ITAT Mumbai allows depreciation on brand license fees and marketing expenses while restoring sports rights valuation for fresh assessment

ITAT Mumbai ruled on multiple transfer pricing and tax issues for the assessee. The tribunal restored the sports rights bundle valuation matter to the assessing officer for fresh adjudication, noting valuation requires technical expertise. It deleted additions for transitional services fees, finding the assessee substantiated benefit received and ESS offered corresponding income to tax in India. The tribunal allowed depreciation claims on brand license fees, following its earlier decisions in the assessee's case for previous years. Marketing expenses were allowed as legitimate business expenditure. Software depreciation was permitted subject to verification. The tribunal directed verification of foreign tax credit claims and TDS/advance tax adjustments.

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The core legal questions considered by the Tribunal in this appeal primarily revolve around the determination of the arm's length price (ALP) of various inter-company transactions under the Income Tax Act, 1961, specifically in the context of transfer pricing. The key issues include:

1. Whether the payment made by the assessee for acquiring a bundle of sports broadcasting rights from its associated enterprise (AE) is at arm's length, particularly focusing on the correctness of the valuation report and the determination of terminal value in the discounted cash flow (DCF) method.

2. Whether the payment made towards transitional services availed from the AE is at arm's length and the validity of the disallowance of certain portions of such payments.

3. The determination of ALP for brand licence fee payments and the consequent allowance of depreciation on such payments.

4. The allowability of deduction claimed towards reimbursement of property tax.

5. The allowability of marketing and publicity expenses claimed by the assessee.

6. The nature of software expenses claimed and the eligibility for depreciation.

7. Issues relating to short grant of tax deducted at source (TDS) and advance tax credits.

8. The grant of foreign tax credit and minimum alternate tax (MAT) credit claims.

Issue-wise Detailed Analysis:

1. Determination of ALP for Acquisition of Bundle of Sports Rights

The assessee, a media company part of a larger group, acquired a bundle of sports broadcasting rights from its AE, ESPN Star Sports Ltd (ESS), which held rights from international sports bodies (ISB). The payment made was benchmarked using the Comparable Uncontrolled Price (CUP) method, comparing the amount paid by ESS to ISB (USD 1,338 million) with the amount paid by the assessee to ESS (USD 1,211 million), reflecting a discount of about 9.5%. The assessee supported this with a valuation report by an independent valuer applying the DCF method, determining the value at USD 1,211 million.

The Transfer Pricing Officer (TPO) challenged this valuation, particularly the terminal value of USD 548 million incorporated in the DCF method, on the ground that the rights were for a finite period, and terminal value should not be computed for such intangible assets. The TPO relied on international valuation standards and authoritative texts, including the book by Professor Aswath Damodaran and International Valuation Standards, to assert that economic life, not merely legal life, should govern valuation, and for finite period assets, terminal value should be nil.

The TPO also pointed out that the independent valuer's projections were overly optimistic and contradicted by the historical losses incurred by ESS and the assessee in the sports broadcasting segment. The TPO noted the valuation report did not consider risks such as non-renewal of rights, competition, and strategic decisions to exit the business, leading to a fundamental error. Consequently, the TPO determined the ALP at USD 411 million, significantly lower than the valuation report.

The Dispute Resolution Panel (DRP) upheld the TPO's adjustment.

The assessee contended that the valuation report was a bona fide expert exercise, that the terminal value was justified due to the economic benefits beyond the contractual period, including synergy with general entertainment channels, and that the TPO selectively and incorrectly interpreted the valuation report and literature. The assessee also furnished additional expert opinions supporting the valuation and argued that the TPO failed to produce any counter valuation report. The assessee highlighted that the payment was at a discount to the price paid by ESS to ISB and that the valuation process was consistent with accepted principles, including game theory.

The Tribunal observed that valuation is a highly technical subject requiring expertise. The TPO's selective use of literature and partial rejection of the valuation report without commissioning a counter valuation was inappropriate. The Tribunal noted that the revenue had not undertaken an independent expert valuation to challenge the assessee's valuation. The Tribunal acknowledged the revenue's objection regarding terminal value but held that the issue required expert examination and could not be conclusively decided by the Tribunal. Accordingly, the Tribunal restored the issue to the Assessing Officer for fresh adjudication, directing that the assessee be given a reasonable opportunity to be heard and that the revenue obtain an independent expert valuation to verify the correctness of the valuation report.

2. ALP of Payment for Transitional Services

The assessee paid transitional fees to ESS for services and facilities during the period it was setting up its sports broadcasting business and awaiting government permissions. The assessee benchmarked the transaction using the Transactional Net Margin Method (TNMM), claiming it was at arm's length. The TPO rejected the benchmarking, disallowing a significant portion of the payment for lack of evidence of services and benefit. The DRP partly allowed the claim, permitting actual costs incurred on a back-to-back basis but disallowing mark-up and certain other costs.

The assessee submitted that the payments were for genuine services, supported by a certificate from a Singapore-based auditor, and that the benefit test was satisfied. The assessee also pointed out that ESS had offered the income to tax in India and complied with transfer pricing regulations.

The Tribunal found that the acceptance by the DRP of a portion of the payment demonstrated that services were indeed availed and benefits derived. The Tribunal held that the TPO's rejection based solely on the benefit test was baseless and that no adjustment was required since the income was taxed in India at ESS's end. The Tribunal deleted the addition.

3. ALP and Depreciation on Brand Licence Fee

The assessee had paid a brand licence fee to an AE for use of the STAR brand and sought depreciation on the payment. The TPO had determined the ALP at nil, disallowing depreciation in earlier years. However, the Tribunal had earlier deleted the transfer pricing adjustment for the relevant year, allowing depreciation. Following the consistent earlier decisions, the Tribunal allowed the claim of depreciation for the impugned year.

4. Deduction for Reimbursement of Property Tax

The assessee claimed deduction for reimbursement of property tax paid on behalf of a related party. The assessing officer disallowed the claim based on earlier decisions and the DRP upheld the disallowance. The Tribunal referred to an earlier decision in the assessee's own case for a prior year, where the issue was restored to the Assessing Officer for fresh examination, noting that the reimbursement appeared disproportionate to rent paid.

Following the earlier decision, the Tribunal restored the issue to the Assessing Officer for fresh consideration with appropriate directions.

5. Marketing and Publicity Expenses

The assessee claimed deduction for marketing and publicity expenses. The assessing officer disallowed 25% of such expenses, and the DRP upheld the disallowance relying on earlier decisions. The assessee submitted that the issue had been consistently decided in its favor by the Tribunal and the jurisdictional High Court in preceding years.

The Tribunal, after reviewing the precedents including decisions by the High Court and the Tribunal, held that incidental benefit to other entities does not disallow the expenditure if it is incurred wholly and exclusively for the assessee's business. The Tribunal deleted the disallowance.

6. Software Expenses and Depreciation

The assessing officer treated part of the software expenses as capital expenditure and allowed depreciation accordingly, disallowing the balance. The DRP upheld the disallowance. The assessee claimed entitlement to depreciation on the software expenses held as capital in nature.

The Tribunal directed the Assessing Officer to verify the facts and allow depreciation as per law, subject to factual verification.

7. Short Grant of TDS and Advance Tax Credits

The assessee raised issues regarding short grant of tax deducted at source and advance tax credits. The Tribunal directed the Assessing Officer to verify the claims based on facts and allow credits as per law.

8. Foreign Tax Credit and MAT Credit

The assessee claimed foreign tax credit and MAT credit. The Tribunal directed the Assessing Officer to verify the claims in light of facts and allow credits if permissible under law.

Significant Holdings and Core Principles Established

The Tribunal emphasized the technical nature of valuation in transfer pricing disputes and underscored that valuation reports by independent experts should not be lightly rejected by tax authorities without commissioning a counter valuation by their own experts. The Tribunal stated:

"Valuation is a highly technical subject which requires expertise in technical knowledge and skill on the subject... a person having no technical knowledge/expertise cannot be in a position to decide whether the value determined by the independent valuer and the expert's opinion in support, are incorrect."

The Tribunal held that selective and partial rejection of valuation reports, without proper expert countervaluation, is an incorrect approach.

Regarding finite-lived intangible assets, the Tribunal recognized the revenue's contention that terminal value should not be attributed beyond the economic life of the asset but refrained from conclusively deciding the issue, restoring it for expert examination.

The Tribunal also affirmed that incidental benefits to other entities do not negate the allowability of marketing and publicity expenses if incurred wholly and exclusively for the assessee's business, following High Court and Tribunal precedents.

On transitional services, the Tribunal held that acceptance of part of the payment by the tax authorities and taxation of income at the AE's end negates the need for adjustment.

On reimbursement of property tax, the Tribunal followed earlier decisions restoring the issue for fresh examination due to factual complexities.

On software expenses, the Tribunal directed factual verification and allowance of depreciation as per law.

On credits for TDS, advance tax, foreign tax, and MAT, the Tribunal directed verification and allowance as per law.

Finally, the Tribunal allowed grounds challenging the transfer pricing adjustments on brand licence fee payments based on consistent earlier decisions.

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