2024 (4) TMI 390 - AT - Income Tax

ITAT allows appeal on transfer pricing royalty adjustment after accepting post facto addendum clarifying original agreement terms

The ITAT Delhi allowed the appellant's appeal regarding TP adjustment on royalty payments. The TPO had rejected a post facto addendum to the royalty ... TP Adjustment - adjustment in the transaction of payment of royalty - Royalty payments made by the subsidiary for using certain intangible properties and services. - TPO Rejecting the Addendum as a piece of evidence - whether the royalty paid by the appellant to the associated enterprise for services rendered to unrelated third parties are covered in the Addendum to Royalty Agreement entered by the appellant? - HELD THAT:- Appellant does not dispute the fact post facto agreement the addendum was entered. We find that more than the Intangible and Proprietary Licence Agreement dated 2nd January, 2002, the Foreign Collaboration Agreement dated 2nd January, 2002 between the TP USA and the assessee is of more significance. There is no material before us on record nor there is any case of the AO that apart from the work solicited by TP USA the assessee company had procured any work outside India on its own. When these clauses are read along with the licensing agreement dated 2nd January, 2002, the only conclusion that can be drawn is that there was consensus ad idem between parties that royalty is to be paid with respect to the entire sales revenue of the assessee in regard to overseas clients of TP USA, including sales to third party customers for TP USA for which Revenue is received from TP USA. We are of the firm view that the addendum was entered upon to just bring more clarity to this understanding and it cannot be said that this post facto addendum was made with intention to undo the findings of DRP. We fail to appreciate the observations and findings of DRP that a subsequent agreement executed in 2014 can not go back and influence the transactions already effected much earlier on the strength of an earlier agreement, so as to determine whether the earlier transaction was carried out at Arm's Length Price or not. If such a position is allowed, then an assessee can modify an agreement at any time after the date of international transaction as per an earlier agreement and by changing the clauses and terms, seek to modify the Arm's Length price already determined for earlier years. If at all, such post facto agreements should only have prospective effect as far as determination of Arm's length price of international transactions is concerned. The addendum does not set forth any new terms or conditions, but, as we discussed earlier, the addendum only crystalises the conduct of parties and when it is related back to the date of original agreement dated 02.01.2002, it does not post facto recognize anything, which is proved to be, not, originally agreed. TPO has observed that services rendered through TP USA fall under the category services rendered through an affiliate. As submitted on behalf of the assessee that “sales through TP USA “differs” from the sales made through an affiliate.” - As we take into consideration the definition reproduced earlier of ‘Affiliate’ and the definition of ‘Third Party’ in the original agreement or the Addendum, it becomes clear that the ‘Affiliates’ refers to an entity other than “Party to this Agreement.” TP USA being the holding company cannot be considered to be an affiliate so as to accept the conclusion of the DRP and TPO that no royalty is payable in respect of sales to AEs (including affiliates.) TPO has held that the services rendered by the Appellant to a third party customer on behalf of its AE are to be considered as sales made to AE - Also, because the bill(s) raised by the assessee to its AE was for the services rendered to the client of the AE, the Appellant was not required to pay the royalty on it. On behalf of assessee it is reiterated that in the case of the appellant, the parties to the agreement, viz, TP USA and the appellant are ad idem that royalty needs to be paid on sale of services rendered by the appellant to third party customers of TP USA. As already concluded that in the understanding of the two contracting parties, it was always the intention that royalty has to be paid for use of intangible property, know-how, customer relationship management (CRM) services, etc. with respect to entire sale revenues of the appellant, including sales to third party customers of TP USA for which revenue is received from TP USA. As we consider the Foreign Collaboration Agreement clause 5 with subclauses, it becomes clear that TP USA had agreed to pay for the services provided by the assessee to the overseas clients of TP USA. Sub-clause 5.7 specifically mentions that the bills can be raised by the assessee on TP USA. This clause 5 of the Collaboration Agreement leaves no doubt that merely due to the fact of raising bills or invoices on the TP USA for services actually rendered to third party customers solicited by TP USA, the sales have to be considered to be one made to TP USA itself. Thus DRP and TPO both have fallen in error in first rejecting the Addendum as a piece of evidence showing the consistency of the conduct and the actual intentions of the parties to the agreement and then has made erroneous interpretation to the clauses of the Collaboration Agreement and the Licence Agreement to conclude that the assessee was providing services to the TP USA only and not to third parties for whom TP USA had, in fact, acted as intermediary. We are inclined to sustain the grounds. Consequently, the appeals of the assessee are allowed with consequential effect. Issues Involved:1. Adjustment to the arm's length price of international transactions of payment of royalty.2. Validity and impact of the addendum to the agreement on the determination of royalty.3. Interpretation of the contractual terms between the appellant and TP USA regarding payment of royalty.Summary:1. Adjustment to the arm's length price of international transactions of payment of royalty:The appellant, a wholly owned subsidiary of Teleperformance USA (TP USA), provided voice-based call center services to third parties, which are customers of TP USA. The appellant paid royalty to TP USA based on an agreement dated 02-01-2002. The Transfer Pricing Officer (TPO) initially accepted the transaction of provision of call center services at arm's length price but applied the Comparable Uncontrolled Price (CUP) method for benchmarking the payment of royalty, resulting in a disallowance of the entire payment of Rs. 1,28,68,402. The Dispute Resolution Panel (DRP) accepted the benefit of royalty but restricted it to services rendered to unrelated third parties, resulting in a disallowance of Rs. 64,75,322.2. Validity and impact of the addendum to the agreement on the determination of royalty:The appellant introduced an addendum to the agreement effective retrospectively from 02-01-2002, which was admitted as additional evidence by the ITAT. The TPO, in the second round of proceedings, sustained the adjustment, disregarding the addendum as a post-facto arrangement to avoid tax liability. The Tribunal found that the addendum was not required to be registered or notarized and that it merely clarified the original intention of the parties. The Tribunal concluded that the addendum should be considered as it reflects the consistent conduct and actual intentions of the parties.3. Interpretation of the contractual terms between the appellant and TP USA regarding payment of royalty:The Tribunal emphasized the importance of the Foreign Collaboration Agreement dated 02-01-2002, which indicated that the appellant was set up to provide services to clients of TP USA. The Tribunal held that the agreement and the addendum clarified that royalty was to be paid on the entire sales revenue, including services rendered to third-party customers of TP USA. The Tribunal rejected the TPO's interpretation that services rendered through TP USA fall under the category of services rendered through an affiliate and concluded that TP USA, being the holding company, cannot be considered an affiliate. The Tribunal sustained the appellant's grounds, allowing the appeals with consequential effect.Order:The appeals of the assessee are allowed with consequential effect.