Transfer Pricing: Arms’ length royalty allowable even in respect of unpaid sales

CIT vs. CA Computer Associates India Pvt. Ltd (Bombay High Court)

The assessee entered into a Software Distribution Agreement with CA Management Inc (“CAMI”) pursuant to which it was appointed as a distributor of CAMI’s products in India. The assessee was required to pay an annual royalty of 30% on sales. The TPO accepted that the rate of royalty was at arms’ length price but held that royalty ought not to have been paid on sales where there was complaints on quality or which had turned into bad debts. The CIT (A) upheld the TPO’s stand though the Tribunal reversed it. On appeal by the department to the High Court, HELD dismissing the appeal:

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 assessee’s customers to pay for the products sold to them by the assessee to be a relevant factor in determining the ALP. In the absence of any statutory provision or the transactions being colourable bad debts on account of purchasers refusing to pay for the goods purchased by them from the assessee can never be a relevant factor while determining the ALP of the transaction between the assessee and its principal. 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 assessee’s customers failing to pay the assessee for the product purchased by them from the assessee. Absent 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.