2025 (5) TMI 615 - AT - Income Tax

Disallowing royalty and interest payments alleging the same to be prior period expenditure - as argued liability in respect of aforesaid expense crystallized during the relevant assessment year under consideration the same could not be regarded as prior period expense - assessee pleaded that it has been carrying on sale of DVD players every year and which has been consistently allowed as revenue expenditure in the earlier years - HELD THAT - We find that the contentions of the assessee to be correct as in view of the letter dated 23.04.2015 relevant to AY 2016- 17 wherein additional royalty and interest had been crystallized in the hands of the assessee and settlement agreed with Philips. The said settlement happened during the year the expenditure had to be construed as having crystallized during the year. We find that the said expenditure is duly subjected to deduction to tax at source. The evidence for settlement arrived with Philips by the assessee vide letter dated 24.03.2015 is enclosed in pages 78 to 81 of the Factual Paper Book. AR before us sought to meet each and every observation by the ld AO and ld CIT(A) which are enclosed in his written submissions. These additional evidences in our considered opinion goes to the root of the matter and are very much crucial for adjudication of the issue in dispute before us. Hence we deem it fit and appropriate to admit those additional evidences and restore the entire issue in dispute to the file of the ld AO for de novo adjudication in accordance with law in the light of the aforesaid observations in the light of additional evidence submitted and after due verification of all the agreements on record. Accordingly Ground Nos. 1 to 1.4 raised by the assessee are allowed for statistical purposes. Non granting full MAT credit u/s 115JAA - This matter requires factual verification with ld AO and hence the ld AO is hereby directed to grant MAT credit in accordance with law after due verification of the computation thereon. Accordingly Ground No. 2 raised by the assessee is allowed for statistical purposes.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal are:

(a) Whether the royalty and interest payments amounting to Rs. 14,48,93,346/- made by the assessee during the relevant assessment year can be disallowed as prior period expenses, or whether such payments crystallized during the year and are therefore allowable as revenue expenditure.

(b) Whether the Assessing Officer and the Commissioner of Income Tax (Appeals) erred in disregarding the binding decision of the jurisdictional High Court regarding the creation of provisions for royalty expenses and the applicability of proviso to section 40(a)(ia) of the Income-tax Act.

(c) Whether the assessee was justified in claiming deduction for royalty and interest payments having duly deducted and deposited tax at source, in view of proviso to section 40(a)(ia) of the Act.

(d) Whether the Assessing Officer erred in not allowing the full Minimum Alternate Tax (MAT) credit available to the assessee under section 115JAA of the Act.

(e) Whether the Assessing Officer erred in charging interest under sections 234B and 234C of the Act, including the correctness of the quantum of such interest.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (a): Disallowance of Royalty and Interest Payments as Prior Period Expenses

Relevant Legal Framework and Precedents: The Income-tax Act, 1961, particularly provisions relating to allowable business expenditure, matching concept in accounting, and section 40(a)(ia) which deals with disallowance of certain payments if tax is not deducted at source. Precedents include the jurisdictional High Court decision in CIT vs. SMCC Construction India, which addresses the necessity of creating provisions for expenses in the year to which they pertain.

Court's Interpretation and Reasoning: The Tribunal carefully examined the factual matrix surrounding the royalty and interest payments. The assessee had entered into a patent license agreement with a foreign company for manufacture and sale of certain electronic products, under which royalty was payable based on units sold. A dispute arose regarding calculation of royalty for prior years, leading to a default notice by the licensor demanding payment of royalty and interest aggregating to USD 13,572,890.30.

Subsequently, the parties settled the dispute during the year under consideration by agreeing to a payment of USD 2,200,000, equivalent to Rs. 14,48,93,346/- which was debited as an exceptional item in the Profit and Loss account. The Assessing Officer disallowed this amount as a prior period expense on grounds including absence of provision in earlier years, non-execution of agreement on stamp paper, and non-disclosure in balance sheet as contingent liability.

The Tribunal found these grounds to be unmerited. It was held that the liability crystallized only during the year of settlement, and the expenditure was therefore allowable in that year. The Tribunal emphasized that the genuineness of the payment was never doubted, and the statutory auditor had classified the payment as an exceptional item, not a prior period item. The absence of provision in earlier years was explained by the fact that royalty was not payable on certain models, and the dispute resolution and settlement arose only subsequently.

Key Evidence and Findings: The settlement letter dated 23.04.2015, the patent license agreements, communications between parties, and the audited financial statements were considered critical evidence. The assessee also furnished additional documentary evidence under Rule 29 of the ITAT Rules, including the original license agreements, side letters, and correspondence relating to default and settlement negotiations.

Application of Law to Facts: The Tribunal applied the principle that expenses are deductible when the liability crystallizes and not necessarily when the underlying transaction occurred. It also noted that the proviso to section 40(a)(ia) protects payments on which tax has been deducted at source, which was complied with by the assessee.

Treatment of Competing Arguments: The Tribunal rejected the Assessing Officer's and CIT(A)'s reliance on procedural irregularities such as non-stamping of the settlement agreement and absence of prior provision. It also declined to follow the CIT(A)'s interpretation of the High Court decision, holding that the decision was distinguishable on facts.

Conclusions: The Tribunal allowed the grounds challenging the disallowance of royalty and interest payments, directing the Assessing Officer to reconsider the issue de novo in light of the additional evidence and observations made.

Issue (b): Applicability of Proviso to Section 40(a)(ia) of the Income-tax Act

The Tribunal noted that the assessee had deducted and deposited tax at source on the royalty and interest payments. The proviso to section 40(a)(ia) states that no disallowance shall be made if the tax is deducted at source and paid to the government. The Assessing Officer and CIT(A) failed to appreciate this legal position. The Tribunal held that since the tax deduction was duly made, the royalty and interest payments could not be disallowed on this ground.

Issue (c): Binding Precedent of Jurisdictional High Court Regarding Provision for Royalty Expenses

The CIT(A) had relied on the Delhi High Court decision in CIT vs. SMCC Construction India to hold that creation of provision for royalty expense in the year to which it pertains is a pre-requisite for claiming deduction on payment basis. The Tribunal distinguished the facts of the present case, emphasizing that the liability was disputed and crystallized only upon settlement during the year under consideration. Hence, the creation of provision in earlier years was not applicable.

Issue (d): Allowance of Full MAT Credit under Section 115JAA

The assessee contended that the Assessing Officer erred in not allowing full credit of Minimum Alternate Tax paid. The Tribunal observed that this issue required factual verification and directed the Assessing Officer to grant MAT credit in accordance with law after proper scrutiny of computations.

Issue (e): Levy of Interest under Sections 234B and 234C

The assessee challenged the levy of interest under section 234B (for default in payment of advance tax) and section 234C (for deferment of advance tax installments). The Tribunal noted that the interest under section 234B was consequential and thus dependent on the outcome of the main issue. Regarding section 234C, the Tribunal reiterated the settled legal position that interest under this section can only be levied on returned income and not on assessed income. The matter was left open for reconsideration in accordance with law.

3. SIGNIFICANT HOLDINGS

"The Tribunal found that the liability for royalty and interest payments crystallized only during the year under consideration upon settlement between the parties and therefore, the expenditure is allowable in that year and cannot be disallowed as a prior period expense."

"The assessee had duly deducted and deposited tax at source on the royalty and interest payments, thereby attracting the proviso to section 40(a)(ia) of the Income-tax Act, which prohibits disallowance of such payments."

"The absence of provision for royalty expenses in earlier years is explained by the disputed nature of the liability and the fact that the settlement was reached only during the year under consideration, distinguishing the case from precedents requiring provision in the year to which the expense pertains."

"Additional evidences relating to the patent license agreements, side letters, and correspondence between the parties are crucial for adjudication and are admitted for de novo consideration by the Assessing Officer."

"The Assessing Officer is directed to grant full MAT credit after due verification, and the levy of interest under sections 234B and 234C is to be reconsidered in accordance with settled legal principles."