Royalty ALP restored as TPO's nil valuation under s.92C read with Rule 10B held beyond jurisdiction

ITAT, Mumbai allowed the assessee's appeals, holding that the Transfer Pricing Officer (TPO) had exceeded his jurisdiction in determining the Arm's Length Price (ALP) of royalty payable to its associated enterprise at nil. The Tribunal held that bad debts written off in respect of software products sold in India cannot be a parameter for determining ALP under s. 92C read with Rule 10B of the I.T. Rules. As the TPO had applied an impermissible method not authorised by the statute, the resultant ALP determination was unsustainable. The AO was directed to accept the royalty ALP as declared by the assessee for both years.

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Issues: (i) Whether the Transfer Pricing Officer validly determined the arm's length price (ALP) of royalty payable to an associated enterprise by treating royalty corresponding to invoiced amounts later written off as nil; (ii) Whether interest under section 234D is leviable for assessment year 2003-04.

Issue (i): Whether the TPO exceeded its jurisdiction and applied an impermissible factor (bad debts written off) in determining ALP of royalty instead of applying methods prescribed under section 92C and Rule 10B.

Analysis: Section 92C prescribes the methods for computation of ALP and Rule 10B prescribes the manner of application of those methods. Determination of ALP must be within the framework of the prescribed methods (for example, Comparable Uncontrolled Price method). The TPO computed ALP by treating royalty on amounts invoiced and subsequently written off as nil on the basis of write-off facts and commercial considerations rather than by applying any of the statutory ALP methods or parameters laid down in Rule 10B. The applicability of bad debts as a separate factor for altering ALP is not authorised by the statutory methods and rules governing computation of ALP.

Conclusion: The TPO's adjustment treating the royalty as nil is not in accordance with section 92C and Rule 10B and is set aside; the ALP of royalty shall be adopted as declared by the assessee for the relevant years.

Issue (ii): Whether interest under section 234D is payable for assessment year 2003-04.

Analysis: Section 234D was not in force for assessment year 2003-04. Precedent on the point supports non-levy of section 234D interest for that assessment year.

Conclusion: Interest under section 234D shall not be levied for assessment year 2003-04; the ground is allowed in favour of the assessee.

Final Conclusion: The appeals are allowed in respect of the ALP determination for royalty (ALP adopted as declared by the assessee) and in respect of non-levy of interest under section 234D for assessment year 2003-04, resulting in overall allowance of the appeals.

Ratio Decidendi: Arm's length price for international transactions must be determined by applying the statutory methods in section 92C and the manner prescribed in Rule 10B; a TPO cannot substitute or introduce non-statutory commercial adjustments (such as treating invoiced amounts later written off as a basis to reduce ALP to nil) outside those prescribed methods.

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