The Bombay High Court has delivered a significant judgment clarifying the taxability of royalties under the India-US Double Taxation Avoidance Agreement (DTAA) when excess payments are refunded pursuant to an Advance Pricing Agreement (APA). The Court held that only the real income - the amount ultimately retained by the taxpayer after refunding excess royalties - can be brought to tax, rejecting the Revenue’s reliance on transfer pricing provisions to tax notional amounts initially received.
Background & Facts
The Dispute
The appeals arose from a series of orders passed by the Income Tax Appellate Tribunal (ITAT) for Assessment Years (A.Y.) 2010-2011 to 2017-2018. The core dispute involved two key issues:
- Royalty Issue: The quantum of royalty paid by GIA India Laboratory Private Limited (GIA India) to Gemological Institute of America Inc. (GIA US) that could be taxed in India.
- Permanent Establishment (PE) Issue: Whether GIA India constituted a Permanent Establishment (PE) of GIA US in India under Article 5 of the India-US DTAA.
For A.Y. 2011-2012, the focus was on the royalty issue, while the PE issue was relevant for all assessment years.
Key Facts
- GIA US, a US-based entity, is a global leader in gem grading and certification services. It incorporated GIA India, a wholly-owned subsidiary, on 26th September 2007 to provide grading services in India.
- GIA US charged royalty to GIA India for technical know-how, expertise, and equipment. Initially, GIA India could grade diamonds only up to 1.99 carats, forwarding higher-carat stones to GIA US or other group entities for grading.
- For A.Y. 2011-2012, GIA US filed its Return of Income on 10th November 2011, declaring royalty income of Rs. 68,53,46,239/- received from GIA India. A revised return was filed on 6th September 2012, reiterating the same income.
- The case was selected for scrutiny, and a reference was made to the Transfer Pricing Officer (TPO) on 18th February 2014. The TPO proposed a NIL adjustment on 29th January 2015.
- The Assessing Officer (AO) passed a draft Assessment Order on 23rd March 2015 under Section 144C(1) read with Section 143(3) of the Income Tax Act, 1961 (IT Act), which was objected to by GIA US before the Dispute Resolution Panel (DRP). The DRP issued directions on 27th October 2015, following which the AO passed a final Assessment Order on 16th December 2015, assessing GIA US’ total income at Rs. 72,88,67,984/- on the basis that GIA US had a PE in India, taxing the entire income at 42.23%.
Procedural History
- 25th January 2016: GIA US filed an appeal before the ITAT against the final Assessment Order.
- 22nd March 2013: GIA India filed an application for an Advance Pricing Agreement (APA) under Section 92CC of the IT Act for A.Y. 2014-2015 to 2017-2019.
- 30th March 2015: GIA India filed another APA application for the rollback period (A.Y. 2010-2011 to 2013-2014).
- 7th May 2018: The CBDT entered into an APA with GIA India, determining the Arm’s Length Price (ALP) of the royalty payable by GIA India to GIA US. For A.Y. 2011-2012, the ALP was determined at Rs. 49,08,99,451/-, requiring GIA US to refund the excess amount of Rs. 19,44,46,788/- to GIA India.
- 30th June 2018: GIA India raised an invoice for the excess royalty paid.
- 18th July 2018: GIA US refunded the excess amount of Rs. 19,44,46,788/- to GIA India.
- 6th November 2018: GIA US raised an additional ground in its pending appeal before the ITAT, contending that only the real income of Rs. 49,08,99,451/- (after refund) could be taxed.
- 30th April 2021: The ITAT allowed the additional ground, holding that only the real income retained by GIA US could be taxed and that GIA US did not have a PE in India. The royalty income was thus taxable at 10% under Section 9 read with Section 115A of the IT Act, as opposed to the 42.23% applied by the AO.
- 15th September 2021: The Revenue filed Income Tax Appeals before the Bombay High Court challenging the ITAT’s orders.
Relief Sought
The Revenue sought to:
- Reverse the ITAT’s finding that only the real income of Rs. 49,08,99,451/- (after refund) could be taxed, contending that the initial amount of Rs. 68,53,46,239/- should be taxed.
- Establish that GIA India constituted a PE of GIA US in India, thereby subjecting GIA US’ entire income to tax at 42.23%.
The Legal Issue
The central legal question was: Whether the taxable royalty under Article 12 of the India-US DTAA is the amount initially received by GIA US (Rs. 68,53,46,239/-) or the amount ultimately retained after refunding the excess (Rs. 49,08,99,451/-), in light of the real income doctrine and transfer pricing provisions?
Arguments Presented
For the Appellant (Revenue)
- Transfer Pricing Provisions: The Revenue argued that Chapter X of the IT Act is a special anti-avoidance regime aimed at preventing profit shifting. The Arm’s Length Price (ALP) is an objective standard determined from the transaction as a whole, not from the perspective of either party. Section 92(3) prohibits downward adjustments where the computation results in a reduction of income, ensuring that transfer pricing provisions cannot erode the Indian tax base.
- APA Limitations: The APA was entered into by GIA India, not GIA US. The binding effect of the APA under Section 92CC(5) is confined to the signatory (GIA India) and does not extend to GIA US. The Revenue contended that GIA US could not indirectly benefit from an APA it did not sign.
- Secondary Adjustments: The Revenue relied on Section 92CE, which mandates secondary adjustments where primary adjustments are made. It argued that the statute contemplates only upward adjustments in the hands of the Indian Assessee (GIA India) and prohibits mirrored downward adjustments in the hands of the counterparty (GIA US).
- Second Proviso to Section 92C(4): This proviso prohibits recomputation of income in the hands of the Associated Enterprise (GIA US) corresponding to the adjustment made in the case of the Assessee (GIA India). The Revenue argued that once an upward adjustment was made in GIA India’s hands, GIA US could not claim a corresponding downward adjustment.
- Real Income Doctrine: The Revenue contended that the repayment of excess royalty by GIA US was a voluntary act occurring years after the income had accrued and been offered to tax. It relied on the decision in Kishinchand Chellaram v. Commissioner of Income-Tax [(1962) 46 ITR 640 (SC)] to argue that once income accrues, subsequent refunds cannot alter its taxability.
For the Respondent (GIA US)
- Real Income Principle: GIA US argued that only the real income - the amount actually retained after refunding the excess - could be taxed. It relied on several decisions
Case Details
Commissioner of Income-tax (IT)-2 v. Gemological Institute of America Inc.
2026:BHC-OS:13178-DB
Court
High Court of Judicature at Bombay
Date
16th June 2026
Case Number
Income Tax Appeal No. 2306 of 2022 (with connected appeals)
Bench
B. P. Colabawalla, J., Firdosh P. Pooniwalla, J.
Counsel
Pet: N. Venkatraman, Senior Advocate (ASG), Subir Kumar, Akhileshwar Sharma, Ashita Aggarwal, Diksha Pandey
Res: J.D. Mistri, Senior Advocate, Niraj Sheth, Gunjan Kakkad, Atul K. Jasani
Frequently Asked Questions
The real income doctrine holds that only the income actually earned or retained by an Assessee can be taxed, not hypothetical or notional income. This principle was established in several judgments, including H.M. Kashiparekh & Co. Ltd. v. CIT [(1960) 39 ITR 706 (Bom)] and Godhra Electricity Co. Ltd. v. CIT [(1997) 225 ITR 746 (SC)]. The doctrine ensures that refunds or adjustments reducing the Assessee’s income are recognised for tax purposes.
While the binding effect of an APA under Section 92CC(5) of the IT Act is confined to the signatory, the impact of the APA’s terms must be considered even for non-signatory Associated Enterprises. In this case, the APA required GIA India to raise an invoice for excess royalty paid to GIA US, and GIA US refunded the excess amount. The Court held that this refund was integrally linked to the APA’s terms and could not be ignored.
Section 92(3) prohibits downward adjustments where a computation under Section 92(1) results in a reduction of income for the same person. Here, the computation was made for GIA India, and Section 92(3) could not be applied to GIA US. The Court held that the provision does not contemplate multiple or divergent prices for the same transaction depending on the perspective of the taxpayer.
The second proviso to Section 92C(4) applies only where the ALP is determined by the Assessing Officer under Section 92C(3), not where the ALP is determined pursuant to an APA. The Karnataka High Court’s decision in PCIT v. EYGBS (India) (P.) Ltd. [(2025) 180 taxmann.com 681] supports this view, holding that once an APA determines the ALP, no adjustments can be made contrary to it.
Section 92CE mandates secondary adjustments only for the Assessee undergoing the primary adjustment. Non-resident entities without a PE in India (like GIA US) are not required to make secondary adjustments if the excess amount is repatriated within the prescribed time. The Court held that the provision applies only to entities maintaining books of account in India.
The Court interpreted the word 'paid' in Article 12 of the India-US DTAA to mean the amount actually and eventually paid, i.e., the amount retained by the recipient after refunding excess payments. In this case, the refund of excess royalty was a bonafide act pursuant to the APA, and only the net amount retained (Rs. 49,08,99,451/-) could be taxed as royalty 'paid'.
