Royalty payment genuineness and section 40(a)(i) timing rules determine deductibility when tax is paid later.

Royalty paid to an associated enterprise was not disallowable where it was supported by invoices, agreements and banking records, and the transfer pricing authority had already accepted the transaction at arm's length; absent material showing lack of genuineness, conjecture could not justify adjustment. Separately, section 40(a)(i) denied deduction for the year under appeal where tax deductible on royalty was deducted and deposited only later, but the proviso allowed the expenditure in the year in which the tax was actually paid. The royalty addition on merits was deleted, while the year-wise disallowance under section 40(a)(i) was confined to the year of default.

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Issues: (i) whether royalty paid to the associated enterprise was liable to disallowance on the ground that the payment was not proved to be necessary or genuine and that the arm's length price required adjustment; (ii) whether disallowance under section 40(a)(i) of the Income-tax Act, 1961 was sustainable for non-payment of tax deducted at source within the prescribed time and, if not, in which year the deduction was allowable.

Issue (i): whether royalty paid to the associated enterprise was liable to disallowance on the ground that the payment was not proved to be necessary or genuine and that the arm's length price required adjustment.

Analysis: The royalty payment was supported by invoices, agreements and banking records. The transfer pricing authority had accepted the international transaction as being at arm's length. There was no change in facts from the earlier year, and the earlier finding that the payment was not a sham transaction continued to apply. The revenue did not produce material to show that the payment lacked genuineness or that the allowance of royalty required interference.

Conclusion: The disallowance of royalty on the ground of lack of genuineness or arm's length adjustment was unjustified and the assessee succeeded on this issue.

Issue (ii): whether disallowance under section 40(a)(i) of the Income-tax Act, 1961 was sustainable for non-payment of tax deducted at source within the prescribed time and, if not, in which year the deduction was allowable.

Analysis: Section 40(a)(i) denies deduction where tax deductible on royalty or similar payments is not deducted or, after deduction, is not paid within the time prescribed under section 200(1). On the facts, the tax was deducted and deposited only in the subsequent year. The proviso to section 40(a)(i) permits deduction in the year in which such tax is paid, and the payment of tax in the subsequent financial year entitled the assessee to claim the expenditure in that later year.

Conclusion: The disallowance under section 40(a)(i) for the year under appeal was upheld, but the assessee was entitled to deduction in the year in which the tax was actually paid, namely assessment year 2008-09.

Final Conclusion: The royalty addition on merits was deleted, while the section 40(a)(i) disallowance operated only for the year under appeal and the corresponding deduction was allowed in the year of tax payment. The revenue's appeals failed and the assessee obtained limited relief on its cross-objection.

Ratio Decidendi: Where a royalty payment is supported by evidence and accepted at arm's length by the transfer pricing authority, it cannot be disallowed as non-genuine merely on conjecture; separately, under section 40(a)(i), a deduction otherwise covered by that provision is allowable in the year in which the deducted tax is actually paid.

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