Invoice on AE to be raised to Recover Excess Payment, If Royalty exceeds its ALP as per Advance Pricing Agreement: ITAT

Invoice on AE - excess payment- ALP- Advance Pricing Agreement - ITAT - taxscan

The Income Tax Appellate Tribunal (ITAT), Mumbai Bench ruled that if payment of royalty by the GIA India to the assessee was to exceed its arm’s length price, as determined in the APA, the applicant, the GIA India shall raise the appropriate invoice on the AE to recover the excess payment.

The royalties so received by the assessee company, Gemological Institute of America Inc. were duly offered to tax, under article 12 of the India US Double Taxation Avoidance Agreement at the rate of 15% on a gross basis. While the authorities below had no issues about the quantum of income so offered to tax, there were certain issues with regard to the manner in which the said income is to be taxed as the stand of the authorities below has been that the assessee had a permanent establishment of the assessee in India, and the royalties so offered to tax, being attributable to such a permanent establishment, are liable to be taxed on a net basis under article 7 of the Indo US tax treaty.

In the meantime, GIA India reached out to the Central Board of Direct Taxes for an Advance Pricing Agreement (APA), under section 92CC, in respect of, inter alia, the above transactions. 0n 7th May 2018, the APA was finally entered into between the GIA India and the CBDT. This APA was for five consecutive previous years, namely financial period ended 31st March 2014, 2105, 2016,and 2017, it also covered, as a rollback period, four consecutive preceding previous years as well i.e., financial periods ended 31st March 2010, 2011,2012 and 2013. This agreement, under clause 12(a) thereof, was to “cease to be binding on parties, subsequent to it having been entered into, if (inter alia), there is failure to meet any of the critical assumptions of this agreement”.

The issue raised in this was is concerning the impact of Advance Pricing Agreement being signed by the assessee’s Indian associated enterprises, namely GIA India Laboratory Pvt. Ltd, with the Central Board of Direct Taxes, in terms of which a part of the royalty received by the assessee company from its Indian AE had to refund to the Indian AE.

The short question requiring the adjudication is whether the amount so refunded by the assessee company to its Indian AE, in terms of the APA terms, can still be taxed in the hands of the assessee company as its income.

The coram of Vice President Pramod Kumar noted that one of the “critical assumptions” in the APA between GIA India, an AE of the assessee, and the CBDT was that if payment of royalty by the GIA India to the assessee was to exceed its arm’s length price, as determined in the APA, “the applicant (i.e., the GIA India) shall raise the appropriate invoice on the AE to recover the aforesaid excess payment made and show the respective excess amounts as additional income in the modified return of the respective years.” Under rule 10F(f) critical assumption means “the factors and assumptions that are so critical and significant that neither party entering into an agreement will continue to be bound by the agreement, if any of the factors or assumptions are changed.”

“These royalty refunds by, or royalty recoveries from, the assessee are not standalone events, which can be seen in isolation with the receipts of related royalties in the corresponding previous year. These refunds and recoveries of royalties are thus required to be seen in conjunction with the associated receipts of royalties from GIA India,” the ITAT said.

The ITAT added that corresponding refund to the GIA-India has been shown as an income of the GIA-India, and offered to tax as such, by way of a modified return in consequence of the APA, as were the terms of critical assumption which required that the GIA India “shall raise an appropriate invoice on the AE to recover the aforesaid excess payment made and show the respective excess amounts as additional income in the modified return of the respective years”. There was also a time limit granted to carry out this exercise inasmuch as under critical assumption 5.2, it was provided that “(f)or the additional income referred to in Para 5.1 the applicant (GIA-India) shall raise an invoice for the equivalent amount in the month following the month in which this Agreement is signed. The invoice shall be realised within 60 days of the date of the issue of the invoice”.

The Tribunal deemed it fit and proper to accept the claim of the assessee, in principle, but remitted it back to the Assessing Officer for verification of factual elements embedded in the claim of the assessee.

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