TPO cannot follow procedure other than given in Act & Rules

Court :
ITAT Mumbai
Brief :
CA Computer Associates Pvt. Ltd. (assessee) was incorporated during the year 1998 and was a 100 % subsidiary of Computer Associates International Inc. USA (CA – USA). The assessee was primarily engaged in the business of (i) licensing mainframe midrange and system infrastructure software products of CA Management Inc. USA (CAMI – USA); (ii) software that can be generally deployed “Out of box” or with customer/ industry specified adaptations; and (iii) development software that can allow technologies and programmes to write custom applications and create new categories of packaged applications. The assessee had set-up a Technical Support Centre in Chennai to provide support services to end users of thesoftware products on behalf of the CAMI – USA. As per the agreement with CAMI – USA, the assessee was appointed as the sole distributor of the products of CAMI – USA in India. The assessee for the assessment year (A.Y.) 2002-03 had declared a loss in its return of income. The case was selected for scrutiny and was referred to theTransfer Pricing Officer (TPO) by the Assessing Officer (AO) for determining the arm’s length price (ALP) of the international transaction entered into by assessee with its associated enterprises (AEs). The assessee had paid royalty amounting to Rs. 7,43,22,376 to CAMI – USA for distribution of thesoftware products in India. The assessee had benchmarked this royalty payment using Comparable Uncontrolled Price Method. However, the TPO had determined the ALP at NIL in relation to the royalty to the extent of Rs. 47,09,755 paid to CAMI-USA, which was corresponding to sales of Rs. 13,33,44,452 written off as bad debts in the books of account, on the following grounds: * The TPO observed that the assessee had written off sales amounting to Rs. 13,33,44,452 as bad debts and the invoices pertaining to these sales were also raised by the assessee during the same financial year relevant to assessment year under consideration. Further, the decision of write off was also taken in all the cases in the meeting of Board of Directors of the company held on 7 March 2002 in the same financial year. * Once the decision of write off of bad debts for the invoices raised during the previous year was taken on 7 March 2002, this amount would get reflected as amount non-receivable in the monthly reports, which would be available with the licensor. If such reports were available with the licensor for the amount of invoices raised duringthe year and written off during the year, the licensor should not have claimed royalty on such amounts written off, in the debit note raised on 31 March 2002. * Any independent entity, acting as a sole distributor of the off- the- shelf product of a licensor, would have sought for a waiver of royalty payable, considering the huge amount of non-receivables which ultimately it is forced towrite off as bad debts. * The assessee should have asked for a waiver of royalty corresponding to such write off, any independent entity, who is just distributor of the products, could have asked for such waiver, irrespective of the agreement provisions. When the assessee could not realize the amounts from the clients, forthe products distributed, belonging to CAMI – USA, how could a Royalty can be considered as payable. The independent entities acting independent of each other, would certainly enter into agreement for payment of Royalty, on the basis of actual collections made and not on the basis of just invoicing. * The contention of the assessee that it paid royalty at a lesser rate than paid in comparable uncontrolled transactions. This contention is not relevant in the present issue, because regarding the rate of royalty, there is no dispute, of being at Arm’s Length but issue at hand deals with the specific issue of royalty onwrite off of the invoiced amount during the year, itself. * In view of the fact that the assessee was only acting as Distributor, the products belonged to the licensor, these were the initial years of the business of the assessee, in the country, the bad debts risks were likely to be there, these facts would certainly be considered by the Independent Parties, while entering into distributor agreement and non-payment of royalty, on non realization of the proceeds would certainly be a condition in agreement entered at arm’s length. The assessee filed an appeal against the above adjustment made by the TPO, which had however been upheld by the Commissioner of Income Tax (Appeals) [CIT(A)]. The assessee filed an appeal against the CIT(A)’s order before the Income Tax Appellate Tribunal (ITAT). The core issue before the ITAT was not the method, which had been adopted for determining the ALP; but the way it was determined by the TPO. Contention of the Assessee before the ITAT: The assessee argued that the jurisdiction of the TPO is restricted to determine the ALP of any international transaction in view of the power vested in him under section 92CA(3) of the Act. The assessee further argued thatwrite off of the bad-debts cannot be the subject matter for determining the ALP so as to power of the TPO is concerned. Merely because royalty payments were relating to the product sold by the assessee to its client and the payment from them could not be recovered, cannot be the consideration before the TPO for deterring ALP of any international transaction. When specific methods have been prescribed in the Income Tax Act, 1961 (Act) and the Income Tax Rules, 1962 (Rules), the TPO is bound to determine ALP of any international transaction within the framework of the method prescribed by the Act.
Citation :
CA Computer Associates Pvt. Ltd. V. DCIT (2010-TIOL-68-ITAT-MUM

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