Distribution Fee for Channel Distribution Not Royalty: ITAT Mumbai

Sony Pictures Networks India Pvt. Ltd. Vs DCIT (ITAT Mumbai)

The Income Tax Appellate Tribunal (ITAT), Mumbai, partly allowed the appeal of the assessee for Assessment Year 2013-14 concerning transfer pricing adjustments relating to distribution fees paid to Associated Enterprises (AEs), selection of comparables, and a claim for deduction of education cess and secondary and higher education cess. The assessee was engaged in the business of distributing television channels to Local Cable Operators (LCOs), Multi System Operators (MSOs), and Direct-to-Home (DTH) operators and had reported international transactions, including payment of distribution fees to its AEs.

The assessee benchmarked the distribution fee transaction using the Transactional Net Margin Method (TNMM) and selected four software distribution companies as comparables. The Transfer Pricing Officer (TPO) rejected all the selected comparables and held that the distribution fee paid by the assessee was in the nature of royalty. The TPO then benchmarked the transaction using royalty agreements sourced from a royalty database and determined an arm’s length royalty rate of 40%, resulting in a transfer pricing adjustment exceeding ₹513.79 crore. The Dispute Resolution Panel (DRP) upheld the TPO’s approach, and the final assessment order incorporated the adjustment.

Before the Tribunal, the assessee contended that the issue was covered by decisions in its own earlier assessment years. The Tribunal noted that in the assessee’s own case for Assessment Year 2011-12, it had already held that distribution fees paid by the assessee to its AEs could not be characterized as royalty. The Tribunal observed that the assessee merely acted as an intermediary between broadcasters and ultimate customers and paid distribution fees under distribution arrangements. It further noted that the view that distribution fees are not royalty had been upheld in earlier Tribunal decisions and affirmed by the Bombay High Court in related cases. Following those precedents, the Tribunal held that the distribution fee paid by the assessee could not be treated as royalty. Consequently, the discussion regarding royalty agreements selected as comparables became academic.

The Tribunal then examined the issue of comparables. It noted that the assessee had selected four software distribution companies—Avance Technologies Ltd., Integra Telecommunication & Software Ltd., Sonata Information Technology Ltd., and Trijal Industries Ltd.—for benchmarking under TNMM. The assessee argued that software distributors had been accepted as valid comparables in earlier years and that similar companies had been approved by the Delhi Tribunal in cases involving channel distributors. The Tribunal observed that two of the comparables, Avance Technologies Ltd. and Sonata Information Technology Ltd., had already been accepted as valid comparables in the assessee’s own case for Assessment Year 2011-12. It also noted that Integra Telecommunication & Software Ltd. and Trijal Industries Ltd. had been accepted as comparables in decisions involving channel distribution businesses.

However, the Tribunal found that the TPO had summarily rejected these companies without properly examining their segmental information. Accordingly, while agreeing in principle that the four companies could be considered comparable to the assessee’s business, the Tribunal directed the Assessing Officer (AO)/TPO to verify their segmental data for the relevant financial year in accordance with Rule 10B(4) and recompute the transfer pricing adjustment after granting an opportunity of hearing to the assessee.

The assessee also raised a grievance regarding short grant of tax deducted at source (TDS) credit. The Tribunal directed the AO to verify the TDS details and grant appropriate relief after examining the records.

Additionally, the assessee raised an additional ground before the Tribunal seeking deduction of education cess and secondary and higher education cess paid on income tax liability while computing business income. The assessee relied on the Bombay High Court decision in Sesa Goa Ltd. The Tribunal admitted the additional ground, observing that all necessary facts were already on record and no fresh investigation was required. Since the claim was raised for the first time before the Tribunal, it restored the issue to the AO for verification of facts and fresh adjudication after considering the Bombay High Court decision and providing an opportunity of hearing to the assessee.

Accordingly, the Tribunal held that distribution fees could not be characterized as royalty, directed verification of the software distributor comparables and recomputation of transfer pricing adjustment, directed verification of TDS credit, and remanded the claim regarding deduction of education cess and secondary and higher education cess to the AO. The appeal was partly allowed.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

1. This appeal by assessee is directed against the final assessment order passed under section 143(3) read with section 144C(13), passed in pursuance of directions of Dispute Resolution Penal (DRP) dated 27/09/2017. The assessee has raised following grounds of appeal:

General Ground

1. Erred in assessing the total income of the Appellant at Rs 544,03,97,977/-against Rs 30,24,26,907/- as computed by the Appellant in its return of income;

Transfer Pricing Grounds

2. Erred in making a transfer pricing adjustment of Rs. 513,79,71,070/- to the total income of the Appellant on the premise that the international transactions entered by the Appellant with its associated enterprises (‘AES’) were not at arm’s length;

Reference made to the Transfer Pricing Officer

3. Erred in referring the Appellant’s case to the Learned Transfer Pricing Officer (‘TPO’) under Section 92CA(I) of the Act, without satisfying the conditions specified therein;

TPO Erred in characterizing the distribution fee paid be MSMD to its AE as Royalty.

4. Erred in characterizing the distribution fee paid/ payable by the appellant to its AE to be in the nature of Royalty.

Rejection of economic analysis undertaken by the Appellant in its transfer pricing study report

5. Erred in not following the Appellant’s own order for AY 2010-11 which was passed by the Hon’ble DRP accepting software distributors as appropriate comparable to benchmark the Appellant’s international transactions inspite of there being no change in facts in A Y 2011-12.

6. Erred in rejecting the transfer pricing analysis undertaken by the Appellant under Section 92C of the Act and disregarding the fact that software distributors are appropriate com parables to benchmark MSMD’s international transactions in the absence of any direct comparables.

7. Erred in law and in facts, in rejecting the following companies from the Transfer Pricing Study for FY 2012-13 which are comparable to the Appellant:

(i) Avance Technology Limited

(ii) Integra Technology and software Limited

(iii) Sonata Information Technology Limited

(iv) Trijal Industries Limited

Benchmarking analysis undertaken by the learned TPO/ Hon’ble DRP by  considering royalty agreements as Comparable Uncontrolled Price (CUP’)  to benchmark Appellant’s international transactions

8. Erred in selecting the CUP to benchmark the international transactions of the Appellant without appreciating that Transaction Net Margin (‘TNMM’) is the most appropriate method to benchmark the Appellant’s international transactions;

9. Erred in not appreciating that the distribution agreements like that entered into by the appellant with its AE is different from a ‘license/Royalty’ agreement selected by honourable DRP/the learned TPO to benchmark the appellant’s international transactions;

10. Erred in considering royalty agreements as comparable to benchmark the appellant’s distribution activity whether its AEs disregarding the fact that all agreements are functionally different and are entered into in different geographies (ie other than India) has the economic and commercial circumstances under which they are entered would be different from the distribution agreement entered by the appellant;

11. Without prejudice to the royalty agreements selected by learned TPO/Hon’ble DRP not being appropriate comparables, the learned TPO/Hon’ble DRP has erroneously arrived at LP of 40% by considering the royalty rate of the agreement between Ruff nations Films and New Line Television at 30% instead of 70%

Internal comparability

12. without prejudice to the other grounds, should software distribution are appropriate comparable, internal comparable are suitable over the royalty agreements selected by the Hon’ble DRP/ learned TPO to benchmark the Appellant’s international transactions;

Selection of local cable operators (LCO)/multisystem operator (MSO)/ direct to home (DTH) as comparables

13. Without prejudice to the other grounds, should software distributors be rejected as comparables then local cable operators (LCO)/ multisystem is operators (MSO)/direct to home(DTH) companies can be considered as appropriate comparables.

Short grant of tax deducted at source (TDS)

14. erred in short granting credit of taxes deducted at source of Rs 362,81,929/- while computing the tax liability for the year;

Penalty Proceedings

15. Erred in initiating penalty proceedings under Section 271 (1)(c) of the Act.

2. The assessee vide its application dated 19.06.2020, has raised following additional grounds of appeal;

16 – Deduction of education and secondary and higher education cess paid on the income-tax liability

1. The assessee submits that deduction shall be granted under the head “Profits and Gains from Business or Profession” with respect to education cess and secondary higher education cess levied on its income under the Act.

3. Brief facts of the case are that the assessee was a joint venture between Multi Screen Media Private Limited (MSMI) and Discovery Communications India (DCI) during the relevant Financial Year, the assessee was engaged in the business of distribution of channels to Local Cable Operators (‘LCOs’), Multi System Operators (‘MSOs’) and Direct to Home (‘DTH’) operators. The assessee while filing return of income reported international transaction with its Associate Enterprises (AE) of distribution fee. The assessee in Form 3CEB, reported international transaction of license fee paid/payable for distribution of Television Channels in the following manner:

4. The assessee bench marked the transaction of ‘distribution fee’ by adopting Transaction Net Margin Method (‘TNMM’) and selected software distributor i.e. company engaged in selling intangible products as comparable on the ground that information regarding the companies carrying on the same function was not available in the public domain. The assessee selected the following four comparable:

5. The assessee claimed its margin of 2.90% from distribution of AE Channel which was higher than the arithmetical means of 0.50% earned by comparable company, hence, the assessee claimed that its transaction with its AE was at arm’s length. The assessee undertook the search and identify the four software distributor as appropriate comparable namely (i) Avance Technology Limited (Avance), (ii) Integra Telecommunication & Software Limited (Integra), (iii) Sonata Information Technology Limited (Sonata) and (iv) Trijal Industries Limited (Trijal). The assessee also claimed that in AY 2010-11, the TPO and DRP accepted software distributor as appropriate comparable to benchmark the assessee’s transaction.

6. The TPO rejected all the comparable of the assessee and held that the comparable selected by the assessee does not fit in the software distribution and that the assessee has selected the comparable having low margin which suits the requirement of TP study.

7. However, during the Transfer Pricing assessment proceeding before the Transfer Pricing Officer (TPO), the assessee vide notice dated 13.09.2016 and 190.09.2016 was asked as to why the bench mark conducted by the assessee should not be rejected on the same basis as in the previous year. The assessee was also asked as to why the agreement based Royalty stat based search conducted by TPO should not be considered as comparable to benchmark the distribution fee paid by assessee to its AEs. The assessee was also show caused as to why the rate of subscription earned by the assessee from third party should be adopted.

8. In reply to the show cause the assessee explained that margin earned by MSMD from distribution of third party channel, the MSMD is involved in the distribution of channels to Local Cable Operators (LCO)/ Multi System Operator (MSO) and Direct to Home (DTH) operators. For this purpose, MSMD had contracted directly with its AEs distribution of its channel in India. Under the said distribution agreement, MSMD collects subscription revenues and remits 90% of the same to AEs while retaining the balance 10%. It was also explained that MSMD also distributes a few channels to third-party channels during FY 2012-13 such as TV Today Network and Neo Sports Broadcast Limited. Copy of those agreements was furnished. The assessee claimed that it had earned a margin of 2.90% from the distribution of AE channel viz-a-vis (-) 25.26% from distribution third-party channels during this year. Thus, the assessee continues to be an arm’s length margin. Even at the gross level MSMD has and a margin of 10% vis-a-vis 6.54% earned from distribution of third-party channels. Thus, even at the gross level the margin earned by MSMD from distribution of a channel is at arm’s length. Assessee further submitted that margin earned by MSMD from distribution of AE is 1.71% as compared to the margins earned from non-AE channels of (-)1.53% where other income and all expenses (other than subscription pay out) are allocated on subscription basis.

9. The TPO after considering the reply summarily rejected the contention of the assessee, without examining the benchmarking of comparables and held that distribution fee paid by assessee is in the nature of ‘Royalty’ and accordingly benchmarked the international transaction on the basis of 2 Royalty-stat database in the following manner:

10. The TPO made the adjustment in the following manner: “The adjustment amount in the case of assessee is worked out as under:

11. Thus, the TPO suggested upward adjustment of Rs. 513,79,71,070/- on account of distribution fee to its AE. The adjustment was rectified by TPO vide order dated 27^th March 2018 under section 92CA(5) and was reduced to Rs. 308,27,82,462/-. On receipt of report of TPO, the Assessing Officer passed the draft assessment order under section 143(3) r.w.s. 144C(1) dated 27.02.2015. The copy of draft assessment order was served upon the assessee. The assessee exercised its option for filing objection before the Dispute Resolution Panel (DRP). The ld. DRP affirm the action of TPO in rejecting the comparable selected by assessee to substantiate its benchmarking under TNMM. The DRP also affirmed the action of TPO in treating the payment of distribution fee as Royalty by taking view that there is no change in the facts as of in earlier years (AY 2012-13), wherein they have a affirmed the order of TPO.

12. On receipt of the direction of the DRP, the assessing officer passed the final assessment order dated 23.10.2017 under section 143(3) read with section 144C(13), in pursuance of direction of ld DRP, by making T.P. Adjustment to Rs. 513,79,71,070/-, (which later on reduced to Rs. 308,27,82,462/-). Further aggrieved, the assessee has filed this appeal before this Tribunal.

13. We have heard the submissions of learned Senior Counsel Sh. J.D. Mistry (ld. AR), of the assessee and the learned CIT-DR for the revenue. At the outset the learned Sr Counsel Mr. Mistry submits that the grounds of appeal related with the transfer pricing (TP) adjustment are covered in favour of assessee by the decision of this Tribunal in assessee’s own case for assessment year 2011-12 (ITA No. 971/Mum/2016) dated 16^th March 2020, wherein the assessee raised identical grounds of appeal. The learned AR of the assessee further submits the lower authorities while passing the orders have relied on the orders for AY 2012-13, which in turn has relied on the orders for AY 2011-12. In AY 2011-12, the Tribunal categorically held distribution fees paid by the assessee to its associated enterprises (AE) is not “Royalty”. The ld. AR of the assessee further submits that “distribution fees” is not in the nature of Royalty has been upheld by Tribunal and affirmed by Hon’ble Bombay High Court in the hands of payer as well as the recipient of distribution fees in case of SET India Private Limited (ITA No. 1347/2013 and in case of recipient of distribution fees in CIT vs. MSM Satellite (Singapore) Pte Limited (ITA No. 103 & 207/2017. The learned AR furnished the copy of decision of Tribunal and copy of decision of Hon’ble Bombay High Court.

14. On the other hand the ld. DR for the revenue supported the order of the lower authorities.

15. We have considered the submissions of both the parties and gone through the order of the lower authorities. We have seen that on similar set of facts the coordinate bench of the Tribunal in assessee’s own case for AY 201-12 on the issue held that the distribution fee paid by the assessee to its AE is not ‘Royalty’. The coordinate bench (authored by JM) passed the following order;

“30. We have considered the rival submissions of the parties and have gone through the orders of the lower authorities. The first issue for our consideration is whether the ‘distribution fee’ is in the nature of ‘Royalty’ or not. Before us the ld. AR for the assessee vehemently submitted that the TPO wrongly characterized the channel distribution fee as Royalty. It was further explained that the assessee acts as a intermediary between the broadcaster and the ultimate customers who uses the channels. Thus, distribution fee paid by the assessee cannot be termed as Royalty. This fact in not controverted by ld. DR for the revenue nor any contrary facts were brought on record by the lower authorities. The ld. DRP in assessee’s MSM Satellite (Singapore) Pte Ltd in its order dated 19.12.2014 for AY 2010-11 by following the order of Tribunal for AY 2005-06 & 2006-07 dated 28.08.2015 held that distribution revenue is not Royalty income. The Hon’ble Bombay High Court in CIT Vs SET India Pvt Ltd (ITA No. 1347 of 2013) held that the distribution fee paid is not in the nature of royalty. Similar view was affirmed by Hon’ble Bombay High Court in CIT Vs MSM Satellite (Singapore) Pte Ltd (ITA No. 103 of 2017). Considering the decision of the Hon’ble Jurisdictional High Court and respectfully following the same, we are of the view that the payment of distribution fee cannot be termed as ‘Royalty’. Since, we have held that distribution fee cannot be termed as ‘Royalty’ thus; discussion on the royalty agreement selected for comparability has become academic.”

16. On the rejection of comparables, the learned AR of the assessee submits that the assessee selected four comparable to benchmark its transaction under TNMM method. The lower authorities rejected all four comparables. The learned AR for the assessee further submits that two comparable companies namely Avance and Sonata are common with the set of comparable with AY 2011-12, which have been held as engaged in software distribution activity and comparable with the assessee. Further, remaining two comparable; namely Integra Telecommunication and Software Ltd and Trijel Industries Ltd are accepted as a valid comparable by Delhi Tribunal in Turner International Private Ltd. Vs DCIT (ITA No.218/ Delhi/2017 and ITA No. 1069/Delhi/2014 for AY 2009-10 and 2012-13). The Delhi Tribunal accepted both these comparable with channel distributor. Trijal was also held to be valid comparable in Turner International Private Ltd. For AY 2010-11.

17. The learned AR submits that in case two comparables, which are common in AY 2011-12, are accepted, the arithmetic mean of comparable set would be in within tolerance range. And remaining two comparable was held as valid comparable for Channel Distribution Company. Accordingly, if all four comparable are reinstated as valid comparable, the arithmetic mean of the comparable would be with tolerance range of assessee’s margin.

18. On the other hand the learned DR for the revenue supported the order of lower authorities.

19. We have considered the rival submission of the parties and have gone through the orders of lower authorities. We have also considered the written submissions filed by ld. Briefing Counsel Sh. Hiten Chande, Advocate on 26.06.2020. We have also deliberated on the case laws relied by learned Sr Counsel of the assessee. We have seen that in assessee’s own case for AY 2011-12, (ITA No. 971/Mum/2016) the coordinate bench while examining and accepting the validity of comparability of Avance and Sonata passed the following order;

“25. We have considered the submission of both the parties and perused the record. The TPO during the TP Adjustment proceeding rejected Avance on the ground that this companies is engaged in software trading, sales of hardware and other services and no segmental information is available. DRP upheld the action of on the basis of order for A.Y. 2010-11.Before Tribunal, the assessee has placed on record the financial statement of Avance. Perusal of financial statement reveals that this company has earned Rs. 140 Crore from sale of software out of total sales of Rs. 176 Crore. This company has approximately 80% of its income from software product. Thus, segmental information as placed before us is available at (Page No. 204 to 205 of Paper Book). Further, while rejecting Empower, the TPO held that this company is engaged in selling of hardware and no segmental are available. From the financial statement placed before Tribunal at (Page No. 207 to 219 of the Paper Book) As per discussion available on Page No. 22 of Annual Report of this comparable (Page No. 209) the company has earned more than 80% of its revenue from software sales. Similarly, Sonata was rejected by TPO by taking view that this company is engaged in software trading, consultancy services. We have noted that this comparable was accepted in A.Y. 2020-11 by TPO himself in its order dated 29.01.2014. Further, financials of this comparable shown that this company has earned Rs. 584 Crore from distribution of software product out of total sales of Rs. 597 Crore, thus, earned 97.49% of its total revenue from software product (Page No. 224 of the Paper Book). SVAM Software was rejected by TPO on the ground that this comparable is engaged in software development, sale purchase of software and computer related hardware. The revenue of software is only Rs. 2 Crore against the total revenue of Rs. 20 Crore. From the financial of this company it is noted that entire income of Rs. 2.09 Crore is shown from sales (sale of product). Considering the nature and activities carried out by all these 4 comparable company which are primarily engaged in distribution of software product as noted above. The software distribution company are held to be good comparable to distributor satellite channels in Turner International India (P.) Ltd. vs. ACIT (supra). Therefore, we accept the submission of ld. AR of the assessee to accept these comparable as comparable with assessee and direct the AO/TPO to work out the T.P. Adjustment afresh. Needless to order that before passing the order, the TPO/Assessing Officer shall grant opportunity to the assessee. In the result, the grounds related to comparability of comparable are allowed in accordance with the aforesaid directions. Considering the fact that we have allowed the functional comparability, therefore, discussions on alternative adjustment held by DRP have become academic.”

20. We have further seen that Delhi Tribunal in Turner International India Private Limited (supra) for AY 2012-13 has accepted Integra and Trijal as valid comparable again in Turner International India Private Limited (supra) for AY 2010-11 (2019 101 com 446 Del Tri) and in AY 2006-07 (ITA No.1204/Del/2014, with Channel Distributor.

21. Considering the facts that the Avance and Sonata were accepted as valid comparable in assessee’s own case in AY 2011-12 in ITA No. 971/Mum/2016 and Trijel and Integra was held as valid comparable with channel distribution, therefore, we in principal agree and accept the submission of ld. AR of the assessee to accept these four comparable as comparable with assessee. However, we have seen that the TPO rejected the comparability of these comparable summarily, without examining their segmental data, hence we direct the AO/TPO to verify the segmental data of these four comparable for the relevant financial years as per Rule 10B(4) and recompute the TP adjustment afresh and allow appropriate relief to the assessee. The assessee is also directed to provide all necessary information and evidence to the TPO/AO. Needless to order that before passing the order, the TPO/Assessing Officer shall grant opportunity to the assessee. In the result, the grounds related to comparability of comparable are allowed in accordance with the aforesaid directions.

22. Ground No. 14 relates to short deduction of TDS. The ld AR for the assessee submits that the assessee has already filed an application for rectification, however, no order has been passed by the assessing officer till now, therefore, the assessing officer be directed to expedite the order. Considering the submissions of the ld. AR for the assessee the assessing officer is directed to verify the TDS details and grant appropriate relief to the assessee after verifying the details as early as possible.

23. Ground No.15 relates to initiation of penalty u/s 271(1)(c). This ground of appeal is premature and needs no specific direction.

24. Ground No. 16 (additional ground of appeal) relates to deduction of education secondary and higher education cess.

25. The learned AR of the assessee submits that assessee has raised additional ground of appeal, with regard to deduction of education secondary and higher education cess paid on the income tax liability. The assessee while filing return of income for A.Y. 2013-14, had paid Education cess and Higher Education cess levied by virtue of the Finance Act, 2013. The Assessing officer after making the addition of Rs. 513,79,71,070/- in the final assessment order computed the Education Cess and Higher Education Cess at Rs. 5,14,11,761/- which was subsequently rectified vide order dated 13.04.2018 to Rs. 3,19,90,320/-. The Jurisdictional High Court in Sesa Goa Ltd Vs JCIT (107 CCH 0376 BHC) have taken a view that the Education cess and Secondary Higher Education cess is deductible as an expenditure while computing the income under the head “Profits and Gains from Business or Profession”. Therefore, considering the decisions of Bombay High Court, the assessee has raises an additional ground of appeal with respect to deduction of Education cess and Secondary Higher Education cess levied on its income. No additional facts are required to be brought on record. All the facts related with the additional ground of appeal are emanating from the record of lower authorities.

26. On the other hand the learned DR for the revenue submits that no such additional ground of appeal or plea was raised by assessee was raised before the lower authorities. The additional ground of appeal is raised belatedly and need no consideration at this stage.

27. In the rejoinder submissions the ld. AR for the assessee submits that his contention was also considered by Hon’ble High Court and held that the Tribunal was duty bound to consider such claims. After seeking permissions to further reply, the learned DR further submits that in case the Hon’ble Tribunal considered it necessary for admitting the additional ground of appeal, the issue raised in additional ground of appeal may be restored to the file of lower authorities for verification of fact and consideration it at the end of lower authorities.

28. We have considering the rival submissions of the parties and gone through the copy of income tax return furnished by the assessee and the assessment order passed by the assessing officer and the working of income tax calculated and rectified by assessing officer. Considering the facts and circumstances of the case and the submissions of ld representatives of the parties that no additional facts are required to the brought on record and the necessary facts for adjudicating the additional grounds of appeal are already available on record, we admits the additional ground of appeal. Further considering the facts that the assessee has raised the additional ground for the first time before the Tribunal, therefore, we direct the assessing officer to verify the facts and pass the order afresh on this issue (claim), after considering the decision of Bombay High Court in Sisa Goa Ltd (supra). Needless to order that before passing the order the assessing officer shall grant opportunity of hearing to the assessee. In the result, the additional ground of appeal is allowed for statistical purpose.

29. In the result, appeal of the assessee is partly allowed.

Order pronounced in the open court on 29/06/2020.