APA Refund Reduces Taxable Royalty, No PE in India: Bombay HC

HC Applies Real Income Doctrine; Holds Excess Royalty Refunded Pursuant to AE’s APA Not Taxable

Summary: The Bombay High Court in Pr Commissioner Of Income Tax vs Gemological Institute Of America Inc on 16 June, 2026 held that only the royalty ultimately retained by the US parent company after implementation of an Advance Pricing Agreement (APA) could be taxed in India, applying the doctrine of real income. The Court observed that the APA determined the arm’s length royalty payable by the Indian subsidiary, requiring the excess royalty already received by the foreign parent to be refunded. Since the refund was genuine, mandatory under the APA, and actually made, the excess amount never constituted the assessee’s real income. The Court rejected the Revenue’s contention that tax should be levied on the original royalty receipt and held that taxing refunded royalty while simultaneously denying deduction to the Indian subsidiary would produce an anomalous result. The Court also upheld the ITAT’s finding that the Indian subsidiary did not constitute a Fixed Place, Service, or Agency Permanent Establishment (PE) of the foreign company under the India-US DTAA, as it functioned independently and bore its own business risks.

Facts:

• The Respondent (GIA US) is a US-based company and a world leader engaged in the business of gem grading/certification, which is a critical function associated with cutting, polishing and sale of diamonds. A large part of the world’s diamond cutting industry is located in India and needs to avail the grading services. The GIA Group, therefore, incorporated a wholly owned subsidiary in India, namely GIA India, on 26th September 2007, to grade diamonds. For this purpose, GIA US also provided it with the required equipment, technical know-how, expertise, etc. Similar to the set up in India, GIA US has also set up subsidiaries in Thailand and Botswana for the same reason.
• For the technical know-how and expertise, etc., royalty was charged by GIA US (the Respondent) to GIA India for A.Y. 2011-2012. In the earlier years, post commencement of business, due to technical and physical constraints, diamonds of more than 1.99 carats, or those in excess of GIA India’s grading capacity, were accepted for grading by GIA India and thereafter sent to GIA US or other subsidiaries of the group for grading. This inter group grading services were charged/paid for by the group companies at an agreed rate as per the GIA Gem Grading Services Agreement, which is accepted by the Indian Tax Authorities to be at an Arm’s Length in case of both GIA India as well as GIA US. It transpires that subsequently GIA India progressively started grading diamonds of higher carats, and currently it can grade diamonds of upto 3.99 carats.
• For A.Y. 2011-2012, GIA US filed its Return of Income on 10^th November 2011, declaring a total income of Rs.68,53,46,239/-, which was the royalty received from GIA India, and offered to tax. A revised Return of Income was also filed on 6th September 2012, which also included the said royalty income. The case of GIA US was selected for scrutiny, and the transaction being an international transaction, initially, on 18th February 2014, a reference was made by the Assistant Commissioner of Income Tax (International Taxation), Circle-2(3)(2) [the Assessing Officer of GIA US] to the Transfer Pricing Officer (“TPO”) for computation of the Arm’s Length Price (“ALP”). On 29th January 2015, the TPO passed his order under section 92CA(3) proposing a NIL adjustment. Thereafter, the Assistant Commissioner of Income Tax (International Taxation), Circle-2(3)(2), passed a draft Assessment Order dated 23rd March 2015 under Section 144C(1) read with Section 143(3) of the Income Tax Act, 1961 (for short “IT Act”).
• Aggrieved by the said draft Assessment Order, GIA US raised its objections before the Dispute Resolution Panel (for short the “DRP”), which issued its directions on 27th October 2015. Thereafter, the said Assistant Commissioner of Income Tax passed a final Assessment Order dated 16th December 2015 and assessed GIA US’ total income at Rs.72,88,67,984/-. This was on the basis that GIA US has a Permanent Establishment (PE) in India and therefore, as per Article 7 of the India-US DTAA, assessed the entire income of GIA US, including the aforementioned royalty income, at 42.23%.
• Aggrieved by the final Assessment Order dated 16th December 2015, GIA US filed an Appeal before the ITAT on 25th January 2016, which was lodged with the ITAT as Income Tax Appeal No. 386/Mum/2016. It is undisputed that much before any reference was made to the Transfer Pricing Officer either in the case of GIA US or GIA India (date of making reference to the TPO in the case of GIA India was 16th December 2013), GIA India filed an application dated 22nd March 2013 for entering into an Advance Pricing Agreement (for short the “APA”) with the Central Board of Direct Taxes (for short the “CBDT”) under Section 92CC of the IT Act for A.Ys. 2014-2015 to 2017-2019. This application was for the determination of the ALP of the royalty paid by GIA India to GIA US. For the roll-back period of A.Y. 2010- 2011 to 2013-2014, GIA India filed an application on 30th March 2015 under Section 92CC(9A) of the IT Act. It appears that after a prolonged negotiation, the CBDT entered into an APA dated 7th May 2018 with GIA India, inter alia, determining the ALP (Arm’s Length Price) of royalty and also requiring the excess royalty received by GIA US to be repaid to GIA India. As mentioned earlier, for A.Y. 2011-2012, royalty paid by the GIA India to GIA US was Rs.68,53,46,239/-. However, the ALP of royalty, as determined by the APA, was Rs.49,08,99,461/-. Accordingly, as per the APA, GIA US was liable to refund to GIA India the excess amount of Rs.19,44,46,788/- within a stipulated period. The aforesaid exercise (with different figures) also applied to A.Y. 2012-2013 to A.Y. 2017-2018. To ensure that the excess amount of royalty paid by GIA India to GIA US was refunded, the APA dated 7th May 2018, inter alia, required GIA India to raise an invoice in respect of the excess royalty paid, and for income tax purposes, to reduce the claim of royalty deduction made by it originally in its Return of Income by filing a modified Return of Income for the Assessment Year under consideration. Accordingly, the aforementioned excess sums were invoiced by GIA India to GIA US, and GIA India filed its modified Return of Income, reducing the deduction claimed on account of payment of royalty. For the excess amount paid for A.Y. 2011-2012 (Rs.19,44,46,788/-) an invoice dated 30th June 2018 was raised by the GIA India on GIA US, and in terms of the said invoice, GIA US paid the aforesaid amount to GIA India on 18th July 2018. Payments for the other Assessment Years were also made within the time stipulated as per the APA.
• Since the ALP was now determined as per the APA entered into between the CBDT and GIA India, and the excess royalty amount paid was also refunded by GIA US to GIA India, GIA US in its Appeal pending before the ITAT (ITXA No. 386/Mum/2016), sought to raise an additional ground by its letter dated 6th November 2018, claiming that the amount of Rs.19,44,46,788/-, which was refunded back to GIA India as per APA dated 7th May 2018, could not be regarded as its income and GIA US should not be assessed on the same. In the Appeals filed in relation to A.Y. 2012-2013 to 2013-2014, similar additional grounds were raised by GIA US before the ITAT. For A.Y. 2014-2015 to 2016-2017, this issue was raised before the DRP, and for A.Y. 2017-2018, the said claim was made by way of a revised Return of Income filed on 30th November 2018. It is pertinent to note that the revised Return of Income of GIA US for A.Y. 2017-2018 was accepted by the Assistant Commissioner of Income Tax (International Taxation), Circle-2(3)(2).
• The appeals for A.Y. 2011-2012 to A.Y. 2016-2017 were consolidated and were decided by the ITAT by a common order dated 30^th April 2021. The additional grounds raised by GIA US in respect of the reduction from its total income of the excess royalty paid back to GIA India were allowed, and the amounts repaid by GIA US to GIA India were directed to be reduced from the total income of GIA US, subject to verification of GIA US having paid the amounts back to GIA India. The ITAT also held that GIA US did not have a PE (Permanent Establishment) in India, and therefore, royalty income was taxable at 10% in terms of Section 9 read with Section 115A of the IT Act, as opposed to the rate of 42.23% applied by the Assistant Commissioner of Income Tax (International Taxation). Thus, by virtue of the ITAT order dated 30th April 2021 passed for A.Y. 2011-2012 to 2016-2017, as well as the Assessment Order dated 20th April 2021 passed by the Assistant Commissioner of Income Tax (International Taxation) for A.Y. 2017-2018,the position was that GIA India got a lesser deduction of royalty and correspondingly, the GIA US’ income was reduced by the same amount. It is aggrieved by this order of the ITAT that ITXA No. 2306 of 2022 (for A.Y. 2011-2012) has been filed.

Issues:

• What is the quantum of royalty that can be brought to tax in India, which was paid by the GIA India Laboratory Private Limited (for short “GIA India”) to the Respondent – Gemological Institute of America Inc. (for short “GIA US”). It is undisputed that GIA US (the Respondent – Assessee) is an Associated Enterprise (for short “AE”) of GIA India.
• Whether GIA India is a Permanent Establishment (for short “PE”) of the Respondent – GIA US in India in terms of Article 5 of the India-US Double Taxation Avoidance Agreement (for short the “India-US DTAA”).

Observations:

• The Hon’ble High Court commenced its examination of the Permanent Establishment issue by observing that for AY 2011-12 and the other years under consideration, the ITAT had merely followed its earlier order passed for AY 2010-11. The Court therefore considered it necessary to examine the findings recorded by the ITAT in its order dated 21 June 2019. Upon reviewing the Tribunal’s discussion contained in paragraphs 9 to 18 of the earlier order, the Court noted that the ITAT had carefully considered the submissions of both the Revenue and the Assessee regarding the existence of a PE in India. The Court observed that the Tribunal had factually found that the grading arrangement between GIA US and GIA India could not be regarded as a joint venture because GIA India possessed independent expertise in grading services and forwarded diamonds to GIA US only due to technological or capacity constraints. The Court further noted that the ITAT had found that the arrangement was not one where both entities contributed resources for carrying on an economic activity under joint control. Rather, “the arrangement was akin to an assignment or sub-contracting of grading services by GIA India to GIA US, whenever GIA India did not have the requisite expertise, technology or capacity for carrying out grading services.” The Court also recorded that this arrangement had been accepted by the TPO as a mere rendering of grading services in the cases of both GIA India and GIA US.
• The Court then examined the ITAT’s findings on whether GIA India could constitute a Fixed Place PE of GIA US under Article 5(1) of the India-US DTAA. The Court noted that Article 5(1) contemplates a PE where the foreign enterprise carries on its business wholly or partly through a fixed place. Referring to the factual findings recorded by the Tribunal, the Court observed that there was no joint venture arrangement between GIA US and GIA India in relation to gem grading services. The Tribunal had found that GIA India entered into agreements with its own customers and bore all risks associated with such engagements, including credit risks and customer-facing risks. The Court further noted that GIA India also bore the risk of loss or damage to diamonds during transit to and from GIA US and even while the diamonds remained at GIA US facilities. The Court recorded the Tribunal’s finding that “the economic risks of gem grading services rendered by GIA US vis-à-vis stones/diamonds of the customers of GIA India were borne by GIA India” and therefore no joint venture arrangement existed. The Court also noted that the ITAT had taken into consideration Article 5(6) of the DTAA, which specifically provides that mere ownership or control of one company by another does not by itself create a PE. The Tribunal had also relied upon the decision of DIT v. E-Funds IT Solution. On this basis, the Court accepted the finding that GIA US did not have a Fixed Place PE in India.
• The Court next considered the Tribunal’s findings regarding Service PE under Article 5. It observed that a Service PE arises only when services are furnished in India by employees or personnel of the foreign enterprise for the prescribed duration. The Court noted that the Tribunal had examined the facts and found that although GIA US rendered grading services and management services to GIA India, two graders who were earlier employed by GIA US had subsequently become employees of GIA India and were working under the payroll, control and supervision of GIA India. The Court further noted that the ITAT had relied upon the decision in E-Funds IT Solution, wherein deputed employees working under the control and supervision of the Indian entity were held not to create a Service PE. The Court specifically recorded the Tribunal’s finding that “the grading services were rendered outside India and none of the employees/personnel of GIA US had visited India.” In these circumstances, the Tribunal had concluded that the Service PE provisions were not attracted, and the Court found no infirmity in that conclusion.
• The Court thereafter examined the Tribunal’s findings regarding Agency PE under Article 5(4) and 5(5) of the India-US DTAA. The Court noted that the Tribunal had first analysed the statutory framework and observed that an Agency PE would arise where a person acting in India on behalf of a foreign enterprise habitually exercises authority to conclude contracts, habitually maintains stock for delivery, or habitually secures orders wholly or almost wholly for the foreign enterprise. The Tribunal had also taken note of Article 5(5), which excludes activities carried on through an independent broker, commission agent or other independent agent acting in the ordinary course of business. The Court observed that after setting out the legal position, the Tribunal proceeded to apply these provisions to the facts of the present case. The Tribunal found that GIA India was “an independent and separate legal entity in India” engaged in rendering grading services. It further found that considering the functions performed and risks assumed by GIA India, it bore all service risks and customer-facing risks in relation to diamonds sent to GIA US for grading. Consequently, the Tribunal concluded that “GIA India is not acting in India on behalf of GIA US.” The Court noted these findings while examining the Agency PE issue.
• After analysing the legal requirements for constituting an Agency PE under Articles 5(4) and 5(5) of the India–US DTAA, the Court noted the factual findings recorded by the ITAT upon applying those provisions to the facts of the present case. The Tribunal had found that GIA India was “an independent and separate legal entity in India” engaged in rendering grading services to its clients. The Court observed that the ITAT had specifically examined the functions performed and risks assumed by GIA India and found that it independently rendered grading services in India while bearing all service risks and customer-facing risks in relation to diamonds sent to GIA US for grading. The Tribunal had therefore concluded that “GIA India is not acting in India on behalf of GIA US.” The Court further noted the factual finding that GIA India neither possessed nor exercised any authority to conclude contracts on behalf of GIA US. It had also not secured any orders in India for GIA US. Since the essential ingredients necessary for creation of an Agency PE were absent, the Tribunal held that Article 5(4) was not attracted. The Court took note of these findings and found no reason to differ from them.
• The Court then independently evaluated the conclusions reached by the Tribunal. After examining the ITAT’s order in detail, the Court expressly recorded its agreement with the factual findings rendered by the Tribunal. The Court observed that the ITAT had “very carefully examined the facts” and thereafter arrived at the conclusion that GIA India was not a PE of GIA US in India. Referring to the factual findings recorded by the Tribunal, the Court categorically held that “GIA India could not be termed as a PE of GIA US in India” because it clearly “did not have a fixed place of business in India”; “was not a service PE as contemplated under Article 5(1)”; and “was not an agency PE as contemplated under Article 5(4) of the India-US DTAA.”
• The Court further observed that GIA India was an independent and separate legal entity carrying on grading services for its own clients up to its grading capacity. At the relevant point of time, GIA India could grade diamonds only up to 1.99 carats. Whenever diamonds exceeded that capacity, GIA India merely forwarded those stones to GIA US or other group entities depending upon the service requirement. The Court emphasised that these transactions were independent commercial transactions and not evidence of any PE arrangement.
• The Court specifically observed that “These were independent and individual transactions and can never be termed as one which could take the colour of a joint venture arrangement, a service PE or an agency PE as contemplated under Article 5 of the India-US DTAA.”
• The Court attached significant importance to the allocation of risks between the parties and noted that “the entire risk in relation to the stones forwarded by GIA India to GIA US on behalf of its own customers was borne entirely by GIA India, and no risk was attached whatsoever to GIA US.” This factual circumstance strongly reinforced the conclusion that GIA India was operating independently and was not carrying on the business of GIA US in India.
• Having accepted the factual findings recorded by the Tribunal, the Court concluded the PE issue. The Court observed that it had not even been argued before it that the findings recorded by the ITAT were either perverse or contrary to the material on record. Since the Tribunal is the final fact-finding authority and its conclusions were fully supported by evidence, there was no occasion for interference by the High Court.
• The Court therefore held that the questions raised by the Revenue concerning the PE issue, namely questions (d) to (g), together with the additional question raised for AY 2017-18, did not give rise to any substantial question of law. The Court categorically held that “the questions raised by the Revenue on the PE issue, namely questions (d) to (g), as well as the additional question raised in A.Y. 2017-2018, do not give rise to any substantial question of law requiring an answer by this Court.”
• Accordingly, the Court held that “questions (d) to (g) reproduced earlier, as well as the additional question raised in A.Y. 2017-2018, also reproduced earlier, are not entertained.” Thus, the Revenue’s challenge on the PE issue failed at the threshold itself.
• The arrangement between GIA India and GIA US was not a joint venture but merely a subcontracting/outsourcing arrangement for grading services. GIA India was an independent legal entity carrying on its own business. GIA US did not have a Fixed Place PE in India. GIA US did not have a Service PE in India. GIA US did not have an Agency PE in India. The findings recorded by the ITAT were pure findings of fact and were neither perverse nor contrary to the record.
• Consequently, questions (d) to (g) and the additional question for AY 2017-18 did not give rise to any substantial question of law and were therefore not entertained.
• The Court commenced its examination of the royalty issue by identifying the precise controversy before it. The Court observed that the dispute related to the quantum of royalty that could be brought to tax in India in the hands of GIA US. The issue arose because the royalty originally paid by GIA India was subsequently revisited pursuant to an APA entered into between GIA India and CBDT. Since questions (a) to (c) framed by the Revenue directly concerned this issue, the Court formally admitted the appeals for AYs 2011-12 to 2016-17 on those questions and proceeded to hear them finally with the consent of the parties.
• The Court first noted the undisputed factual position regarding AY 2011-12. It observed that GIA US had originally received royalty of Rs.68,53,46,239 crore from GIA India and had offered the same to tax in India. Subsequently, an APA was entered into between GIA India and CBDT under section 92CC of the Act. Under the APA, the Arm’s Length Price of royalty payable by GIA India for AY 2011-12 was determined at Rs.49,08,99,461 crore. Consequently, excess royalty amounting to ₹19.44 crore became refundable by GIA US to GIA India. The Court noted that the excess amount was in fact refunded. The central controversy therefore was whether tax should be levied on the royalty originally received or only on the royalty finally retained by GIA US.
• The Court observed that pursuant to the APA, GIA India had raised invoices upon GIA US seeking refund of excess royalty. The Court further noted that GIA US had actually remitted the excess amount back to GIA India. Thus, the refund was not a notional or hypothetical adjustment. The Court considered this factual aspect to be significant because the refund had actually taken place and had altered the ultimate quantum retained by GIA US.
• The Court then examined the argument of the Revenue that the APA was entered into only between GIA India and CBDT and that GIA US was not a party thereto. The Court observed that although GIA US was not formally a signatory to the APA, the consequences flowing from the APA could not be ignored. The APA had determined the Arm’s Length Price of royalty payable by GIA India and one of its critical assumptions was that excess royalty paid would be recovered from GIA US. Therefore, the implementation of the APA necessarily resulted in refund of excess royalty by GIA US.
• The Court observed that the APA was not merely a unilateral arrangement affecting GIA India alone. The determination of ALP under the APA directly impacted the royalty entitlement of GIA US because the excess royalty originally received by it was required to be refunded. Consequently, the Court considered it artificial to examine the original royalty receipt while completely ignoring the subsequent refund transaction.
• The Court emphasised that the receipt of royalty and the subsequent refund of excess royalty were not two disconnected events. Rather, both formed part of one integrated transaction arising from implementation of the APA. The Court observed that the Revenue’s approach of looking only at the original receipt and ignoring the subsequent refund failed to appreciate the true commercial effect of the APA arrangement.
• The Court then turned to the concept of “real income”. It observed that income-tax is levied on real income and not on hypothetical income. The Court noted that while income may initially accrue or arise, subsequent events may reveal that a portion of that amount never ultimately belonged to the assessee. In such circumstances, taxation must follow commercial reality rather than mere book entries.
• The Court discussed the jurisprudence relating to the doctrine of real income and noted that the principle has repeatedly been recognised by the Supreme Court. The Court observed that the purpose of taxation is to tax income that has actually accrued to or been retained by the assessee and not amounts which the assessee is subsequently obliged to return.
• Applying the doctrine of real income to the facts of the present case, the Court observed that after implementation of the APA, GIA US could not retain the excess royalty originally received. The refund obligation was neither voluntary nor gratuitous but arose directly from implementation of the APA framework. Consequently, the refunded amount ceased to represent income belonging to GIA US.
• The Court further noted that the excess royalty refunded by GIA US had already been taken into account in the hands of GIA India through modified returns filed pursuant to the APA. As a result, the corresponding royalty deduction originally claimed by GIA India stood reduced. This aspect assumed significance while examining the Revenue’s argument regarding taxability of the same amount in the hands of GIA US.
• The Court observed that acceptance of the Revenue’s argument would lead to an anomalous result. While GIA India would be denied deduction for the excess royalty, GIA US would simultaneously be taxed on that very amount despite having refunded it. Such treatment would fail to reflect the true commercial effect of the APA arrangement.
• The Court emphasised that taxation must proceed on the basis of substance rather than form. Merely because the royalty was initially received by GIA US could not conclude the matter. What was relevant was the amount that ultimately remained with GIA US after giving effect to the APA and the corresponding refund mechanism.
• The Court observed that the refund transaction was genuine, bona fide and supported by documentary evidence. It was not suggested by the Revenue that the refund was sham, fictitious or colourable. The Court therefore accepted the refund as an actual commercial event which had to be given due effect while determining taxable income.
• The Court concluded this stage of its analysis by observing that the controversy could not be resolved merely by focusing on the original receipt of royalty. The real question was whether the refunded amount could still be regarded as income that had truly accrued to GIA US. This enquiry required examination of the doctrine of real income and the legal consequences flowing from the APA, which the Court proceeded to undertake in the succeeding paragraphs.
• The Court proceeded to examine the doctrine of real income in greater detail. It observed that tax can be levied only on income which has genuinely accrued to or been received by the assessee as its own income. Merely because an amount is initially received does not necessarily mean that the entire amount constitutes taxable income if subsequent events establish that a part thereof never truly belonged to the recipient. The Court therefore considered it necessary to determine whether the excess royalty refunded pursuant to the APA could be regarded as real income of GIA US.
• The Court referred to the settled principle that income-tax law recognises commercial realities and does not proceed merely on theoretical accruals. The Court noted that where a legal or commercial obligation exists requiring an assessee to part with an amount, such amount may not constitute its real income. The enquiry therefore had to focus on the substance of the transaction and not merely its initial form.
• The Court observed that in the present case, the APA fundamentally altered the quantum of royalty that GIA India was required to pay. Once the ALP was determined under the APA and excess royalty became refundable, the original royalty figure ceased to represent the amount ultimately payable by GIA India. Consequently, the Court considered it necessary to determine taxability with reference to the royalty ultimately retained and not merely originally received.
• The Court relied upon the decision of the Supreme Court in Shoorji Vallabhdas & Co. and reiterated that income-tax is levied on real income and not on hypothetical income. The Court emphasised that where income does not ultimately materialise or where circumstances show that the assessee is not entitled to retain the amount, taxation cannot be imposed on a fictional basis.
• The Court effectively applied the principle that income-tax is a levy on real income and not on hypothetical income.
• The Court further examined the decision in Godhra Electricity Co. Ltd. v. CIT and observed that the concept of real income must be applied by considering the actual state of affairs. The Court noted that accrual of income cannot be divorced from commercial reality and that an amount which the assessee is ultimately unable to realise or retain may not constitute taxable income.
• The Court observed that the facts of the present case squarely attracted the doctrine of real income because GIA US had not merely agreed to reduce the royalty; it had actually refunded the excess amount. Therefore, the Court found that the controversy was not one involving a hypothetical future adjustment but an actual reduction in royalty entitlement that had already been implemented.
• The Court emphasised that the refund was made pursuant to the APA framework and therefore formed an integral part of the transaction. It was not an ex gratia payment, a voluntary concession or a unilateral waiver. The refund flowed directly from the determination of ALP under the APA and consequently had to be recognised while determining taxable income.
• The Court observed that if the Revenue’s argument were accepted, GIA US would be taxed on an amount that it had already returned and which it was never ultimately entitled to retain. Such an approach would be contrary to the settled jurisprudence governing taxation of real income.
• The Court further noted that implementation of the APA resulted in corresponding consequences in the hands of GIA India. GIA India reduced its royalty deduction through modified returns and accepted the consequences flowing from the APA. Therefore, ignoring the same consequences in the hands of GIA US would result in inconsistent treatment of the very same transaction.
• The Court observed that taxation statutes must be interpreted in a manner that avoids absurd or incongruous results. If the excess royalty were denied as deduction to GIA India while simultaneously being taxed in the hands of GIA US despite having been refunded, the same amount would effectively suffer tax consequences twice without commercial justification.
• The Court therefore found considerable force in the argument that only the royalty ultimately retained by GIA US could be regarded as its income. The Court observed that the refunded amount never became part of GIA US’s enduring economic gain and therefore could not be treated as real income.
• The Court then examined the language of Article 12 of the India–US DTAA dealing with royalty taxation. The Court observed that the DTAA contemplates taxation of royalty that is actually payable and retained under the arrangement between the parties. The expression used in the treaty had to be interpreted in light of the actual commercial transaction after implementation of the APA.
• The Court observed that after the APA, the royalty legally payable by GIA India stood reduced to the amount determined under the APA. Therefore, for treaty purposes, the relevant royalty could only be the amount that ultimately remained payable and retained after giving effect to the APA.
• The Court recorded one of its most significant findings. It held that the royalty originally received and the royalty subsequently refunded could not be viewed in isolation. Both events constituted parts of the same commercial arrangement. The Court therefore held that only the royalty finally retained by GIA US represented the amount that could properly be subjected to tax in India.
• This paragraph effectively forms the foundation of the Court’s ultimate conclusion that only Rs.49,08,99,461 crore constituted taxable royalty and not Rs.68,53,46,239 crore.
• The Court thereafter considered the authorities relied upon by the Revenue in support of its contention that taxability must be determined with reference to the original receipt. The Court carefully examined those decisions and observed that the factual circumstances involved therein were materially different from those arising in the present case.
• The Court distinguished the authorities cited by the Revenue on the ground that those cases did not involve a situation where an APA had subsequently altered the ALP and where the excess amount had actually been refunded. The Court therefore found that those precedents did not advance the Revenue’s case.
• The Court then examined the reliance placed by the Revenue on Kishinchand Chellaram. The Court analysed the decision in detail and observed that the principles emerging from that case had no application to the peculiar factual circumstances before it.
• After analysing the judgment, the Court categorically rejected the Revenue’s reliance upon it and held that “the reliance placed by the Department on the judgment in Kishinchand Chellaram is wholly misplaced and does not carry their case any further.”
• Having completed its analysis of the APA, the doctrine of real income, the treaty provisions and the judicial precedents cited before it, the Court answered the substantial questions of law in favour of the assessee.