21. We also consider it apposite to set out Section 92C of the Act,
in its entirety.
“92C. (1) The arm’s length price in relation to an
international transaction [or specified domestic
transaction] shall be determined by any of the following
methods, being the most appropriate method, having
regard to the nature of transaction or class of transaction
or class of associated persons or functions performed by
such persons or such other relevant factors as the Board
may prescribe, namely:-
(a) comparable uncontrolled price method;
(b) resale price method;
(c) cost plus method;
(4) profit split method;
(e) transactional net margin method;
(f) such other method as may be prescribed by the
Board.
(2) The most appropriate method referred to in subsection
(1) shall be applied for determination of arm’s length
price, in the manner as may be prescribed:
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ITXA-2306-2022 and ORS (F).docxProvided that where more than one price is determined by
the most appropriate method, the arm’s length price shall
be taken to be the arithmetical mean of such prices:
Provided further that if the variation between the arm’s
length price so determined and price at which the
international transaction [or specified domestic
transaction] has actually been undertaken does not exceed
such percentage not exceeding three per cent of the latter,
as may be notified by the Central Government in the
Official Gazette in this behalf, the price at which the
international transaction or specified domestic transaction
has actually been undertaken shall be deemed to be the
arm’s length price:]Provided also that where more than one price is
determined by the most appropriate method, the arm’s
length price in relation to an international transaction or
specified domestic transaction undertaken on or after the
1st day of April, 2014, shall be computed in such manner
as may be prescribed and accordingly the first and second
proviso shall not apply.
Explanation-For the removal of doubts, it is hereby
clarified that the provisions of the second proviso shall
also be applicable to all assessment or reassessment
proceedings pending before an Assessing Officer as on the
1st day of October, 2009.
(2A) Where the first proviso to sub-section (2) as it stood
before its amendment by the Finance (No. 2) Act, 2009 (33
of 2009), is applicable in respect of an international
transaction for an assessment year and the variation
between the arithmetical mean referred to in the said
proviso and the price at which such transaction has
actually been undertaken exceeds five percent of the
arithmetical mean, then, the assessee shall not be entitled
to exercise the option as referred to in the said proviso.
(2B) Nothing contained in sub-section (2A) shall empower
the Assessing Officer either to assess or reassess under
section 147 or pass an order enhancing the assessment or
reducing a refund already made or otherwise increasing
the liability of the assessee under section 154 for anyPage 57 of 99
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completed before the 1st day of October, 2009.
(3) Where during the course of any proceeding for the
assessment of income, the Assessing Officer is, on the
basis of material or information or document in his
possession, of the opinion that-
(a) the price charged or paid in an international
transaction or specified domestic transaction has not
been determined in accordance with sub-sections (1)
and (2); or
(b) any information and document relating to an
international transaction specified domestic transaction
have not been kept and maintained by the assessee in
accordance with the provisions contained in sub-section
(1) of section 92D and the rules made in this behalf; or
(c) the information or data used in computation of the
arm’s length price is not reliable or correct; or
(d) the assessee has failed to furnish, within the specified
time, any information or document which he was
required to furnish by a notice issued under sub-section
(3) of section 92D,the Assessing Officer may proceed to determine the arm’s
length price in relation to the said international
transaction or specified domestic transaction in
accordance with subsections (1) and (2), on the basis of
such material or information or document available with
him:
Provided that an opportunity shall be given by the
Assessing Officer by serving a notice calling upon the
assessee to show cause, on a date and time to be specified
in the notice, why the arm’s length price should not be so
determined on the basis of material or information or
document in the possession of the Assessing Officer.
(4) Where an arm’s length price is determined by the
Assessing Officer under sub-section (3), the Assessing
Officer may compute the total income of the assessee
having regard to the arm’s length price so determined:
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ITXA-2306-2022 and ORS (F).docxProvided that no deduction under section 10A “or section
10AA or section 10B or under Chapter VI-A shall be
allowed in respect of the amount of income by which the
total income of the assessee is enhanced after computation
of income under this sub-section:
Provided further that where the total income of an
associated enterprise is computed under this subsection in
determination of the arm’s length price paid to another
associated enterprise from which tax has been deducted or
was deductible under the provisions of Chapter XVIIB, the
income of the other associated enterprise shall not be
recomputed by reason of such determination of arm’s
length price in the case of the first mentioned enterprise.
22. It is apparent from a plain reading of sub-section (4) of
Section 92C of the Act that the same is inapplicable. The said
subsection requires the AO to compute the total income, having
regard to the ALP determined by the AO under sub-section (3) of
Section 92-C of the Act.
23. Sub-section (3) of Section 92C provides that the AO can
proceed to determine the ALP only in cases he is of the opinion on
the basis of material that (a) the price charged or paid in
international transaction, has not been determined in accordance
with sub-sections (1) and (2) of Section 92-C; or (b) that
information and documentation relating to the international
transaction has not been maintained as mandatorily required; or
(c) that the information or data for computing the ALP is
unreliable; or there is failure on the part of the assessee to furnish
any information or document required to be furnished along with
the notice.
24. It is apparent that in a case where the assessee voluntarily
computes the ALP pursuant to an APA entered into with CBDT,
none of the conditions as set out in sub-section (3) of Section 92C
are attracted. It follows that sub-section (4) of Section 92C is not
attracted.
25. More importantly, the proviso to sub-section (4) of Section
92C also clearly states that no deduction under Section 10A or
10AA or 10B or under Chapter VI-A of the Act would be allowed
in respect of the amount of income by which the total income of
the assessee is enhanced after computation under the said section.
Thus in a case where the assessee voluntarily declares his income
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based on the ALP determined on the basis of an APA, there would
be no occasion for the AO to enhance the income of the assessee.
26. Absent any enhancement of income, the proviso to subsection
(4) of Section 92C is clearly inapplicable.”
59. Though we are mindful of the fact that the Karnataka High Court
was considering the provisions of the first proviso to Section 92C(4), we find
that the ratio of this decision would equally apply even to the second proviso.
The second proviso applies only where the total income of an Associated
Enterprise (GIA India) is computed under Section 92C(4) after
determination of the Arm’s Length Price [under Section 92C(3)] paid to
another Associated Enterprise (GIA US) from which tax has been deducted or
deductible under Chapter XVIIB. Then, the total income of the other
Associated Enterprise (GIA US) cannot be recomputed by reason of such
determination of the Arm’s Length Price in the case of the first-mentioned
Enterprise (GIA India). Hence, the second proviso would apply only where
the ALP is first determined under sub-section (3) of Section 92C and
thereafter the total income is computed under sub-section (4) of Section 92C,
and not otherwise. It is only when Section 92C(3) comes into play that
Section 92C(4) is attracted and consequently its provisos. If the Arm’s Length
Price is determined on the basis of an APA, Section 92C(3) has no
application, and consequently neither does Section 92C(4) or its 2 provisos.
We therefore find that though the Karnataka High Court was examining the
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first proviso to Section 92C(4), the ratio laid down therein would equally
apply to the second proviso to Section 92C(4) as well. Hence, the reliance
placed on the second proviso to Section 92C(4) cannot and does not assist the
Revenue in contending that GIA US ought to be taxed on the amount of
Rs.68,53,46,239/- that was initially received by it and offered to tax, and not
the amount of Rs. Rs.49,08,99,451/- which is the amount that was ultimately
retained by GIA US after it refunded the amount of Rs.19,44,46,788/- to GIA
India.
60. The next provision on which reliance was placed by the Revenue
was Section 92CE(3) regarding primary and secondary adjustments to
contend that these provisions do not operate to recompute or reduce the
taxable income and are confined to the Assessee who has undergone a
primary adjustment. To put it in a nutshell, it was the argument that the
statute consistently proceeds on the basis of the upward adjustments i.e.
adjustments in the hands of the Indian Assessee, without any mirrored
downward adjustment in the hands of the counterparty. Section 92CE talks
about secondary adjustment in certain cases. Section 92CE(1) stipulates that
where a primary adjustment to the transfer price (i) has been made suo motu
by the Assessee in his Return of Income; (ii) made by the Assessing Officer
has been accepted by the Assessee; (iii) is determined by an Advance Pricing
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Agreement entered into by the Assessee under Section 92CC on or after 1st
April 2017; (iv) is made as per the safe harbour rules framed under Section
92CB; or (v) is arising as a result of resolution of an assessment by way of a
mutual agreement procedure under an agreement entered into under Section
90 or Section 90A for avoidance of double taxation, the Assessee shall make a
secondary adjustment. Section 92CE reads as under:-
“92CE. (1) Where a primary adjustment to transfer price, –
(i) has been made suo motu by the assessee in his return of
income;
(ii) made by the Assessing Officer has been accepted by
the assessee;
(iii) is determined by an advance pricing agreement
entered into by the assessee under section 92CC, on or
after the 1st day of April, 2017;
(iv) is made as per the safe harbour rules framed under
section 92CB; or
(v) is arising as a result of resolution of an assessment by
way of the mutual agreement procedure under an
agreement entered into under section 90 or section 90A
for avoidance of double taxation,the assessee shall make a secondary adjustment:
Provided that nothing contained in this section shall apply, if,–
(i) the amount of primary adjustment made in any
previous year does not exceed one crore rupees; or
(ii) the primary adjustment is made in respect of an
assessment year commencing on or before the 1st day of
April, 2016:
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ITXA-2306-2022 and ORS (F).docxProvided further that no refund of taxes paid, if any, by virtue of
provisions of this sub-section as they stood immediately before
their amendment by the Finance (No. 2) Act, 2019 shall be
claimed and allowed.
(2)Where, as a result of primary adjustment to the transfer price,
there is an increase in the total income or reduction in the loss, as
the case may be, of the assessee, the excess money or part thereof,
as the case may be, which is available with its associated
enterprise, if not repatriated to India within the time as may be
prescribed, shall be deemed to be an advance made by the
assessee to such associated enterprise and the interest on such
advance, shall be computed in such manner as may be prescribed.
Explanation.–For the removal of doubts, it is hereby clarified
that the excess money or part thereof may be repatriated from any
of the associated enterprises of the assessee which is not a
resident in India.
(2A) Without prejudice to the provisions of sub-section (2), where
the excess money or part thereof has not been repatriated within
the prescribed time, the assessee may, at his option, pay
additional income-tax at the rate of eighteen per cent on such
excess money or part thereof, as the case may be.
(2B) The tax on the excess money or part thereof so paid by the
assessee under sub-section (2A) shall be treated as the final
payment of tax in respect of the excess money or part thereof not
repatriated and no further credit therefor shall be claimed by the
assessee or by any other person in respect of the amount of tax so
paid.
(2C) No deduction under any other provision of this Act shall be
allowed to the assessee in respect of the amount on which tax has
been paid in accordance with the provisions of sub-section (2A).
(2D) Where the additional income-tax referred to in sub-section
(2A) is paid by the assessee, he shall not be required to make
secondary adjustment under sub-section (1) and compute interest
under sub-section (2) from the date of payment of such tax.
(3) For the purposes of this section,-
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(i) “associated enterprise” shall have the meaning
assigned to it in sub-section (1) and sub-section (2) of
section 92A;
(ii) “arm’s length price” shall have the meaning assigned
to it in clause (ii) of section 92F;
(iii) “excess money” means the difference between the
arm’s length price determined in primary adjustment and
the price at which the international transaction has
actually been undertaken;
(iv) “primary adjustment” to a transfer price, means the
determination of transfer price in accordance with the
arm’s length principle resulting in an increase in the total
income or reduction in the loss, as the case may be, of the
assessee;
(v) “secondary adjustment” means an adjustment in the
books of account of the assessee and its associated
enterprise to reflect that the actual allocation of profits
between the assessee and its associated enterprise are
consistent with the transfer price determined as a result of
primary adjustment, thereby removing the imbalance
between cash account and actual profit of the assessee.”
61. We fail to understand how this Section can be of any assistance
to the Revenue. All that this Section stipulates is that where a primary
adjustment to the transfer price has been made, the Assessee shall make a
secondary adjustment. This, in the present case, would apply squarely to GIA
India and would have no application to GIA US. “Secondary adjustment” has
been defined in sub-section (3) of Section 92CE to mean an adjustment in the
books of account of the Assessee (GIA India) and its associated enterprise
(GIA US) to reflect that the actual allocation of profits between the Assessee
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and its Associated Enterprise is consistent with the transfer price determined
as a result of the primary adjustment, thereby removing the imbalance
between the cash accounts and the actual profit of the Assessee. This
provision in no way assists the Revenue in contending that the Revenue can
bring to tax the amount of Rs.68,53,46,239/- initially received by GIA US
from GIA India and not the amount of Rs.49,08,99,451/-, which was the
amount ultimately retained by GIA US towards payment of its royalty
because of the APA entered into by GIA India with the CBDT. In fact, on this
issue, we find that the discussion of ITAT at paragraphs 19 and 20 is the
correct understanding regarding primary and secondary adjustments as
contemplated in Section 92CE. For the sake of convenience, the same are
reproduced as under:-
“19. Section 92 CE, as introduced by the Finance Act 2017
w.e.f. 1st April 2018, provides where a primary adjustment to
transfer price has been made suo motu by the assessee in his
return of income, made by the Assessing Officer has been
accepted by the assessee, is determined by an advance pricing
agreement entered into by the assessee under section 92CC, on or
after the 1st day of April, 2017, is made as per the safe harbour
rules framed under section 92CB; or is arising as a result of the
resolution of an assessment by way of the mutual agreement
procedure under an agreement entered into under section 90 or
section 90A for the avoidance of double taxation, the assessee
“shall” make a secondary adjustment. This provision, however,
does not apply where primary adjustment does not exceed Rs
1,00,00,000 or where primary adjustment is made in respect of an
assessment year prior to the assessment year 2016-17. The way in
which secondary adjustment works is like this. Where as a result
of a primary adjustment to the transfer price, there is an increase
in income or reduction in loss, the excess payment (i.e., amount
actually paid minus the arm’s length price) will have to be
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ITXA-2306-2022 and ORS (F).docxrepatriated by the foreign AE, or any other AE, within the time
prescribed, and, if no such repatriation takes place, (a) the excess
amount not so repatriated will be treated as an advance to the AE
bearing such interest as may be prescribed; or (b) the assessee, at
his option, pay additional income-tax @ 18% on such excess
payment or part thereof. Once the assessee so pays the additional
income tax @18%, the assessee is not required to make any
secondary adjustment under section 92CE(1), and, in that sense,
18% additional income tax is in lieu of inward remittance on
account of secondary adjustment. This option of paying 18% as
additional income tax was introduced by subsequent amendment
in Section 92CE by the Finance Act 2019. While dealing with the
introduction of Section 92CE, the Central Board of Direct Taxes,
vide circular no. 2/2018, had observed, inter alia, as follows:
45.3 In order to align the transfer pricing provisions in
line with OECD transfer pricing guidelines and
international best practices, a new section 92CE has been
inserted in the Income-tax act so as to provide that the
assessee shall be required to carry out secondary
adjustment where the primary adjustment to transfer
price, has been made suo motu by the assessee in his
return of income; or made by the Assessing Officer has
been accepted by the assessee; or is determined by an
advance pricing agreement entered into by the assessee
under section 92CC of the Income-tax Act; or is made as
per the safe harbour rules framed under section 92CB of
the Income-tax Act; or is arising as a result of resolution
of an assessment by way of the mutual agreement
procedure under an agreement entered into under section
90 or 90A of the Income-tax Act.
45.4 It is also provided that where as a result of primary
adjustment to the transfer price, there is an increase in the
total income or reduction in the loss, as the case may be,
of the assessee, the excess money which is available with
its associated enterprise, if not repatriated to India within
the time as may be prescribed, shall be deemed to be an
advance made by the assessee to such associated
enterprise and the interest on such advance, shall be
computed as the income of the assessee; in the manner as
may be prescribed.
45.5 It is also further provided that such secondary
adjustment shall not be carried out if, the amount of
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ITXA-2306-2022 and ORS (F).docxprimary adjustment made in the case of an assessee in any
previous year does not exceed one crore rupees or the
primary adjustment is made in respect of an assessment
year commencing on or before 1st April, 2016.
45.6 Applicability: This amendment takes effect from 1st
April, 2018 and will, accordingly, apply from assessment
year 2018-19 and subsequent years.
[Emphasis, by underlining, supplied by us]
20. Quite clearly, Section 92CE is in the nature of an
additional obligation on the assessee to either repatriate back to
India the excess payment made (i.e. actual payment minus the
arm’s length price) or to pay additional income tax @ 18%
thereon. The secondary adjustment under section 92CE is thus not
in a vacuum but in the light of the corresponding obligation to
either repatriate back that amount to India or pay additional
income tax thereon. While proviso to Section 92CE(1) does clarify
that the above provisions do not apply where primary adjustments
are less than Rs 1 crore or where primary adjustments are made
in respect of an assessment year prior to 2016-17, that exception
refers to the scheme of this section as a whole because a
secondary adjustment under section 92CE(1) is an obligation on
the assessee with certain mandatory consequences under section
92CE(2) as also 92CE(2A to 2D), rather than a secondary
adjustment simplicitor. Learned CIT(DR) proceeds on the basis
that Section 92CE gives certain concession or relief when he
treats Section 92CE as “permitting” the secondary adjustments,
whereas as a matter of fact, Section 92CE “requires” that the
assessee “shall” make the secondary adjustment which being
coupled with certain further requirements under section 92CE(2)
and 92CE(2A to D), operate in favour of the revenue. Given the
scheme of Section 92CE, secondary adjustments are not
concessions to an assessee but obligations on the assessee. The
proviso to Section 92CE(1) cannot, therefore, be interpreted as a
bar on any secondary adjustment by the assessee, even dehors the
requirements under section 92CE(1). In any case, Section 92CE
has nothing to do with the taxability of correct income in the
hands of the foreign AE to which payment for the international
transaction has been made, inasmuch as, this provision cannot be
seen as a bar on repatriating back the excess payment made (i.e.
actual payment minus the arm’s length price) even if there was no
statutory obligation to do so. In our humble understanding, there
was no bar, even in respect of the period prior to insertion of
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Section 92CE, on any secondary adjustments being made by
parties to a transaction. It is also important to note that so far as
the APs are concerned, under rule 10M(1)(vi) of the Income Tax
Rules 1962, an APA may, amongst other things, include “the
conditions, if any, other than provided in the Act or these rules”
and, therefore, as long as an APA refers to secondary adjustments,
whether specifically permissible under the law or not, these
secondary adjustments are to be carried out. It is also important
to bear in mind the fact that no secondary adjustment can anyway
be unilateral in nature. When an assessee is to raise an invoice on
its AE abroad, that invoice is to be accounted for by the entity
issuing the invoice as also by the entity receiving the invoice.
These two facets of the transactions are two sides of the same coin
Section 92CE(3)(v) aptly defines, consistent with the first
principles as well, ‘secondary adjustment’ means an adjustment in
the books of account of the assessee and its associated enterprise
to reflect that the actual allocation of profits between the assessee
and its associated enterprise are consistent with the transfer price
determined as a result of the primary adjustment, thereby
removing the imbalance between a cash account and actual profit
of the assessee.” It is, therefore, not correct to say that when an
APA requires an assessee to raise debit notes or invoices on its AE
abroad, it is open to the AE abroad to ignore those invoices or
debit notes and continue with computation of its income dehors
these invoices or debit notes, because the said AE is not a party to
the APA. The AE may not be party to the APA, yet the impact of
the terms of the APA has to be taken note of when these terms
affect the AE. That’s a reality and cannot be wished away. We,
therefore, reject this objection raised by the learned CIT(DR) as
well. As for learned CIT(DR)’s observation that “the second
proviso to section 92CE(1) stipulates that no refund of taxes paid
could be claimed or allowed”, which suggests that no refund of
taxes paid could be claimed or allowed as a result of the
secondary adjustment, this observation is wholly misconceived
inasmuch as while the second proviso states that “Provided
further that no refund of taxes paid, if any, by virtue of provisions
of this sub-section as they stood immediately before their
amendment by the Finance (No. 2) Act, 2019 shall be claimed and
allowed”, this proviso was quite clearly in specific context of
insertion of words “on or after the 1st day of April, 2017” in
Section 92CE(1)(iii) by the same Finance Act 2019 which had
resulted in the exclusion of rigours of Section 92CE in respect of
the cases in which the additional obligations were incurred by the
assessee in respect of the APAs concluded even prior to 1st April
2017. All that this proviso meant was that even though the
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consequences envisaged in Section 92CE(2), with respect to APAs
concluded before 1st April 2017, these taxes will not be refunded.
In still other words, in our considered view, the practical
connotations of the second proviso to Section 92CE(1) was that
relief granted by insertion of words “on or after the 1st day of
April 2017” in Section 92CE(1)(iii) was with prospective effect.
Learned CIT(DR) has been a bit too naive in ignoring the import
of words “if any, by virtue of provisions of this sub-section as they
stood immediately before their amendment by the Finance (No. 2)
Act, 2019 shall be claimed and allowed” in the proviso, and,
therefore, ended up reading a bit too much into this rather
innocuous and unidimensional provision. It is thus not correct to
say that, in principle, in terms of the provisions of section 92CE,
no refund of taxes could be claimed or allowed on account of
secondary adjustments- even if, for example, as in this case, such
secondary adjustments end up reducing the income of the foreign
AE assesses as a result of partial repatriation of income. A lot of
emphasis is then placed by the learned CIT(DR) on the claim that
the action of the assessee, in partially refunding the royalty
amount to the GIA India, i.e., Indian AE, was voluntary inasmuch
as the assessee was not a party to the APA. Nothing, however,
turns on this plea. Whether the refund was voluntary or under a
legal obligation, it does not really make any difference as long as
the refund is bonafide and particularly when its commercial
expediency is not, and rightly so, even called into question. None
of the objections taken by the DRP or raised by the learned
CIT(DR), for the detailed reasons, set out above, really impresses
us.”
62. In light of the aforesaid discussion, we find that the reliance
placed on Section 92CE also does not assist the Revenue in their cause. To
put it in a nutshell, the transfer pricing provisions discussed earlier do not
come to the aid of the Revenue to contend that the amount of
Rs.68,53,46,239/- initially received by GIA US from GIA India is the amount
that has to be brought to tax in India and not the amount of
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Rs.49,08,99,451/- [which was ultimately retained by GIA US after refunding
Rs.19,44,46,788] as contended by GIA US [the Assessee].
63. This now leaves us to deal with the issue of “real income”, which
was the main argument of GIA US not only before the ITAT but also before
us. In the facts of the present case, it is an undisputed position that initially
for A.Y. 2011-2012, GIA US received from GIA India a sum of
Rs.68,53,46,239/- as and by way of royalty. It is also undisputed that this
amount was offered to tax by GIA US by filing its Return of Income on 10th
November 2011. It is also undisputed that after prolonged negotiations, on
7th May 2018, an APA was entered into between GIA India and the CBDT,
which determined the ALP (Arm’s Length Price) to be paid by GIA India to
GIA US for all the Assessment Years which formed the subject matter of the
APA. One of the critical conditions of this APA was that GIA India raises an
invoice on GIA US to refund to GIA India the excess royalty paid by GIA
India to GIA US. It is undisputed that these invoices for all the relevant
Assessment Years were raised, and pursuant to the said invoices, the excess
amounts have been repaid by GIA US to GIA India. As far as A.Y. 2011-2012
is concerned, as mentioned earlier, initially the amount of royalty paid by
GIA India to GIA US was Rs.68,53,46,239/-. After the execution of the APA
[between GIA India and the CBDT], GIA US refunded to GIA India the excess
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amount of royalty paid, namely, Rs.19,44,46,788/-. It is on this basis that
GIA US contends that what can be brought to tax in India in the hands of GIA
US is only the sum of Rs.49,08,99,451/- (i.e. Rs.68,53,46,239 minus
Rs.19,44,46,788). This, according to GIA US, is its real income, and it is only
this amount that could be brought to tax in India.
64. What is “real income” and how it is to be taxed has been the
subject matter of several decisions not only of this Court but also that of the
Hon’ble Supreme Court. This Court in H. M. Kashiparekh & Co. Ltd. Vs.
Commissioner of Income-tax [1960] 39 ITR 706 (Bombay) was
considering a question relating to the income of payment of managing agency
commission. This Court, being mindful of the fact that under the IT Act each
year is a self-contained period, also took note of the basic principle of tax law,
which requires the Court (cases of deemed income apart) to see that
ultimately it is the real income of the Assessee which alone is brought to tax
and not any artificial or notional income that may be said to have accrued to
him. The facts of the case were that the Assessee company was the managing
agent of Gujarat Paper Mills Ltd. The A.Y. was 1950-1951, and during the
accounting year, a commission of Rs.1,17,644/- was earned by the Assessee.
At the instance of the managed company, namely Gujarat Paper Mills Ltd.,
the Assessee company surrendered Rs.97,000/-. The Income-tax Officer
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accepted this position, but the Commissioner of Income-tax disapproved the
same and served a notice on the Assessee company under Section 33B(1) of
the Income Tax Act, 1922. He passed an order directing the Income-tax
Officer to include the amount of Rs.97,000/- in the Assessee company’s total
income for the A.Y. 1950-1951. The matter was carried to the Tribunal, and
one of the contentions urged on behalf of the Assessee company was that
clause 5 of the managing agency agreement authorised the managed
company to cut down a portion of the commission earned by the managing
company and that therefore, surrender of Rs.97,000/- was justified. After
examining clauses 5 and 6, the Tribunal took the view that the Assessee
company was bound to forgo only ⅓ of Rs.1,17,644/-, namely the amount of
Rs.39,214/-. The Tribunal accordingly decided in favour of the Assessee
company only to this extent and rejected the contention of the Assessee
company as to the balance amount of surrender, namely Rs.57,785/-. This
made the matter come before this Court in a reference. One of the questions
in the reference was whether the sum of Rs.57,785/- (Rs.97,000 – Rs.39,214)
could legally be included in the Assessee company’s total income. This Court
accordingly held as under:-
“Succinctly stated, the contention on behalf of the Revenue is that
the income accrued to the assessee company in the accounting
year, whereas the surrender on ground of commercial expediency
of the amount of Rs. 57,000 odd out of the same took place eight
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ITXA-2306-2022 and ORS (F).docxcould not be treated as an expenditure incurred in the accounting
year.
The contention urged on behalf of the assessee company is
twofold. It has been urged firstly that in any event and in any view
of the case, it is the real income of the assessee company for the
accounting year that is liable to tax and that real income cannot
be arrived at without taking into account the amount which was
forgone by the assessee company. The second contention urged by
Mr. Palkhivala is that the amount of Rs. 57,000 odd had been
given up by the assessee company on the ground of commercial
expediency when the quantum of the entire amount of commission
was determined and, therefore, it must necessarily be treated as
an expenditure of the year of which the determined amount is
taken as the income. It will not be necessary for us to decide the
second contention of Mr. Palkhivala and we have not heard
counsel for the Revenue on the same. In our opinion, the first
contention of Mr. Palkhivala is substantial and must prevail.
Counsel for the Revenue does not question the importance of what
he describes as the doctrine of real income. His contention
strongly urged before us, however, is that a party who follows the
mercantile system of account-there is no dispute that the assessee
company follows the mercantile system of account-cannot avail of
the benefit of the doctrine where, for instance as in the case
before us, the income of managing agency commission is credited
in the books in one year and has been surrendered by him in the
next year. In such a case, his income accrues in the year in which
it is entered in the books and if the surrender is not made and
entered in the same year, no question of real income can arise. It
is said that the surrender can, if at all, be taken into consideration
only in the year in which it is made, i.e., in the next accounting
year, and according to learned counsel for the Revenue, in that
next year also, he would not be able to avail of the same as an
item of expenditure because it could have no bearing on the
managing agency commission that may accrue to him in that year.
Therefore, so the argument for the Revenue had to run, unless the
surrender was made in the very year in respect of which the
commission became due, the amount of the commission, even if it
was wholly surrendered, would yet remain liable to tax. In
support of his argument, Mr. Joshi relied on the following
observations of their Lordships of the Privy Council in CIT v.
Chitnavis [1932] 2 Comp. Cas. 464:
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ITXA-2306-2022 and ORS (F).docx“For the purpose of computing yearly profits and gains,
each year is a separate self contained period of time in
regard to which profits earned or losses sustained before
its commencement are irrelevant.”
Of course, if this principle that you have to measure the income of
the year of assessment bearing in mind that for the purpose of
computation each year is a separate self-contained period is so
absolute that it has no relation with the principle of real income,
the court must arrive at the result suggested by Mr. Joshi.
The two rules that income-tax is annual in its structure meaning
thereby that for computation each year is a distinct self-contained
unit and the other that the income to be taxed is the real income of
the assessee do not seem to us to be incompatible or
irreconcilable. Mr. Joshi also is not prepared to go so far as that
and has fairly stated that there is no antithesis between the two
rules. The facts of a case may present some difficulty in applying
the rules but the conflict would, in our opinion, be rather
apparent than real. The facts of a given case may create the
impression of a discrepant situation but the apparent discrepancy
can be resolved in a manner not inconsistent with the basic
concepts underlying the two rules. In our judgment, they permit of
harmonious application, though the application to a degree must
depend on the circumstances of each case. Some propositions
could be formulated but whether a general formula applicable to
all circumstances could be hit on we rather doubt.
Though it may not be possible to prescribe a general formula
which may successfully compose every conflicting situation, the
position in law seems clear to us that in applying the two rules to
particular transactions regard must be had to the true legal rights
and the true situation. A fair interpretation of the transaction and
the situation would lead to a preferable and, if we may say so, a
correct solution than sheer adherence to one rule and discounting
of the other. If this be the true approach, and we feel little doubt
that it is, the result cannot be said to flow from any non-
conformity with the rule that income-tax is annual in its structure
and organisation. One merit of this approach would be the
avoidance on the one hand of any a prior construction of a legal
situation for the purpose of attracting tax to it and on the other
allowing escape from liability. After all, each case must depend
and its decision turn on its own facts and circumstances and that
is how we prefer to deal with this case.
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The leading facts to our mind are these. The assessee company
had surrendered a part of its managing agency commission for a
series of years. A chart showing such surrender is on the record
and forms part of the case. The managing agency agreement, the
material and relevant part of which we have already set out, in
terms contains a provision affecting the quantum of the
commission payable by the managed company to the managing
company. The proviso must be read as part and parcel of clause 5
and so read, the clause makes it abundantly clear that the
quantum of the remuneration that the managing company would
ultimately receive would depend on the sufficiency of profits to
pay a dividend in the manner there stated. If the profits are not
sufficient, the managing company is under a legal obligation to
forgo a part of its commission. The amount of commission to be
forgone for the purpose of making up such deficit however is not
to exceed 1/3rd of the entire commission which the managing
company would otherwise become entitled to receive in a
particular year.
Then come the balance-sheet of the company and the two
resolutions which we have already set out. The system adopted by
the assessee company was the mercantile system. A good deal of
argument has been advanced before us by Mr. Joshi, who has
drawn our attention to a number of decisions explaining the
meaning of the expression “mercantile system”. The connotation
of that expression is well understood and it is not necessary to
burden this judgment with citations from those decisions. In the
course of his argument, learned counsel for the Revenue stated
that there must have been entries in the books of the managed
company and the managing company in consonance with clause 5
of the managing agency agreement. Only the balance-sheet of the
company seems to have been brought on the record and the
entries in those books do not form part of the statement of the
case. Even so, we shall proceed on the footing that, the assessee
company having followed the mercantile system of account, there
must have been entries made in its books in the accounting year
in respect of the amount of the commission. In our judgment, we
would not be justified in attaching any particular importance in
this case to the fact that the company followed the mercantile
system of account. That would not have any particular bearing in
applying the principle of real income to the facts of this case.
Incidentally, we may observe that we ourselves pointed out in the
case of CIT v. Shoorji Vallabhdas & Co. [1959| 36 ITR 25, that
the question whether the income accrued or not is not a mere
matter of cogency of the entries made in the account books of the
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assessee but is essentially one of substance and of the real nature
of what happened; a mere book entry is not conclusive of the
question whether the assessee had become entitled to the sums or
not. It may also be mentioned that in that case we were dealing
with an assessee who followed the mercantile system of account.
The crucial question before us, therefore, is whether the two facts,
one the amount of Rs. 1,17,644-4-0, which would have become
payable to the managing company but for the surrender and the
factum of surrender, are to be isolated or treated as of cogency in
determining the actual accrual of income, by which we mean the
real income of the assessee company. If the fact of forgoing or
surrendering the amount of Rs. 57,000 odd is to be regarded as of
cogency in the context of the present point of real income and if it
be remembered that the surrender was made at the time of
ascertaining the quantum of the commission payable to the
assessee company and further if it be remembered, as now found
by the Tribunal, that the surrender was made bona fide and on
grounds solely of commercial expediency, it seems very difficult to
us to see how the Revenue is justified in contending that the real
income of the assessee was something different than the amount of
Rs. 20,000, which was shown by it at the time of assessment as its
income from managing agency commission. To accede to that
suggestion would lead to a result highly unfair, though that is not
a consideration which can be permitted to influence us in
deciding any matter when we have to give effect to the provisions
of a fiscal enactment. At the same time, we would not be justified
in being unmindful of the consequences of any opinion which we
may give on a reference. The enquiry must depend mainly on the
broad aspects and the facts and circumstances of the particular
case and not on any wire-drawn technicality.
Now the argument of Mr. Palkhivala before us is that having
regard to the facts and circumstances of the case before us it
cannot be said that any income–any real income–accrued to the
assessee company till the accounts were made for the purpose of
satisfying the requirements of clause (5) of the managing agency
agreement and particularly the proviso to the same. There is, in
our opinion, force in this argument. Another facet of the same
argument for the assessee company has been presented in this
manner. If the year in which income was earned is chosen as the
year of taxability, the subsequent settlement of the liability must
relate back to the year in which the income was earned. Then, it is
said that the right of the assessee company to receive the
commission arose only after the accounting year and only when
accounts were made up in December, 1950. The crux of the whole
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argument is that it is the real income of the assessee company that
must be ascertained and that alone should be taxed.
In the present case surrender of commission has been made bona
fide and as a matter of commercial expediency and at an early
point of time when accounts were made up. We need not
recapitulate what we have already stated. The accrual of the
commission, the making of the accounts, the legal obligation to
give up a part of the commission and the forgoing of the
commission at the time of the making of the accounts are not
disjointed facts. There is a dovetailing about them which cannot
be ignored.
We do not think it to be in accord either with the authorities cited
that the principle of real income is to be so subordinated as to
amount virtually to negation of it when a surrender or concession
or rebate in respect of managing agency commission is made
agreed to or given on grounds of commercial expediency simply
because it takes place some time after the close of an accounting
year. In examining any transaction and situation of this nature the
court would have more regard to the reality and speciality of the
situation rather than the purely theoretical or doctrinaire aspect
of it. It will lay greater emphasis on the business aspect of the
matter viewed as a whole when that can be done without
disregarding statutory language.
For all these reasons, we are of the opinion that the real income
of the assessee company was Rs. 20,000 odd and the amount of
Rs. 57,839-12-7 cannot be included in the real income of the
accounting year. The opinion we give is in no respect out of
harmony with any statutory provision, the decisions on the
question of accrual of income or the principle that income-tax is
annual in its structure.”
(emphasis supplied)
65. The next decision, which discussed the concept of real income, is
the decision of the Hon’ble Supreme Court in Godhra Electricity Co. Ltd.
Vs. Commissioner of Income-tax [1997] 91 Taxman 351 (SC). The
facts of this case were that the Assessee company, a licensee to generate
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supply of electricity to its consumers, enhanced the charges for electricity and
motive power in 1963. Suits filed by the consumers challenging the
enhancement were allowed by the lower Courts except the Division Bench of
the High Court. The Hon’ble Supreme Court in 1969 ultimately decided the
case in favour of the Assessee. Shortly thereafter, the Under Secretary of the
Government of Gujarat wrote a letter advising the Assessee company to
maintain the status quo for the rates to the consumers for at least 6 months.
During this period, the consumers also filed another representative Suit
wherein an interim injunction was granted and finally decreed in favour of
the consumers by the lower Court. During the pendency of the subsequent
Suit, the management of the undertaking of the Assessee company was taken
over by the Government of Gujarat under the Defence of India Rules, 1971.
During the pendency of these litigations, the Assessee company was not able
to realise the enhanced charges from the consumers from A.Y. 1969-1970 to
1972-1973. The Assessing Officer, while making the assessment, included the
disputed amount in the hands of the Assessee company on the ground that it
was following the mercantile system of accounting and it had the legal right
to recover the said amount. The first appellate authority, however, deleted
the additions, and that was affirmed by the Tribunal. However, on a
reference, the High Court upheld the view taken by the Assessing Officer.
This is how the matter ultimately reached the Hon’ble Supreme Court. The
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Hon’ble Supreme Court, in its decision, held that under the Act, income
chargeable to tax is the income that is received or is deemed to be received in
the previous year relevant to the year for which assessment is made or on the
income that accrues or is deemed to accrue during such year. The Hon’ble
Supreme Court ultimately held that the question whether there was real
accrual of income to the Assessee company in respect of the enhanced
charges for the supply of electricity had to be considered by taking the
probability or improbability of realisation in a realistic manner. The Hon’ble
Supreme Court held that if the matter was considered in this light, it was not
possible to hold that there was a real accrual of income to the Assessee
company in respect of the enhanced charges for supply of electricity which
were added by the Assessing Officer while passing the assessment orders in
respect of the Assessment Years under consideration. The Hon’ble Supreme
Court therefore opined that the Tribunal had rightly held that the claim at the
increased rates as made by the Assessee company on the basis of which
necessary entries were made, represented only hypothetical income, and the
impugned amounts as brought to tax by the Assessing Officer did not
represent the income which had really accrued to the Assessee company
during the previous years. The relevant portion of this decision reads thus:-
“9. Shri S. Ganesh, the learned counsel appearing for the
assessee-company, has submitted that in the facts and
circumstances of this case it must be held that no real income had
accrued to the assessee-company on account of enhanced charges
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the said enhanced charges from the consumers in view of the
protected litigation during the period from 1963 to 1969 and
thereafter on account of the letter from the Under Secretary to the
Government of Gujarat dated 19-3-1969 asking the assessee-
company not to charge the enhanced rates for at least six months
and the subsequent suit (Suit No. 118 of 1969) filed by the
consumers in 1969 and the taking over of the management of the
assessee-company by the Collector, Godhra in pursuance of the
order passed under rule 115(2). It has been urged that though the
assessee-company was following the mercantile system of
accounting but in the mercantile system also tax can be imposed
only if there is real income and income-tax cannot be imposed on
hypothetical income. The learned counsel has placed reliance on
the decisions of this Court in CIT v. Shoorji Vallabhdas & Co.
[1962] 46 ITR 144, CIT v. Birla Gwalior (P.) Ltd. [1973] 89 ITR
266, Poona Electric Supply Co. Ltd. v. CIT (1965) 57 ITR 521,
R.B. Jodha Mal Kuthiala v. CIT [1971] 82 ITR 570 and State
Bank of Travancore v. CIT [1986] 158 ITR 102/ 24 Taxman 337.
10. Under the Act income charged to tax is the income that is
received or is deemed to be received in India in the previous year
relevant to the year for which assessment is made or on the
income that accrues or arises or is deemed to accrue or arise in
India during such year. The computation of such income is to be
made in accordance with the method of accounting regularly
employed by the assessee. It may be either the cash system where
entries are made on the basis of actual receipts and actual
outgoings or disbursements or it may be the mercantile system
where entries are made on accrual basis, i.e., accrual of the right
to receive payment and the accrual of the liability to disburse or
pay. In Shoorji Vallabhdas & Co.‘s case (supra), it has been laid
down:
… Income-tax is a levy on income. No doubt, the Income-
tax Act takes into account two points of time at which the
liability to tax is attracted, viz., the accrual of the income
or its receipt; but the substance of the matter is the
income. If income does not result at all, there cannot be a
tax, even though in book-keeping, an entry is made about
a ‘hypothetical income’, which does not materialise….” (p.
148)
This principle is applicable whether the accounts are maintained
on cash system or under the mercantile system. If the accounts are
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whether income can be said to have really accrued to the
assessee-company. In H.M. Kashiparekh & Co. Ltd. v. CIT [1960]
39 ITR 706, the Bombay High Court had said:
“… Even so, [the failure to produce account losses] we
shall proceed on the footing that, the assessee-company
having followed the mercantile systme of account, there
must have been entries made in its books in the accounting
year in respect of the the amount of the commission. In our
judgment, we would not be justified in attaching any
particular importance in this case to the fact that the
company followed the mercantile system of account. That
would not have any particular bearing in applying the
principle of real income to the facts of this case…..” (p.
720)
The said view was approved by this Court in Birla Gwalior (P.)
Ltd.‘s case (supra) where the assessee maintained its accounts on
the mercantile system. In that case this Court, after referring to
the decision in Morvi Industries Ltd. v. CIT [1971] 82 ITR 835,
which was also a case where the accounts were maintained on
mercantile system, has said:
“Hence it is clear that this court in Morvi Industries case
did emphasise the fact that the real question for decision
was whether the income had really accrued or not. It is
not a hypothetical accrual of income that has got to be
taken into consideration but the real accrual of the
income.” (p. 273)In Poona Electric Supply Co. Ltd.‘s case (supra) this Court has
said:
.. Income-tax is a tax on the real income, i.e., the profits
arrived at on commercial principles subject to the
provisions of the Income-tax Act….” (p. 530)In that case the Court has approved the following principle laid
down by the Bombay High Court in KM. Kashiparekh & Co.
Ltd.‘s case (supra):
The principle of real income is not to be so subordinated as
to amount virtually to a negation of it when a surrender or
concession or rebate in respect of managing agency
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ITXA-2306-2022 and ORS (F).docxcommission is made, agreed to or given on grounds of
commercial expediency, simply because it takes place some
time after the close of an accounting year. In examining
any transaction and situation of this nature the Court
would have more regard to the reality and speciality of the
situation rather than the purely theoretical or doctrinaire
aspect of it. It will lay greater emphasis on the business
aspect of the matter viewed as a whole when that can be
done without disregarding statutory language.” (p. 707) ]
11. If the matter is examined in the light of the aforementioned
principles laid down by this Court, it must be held that even
though the assessee-company was following the mercantile system
of accounting and had made entries in the books regarding
enhanced charges for the supply made to the consumers, no real
income had accrued to the assessee-company in respect of those
enhanced charges in view of the fact that soon after the assessee-
company decided to enhance the rates in 1963 representative suits
(Civil Suit Nos. 152 of 1963 and 50 of 1964) were filed by the
consumers which were decreed by the trial court and which
decree was affirmed by the appellate court and the learned single
Judge of the High Court and it is only on 3-12-1968 that the
letters patent appeals filed by the assessee-company were allowed
by the Division Bench of the High Court and the said suits were
dismissed. But appeals were filed against the said judgment by the
consumers in this Court and the same were dismissed by the
judgment of this Court dated 26-2-1969. Shortly thereafter, on 19-
3-1969, the Under Secretary to the Government of Gujarat wrote
a letter advising the assessee-company to maintain the status quo
for the rates to the consumers for at least six months and the
Chief Electrical Inspector was directed to go through the
accounts of the assessee-company from year to year and to report
to the Government about the actual position about the reasonable
returns earned by the assessee-company. On 16-5-1969 another
representive suit (Suit No. 118 of 1969) was filed by the
consumers wherein interim injunction was granted by the Court
and which was finally decreed in favour of the consumers on 23-
6-1974. It would thus appear that after the decision was taken by
the assessee-company to enhance the charges it was not able to
realise the enhanced charges on account of pendency of the
earlier representative suits of the consumers followed by the letter
of the Under Secretary to the Government of Gujarat and the
subsequent suit of the consumers and during the pendency of the
subsequent suit the manage- ment of the undertaking of the
assessee-company was taken over by the Government of Gujarat
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subsequently transferred to the Gujarat State Electricity Board.
14. The question whether there was real accrual of income to
the assessee-company in respect of the enhanced charges for
supply of electricity has to be considered by taking the probability
or improbability of realisation in a realistic manner. If the matter
is considered in this light, it is not possible to hold that there was
real accrual of income to the assessee-company in respect of the
enhanced charges for supply of electricity which were added by
the ITO while passing the assessment orders in respect of the
assessment years under consideration. The AAC was right in
deleting the said addition made by the ITO and the Tribunal had
rightly held that the claim at the increased rates as made by the
assessee- company on the basis of which necessary entries were
made represented only hypothetical income and the impugned
amounts as brought to tax by the ITO did not represent the income
which had really accrued to the assessee-company during the
relevant previous years. The High Court, in our opinion, was in
error in upsetting the said view of the Tribunal.”
66. The Hon’ble Supreme Court, thereafter in the case of
Commissioner of Income-tax Vs. Bokaro Steel Ltd. [1999] 102
taxman 94 (SC) followed its decision in Godhra Electricity Co. Ltd.
(supra). In the case of Bokaro Steel Ltd. (supra), the Assessee had during the
Assessment Year 1971-1972 shown in its accounts as income from interest, a
certain sum said to have been accrued to the Assessee from Hindustan Steel
Ltd. for eight locomotives supplied by the Assessee company to it. The
Assessee company, however, reversed this entry next year because Hindustan
Steel Ltd. has replaced the eight locomotives lent by the Assessee company to
it with new ones, and no interest income actually accrued to the Assessee
company. In these facts, the Hon’ble Supreme Court held as under:-
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ITXA-2306-2022 and ORS (F).docx“9. In the assessment year 1971-72, the assessee had shown in
its books of account a sum of Rs.7,39,232 as income from interest
received from Hindustan Steel Ltd. for the eight locomotives
supplied by the assessee-company to them. The entry in this
regard was reversed in the next year since Hindustan Steel Ltd.
had replaced the eight locomotives lent by the assessee-company
to it by new ones. The entire nature of the transaction was
changed between the parties. There was a resolution of the
assessee-company in this regard and the income from interest did
not result at all as the original agreement ceased to be operative
ab initio. The entry in the books which was made was about a
hypothetical income which did not materialise and the entry was
reversed in the next year. Both the Tribunal as well as the High
Court have held that since this entry reflected only hypothetical
income, it could not be brought to tax as income. Only real
income can be brought to tax.
10. In support of this finding, the assessee had drawn our
attention to a decision of this Court in Godhra Electricity Co. Ltd.
v. CIT [1997] 225 ITR 746/91 Taxman 286, where the Court, inter
alia, examined the cash system and the mercantile system of
accounting in the context of hypothetical income. The
computation of income is made in accordance with the method of
accounting regularly employed by the assessee. It may be either
the cash system where entries are made on the basis of actual
receipts and actual outgoings or disbursements; or it may be the
mercantile system where entries are made on accrual basis, that is
to say, accrual of the right to receive payment and the accrual of
the liability to disburse or pay. However, in both cases unless
there is real income, there cannot be any income-tax. Considering
the facts before it, the Court said that although the assessee-
company was following the mercantile system of accounting and
had made entries in the books regarding enhanced charges for the
supply of electricity made to its consumers, no real income had
accrued to the assessee-company in respect of those enhanced
charges in view of the fact that soon after the assessee-company
decided to enhance the rate, representative suits were filed by the
consumers which were decreed by the Court and utlimately, after
various proceedings which took place, the assessee-company was
not able to realise the enhanced charges. The Court held that no
real income had accrued to the assessee-company and, hence, the
entries in respect of enhanced charges did not reflect the real
income of the assessee and could not be brought to tax by the
ITO.
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11. In the present case also, the entry which was initially made as
interest was reversed the next year because in fact the nature of
the transaction was changed and the assessee did not receive any
real income. The High Court has, therefore, rightly held this entry
as not reflecting the real income of the assessee and, hence, not
exigible to income-tax.”
67. The next decision is the decision of this Court in
Commissioner of Income-tax-8, Mumbai Vs. Lok Housing &
Constructions Ltd. [2015] 58 taxmann.com 179 (Bombay). The
facts of this case reveal that a survey action was carried out on the Assessee’s
business premises on 11th September 2008. Subsequent to the survey, a
notice under Section 142(1) of the IT Act was issued to the Assessee calling
for its Return of Income for A.Y. 2007-2008. That was not filed by the
Assessee. In response to this notice, the Assessee filed a Return of Income on
23rd September 2008 declaring a total income of Rs.1,35,47,15,708/-. In this
Return of Income, the Assessee company inter alia declared income on
account of sales on land/FSI to 5 parties, which were its associates/sister
concerns. Subsequently, on 1st January 2009, the Assessee filed another
Return of Income declaring NIL income. It claimed that the income declared
in the original Return in respect of the 5 transactions of sales of land/FSI to 5
parties stands withdrawn due to the cancellation of 5 sale agreements. It was
argued that the Assessee discovered an omission of cancellation of sale
agreements which was not disclosed in the original Return, and hence revised
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the same by filing the revised Return of Income. The Assessing Officer passed
an order under Section 143(3) and taxed the income from the sale of
land/FSI. The Assessee was aggrieved by this order and filed an Appeal
before the Commissioner of Income-tax (Appeals), which was also dismissed.
The Assessee, therefore, approached the Tribunal by way of an Appeal, which
was partly allowed. Being aggrieved by the Tribunal’s order, the Revenue
approached this Court. In the facts narrated above, this Court held as under:-
“10. In relation to the third question, what we have noticed is
that the Revenue is seeking re-appreciation and re-appraisal of
the factual material on record. That is a course permissible,
provided the factual findings can be termed as perverse or
vitiated by any error of law apparent on the face of the record. In
the present case, the argument was, that this income which was
declared could not have been thereafter termed as such. It not
being realised as the Sale Agreements have been cancelled.
11. In that regard, we find that the Tribunal was informed by
the Revenue that there is a doubt about the cancellation of the
relevant Agreements. That cancellation is not genuine and bona
fide. The other argument was that these are Agreements with
sister concerns and therefore in the first place, there was some
deliberate exercise and with a view to avoid paying the legitimate
taxes. In any event, the Agreements being subsequently cancelled
supports the Revenue’s version as above.
12. On both counts, the Tribunal has in a detailed discussion
of more than 40 paragraphs found that there is no substance in
the objections of the Revenue. If the Revenue is trying to show
that the relevant transactions were sham and not real, then it has
to bring in satisfactory material. The Tribunal found in paras 37
to 40 of the impugned order that the income which was earlier
disclosed was not as such because the Agreements were
terminable or could have been cancelled. Once they were
cancelled, the properties have reverted back to the assessee. They
are duly reflected in the balance sheet and as assets of the
assessee. There were revised accounts and which were also
scrutinized. They were found to be in order and meeting the
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ITXA-2306-2022 and ORS (F).docxaccounting practice adopted. Therefore, the accounting policy
also could not have been faulted. In para 42 of the impugned
order, the Tribunal held that income could not have really accrued
because of the fact that these Agreements were cancelled. Then
the issue of their cancellation has been gone into, and in extensive
details. The correct legal principles were applied and a finding of
fact is arrived at in para 48, that no income could be said to have
really accrued to the assessee as a result of the five transactions
in the immovable properties and which income was chargeable to
tax in the year under consideration. Once income had not accrued
to the assessee in the real sense, then the original return
represents wrong statement which was corrected by the assessee
by filing a revised return. Therefore, no hypothetical income of the
assessee could have been brought to tax.”
68. We must mention that a Civil Appeal from this decision of the
Bombay High Court was dismissed by the Hon’ble Supreme Court vide its
judgment and order dated 24th April 2025 in Commissioner of Income-
tax Vs. Lok Housing and Construction Ltd. (2025) 175
Taxmann.com 848 (SC). The order of the Hon’ble Supreme Court reads
thus:-
“1. Having heard Mr. Arijit Prasad, the learned Senior
counsel appearing for the appellant – Revenue and having gone
through the materials on record, we find no good reason to
interfere with the impugned order dated 13-04-2015 passed by the
High Court of Judicature at Bombay.
2. The Civil Appeal is, accordingly, dismissed.”
69. From all the aforesaid decisions, one salutary principle that
emerges is that in order that income is taxed in the hands of the Assessee, it
must be the real income (cases of deemed income apart), which the Assessee
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has actually earned and not a mere hypothetical income which the Assessee
could have earned but in fact did not earn.
70. Having said this, we will now proceed to determine as to what
was the quantum of royalty paid by GIA India to GIA US that could be taxed
in the hands of GIA US. Was it the figure of Rs.68,53,46,239/-, which was
initially paid, or is the amount of Rs.49,08,99,451/-, which is the amount that
is finally retained by GIA US after refunding the amount of Rs.19,44,46,788/-
as mandated by the APA entered into by GIA India and CBDT.
71. By virtue of the India-US DTAA, royalty paid by GIA India to
GIA US is to be taxed as per Article 12, which reads thus:-
“ARTICLE 12 – Royalties and fees for included services – 1.
Royalties and fees for included services arising in a Contracting
State and paid to a resident of the other Contracting State may be
taxed in that other State.
2. However, such royalties and fees for included services may also
be taxed in the Contracting State in which they arise and
according to the laws of that State; but if the beneficial owner of
the royalties or fees for included services is a resident of the other
Contracting State, the tax so charged shall not exceed:
(a) in the case of royalties referred to in sub-paragraph (a) of
paragraph 3 and fees for included services as defined in this
Article [other than services described in sub-paragraph (b) of
this paragraph] :
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(a) 15 percent of the gross amount of the royalties or
fees for included services as defined in this Article,
where the payer of the royalties or fees is the
Government of that Contracting State, a political sub-
division or a public sector company; and
(b) 20 per cent of the gross amount of the royalties or
fees for included services in all other cases; and
(ii) during the subsequent years, 15 per cent of the gross
amount of royalties or fees for included services; and
(b) in the case of royalties referred to in sub-paragraph (b) of
paragraph 3 and fees for included services as defined in this
Article that are ancillary and subsidiary to the enjoyment of the
property for which payment is received under paragraph 3(b)
of this Article, 10 percent of the gross amount of the royalties
or fees for included services.
3. The term “royalties” as used in this Article means :
(a) payments of any kind received as a consideration for the
use of, or the right to use, any copyright or a literary, artistic,
or scientific work, including cinematograph films or work on
film, tape or other means of reproduction for use in connection
with radio or television broadcasting, any patent, trade mark,
design or model, plan, secret formula or process, or for
information concerning industrial, commercial or scientific
experience, including gains derived from the alienation of any
such right or property which are contingent on the productivity,
use, or disposition thereof; and
(b) payments of any kind received as consideration for the use
of, or the right to use, any industrial, commercial, or scientific
equipment, other than payments derived by an enterprise
described in paragraph 1 of Article 8 (Shipping and Air
Transport) from activities described in paragraph 2(c) or 3 of
Article 8.
4. For purposes of this Article, “fees for included services” means
payments of any kind to any person in consideration for the
rendering of any technical or consultancy services (including
through the provision of services of technical or other personnel)
if such services :
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(a) are ancillary and subsidiary to the application or
enjoyment of the right, property or information for which a
payment described in paragraph 3 is received; or
(b) make available technical knowledge, experience, skill,
know-how, or processes, or consist of the development and
transfer of a technical plan or technical design.
5. Notwithstanding paragraph 4, “fees for included services” does
not include amounts paid :
(a) for services that are ancillary and subsidiary, as well as
inextricably and essentially linked, to the sale of property other
than a sale described in paragraph 3(a) ;
(b) for services that are ancillary and subsidiary to the rental
of ships, aircraft, containers or other equipment used in
connection with the operation of ships or aircraft in
international traffic;
(c) for teaching in or by educational institutions;
(d) for services for the personal use of the individual or
individuals making the payments; or
(e) to an employee of the person making the payments or to any
individual or firm of individuals (other than a company) for
professional services as defined in Article 15 (Independent
Personal Services).
6. The provisions of paragraphs 1 and 2 shall not apply if the
beneficial owner of the royalties or fees for included services,
being a resident of a Contracting State, carries on business in the
other Contracting State, in which the royalties or fees for
included services arise, through a permanent establishment
situated therein, or performs in that other State independent
personal services from a fixed base situated therein, and the
royalties or fees for included services are attributable to such
permanent establishment or fixed base. In such case the
provisions of Article 7 (Business Profits) or Article 15
(Independent Personal Services), as the case may be shall apply.
7. (a) Royalties and fees for included services shall be deemed to
arise in a Contracting State when the payer is that State itself, a
political sub-division, a local authority, or a resident of that State.
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Where, however, the person paying the royalties or fees for
included services, whether he is a resident of a Contracting State
or not, has in a Contracting State a permanent establishment or a
fixed base in connection with which the liability to pay the
royalties or fees for included services was incurred, and such
royalties or fees for included services are borne by such
permanent establishment or fixed base, then such royalties or fees
for included services shall be deemed to arise in the Contracting
State in which the permanent establishment or fixed base is
situated.
(b) Where under sub-paragraph (a) royalties or fees for included
services do not arise in one of the Contracting States, and the
royalties relate to the use of, or the right to use, the right or
property, or the fees for included services relate to services
performed, in one of the Contracting States, the royalties or fees
for included services shall be deemed to arise in that Contracting
State.
8. Where, by reason of a special relationship between the payer
and the beneficial owner or between both of them and some other
person, the amount of the royalties or fees for included services
paid exceeds the amount which would have been paid in the
absence of such relationship, the provisions of this Article shall
apply only to the last-mentioned amount. In such case, the excess
part of the payments shall remain taxable according to the laws of
each Contracting State, due regard being had to the other
provisions of the Convention.”
(emphasis supplied)
72. What is clear from Article 12 of the US – India DTAA is that only
the royalties that are paid by GIA India to GIA US can be taxed in India. To
our mind, and especially considering the facts of the present case, the word
“paid” appearing in Article 12 would denote that amount which is actually
and eventually paid i.e. the amount that remains or is retained by GIA US by
virtue of the APA entered into between GIA India and the CBDT. We say this
because we find that one of the critical assumptions in the APA between GIA
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India [the Associated Enterprise of the GIA US (the Assessee)], and the
CBDT, was that if payment of royalty by GIA India to GIA US exceeds the
ALP (Arm’s Length Price) as determined in the APA, GIA India shall raise the
appropriate invoice on GIA US to recover the aforesaid excess payment made
and show the respective excess amounts as additional income in the modified
Return. Under Rule 10F(f), a critical assumption means the factors and
assumptions that are so critical and significant that neither party entering
into an agreement will continue to be bound by the agreement if any of the
factors or assumptions are changed. It is thus clear that one of the
fundamental assumptions of the APA entered into between GIA India and
the CBDT was partial recovery of royalty from GIA US, namely, excess
payment of royalty by GIA India to GIA US. When one takes into
consideration the facts of the present case, we are clearly of the view that the
royalty refunds by, or the royalty recoveries from GIA US are not standalone
events which can be seen in isolation with the receipts of related royalties in
the corresponding previous year. These refunds and recoveries of royalties
are required to be seen in conjunction with the associated receipts of the
royalties from GIA India. One can hardly dispute that the refund of excess
royalty by GIA US to GIA India was one which was bonafide and to adhere to
one of the critical assumptions in the APA entered into between GIA India
and the CBDT. Any part of the royalty received, which had to be bonafide
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refunded to the payer of royalty (namely GIA India), could not be taxed in the
hands of GIA US as this money did not eventually belong to GIA US. It is for
this very reason that the excess amount was refunded by GIA US to GIA
India. Just as an example, for A.Y. 2011-2012, GIA US had initially received
an amount of Rs.68,53,46,239/- as royalty from GIA India. However, once an
APA was entered into between GIA India and the CBDT, the ALP of the
royalty to be paid for A.Y. 2011-2012 was Rs.49,08,99,451/-. Hence, under
the APA, GIA India was under an obligation to call upon GIA US to refund
the excess royalty paid of Rs.19,44,46,788/-. This, in fact, was done, and
there is no dispute on this count.
73. Once this is the factual scenario before us, we are clearly of the
view that the royalty “paid” as contemplated under Article 12 was the amount
of Rs.49,08,99,451/-, which was ultimately retained by GIA US and not the
figure of Rs.68,53,46,239/-, which was initially received by GIA US from GIA
India on account of royalty.
74. There is yet another factor why we have taken this view. It is very
important to note that the refund received by GIA India from GIA US has
been shown as income of GIA India and offered to tax as such. This is by way
of a modified Return filed by GIA India pursuant to the APA entered into
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with the CBDT. Hence, we fail to understand how the Department can tax the
same amount twice, once in the hands of GIA India and then again in the
hands of GIA US. Further, the excess royalty payment, which is sought to be
taxed in the hands of GIA US, has already been declined as a deduction in the
hands of GIA India, and, correspondingly, higher income has been brought to
tax in the hands of GIA India. This treatment would clearly be incongruous
inasmuch as what has been treated as income in the hands of the recipient of
royalty (GIA US) has not been treated as expenditure in the hands of the
person paying the royalty in question (GIA India). What is thus admittedly
not treated as paid by the payer of royalty is being sought to be treated as
what is received by the recipient of the royalty. This, to our mind, and as
correctly held by the ITAT in its impugned judgment dated 30th April 2021,
is wholly incongruous. We are therefore clearly of the view that when one
takes all these factors into consideration, coupled with the fact that under the
IT Act, only real income in the hands of the Assessee can be taxed, the
quantum of royalty that could be brought to tax for A.Y. 2011-2012 was the
amount of Rs.49,08,99,451/- and not the amount of Rs.68,53,46,239/-.
75. This now leaves us to deal with the decision that was relied upon
by the Department rendered by the Hon’ble Supreme Court in the case of
Kishinchand Chellaram Etc. Vs. Commissioner of Income Tax,
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(Central) Bombay (In all the Appeals) (1962) 46 ITR 640. We find
that this judgment is clearly distinguishable on the facts. In Kishinchand
Chellaram (supra), Mr. Kishinchand was a shareholder and director of a
company called Chellsons Ltd. At the general meeting of the shareholders of
the company held on 10th July 1943, it was resolved to declare a dividend at
“60% on the shares” of the company, and for the purpose of that declaration,
the profits of the year 1941-1942 were included in the profit of the year 1942-
1943. Pursuant to this resolution, Rs.46,000/- was credited in the books of
the company to the account of Kishinchand Chellaram on 31st March 1944,
and Rs.23,000/- was credited to each of the other 3 shareholders. Another
meeting of the shareholders was held on 15th July 1944, and it was resolved
to declare dividend at “60% on the shares” out of the profits of the company
for 1943-1944. Pursuant to this resolution, on 29th September 1944,
Rs.30,000/- was credited in the company’s books of account to Kishinchand
and Rs.15,000/- was credited to the accounts of each of the other 3
shareholders. In the Return for A.Y. 1945-1946, Kishinchand included the
amounts credited to him in the company’s books of account as dividends for
3 years, 1941-1942 to 1943-1944. Thereafter, on 4th December 1947, at an
extraordinary general meeting, another resolution purporting to reverse the
earlier resolutions dated 10th July 1943 and 15th July 1944 was passed by the
company. By virtue of the resolution dated 4th December 1947, the company
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resolved that the dividend paid by the company to its shareholders was
without taking into consideration the company’s liability for taxation,
including excess profit tax and because of this, such a dividend inadvertently
paid by the company to the shareholders would be considered as a loan to
such individual shareholders and be paid back to the company forthwith. It is
by virtue of this resolution that Kishinchand then contended that he had not
received any dividend at all and could not be taxed as such.
76. It was this contention of Kishinchand that was negated not only
by this Court but also by the Hon’ble Supreme Court. In fact, the Hon’ble
Supreme Court in paragraph 7 (of ITR report) held that by virtue of Section
16(2), the liability to pay tax attached as soon as dividend was paid, credited
or distributed or deemed to have been paid or distributed to the shareholders
and IT Act contained no provision for altering the incidence of liability to pay
tax on the dividend, merely because it was found that in declaring dividend
and paying it, the company violated the prohibition relating to payment of
dividend in the Indian Companies Act. In fact, the Hon’ble Supreme Court
went on to hold that even if the shareholders agree to refund the amounts
received by them as dividend, the original character of the receipt as dividend
was not thereby altered. In ascertaining whether liability to pay Income Tax
on dividends arose, a resolution of the company whereby payments made to
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the shareholders as dividend were to be treated as loans could not
retrospectively alter the character of the payment and thereby exempt it from
liability which had already attached thereto, was the finding of the Hon’ble
Supreme Court. The Hon’ble Supreme Court, in fact, also went on to hold
that a payment made as dividend by the company to its shareholders does not
lose that character merely because it is paid out of the capital. Under the IT
Act, the liability to pay tax attaches as soon as the dividend is paid, credited
or distributed or is so declared. The Act does not contemplate an inquiry
whether the dividend is properly paid, credited or distributed before the
liability to pay tax attaches thereto.
77. The facts of the present case are completely different. What we
are considering is what is the amount “paid” as contemplated under Article
12 of the India-US DTAA. In fact, in Pfizer Corporation Vs.
Commissioner of Income-Tax (2003) 259 ITR 391 the word “paid”
was considered by this Court. The facts in Pfizer Corporation (supra) were
that the Assessee Pfizer Corporation was a non-resident company. Pfizer
Corporation was a shareholder of its Indian subsidiary, Pfizer Limited, a
company registered under the Indian Companies Act and assessed to tax. For
the A.Y. 1976-1977, Pfizer Limited (Indian entity) declared a final dividend on
31st July 1975. According to the Department, income accrued to Pfizer
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Corporation (the non-resident company) during the A.Y. 1976-1977, whereas
according to the Pfizer Corporation (the non-resident company), the income
accrued to them during A.Y. 1977-1978 as the remittance was permitted by
RBI only on 3rd September 1976 i.e. during the A.Y. 1977-1978. This Court
after considering the provisions of the IT Act, and more particularly Section
5(2)(b) and Section 9(1)(iv), came to the conclusion that the income could be
taxed only in the A.Y. 1977-1978 because Section 9(1)(iv) contemplated that
dividend “paid” by an Indian company outside India would constitute income
deemed to accrue in India. This was in contra distinction to Section 8, which
refers to dividend declared, distributed or paid by the company. The words
“declared or distributed” occurring in Section 8 do not find place in Section
9(1)(iv). It is in these circumstances that this Court took the view that
dividend income paid to a non-resident is deemed to accrue in India only on
payment and not on declaration.
78. For all the aforesaid reasons, we find that the reliance placed by
the Department on the judgment in Kishinchand Chellaram (supra) is
wholly misplaced and does not carry their case any further.
79. In view of the aforesaid discussion, we answer questions (a) to
(c) in the affirmative and in favour of the Assessee and against the Revenue.
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As mentioned earlier, questions (d) to (g), and the additional question raised
in A.Y. 2017-18, are not entertained as they do not give rise to any substantial
question of law.
80. All the Appeals are disposed of in the aforesaid terms. However,
there shall be no order as to costs.
81. This order will be digitally signed by the Private Secretary/
Personal Assistant of this Court. All concerned will act on production by fax
or email of a digitally signed copy of this order.
[FIRDOSH P. POONIWALLA, J.] [B. P. COLABAWALLA, J.]
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Signed by: Darshan Patil
Designation: PA To Honourable Judge
Date: 16/06/2026 16:50:06
