Head-count allocation and cost-to-cost reimbursements rejected as royalty or technical fees where arm's-length treatment stood accepted.

Common employee costs reimbursed to an associated enterprise were accepted as allocable on a head-count basis because the shared finance, administration and human resource functions were run through common staff on a cost-to-cost basis. An ad hoc 30% disallowance was unsustainable where the transfer pricing authority had accepted the transaction at arm's length and no contrary material justified replacing the chosen allocation method with estimation. Amounts recovered from group entities for circuit and related charges were treated as reimbursements of common expenses, not as royalty or fees for technical services, because the receipts were on a cost-to-cost basis and the same factual treatment had been accepted earlier. The additions were therefore deleted.

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Issues: (i) Whether the common employee costs reimbursed to the associated enterprise could be allocated on head count basis and whether an ad hoc disallowance of 30% of such expenses was sustainable. (ii) Whether the amounts recovered from group entities towards circuit and related charges could be treated as royalty or fees for technical services.

Issue (i): Whether the common employee costs reimbursed to the associated enterprise could be allocated on head count basis and whether an ad hoc disallowance of 30% of such expenses was sustainable.

Analysis: The common finance, administration and human resource functions were managed through shared staff, and the reimbursement represented the assessee's share of those common costs on cost-to-cost basis. The rejection of head count as the allocation key was not justified merely because employee strength fluctuated without a corresponding month-to-month variation in costs. Once the transfer pricing authority had accepted the transaction at arm's length, the income-tax authorities could not substitute an ad hoc disallowance in place of a reasoned allocation method. A disallowance under section 37(1) could not rest on conjecture or estimate without a proper basis.

Conclusion: The head count basis for allocation was accepted and the ad hoc disallowance was deleted in favour of the assessee.

Issue (ii): Whether the amounts recovered from group entities towards circuit and related charges could be treated as royalty or fees for technical services.

Analysis: The receipts were found to be reimbursements on cost-to-cost basis for expenses incurred on behalf of group entities. The earlier year's treatment, including the subsequent verification on giving effect to the tribunal's order, supported the view that the amounts were not consideration for technical services or royalty. On the same facts, the recharacterisation of the receipts as royalty or fees for technical services could not be sustained.

Conclusion: The addition treating the reimbursements as royalty or fees for technical services was deleted in favour of the assessee.

Final Conclusion: The additions made on account of allocation of common expenses and reclassification of reimbursements were set aside, and the assessee's appeals succeeded.

Ratio Decidendi: Once a transfer pricing transaction is accepted at arm's length, the assessing authority cannot replace the accepted allocation basis with an ad hoc estimate absent contrary material, and cost-to-cost reimbursements for common expenses do not become royalty or fees for technical services merely because they arise from shared service arrangements.

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