Once the Transfer Pricing Officer accepted arm’s length price of royalty payments, the Assessing Officer could not examine the reasonableness of the said expenditure for disallowance

Delhi High Court in the case of CIT Vs. Oracle India Pvt. Ltd. (ITA No. 383 of 2009, 987 of 2010, 1242 of 2010 and 1247 of 2010) held that once the Transfer Pricing Officer (TPO) has accepted a royalty payment to be at arm’s length, the Assessing Officer (AO) could not disallow the expenditure by applying Section 37 of the Income–tax Act, 1961 (the Act). The High Court further observed under Section 37 of the Act the AO had powers only to examine whether the expenditure claimed has been actually expended and was incurred wholly and exclusively for the purpose of business, and not its reasonableness, which lies solely in the domain of the businessman.

Facts of the case

• The taxpayer, a wholly owned subsidiary of Oracle Corporation, USA imported master copies of software from its parent company, duplicated them on blank discs and sub-licensed the same in the market along with relevant brochures and documents.
• The taxpayer paid a lump sum amount to its parent company for the import of the master copy of the software. It paid royalty at 30 percent of the list price of the products licensed by it. For the Assessment year 1999-00, payment of royalty amounted to INR 350.09 million
• The AO during the course of scrutiny observed that receipts from software licensing amounted to INR 596.88 million however the actual payment of royalty made was more than 30 percent of such receipts since the same was computed on the basis of list price. Hence the AO inter-alia, disallowed an amount of INR 171.02 million under Section 92 read with Section 37(1) of the Act, being the excess amount of royalty paid.
• The Commissioner of Income-tax [CIT (A)] upheld the order of the AO. The Income-tax Appellate Tribunal (the Tribunal) however, reversed the order of the CIT (A) and deleted the dis allowance.

Tax department’s contentions