2018 (12) TMI 1556 - AT - Income Tax

Tribunal overturns transfer pricing adjustment and royalty expense disallowance, citing arm's length pricing and tax treaty compliance.

Sophos Technologies Private Limited (Formerly known as Cyberoam Technologies Pvt Ltd) Versus Dy. Commissioner of Income-tax, Circle 4 (1) (1), Ahmedabad

Sophos Technologies Private Limited (Formerly known as Cyberoam Technologies Pvt Ltd) Versus Dy. Commissioner of Income-tax, Circle 4 (1) (1), Ahmedabad - ... Issues Involved:1. Transfer Pricing Adjustment2. Disallowance of Provision for Royalty ExpensesIssue-wise Detailed Analysis:1. Transfer Pricing Adjustment:1.1 Upward Adjustment under Section 92CA(3): The assessee contested the upward adjustment of Rs. 2,04,090 made by the AO/TPO, arguing that the outstanding receivables were part of the main international transaction of software sales and should not be treated separately.1.2 Separate International Transaction for Receivables: The CIT(A) confirmed the AO/TPO's view that receivables outstanding for more than 90 days constituted a separate international transaction.1.3 Working Capital Adjusted Margins: The assessee contended that even with delayed receivables, its working capital adjusted operating margins were higher than those of comparable companies, negating the need for separate adjustment.1.4 Rejection of Internal CUP Method: The CIT(A) upheld the AO/TPO's rejection of the Internal Comparable Uncontrolled Price (CUP) method, despite the assessee's argument that it did not charge interest on receivables from Non-AEs beyond the credit period.1.5 Application of External CUP Method: The CIT(A) also confirmed the use of the External CUP method by the AO/TPO.1.6 Adhoc Adjustment for Foreign Exchange Risk: The assessee challenged the 100 basis points adjustment for foreign exchange risk, which the CIT(A) had upheld.Tribunal's Findings:- The Tribunal referred to its previous decision in the case of Micro Inks Limited, which was in favor of the assessee, stating that the cost of funds blocked in the credit period was inbuilt in the sale price.- The Tribunal noted that the assessee had allowed similar credit periods to Non-AEs, validating the Internal CUP method.- The Tribunal concluded that making a separate adjustment for delayed receivables when the arm's length price was determined using TNMM would be inappropriate.- The Tribunal directed the deletion of the Rs. 2,04,090 adjustment.2. Disallowance of Provision for Royalty Expenses:2.1 Disallowance under Section 40(a)(i): The assessee challenged the disallowance of Rs. 91,97,594 for royalty expenses, arguing that the provision was made for potential liabilities and no tax was required to be deducted at the time of provision.2.2 Timing of Tax Deduction: The assessee argued that tax was appropriately deducted when the actual liability arose, i.e., when the end customer activated the license key.Tribunal's Findings:- The Tribunal noted that under the Indo-Russian and Indo-Israel Tax Treaties, royalty income becomes taxable when paid, not when provisioned.- The Tribunal referenced the decision in Saira Asia Interiors (P.) Ltd., which supported the view that tax withholding obligations arise only when the income is exigible to tax.- The Tribunal found that the assessee's approach of deducting tax at the time of activation was legally correct.- The Tribunal directed the deletion of the disallowance under Section 40(a)(i).Conclusion:The appeal of the assessee was allowed, with the Tribunal directing the deletion of both the transfer pricing adjustment and the disallowance of provision for royalty expenses.