Transfer Pricing: Tax Tribunal Allows Refund To Overseas Entity

Tax tribunal allows refund to foreign company saying if the income has reduced, so should tax.

<div class="paragraphs"><p>A calculator sits on the desk. (Photographer Luke Sharrett/Bloomberg)</p></div>
A calculator sits on the desk. (Photographer Luke Sharrett/Bloomberg)

In a landmark ruling last month, the Mumbai bench of the Income Tax Appellate Tribunal has granted relief to a foreign entity on the tax paid by it. If the foreign company has returned the excess royalty paid by its Indian entity, its tax outgo will also stand reduced, the ITAT has held.

Welcoming the ruling, Maulik Doshi, executive director at consulting firm Nexdigm said currently there is no provision in the tax law to claim such a refund. Hence, the ruling would provide a good precedent for non-resident taxpayers on similar issues emanating from the conclusion of APAs in the hands of their Indian related parties.

APAs or advance pricing agreements allow taxpayers and tax authorities to determine in advance, an appropriate transfer pricing methodology for a given set of transactions over a fixed period of time.

Transfer pricing is the price at which related parties, for instance a parent and its subsidiary, transact with each other. Under the law, such transactions need to be at an arm’s length price, that is the price at which two unrelated parties would do such a transaction.

GIA America, Royalty And Refund

Gemological Institute of America Inc. had provided certain services to its Indian subsidiary GIA India for which it received certain royalty income. Tax on this royalty income was duly paid by GIA America. This transaction between a parent and its subsidiary attracted the transfer pricing provisions.

Subsequently, GIA India entered into an APA with the revenue department. The APA laid down the arm’s length price for transactions between GIA America and GIA India. It also stated that royalties received in excess of the arm’s length price, in the previous years, should be remitted back to GIA India.

After GIA America did so, it argued before the revenue department that the tax already paid on this excess royalty must be refunded to it. This request was denied by the department citing Section 92(3) of the income tax law. The provision said that arm’s length price will not apply if it has the effect of reducing the income chargeable to tax.

Tribunal Upholds Real-Income Theory

The ITAT accepted GIA America’s arguments. It relied on the ‘real-income theory’ to say that only the income actually belonging to the taxpayer can come under the tax net. The amount of royalty, which was received earlier but later refunded, cannot form part of taxable income, the tribunal said.

There can be no way in which an assessee can be taxed in respect of that part of receipt of an income which the assessee has bonafide refunded to the person from whom such an income was received. As is the well-settled legal position, in order that an income is taxed in the hands of an assessee, it must be a real income.
ITAT Mumbai

Experts BloombergQuint spoke with said this is a beneficial precedent for overseas companies that regularly transact with their domestic entities.

But this benefit won’t come easy, cautioned Vijay Iyer, partner at EY India. He explained that currently, there is no mechanism in the law which enables taxpayers to file such refunds. It’s possible only via filing revised returns for which the timelines are very short or during assessment or appellate proceedings, Iyer pointed out.

There must be some special dispensation granted by the government to either permit filing of belated returns or a direct enabling mechanism to allow refund in such cases.
Vijay Iyer, Partner and National Leader, EY India

Voicing similar sentiments, Doshi said tax authorities should not only accept this by not litigating further but the government should amend the law to provide relief in all such cases.

The tax department has four months to appeal this decision before the Bombay High Court.