Bombay High Court Upholds APA-Based Royalty Adjustment; Refunded Rs. 19.44 Crore Cannot Be Taxed as Income of Foreign AE

The assessee, Gemological Institute of America Inc. (GIA US), is a US-based organization engaged in gem grading and certification services. It operated in India through its wholly-owned subsidiary, GIA India Laboratory Private Limited (GIA India), which carried out grading activities and paid royalty to GIA US for technical know-how, equipment, and group grading services. For Assessment Year 2011-12, GIA US declared royalty income of Rs.68.53 crore.

Meanwhile, GIA India entered into an Advance Pricing Agreement (APA) process with the CBDT covering future years as well as rollback years, including AY 2011-12. During the pendency of the APA proceedings, the Assessing Officer completed assessment of GIA US and held that GIA India constituted a Permanent Establishment (PE) of GIA US under the India–US DTAA. Consequently, the entire royalty income was taxed at a higher rate.

Subsequently, the APA was executed on 7 May 2018, under which the arm’s length royalty for AY 2011-12 was revised to Rs.49.08 crore. This resulted in excess royalty of Rs.19.44 crore having been paid to GIA US. In accordance with the APA terms, GIA India raised an invoice and GIA US refunded the excess amount on 18 July 2018.

Based on the executed APA and evidence of repayment, GIA US raised an additional ground before the ITAT seeking reduction of its taxable royalty income by the refunded amount. The ITAT accepted the claim, directed reduction of income to the extent of the actual refund, and further held that GIA India did not constitute a PE of GIA US. The Revenue challenged the order before the Bombay High Court.

The Bombay High Court dismissed the Revenue’s appeals and upheld the ITAT’s findings on both issues. On the question of Permanent Establishment, the Court observed that GIA India functioned as an independent legal entity carrying on its own business operations, entering into contracts with customers in India and assuming all business and commercial risks.

The mere fact that certain higher-carat diamonds were sent to GIA US for grading due to technological limitations did not transform the arrangement into a joint enterprise or create a fixed place, service, or agency PE under Article 5 of the India–US DTAA. The Court found no perversity in the Tribunal’s factual findings and held that no substantial question of law arose on this issue.

Regarding taxation of royalty, the Court rejected the Revenue’s reliance on Sections 92(3), 92C(4), and 92CE of the Income-tax Act. It held that these provisions could not prevent reduction of taxable income where excess royalty had actually been repaid pursuant to a valid APA executed with the CBDT. The Court emphasized that transfer pricing provisions cannot be applied in a manner that taxes income which was never ultimately retained by the assessee.

Applying the doctrine of real income and Article 12 of the India–US DTAA, the Court held that only the royalty actually retained by GIA US could be subjected to tax in India. Since the excess amount had been refunded under a bona fide APA framework, it did not represent real accrued income of the assessee. Thus, the ITAT was justified in admitting the additional ground and reducing the taxable royalty income by the amount refunded.

To Read Full Judgment, Download PDF Given Below