2012 (7) TMI 560 - HC - Income Tax

High Court Upholds ITAT Decision on Royalty Payments

The High Court upheld the ITAT's decision in the appeal under section 260-A of the Income Tax Act, ruling in favor of the respondent-assessee. The court ... Disallowance made of royalty paid by the assessee to CAMI USA for distribution of software products in India - whether the royalty should be allowed to be written off to the extent of the unpaid invoices during the year itself - ITAT deleted the disallowance - Held that:- Merely because the respondent had paid the royalty even in respect of the products sold by it to the clients, who had not paid for the same, it would make no difference to the determination of the Arm's Length Price of the transaction - Once it is accepted that the ALP of the royalty is justified, there can be no reduction in the value thereof on account of the assessee's customers failing to pay the assessee for the product purchased by them from the assessee. Transactions between the respondent and CAMI are unrelated to the transactions between the respondent and its clients i.e. purchasers of the products from the respondent. CAMI was not concerned with the respondent's inability to recover the consideration from its clients. It is not suggested that the transactions in this case either between the respondent and CAMI or the respondent and its clients are colourable - in favour of assessee. Issues:1. Appeal under section 260-A of the Income Tax Act against ITAT order.2. Substantial question of law regarding disallowance of royalty paid for distribution of software products.3. Determination of Arm's Length Price (ALP) for royalty paid to CA Management Inc. USA.4. Rejection of appeal by CIT (A) and observations by TPO and CIT (A).5. Interpretation of Section 92C for determining ALP in international transactions.6. Distinction between transactions with principal and clients regarding payment obligations.Analysis:1. The case involves an appeal under section 260-A of the Income Tax Act against the ITAT order allowing the respondent's appeal against the CIT (A) order.2. The substantial question of law in focus is whether the ITAT was justified in deleting the disallowance made of royalty paid by the assessee to CA Management Inc. USA for distributing software products in India, especially considering the payment of royalty on bad debts where the software did not work.3. The dispute revolves around the determination of the Arm's Length Price (ALP) for the royalty paid by the respondent to CA Management Inc. USA. The respondent claimed the ALP at the contractual value, while the AO computed it at a lower value, resulting in a reduction of the loss declared by the respondent.4. The appeal made by the respondent was rejected by the CIT (A), and both the TPO and CIT (A) made observations regarding the payment of royalty on bad debts and the quality of products, leading to the disallowance.5. The interpretation of Section 92C of the Income Tax Act is crucial in this case, as it provides the basis for determining the ALP in international transactions. The section does not consider the failure of customers to pay as a relevant factor in determining the ALP, emphasizing the distinction between transactions with the principal and clients.6. The judgment highlights the distinction between transactions with the principal, CA Management Inc. USA, and the clients purchasing products from the respondent. The court emphasizes that the ALP of the royalty should not be reduced due to the respondent's clients failing to pay, as these are separate transactions, and the vendor is not concerned with the recovery of prices from the clients.In conclusion, the High Court upheld the ITAT's decision, ruling in favor of the respondent-assessee, dismissing the appeal and emphasizing the importance of distinguishing between transactions with the principal and clients in determining the Arm's Length Price for royalty payments in international transactions.