2025 (2) TMI 498 - HC - Income Tax

HC upholds deletion of TP additions on expatriate salary reimbursements and royalty payments, rejecting double deduction claim

HC upheld ITAT's deletion of TP additions relating to reimbursement of expatriate salaries and royalty payments, rejecting Revenue's claim of double ... TP Adjustment - Additions made for purported reimbursement of expatriate salaries and payment for royalty - finding and determination on the “double deduction” nature of the claim for such purported expenses along with “reimbursement of software expenses” with near identical details, use, functions and purposes purportedly served - ITAT deleted addition Determination of the ALP of reimbursement of software expenses - HELD THAT:- It is material to note that in the present appeal as well, no specific ground relating to the reimbursement of costs for provision of information technology services, which were erroneously included as a part of the costs relating to expatriates has been raised. Thus, the issue regarding determination of ALP or the payments made for information technology related services, does not sensu stricto arise. Reimbursement of Expatriate Costs - Assessee had disclosed the role of each of the expatriate employees. It had also produced sufficient evidence to show that the employees had served in India. It is further the Assessee’s contention that it had only reimbursed the amounts paid by the AEs to the expatriate employees without any mark-up. Since there was no element of any mark-up, the ALP could not be lower than the cost paid. Indisputably, the TPO cannot question the commercial wisdom in hiring expatriate employees for rendering assistance. The said decision falls within the scope of commercial expediency and the TPO cannot supplant its opinion in place of the Assessee in regard to need for such services. Plainly, price of resources employed to carry on business cannot be treated as nil if the assessee makes a loss. Illustratively, an assessee may lease an office for its business purposes but incurs a loss. Clearly the ALP of the lease rentals would not be nil because the assessee does not make a profit in the given year. The price of a resource is not contingent on whether the assessee makes a loss or profit. Assessee is required to maintain proper documentation with regard to any international transaction. Thus, the Assessee was obliged to produce relevant documents to establish the arrangement with the AE for employees seconded to the Assessee in India and the remuneration paid to each of the said expatriate employees. It is apparent from the order passed by the TPO that the Assessee had not produced such documentation. The TPO had also noted that the Assessee had not produced the break-up of the payments made to each of the employees. The international transactions regarding receipt of commission for assistance and sourcing was benchmarked using transactional net margin method (TNMM) as the most appropriate method. The commission earned for sourcing activities was found to be on arm’s length basis. Indisputably, the cost of any expatriate employees seconded to the Assessee for assistance in such activities would be subsumed as an element of cost. In the present case, the commission earned by the Assessee had been determined on arm’s length basis. This would necessarily take into account all elements of costs including payments made to AEs for reimbursement of salaries to expatriate employees. In the aforesaid view, we find no infirmity with the decision of the learned ITAT in accepting the CIT(A)’s decision to delete the addition made by the TPO in respect of reimbursement of costs of expatriate employees. Royalty receipts - ALP in respect of royalty cannot be determined as Nil on the ground that the Assessee had incurred losses. The decision of the Assessee to procure technical know-how for its activities is a commercial decision. The cost paid for technical know-how is one of the elements of costs, which was incurred by the Assessee for carrying on its business. The fact that the business retuned a loss cannot possibly lead to the conclusion that the ALP of the technical know-how is Nil. TPO’s reasoning in this regard is clearly flawed. Apart from acquiring technical know-how, there may have several other elements of costs such as cost for utilities, cost of labour etc. The fact that an assessee may incur a loss in its business, does not necessarily mean that the value of the utilities availed by it or the value of the labour employed is Nil. As noted hereinbefore, the arms’ length analysis is not concerned with the commercial expediency of incurring costs. It is merely confined to determining the ALP of the material or the services used. In the present case, the Assessee had in its commercial wisdom decided to acquire technical know-how for carrying on its business activities. This decision is not subject of a review on merits by the learned TPO. The learned TPO is to merely examine whether the amount paid by the Assessee for acquiring the technical know-how was on arms’ length basis. In other words, what would be the costs an assessee would require to pay if it had acquired the technical know-how from an entity other than its AE on an arms’ length basis. No infirmity found in the decision of the learned CIT(A) or the learned ITAT in setting aside the ALP adjustment as made by the AO on the recommendation of the TPO. Double deduction - We had pointedly asked Revenue as to what is the element of double deduction, however, apart from referring to the merits of the deletion of the ALP adjustments recommended by the TPO, the learned counsel did not point out any other aspect, which could possibly lead to the conclusion that the Assessee had availed of any double deduction in respect of any element of international transaction. Decided against revenue. ISSUES PRESENTED and CONSIDEREDThe core legal issue considered in the appeals was whether the Income Tax Appellate Tribunal (ITAT) unlawfully deleted the additions made by the Revenue for purported reimbursement of expatriate salaries and payment for royalty, without making an independent finding on the 'double deduction' nature of the claim. The issue also encompassed the question of whether the ITAT failed to assess the arm's length price (ALP) concerning these expenses and the reimbursement of software expenses with similar details, use, functions, and purposes.ISSUE-WISE DETAILED ANALYSIS1. Reimbursement of Expatriate Salaries:The legal framework involved the determination of the ALP under the transfer pricing regulations, particularly Sections 92B and 92CA of the Income Tax Act, 1961. The Tribunal was tasked with evaluating whether the reimbursement of expatriate salaries to the associated enterprises (AEs) was at arm's length.The Court noted that the Transfer Pricing Officer (TPO) had determined the ALP for the expatriate salary reimbursement as Nil, arguing that the expatriates were performing functions for the benefit of the AE, not the Assessee. The TPO also questioned the commercial wisdom of the Assessee in employing expatriates and doubted the benefit derived from them.The CIT(A) and ITAT, however, found that the Assessee had adequately demonstrated that the expatriates were working in India and that their salaries were reimbursed at cost without markup, thus meeting the arm's length standard. The Assessee had provided documentation, including visa and tax deduction at source (TDS) details, to substantiate the presence and roles of the expatriates in India.The Court held that the TPO's role is limited to determining the ALP and not questioning the commercial necessity of the transaction, citing precedents like Commissioner of Income Tax v. Cushman and Wakefield (India) Pvt. Ltd. The Court concluded that the ITAT was correct in upholding the CIT(A)'s deletion of the additions made by the TPO.2. Payment of Royalty:The issue involved the ALP determination for royalty payments made by the Assessee to its AE, Bencom S.R.L., for technical know-how and designs. The TPO had rejected the Assessee's Comparable Uncontrolled Price (CUP) method for benchmarking royalty, arguing that the Assessee incurred losses, which indicated that the technical know-how was of no value.The CIT(A) and ITAT disagreed with the TPO's reasoning, emphasizing that the commercial decision to pay royalty cannot be judged solely on the profitability of the Assessee. The Assessee had provided comparables showing royalty rates in the industry, which were consistent with the rates paid by the Assessee. The Court reiterated that the TPO should focus on whether the payment was at arm's length, not on the commercial expediency of the transaction.The Court upheld the ITAT's finding that the royalty payment was at arm's length, noting that the Assessee had furnished adequate documentation to demonstrate the receipt of technical know-how and its utility in maintaining the quality and design standards of its products.3. Reimbursement of Software Expenses:Although the issue of software expenses was mentioned, it was not a focal point in the appeals, as the Revenue did not specifically challenge the deletion of these expenses. The ITAT did not address this issue separately, as it was subsumed under the expatriate salary reimbursement, which was benchmarked using the transactional net margin method (TNMM).SIGNIFICANT HOLDINGSThe Court emphasized that the TPO's role is confined to determining the ALP and not questioning the business decisions of the Assessee. The Court upheld the ITAT's decision to delete the additions made by the TPO, finding no merit in the Revenue's appeals. The Court also noted that the Revenue failed to substantiate any claim of double deduction.The Court concluded that the Assessee had adequately demonstrated that the transactions were at arm's length, and the ITAT's decision was based on sound reasoning and evidence.