The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has partly allowed an appeal for Assessment Year 2016-17, deleting a transfer pricing adjustment of ₹5.02 crore relating to royalty paid to its overseas associated enterprise (AE), while also granting relief on several corporate tax disallowances.
The bench of Vimal Kumar (Judicial Member) and S. Rifaur Rahman (Accountant Member) has observed that the Transfer Pricing Officer (TPO) could not rely on unsigned and unexecuted franchise agreement templates obtained from the RoyaltyStat database to benchmark the royalty transaction under the Comparable Uncontrolled Price (CUP) method. At the same time, the Tribunal declined the assessee’s broader argument that royalty and purchase of branded products had to be aggregated and benchmarked together under the Resale Price Method (RPM).
The appellant/assessee was engaged in the wholesale distribution of branded cosmetic products purchased from its group entities and sold to retailers in India. Its portfolio included brands such as MAC, Clinique and Bobbi Brown. The company purchased the products in bulk from its associated enterprises and supplied them to retailers, which ultimately sold them to consumers.
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As part of its business arrangement, ELCA had entered into a Trademark License Agreement and a Marketing Knowhow License Agreement. Under each agreement, it was required to pay royalty at 3% of net sales, resulting in a combined royalty burden of 6%.
The trademark arrangement permitted ELCA to use and sub-license the relevant trademarks, while the marketing knowhow agreement covered knowhow and expertise intended to ensure that the branded products were marketed and sold in a manner consistent with the global brand image and customer experience. ELCA, in turn, passed the trademark and marketing knowhow rights to its retailers without charging them separately.
The assessee therefore contended that the purchase of products and payment of royalty constituted an interconnected and composite distribution transaction. It aggregated the transactions and benchmarked them under the RPM.
According to the assessee’s transfer pricing study, its distribution business generated a gross profit margin of 37.97%, compared with an average gross-profit margin of 32.28% for the selected comparables. On this basis, it claimed that the royalty payment was at arm’s length.
TPO Rejects RPM and Makes ₹5.02 Crore Adjustment
The TPO rejected the assessee’s approach and selected the CUP method as the most appropriate method for benchmarking the royalty.
For this purpose, the TPO relied on four agreements obtained from the RoyaltyStat database. Based on the royalty rates contained in those agreements, the TPO arrived at an average royalty rate of 2.65%, determined the arm’s length royalty at approximately ₹3.80 crore, and consequently proposed an adjustment of ₹5,02,84,262 to the assessee’s income.
The Dispute Resolution Panel sustained the proposed adjustments, following which ELCA approached the ITAT.
The overall assessment had increased the assessee’s business income to ₹12.95 crore, against returned business income of approximately ₹1.43 crore, with aggregate additions and disallowances of about ₹11.51 crore.
One of the most significant aspects of the ruling concerns the comparables used by the TPO.
The Tribunal examined the four franchise agreements relied upon by the Revenue and found that they were non-executed, unsigned templates, rather than actual transactions between independent parties.
The Tribunal held that such templates could not constitute proper comparables for determining the arm’s length price of ELCA’s actual royalty transaction. It observed that the TPO could not bring merely unexecuted templates on record and use them to benchmark the transaction.
The Tribunal therefore rejected the CUP analysis adopted by the TPO, holding that the method had been applied without proper comparable transactions being available.
This finding effectively removed the foundation on which the ₹5.02 crore adjustment had been made.
Although the Tribunal rejected the Revenue’s comparables, it did not accept the assessee’s contention that royalty and product purchases should necessarily be treated as one composite transaction under RPM.
The Tribunal noted that the assessee’s business involved the resale of high-end branded products and that the trademark and marketing knowhow were closely associated with the products. However, it also noted that the associated enterprise was recovering the royalty separately from the basic product price.
According to the Tribunal, if the trademark and marketing knowhow were being separately monetised, the royalty transaction had to be benchmarked separately rather than automatically being absorbed into the product-purchase transaction.
The Bench distinguished earlier decisions relied upon by ELCA, including cases involving TNMM, because the present dispute concerned the use of RPM and the separate benchmarking of royalty under CUP.
The Tribunal explained that RPM focuses on gross margins, whereas TNMM examines net operating profit. It also noted that RPM is more sensitive to product and functional comparability and does not absorb operating expenses in the same way as TNMM.
Despite rejecting the assessee’s aggregation theory, the Tribunal ultimately deleted the royalty adjustment.
The Bench noted that ELCA had achieved a 37.97% gross profit margin, significantly higher than the 32.28% margin of the comparables selected in its transfer pricing study.
The Tribunal further observed that the assessee had achieved this margin without absorbing the 6% royalty payment. After taking the royalty into account, the adjusted gross profit margin worked out to approximately 31.97%, which was close to the 32.28% comparable margin and within a 3% variation.
On the basis of the information available on record and in order to resolve the dispute for the assessment year under consideration, the Tribunal concluded that the benefit of the arm’s length principle could be granted to the assessee.
It accordingly deleted the royalty adjustment of ₹5,02,84,262. Significantly, the Tribunal cautioned that this particular approach was based on the facts and material available for AY 2016-17 and should not be treated as a general benchmarking method for other years or other assessees.
The Tribunal also granted relief to ELCA on the disallowance of expenditure relating to Restricted Stock Units (RSUs).
During the relevant year, ELCA had paid ₹35,84,521 to its overseas group company towards RSUs granted to certain employees. The company claimed the amount as a business deduction under Section 37(1) of the Income-tax Act.
The Assessing Officer had disallowed the expenditure, relying on an earlier Tribunal ruling in Ranbaxy Laboratories. The assessee pointed out that the issue had subsequently been decided in its favour in its own case for AY 2015-16 and that the Special Bench decision in Biocon had also supported the allowability of ESOP expenditure.
The Tribunal found that the issue was covered in favour of ELCA by earlier decisions in the assessee’s own case and other judicial precedents.
Since the facts for the year under consideration were identical, the Bench allowed the assessee’s ground concerning ESOP expenditure.
The Tribunal further deleted the disallowance of ₹48,02,128 towards IT support services obtained from the associated enterprise.
The services included development and maintenance of India-specific websites for brands such as MAC, Clinique and Bobbi Brown, besides global information services provided under a shared-services arrangement.
ELCA had produced the relevant agreement, website screenshots, global information-services catalogue, allocation details and email correspondence to demonstrate that the services had actually been received.
The Tribunal noted that the same issue had already been decided in the assessee’s favour for AY 2015-16. Since the facts were identical, the coordinate Bench followed its earlier decision and deleted the addition.
Another major relief concerned expenditure incurred on testers and sales promotion.
ELCA had incurred approximately ₹22.87 crore towards advertisement and sales promotion during the year. The company explained that testers were an important part of the cosmetics business because retailers needed samples and testers to allow prospective customers to experience the products.
The company also pointed out that the cosmetics market was highly competitive and volatile, with frequent product launches, making advertising and promotional activity necessary to maintain market share and introduce new products.
Although the Assessing Officer accepted that such expenditure was justified considering the nature of the business, an ad hoc disallowance of ₹5,65,11,631 was nevertheless made on the ground that the expenditure was excessive.
The Tribunal found that the issue was recurring and had already been decided in ELCA’s favour for earlier assessment years. Following the coordinate Bench’s earlier ruling, it deleted the disallowance of tester and promotional expenditure.
The assessee had also challenged the non-allowance of a deduction of ₹36,04,725 relating to reversal of a provision for sales returns.
The Tribunal noted that the deduction had already been allowed in AY 2015-16 and that the allowance had subsequently been upheld by the Tribunal in an order dated August 19, 2025.
Since the issue had no impact on the year under consideration, the Tribunal treated the ground as academic and dismissed it.
On the issue of brought-forward business losses and unabsorbed depreciation, the assessee submitted that the DRP had specifically directed the Assessing Officer to verify the claim and allow the set-off in accordance with law.
The AO, however, had not dealt with the DRP’s direction in the final assessment order.
The Tribunal therefore directed the AO to consider the issue after providing the assessee an opportunity of being heard and to allow the set-off in accordance with law. The ground was consequently allowed for statistical purposes.
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