Excess Royalty Refunded To Indian Subsidiary Under APA Cannot Be Taxed As Income Of GIA US: Bombay High Court

The Bombay High Court has upheld relief granted to Gemological Institute of America Inc. (GIA US) in a dispute over royalty payments received from its Indian subsidiary.

The court ruled that royalty amounts bona fide refunded pursuant to a CBDT-approved Advance Pricing Agreement (APA) could not be brought to tax in the hands of the US entity because the amounts did not ultimately belong to it.

A Division Bench of Justice B.P. Colabawalla and Justice Firdosh P. Pooniwalla dismissed a batch of appeals filed by the Income Tax Department. The appeals arose from assessment years between 2010-11 and 2017-18.

The principal issue before the Court was whether GIA US could be taxed on the entire royalty initially received from GIA India. The alternative question was whether tax could be levied only on the amount ultimately retained after excess royalty was refunded pursuant to an APA entered into between GIA India and the Central Board of Direct Taxes.

Answering that question in favour of GIA US, the court reiterated the doctrine of real income. The Bench relying on apex court's ruling in Commissioner of Income Tax Vs. Lok Housing and Construction Ltd. (2025), held,

"one salutary principle that emerges is that in order that income is taxed in the hands of the Assessee, it must be the real income (cases of deemed income apart), which the Assessee has actually earned and not a mere hypothetical income which the Assessee could have earned but in fact did not earn."

GIA US is engaged in the business of gem grading and certification. To cater to India's diamond industry, it incorporated GIA India Laboratory Private Limited as its wholly owned subsidiary. GIA India paid royalty to GIA US for technical know-how, expertise and related intellectual property.

For assessment year 2011-12, GIA US offered royalty income of about ₹68.53 crore to tax in India. An APA subsequently entered into by GIA India revised the arm's length price of the royalty transaction. It determined that a portion of the royalty already paid exceeded the arm's length price.

For that year, the excess royalty worked out to about ₹19.44 crore. GIA US later refunded that amount to GIA India. Similar adjustments were made for other years covered by the APA.

After making the refunds, GIA US contended that the returned amounts could not be treated as its taxable income. According to the company, those sums had not ultimately been retained by it. The Income Tax Appellate Tribunal accepted that contention. It directed that the refunded royalty be excluded from taxable income, subject to verification of the repayments.

Before the High Court, the Revenue argued that GIA US was not a party to the APA. It therefore could not claim any consequential reduction in its taxable income, the Department contended. The Revenue further argued that the transfer pricing framework did not permit a downward adjustment in the hands of a foreign associated enterprise merely because an APA had been entered into by the Indian entity.

Rejecting those submissions, the Court noted that recovery of excess royalty from GIA US formed a critical assumption underlying the APA. The Bench held that the subsequent refunds could not be divorced from the original royalty payments.

The Court observed, "the royalty refunds by, or the royalty recoveries from GIA US are not standalone events which can be seen in isolation with the receipts of related royalties in the corresponding previous year."

The court further held, "Any part of the royalty received, which had to be bonafide refunded to the payer of royalty (namely GIA India), could not be taxed in the hands of GIA US as this money did not eventually belong to GIA US."

Applying that principle to the facts before it, the Court concluded that the royalty liable to tax was the amount ultimately retained by GIA US after the implementation of the APA. It was not the higher amount initially received from GIA India.

The revenue also challenged the tribunal's finding that GIA India did not constitute a permanent establishment of GIA US in India. According to the Department, the Indian subsidiary was carrying on the business of the US company in India. Profits attributable to that presence were therefore liable to be taxed in India, it argued.

The High Court declined to entertain that challenge. It held that the questions raised by the Revenue did not give rise to any substantial question of law.

The court observed, "As mentioned earlier, questions (d) to (g), and the additional question raised in A.Y. 2017-18, are not entertained as they do not give rise to any substantial question of law."

The appeals were accordingly dismissed. The relief granted to GIA US by the tribunal remains undisturbed.

For Appellants: Senior Advocate N. Venkatraman, ASG, along with Advocates Subir Kumar, Akhileshwar Sharma, Ashita Aggarwal, Diksha Pandey.

For Respondents: Senior Advocate J.D. Mistri, along with Advocates Niraj Sheth, Gunjan Kakkad, instructed by Atul K. Jasani