Facts of the Case

  • M/s Nestle India Ltd., engaged in manufacturing and marketing of food and beverages, paid royalty/technical assistance fees to two foreign subsidiaries (Nestec S.A. and Societe Des Produits Nestle S.A., Switzerland).
  • Payments were claimed as business expenditure in IT returns.
  • Assessing Officer (AO) challenged the deductions, citing Sections 40A(2) and 92 of the IT Act, considering the payments excessive and non-arm’s length, totaling ₹47 crores.
  • CIT(A) allowed the deduction for royalty payments, finding them reasonable and linked to sales rather than profit.
  • The Tribunal upheld CIT(A)’s order, recognizing royalty as necessary for business operations, providing technical know-how, and enabling continuous product development and quality assurance.

 Issues Involved

  1. Whether AO could disallow deductions under Sections 40A(2) and 92 due to payments made to foreign subsidiaries of the parent company.
  2. Whether RBI’s approval for payments precluded AO from examining reasonableness and genuineness of royalty payments.
  3. Applicability of Article 9 of DTAA in taxing royalty payments made to foreign associated enterprises.

 Petitioner’s Arguments (Revenue)

  • Payments were excessive and siphoned profits from India to foreign subsidiaries.
  • Section 40A(2) and Section 92 allowed AO to adjust income to an arm’s length price.
  • Royalty payments diverted income under Article 9 of DTAA.

 Respondent’s Arguments (Nestle India Ltd.)

  • Payments were for genuine business purposes: technical know-how, continuous R&D, and training.
  • Royalty linked to turnover, not profit, and within approved limits.
  • Assessing quantum of payments against annual profit was improper due to long-term benefits.
  • RBI’s approval did not bar AO from verifying reasonableness, but expenditures were reasonable.
  • Provided extensive documentation evidencing technical assistance, operational support, and benefit to Indian operations.

 Court Order / Findings

  • Expenditure was business-related, reasonable, and necessary, thus deductible under Section 37.
  • Sections 40A(2) and 92 did not apply since payments were not excessive and arm’s length issue not established.
  • Article 9 DTAA applies to taxing income in India of non-residents, not for disallowing deductions in Indian company’s hands.
  • Tribunal’s findings affirmed: no evidence of profit diversion, payments justified, royalty payments integral for product manufacturing, technical assistance, and quality control.
  • Appeals of the Revenue dismissed.

 Important Clarifications

  • RBI approval does not prevent income tax authorities from examining reasonableness of expenditure.
  • Section 92 of IT Act does not apply to payments like royalty/technical assistance outside regular business transactions.
  • Business expenditure linked to turnover, continuous R&D, and technical assistance can be deducted even if exact quantification of benefits is difficult.

Link to download the order - https://delhihighcourt.nic.in/app/case_number_pdf/2011:DHC:2651-DB/AKS11052011ITA6622005.pdf

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