Franchisee bottler wins royalty deduction under section 37(1) despite non-compliance with section 133(6) notice requirements

ITAT Mumbai allowed the assessee's claim for royalty deduction under section 37(1). The assessee, a franchisee bottler for Aquafina brand, paid royalty to PepsiCo entity. Revenue disallowed the payment citing non-compliance with section 133(6) notice and non-production of the franchisor for verification. ITAT held that mere non-compliance cannot establish non-existence of a well-known global company or prove transaction genuineness. No evidence showed trademark infringement or that assessee operated without proper licensing agreement. Royalty payment was allowed as legitimate business expenditure.

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Issues Involved:
1. Disallowance of Royalty Expenses under section 37(1) of the Income Tax Act.
2. Validity of the agreement between the assessee and Pepsi Foods Private Ltd.
3. Non-compliance with notice issued under section 133(6) of the Act.
4. Non-production of Pepsi Foods Private Ltd. for verification.

Summary:

Disallowance of Royalty Expenses under Section 37(1) of the Act: The primary issue in both appeals is the disallowance of royalty expenses paid to Pepsi Foods Private Ltd. under section 37(1) of the Income Tax Act. The assessee, a franchisee bottler for the brand Aquafina, claimed royalty expenses based on an agreement dated 09/06/2003. The Assessing Officer (AO) disallowed the expenses, citing the non-renewal of the agreement after its initial five-year term.

Validity of the Agreement: The assessee argued that the agreement continued to subsist beyond the initial term, supported by correspondences and monthly invoices raised by Pepsi Foods Private Ltd. The Tribunal found that both parties continued to honor their obligations under the agreement, even after the initial term, and referred to the agreement in their correspondences. Thus, the Tribunal held that the payment of royalty was valid and pursuant to the agreement.

Non-compliance with Notice under Section 133(6): The Revenue emphasized the non-compliance of Pepsi Foods Private Ltd. with the notice issued under section 133(6) and the non-production of the party by the assessee. The Tribunal noted that Pepsi Foods Private Ltd., now merged with PepsiCo India Holdings Pvt. Ltd., is a well-known entity, and mere non-compliance with the notice does not render the transaction non-genuine.

Non-production of Pepsi Foods Private Ltd. for Verification: The Tribunal observed that the non-production of Pepsi Foods Private Ltd. for verification does not lead to the conclusion that the entity is non-existent or the transaction is not genuine. The Tribunal found no material evidence from the Revenue to show that the assessee did not use the trademark or that the royalty payment was without basis.

Conclusion: The Tribunal set aside the impugned orders passed by the learned Commissioner of Income Tax (Appeals) and directed the AO to allow the claim of royalty expenses for both assessment years 2010-11 and 2011-12. Other grounds raised by the assessee were dismissed as not pressed. Both appeals by the assessee were partly allowed.

Order pronounced in the open Court on 09/10/2023.

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