Facts of the Case

The Revenue filed an appeal under Section 260A of the Income-tax Act, 1961 challenging the order dated 17 October 2022 passed by the Income Tax Appellate Tribunal (ITAT) in the case of Sony India Pvt. Ltd. for Assessment Year 2016-17.

The assessee is engaged in the business of import and distribution of audio and visual entertainment products under the “Sony” brand. The return of income was filed declaring total income under the normal provisions and book profits under Section 115JB. The case was selected for scrutiny and, owing to international transactions with associated enterprises, a reference was made to the Transfer Pricing Officer (TPO).

The TPO proposed a substantial transfer pricing adjustment in respect of royalty payments. The Assessing Officer incorporated the proposed adjustments in the draft assessment order, which was upheld by the Dispute Resolution Panel. The final assessment order was thereafter passed making additions on account of royalty, valuation of closing stock, excess provision for warranties, and exclusion of CSR expenditure for computation of book profits under Section 115JB.

The ITAT partly allowed the assessee’s appeal and deleted the aforesaid additions. Aggrieved, the Revenue preferred an appeal before the Delhi High Court.

 

Issues Involved

Whether the TPO was justified in determining the arm’s length price of royalty payment at NIL by questioning commercial expediency.

Whether royalty paid by the assessee was allowable when manufacturing was outsourced to original equipment manufacturers.

Whether valuation of closing stock at cost or net realisable value, whichever is lower, was permissible.

Whether provision for warranties constituted an allowable deduction.

Whether CSR expenditure was required to be added back while computing book profits under Section 115JB.

 

Petitioner’s (Revenue’s) Arguments

The Revenue contended that royalty was not payable as the manufacturing activity was carried out by third-party OEMs and not by the assessee itself. It was argued that the licensed patents and know-how were not used by the assessee and, therefore, the arm’s length price of royalty ought to be NIL.

The Revenue further submitted that the Tribunal erred in deleting additions relating to stock valuation loss, excessive warranty provisions, and CSR expenditure while computing book profits under Section 115JB of the Act.

 

Respondent’s (Assessee’s) Arguments

The assessee argued that it was granted a valid license by its associated enterprise for use of patents, know-how, and trademarks, including the right to manufacture products through subcontractors. The royalty was paid in accordance with the licensing agreements and commercial arrangements.

It was submitted that the TPO exceeded his jurisdiction by questioning the commercial expediency of the transaction instead of determining the arm’s length price in accordance with law. The assessee also contended that valuation of stock, warranty provisions, and CSR expenditure were consistently and scientifically accounted for and fully allowable under settled law.

 

Court Order / Findings

The Delhi High Court dismissed the Revenue’s appeal and upheld the order of the ITAT. The Court held that the role of the TPO is confined to determining the arm’s length price and not to evaluate the necessity or commercial expediency of the transaction.

The Court observed that the assessee had been granted a license to use intellectual property and was entitled to get products manufactured through subcontractors. Benchmarking royalty at NIL merely because manufacturing was outsourced was impermissible.

The Court further held that valuation of closing stock at cost or net realisable value, whichever is lower, is a well-accepted accounting principle. The provision for warranties was found to be based on scientific methodology and past experience and therefore allowable. The Court also upheld the Tribunal’s finding that CSR expenditure is not required to be added back while computing book profits under Section 115JB, as no such adjustment is prescribed under the statute.

No substantial question of law was found to arise.

 

Important Clarification

This judgment clearly reiterates that:

The TPO cannot determine ALP at NIL by questioning the commercial rationale of royalty payments.

Outsourcing manufacturing to OEMs does not negate the assessee’s obligation to pay royalty under valid licensing agreements.

Valuation of stock at cost or NRV, whichever is lower, is legally permissible when followed consistently.

Warranty provisions based on past experience and scientific computation are allowable deductions.

CSR expenditure cannot be excluded while computing book profits under Section 115JB in the absence of express statutory provision.

The decision reinforces long-standing transfer pricing jurisprudence and limits unwarranted interference with legitimate commercial arrangements.

Link to download the order - https://www.mytaxexpert.co.in/uploads/1770194772_PR.COMMISSIONEROFINCOMETAX7DELHIVsSONYINDIAPVT.LTD..pdf

Disclaimer

This content is shared strictly for general information and knowledge purposes only. Readers should independently verify the information from reliable sources. It is not intended to provide legal, professional, or advisory guidance. The author and the organisation disclaim all liability arising from the use of this content. The material has been prepared with the assistance of AI tools.