Recently, the Hon’ble Delhi High Court, in the case of Pr. Commissioner of Income Tax – 7, Delhi vs Sony India Pvt. Ltd.[1]  has adjudicated whether the role of the Transfer Pricing Officer (‘TPO’) is limited to determining the Arm’s Length Price (‘ALP’) of transactions between associated enterprises or can be extended to the determination of commercial expediency for entering into the transaction as well.

The summary of the judgment is as follows:

Facts

• Sony India Pvt. Ltd. (‘the Assessee’) is engaged in  importing and distributing various products under the brand name ‘Sony’.
• As per the internal arrangement between the Assessee and its Associated Enterprise, i.e., Sony Corporation, Japan (referred to as ‘Sony Japan’),the taxpayer has obtained a license for manufacturing and selling of various products, e.g., CD-R, CD-RW, USB Memory, etc., under the Sony brand. As per the arrangement, the Assessee is required to pay a royalty equal to 2% of the net sales as a license fee.
• However, the manufacturing activities for certain products were outsourced to OEMs appointed by Sony Japan, namely, Moser Bear India Ltd. and Competition Team Technology [India] Pvt. Ltd. (collectively referred to henceforth as ‘OEMs’). However, Sony Japan had not licensed any technology to the OEMs, and the products were required to be manufactured by the OEMs and supplied to the Assessee.

Contentions of the Ld. Transfer Pricing Officer

• The Ld. Transfer Pricing Officer (‘TPO’) held that since the OEMs manufactured the goods, the same did not justify any royalty payment by the Assessee to Sony Japan. Therefore, the Ld. TPO held that no royalty was payable on the Sony brand’s goods, which the OEMs manufactured.
• Pursuant to this, the Ld. Assessing Officer (‘AO’) passed a draft assessment order by disallowing the royalty amount paid. It is to be noted here that the Ld. TPO has disallowed the amount on the grounds that payment was not justified and not because the transaction was not at ALP.
• The Assessee filed its objections before the Hon’ble Dispute Resolution Panel against the draft assessment order, which was rejected. Pursuant to this, the Ld. AO passed the final assessment order.

Ruling of the Hon’ble Delhi ITAT

• On appeal to the Hon’ble Delhi ITAT against the final assessment order, the Hon’ble Delhi ITAT deleted the disallowance of the royalty paid to Sony Japan by relying upon the judgment in M/s Cushman and Wakefield’s case ^[2].
• It was held in Cushman and Wakefield (supra) that the TPO is required only to conduct a study to determine the ALP of an international transaction and not to determine the commercial expediency of the international transactions entered by the assessee with its associated enterprise.

Aggrieved by the decision of the Hon’ble Delhi ITAT, the Revenue filed an appeal before the Hon’ble Delhi High Court.

Question before the Hon’ble Delhi High Court

• Was the Hon’ble ITAT correct in not appreciating the Ld. TPO’s action of calculating the ALP at NIL for the royalty payments made by the Assessee to Sony Japan for the licenses that were used by the OEMs and not by the Assessee.

Judgment of the Hon’ble Delhi High Court

• Relying upon the judgment of the Hon’ble Delhi High Court in Cushman and Wakefield (supra), it was held that the Ld. TPO is not required to examine the efficacy of commercial transactions, and its role is confined only to determining the ALP of international transactions. Accordingly, the Hon’ble Delhi High Court upheld the order of the Hon’ble Delhi ITAT.

KNAV Comments

This judgment clarifies that the role of the TPO is limited to determining the arm’s length nature of international transactions, and the TPO cannot determine the commercial expediency of the transactions entered.

However, as per provisions of Chapter X-A of the Income-tax Act, 1961, i.e., General Anti-Avoidance Rules, the tax authorities may examine the commercial expediency of a transaction.

[1] ITA 551/2023 & CM Nos. 49717/2023 & 49718/2023

[2] Commissioner of Income Tax-I Vs. M/s Cushman and Wakefield (India) Pvt. Ltd., Neutral Citation No. 2014:DHC:2764-DB

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