The ITAT Mumbai Bench has explained the impact of an Advance Pricing Agreement being signed by the assessee’s Indian associated enterprises, namely GIA India Laboratory Pvt Ltd, with the Central Board of Direct Taxes, in terms of which a part of the royalty received by the assessee company from its Indian AE had to refund to the Indian AE. It has adjudicated the point whether the amount so refunded by the assessee company to its Indian AE, in terms of the APA terms, can still be taxed in the hands of the assessee company as its income.

The core issue adjudicated is whether, given the framework of law on transfer pricing, any such adjustment in royalty income can be allowed to the assessee as a result of an APA to which the assessee is not even a party and whether or not the quantification of royalty income in the hands of the assessee will stand reduced by the refund granted by the assessee in terms of the APA that the assessee’s AE has entered into with the CBDT.

20. Quite clearly, Section 92CE is in the nature of an additional obligation on the assessee to either repatriate back to India the excess payment made (i.e. actual payment minus the arm’s length price) or to pay additional income tax @ 18% thereon. The secondary adjustment under section 92CE is thus not in a vacuum but in the light of the corresponding obligation to either repatriate back that amount to India or pay additional income tax thereon. While proviso to Section 92CE(1) does clarify that the above provisions do not apply where primary adjustments are less than Rs 1 crore or where primary adjustments are made in respect of an assessment year prior to 2016-17, that exception refers to the scheme of this section as a whole because a secondary adjustment under section 92CE(1) is an obligation on the assessee with certain mandatory consequences under section 92CE(2) as also 92CE(2A to 2D) , rather than a secondary adjustment simplicitor. Learned CIT(DR) proceeds on the basis that Section 92CE gives certain concession or relief when he treats Section 92CE as “permitting” the secondary adjustments, whereas as a matter of fact, Section 92CE “requires” that the assessee “shall” make the secondary adjustment which being coupled with certain further requirements under section 92CE(2) and 92CE(2A to D), operate in favour of the revenue. Given the scheme of Section 92CE, secondary adjustments are not concessions to an assessee but obligations on the assessee. The proviso to Section 92CE(1) cannot, therefore, be interpreted as a bar on any secondary adjustment by the assessee, even dehors the requirements under section 92CE(1). In any case, Section 92CE has nothing to do with the taxability of correct income in the hands of the foreign AE to which payment for the international transaction has been made, inasmuch as, this provision cannot be seen as a bar on repatriating back the excess payment made (i.e. actual payment minus the arm’s length price) even if there was no statutory obligation to do so. In our humble understanding, there was no bar, even in respect of the period prior to insertion of Section 92CE, on any secondary adjustments being made by parties to a transaction. It is also important to note that so far as the APAs are concerned, under rule 10 M (1)(vi) of the Income Tax Rules 1962, an APA may, amongst other things, include “the conditions, if any, other than provided in the Act or these rules” and, therefore, as long as an APA refers to secondary adjustments, whether specifically permissible under the law or not, these secondary adjustments are to be carried out. It is also important to bear in mind the fact that no secondary adjustment can anyway be unilateral in nature. When an assessee is to raise an invoice on its AE abroad, that invoice is to be accounted for by the entity issuing the invoice as also by the entity receiving the invoice. These two facets of the transactions are two sides of the same coin Section 92CE(3)(v) aptly defines, consistent with the first principles as well, ‘secondary adjustment’ means “an adjustment in the books of account of the assessee and its associated enterprise to reflect that the actual allocation of profits between the assessee and its associated enterprise are consistent with the transfer price determined as a result of the primary adjustment, thereby removing the imbalance between a cash account and actual profit of the assessee.” It is, therefore, not correct to say that when an APA requires an assessee to raise debit notes or invoices on its AE abroad, it is open to the AE abroad to ignore those invoices or debit notes and continue with computation of its income dehors these invoices or debit notes, because the said AE is not a party to the APA. The AE may not be party to the APA, yet the impact of the terms of the APA has to be taken note of when these terms affect the AE. That’s a reality and cannot be wished away. We, therefore, reject this objection raised by the learned CIT(DR) as well. As for learned CIT(DR)’s observation that “the second proviso to section 92CE(1) stipulates that no refund of taxes paid could be claimed or allowed”, which suggests that no refund of taxes paid could be claimed or allowed as a result of the secondary adjustment, this observation is wholly misconceived inasmuch as while the second proviso states that “Provided further that no refund of taxes paid, if any, by virtue of provisions of this sub-section as they stood immediately before their amendment by the Finance (No. 2) Act, 2019 shall be claimed and allowed”, this proviso was quite clearly in specific context of insertion of words “on or after the 1st day of April, 2017” in Section 92CE(1)(iii) by the same Finance Act 2019 which had resulted in the exclusion of rigours of Section 92CE in respect of the cases in which the additional obligations were incurred by the assessee in respect of the APAs concluded even prior to 1st April 2017. All that this proviso meant was that even though the assessee may have paid the additional tax, on account of consequences envisaged in Section 92CE(2), with respect to APAs concluded before 1st April 2017, these taxes will not be refunded. In still other words, in our considered view, the practical connotations of the second proviso to Section 92CE(1) was that relief granted by insertion of words “on or after the 1st day of April 2017” in Section 92CE(1)(iii) was with prospective effect. Learned CIT(DR) has been a bit too naïve in ignoring the import of words “if any, by virtue of provisions of this sub-section as they stood immediately before their amendment by the Finance (No. 2) Act, 2019 shall be claimed and allowed” in the proviso, and, therefore, ended up reading a bit too much into this rather innocuous and unidimensional provision. It is thus not correct to say that, in principle, in terms of the provisions of section 92CE, no refund of taxes could be claimed or allowed on account of secondary adjustments- even if, for example, as in this case, such secondary adjustments end up reducing the income of the foreign AE assesses as a result of partial repatriation of income. A lot of emphasis is then placed by the learned CIT(DR) on the claim that the action of the assessee, in partially refunding the royalty amount to the GIA India, i.e., Indian AE, was voluntary inasmuch as the assessee was not a party to the APA. Nothing, however, turns on this plea. Whether the refund was voluntary or under a legal obligation, it does not really make any difference as long as the refund is bonafide and particularly when its commercial expediency is not, and rightly so, even called into question. None of the objections taken by the DRP or raised by the learned CIT(DR), for the detailed reasons, set out above, really impresses us.