Net royalty taxation applies where excess payment is repaid under an Advance Pricing Agreement and only retained income is taxable.

Royalty paid to a non-resident under a treaty taxing only amounts actually "paid" was taxable only to the extent finally retained after a bona fide repayment made under an Advance Pricing Agreement. The agreement fixed a lower arm's length royalty and required the excess to be repaid to the Indian associated enterprise, with corresponding income reflected in the enterprise's modified return. The transfer pricing provisions invoked by the Revenue did not justify taxing the gross amount originally received, and the real income principle supported taxation only on the net amount retained.

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Issues: Whether the royalty actually taxable in India in the hands of the non-resident assessee was the full amount originally received from the Indian associated enterprise or only the reduced amount retained after repayment made pursuant to an Advance Pricing Agreement.

Analysis: The relevant treaty provision taxed only royalties "paid" to the non-resident. The Advance Pricing Agreement determined a lower arm's length royalty and required the excess to be repaid by the non-resident to the Indian associated enterprise. The repayment was made bona fide in implementation of the agreement, and the amount repaid was also reflected as income in the hands of the Indian enterprise through a modified return. The transfer pricing provisions did not justify taxing the gross amount originally received, because the adjustment under the agreement did not involve a transfer pricing recomputation under the statutory provisions invoked by the Revenue. The principle of real income also supported taxation only of the amount finally retained.

Conclusion: The royalty chargeable to tax in India was the amount finally retained after repayment under the agreement, not the gross amount initially received.

Ratio Decidendi: Where a treaty taxes only amounts actually "paid" and an excess royalty is bona fide repaid pursuant to a binding Advance Pricing Agreement, only the net amount ultimately retained constitutes taxable income in the hands of the recipient.

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