2017 (4) TMI 1437 - AT - Income Tax

Tribunal overturns CIT order under Income Tax Act, finding AO's treatment of royalty payments valid.

The Tribunal quashed the order passed by the CIT under Section 263 of the Income Tax Act, holding that the AO had taken a possible view by treating the ... Revision u/s 263 - Royalty Payment to its Associated Enterprise (AE) (DIC Asia Pacific PTE Ltd of Singapore and DIC Corporation of Japan) as revenue expenditure for using technical knowhow and upgrading manufacturing technology and right to use the trade names and brand names and reported in Form 3CEB as required u/s 92E - HELD THAT:- We find that the AO had simply adopted the upward adjustment to ALP contemplated by the TPO in his order which admittedly included an adjustment towards royalty in the sum. That does not automatically mean that the entire issue of payment of royalty on propriety basis had been duly examined by the subordinate authorities precluding the ld. CIT from exercising his revisionary jurisdiction on the same. We are also not in agreement with the argument advanced by the AR that the AO had made a reference to TPO on the international transactions carried out by the assessee and hence the ld. AO had applied his mind that the royalty payment was in the revenue field and addition had been made thereon by the TPO and AO. Hence it amounts to application of mind by the AO. We find that the international transactions carried out by the assessee would. be both on capital as well as on revenue account. The entire international transactions would have to be referred by the ld. AO to the ld. TPO u/s 92CA. As we had already stated that the scope of enquiry of the ld. TPO is merely restricted to determination of ALP of international transactions which would. be both on capital and on revenue account. Hence the order of ld. TPO on royalty payment and addition made thereon would. not come to the rescue of the assessee. We find that the CIT considered the order of the AO to be erroneous at the show cause notice stage by stating the royalty payment should be construed as capital expenditure and hence should. be disallowed, he later on in the order passed u/s 263 of the Act changed the track and considered the order to be erroneous for “lack of enquiry‟ on the part of the ld. AO. This finding of the ld. CIT recorded on altogether new footing without giving opportunity of being heard to the assessee, itself rendered the revision order u/s 263 of the Act as invalid and bad in law. CIT erred in invoking revisionary jurisdiction u/s 263 in the instant case. Hence the order passed by the CIT u/s 263 of the Act is hereby quashed and grounds raised by the assessee are allowed. Issues Involved:1. Justification of invoking revisionary jurisdiction under Section 263 of the Income Tax Act.2. Nature of royalty payments: whether they should be classified as revenue expenditure or capital expenditure.3. Examination and verification of the royalty payment details by the Assessing Officer (AO) and Transfer Pricing Officer (TPO).Detailed Analysis:Issue 1: Justification of Invoking Revisionary Jurisdiction under Section 263 of the Income Tax ActThe primary issue to be decided was whether the Principal Commissioner of Income Tax (CIT) was justified in invoking revisionary jurisdiction under Section 263 of the Income Tax Act. The CIT issued a show cause notice to the assessee on the grounds that the royalty payment made to its Associated Enterprises (AE) was erroneously treated as revenue expenditure instead of capital expenditure. The CIT held that the assessment order passed by the AO was erroneous and prejudicial to the interests of the revenue. However, the Tribunal found that the AO had considered the royalty agreements and had taken a possible view by treating the royalty payments as revenue expenditure. The Tribunal emphasized that the CIT was merely substituting his own view for that of the AO without bringing any new material on record, which is not permissible under Section 263.Issue 2: Nature of Royalty Payments: Revenue or Capital ExpenditureThe CIT argued that the royalty payments made by the assessee to its AEs for the use of technical know-how, trademarks, and brand names should be treated as capital expenditure, as they provided an enduring benefit to the assessee. The assessee contended that the payments were made periodically and were directly correlated with sales, thereby qualifying as revenue expenditure. The agreements with the AEs granted the assessee a non-exclusive, non-transferable license to use the technical know-how and trademarks, which were to be returned upon the termination of the agreement. The Tribunal, after examining the agreements and relevant judicial precedents, concluded that the royalty payments were indeed revenue in nature, as they did not result in the acquisition of any capital asset or enduring benefit.Issue 3: Examination and Verification of Royalty Payment Details by AO and TPOThe CIT alleged that the AO had not conducted a proper inquiry into the nature of the royalty payments. However, the Tribunal found that the AO had called for and examined the royalty agreements during the assessment proceedings. Additionally, the TPO had scrutinized the royalty payments and made an upward adjustment to the Arm's Length Price (ALP) for the royalty transactions. The Tribunal held that the AO had taken a possible view based on the facts and circumstances of the case, and the CIT's invocation of Section 263 was unjustified. The Tribunal emphasized that the CIT cannot invoke revisionary jurisdiction merely because he holds a different view from that of the AO.Conclusion:The Tribunal quashed the order passed by the CIT under Section 263 of the Income Tax Act, holding that the AO had taken a possible view by treating the royalty payments as revenue expenditure. The Tribunal concluded that the CIT was not justified in invoking revisionary jurisdiction, as there was no lack of inquiry or erroneous application of law by the AO. The appeal of the assessee was allowed, and the assessment order treating the royalty payments as revenue expenditure was restored.