It was held that the ALP should be determined as per the procedure prescribed. Any deviation from the prescribed procedure cannot be sustained.


The taxpayer was engaged in the business of licensing mainframe, midrange and system infrastructure software products of CA Management Inc. of the USA. The taxpayer had set-up a Technical Support Centre in Chennai to provide support services to end users of the software products on behalf of the AE.

The taxpayer had entered into a Software Distribution Agreement with the AE for distribution of products of AE in India. Under the agreement, the taxpayer was liable to pay an annual royalty on all amounts invoiced at a rate of 30 percent of sales. During the year under consideration, the taxpayer had also written off bad debts to the extent of Rs 13.33 crores. The royalty was paid on debts written off also.

The TPO held that taxpayer was wrong in paying royalty even on bad debts and in cases where the customers had raised complaints regarding the quality of the products. The TPO held that such cases ought to be dealt with on the basis that no sales had occurred and that, therefore, there was no question of payment of any royalty to that extent. Accordingly, additions were made by the TPO. CIT(A) confirmed the additions.

The taxpayer filed an appeal to ITAT (reported in [2010] 37 SOT 306 (Mum), [2011] 8 ITR (Trib.) 142 (Mum)). The ITAT reversed the order of CIT(A). The ITAT held the manner in which the ALP is to be determined by any of the method prescribed in s 92C as provided in r 10B of the Rules. The ITAT after examining the parameters prescribed in r 10B held that bad debts written off cannot be factor to determine the ALP of any international transaction. The ITAT held that the TPO has exceeded his limitation by following the method which is not authorised under the Act or rules. The ITAT held that the ALP determined by the TPO to the extent of royalty payable to the AE is not as per the procedure prescribed and same cannot be sustained. The additions were therefore deleted.

The tax department filed an appeal before the High Court.


The High Court held that s 92C provides the basis for determining the ALP in relation to international transactions. It does not either expressly or impliedly consider failure of the taxpayer’s customers to pay for the products sold to them by the taxpayer to be a relevant factor in determining the ALP. The High Court observed that in the absence of any statutory provision or the transactions being colourable, bad debts written off on account of purchasers refusing to pay for the goods purchased by them from the taxpayer, can never be a relevant factor while determining the ALP of the transaction between the taxpayer and its AE. Once it is accepted that the ALP of the royalty is justified, there can be no reduction in the value thereof on account of the taxpayer’s customers failing to pay the taxpayer for the product purchased by them from the taxpayer. The High Court held that in the absence of a contract to the contrary, the vendor or licensor is not concerned with whether its purchaser/licensee recovers its price from its clients to which it has in turn sold/licensed such products. The two are distinct, unconnected transactions. The purchaser’s/licensee’s obligation to pay the consideration under its transaction with its vendor/licensor is not dependent upon its recovering the price of the products from its clients.

The High Court held that in the present case the transactions between the taxpayer and AE are unrelated to the transactions between the taxpayer and its clients. AE was not concerned with the taxpayer’s inability to recover the consideration from its clients. The High Court upheld the Order of the ITAT.

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