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Category: International Taxation

Section 9(1)(vii) – Scope of FTS service includes professional service – Independent Personal Service (IPS) Article of DTAA – Professional services are taxable in resident state if service provider is person specified in IPS Article of DTAA and satisfies exemption conditions – Services are taxable in source state if service provider is not person specified in IPS Article – Benefit of non-taxation in absence of PE under Article 7 is not available

8. [2020] 121 taxmann.com 189 (Del.)(Trib.) Hariharan Subramaniam vs. ACIT ITA No.: 7418/Del/2018 A.Y: 2015-16 Date of order: 6th
November, 2020

 

Section
9(1)(vii) – Scope of FTS service includes professional service – Independent
Personal Service (IPS) Article of DTAA – Professional services are taxable in
resident state if service provider is person specified in IPS Article of DTAA
and satisfies exemption conditions – Services are taxable in source state if
service provider is not person specified in IPS Article – Benefit of non-taxation
in absence of PE under Article 7 is not available

 

FACTS

The
assessee is an advocate practising in the field of intellectual properties law.
It obtained the services of foreign legal professionals who were individuals,
law firms and companies for filing of various patent applications in foreign
countries. Payment was made without deduction of taxes. Therefore, the A.O.
disallowed payment u/s 40(a)(ia). On appeal, the CIT(A) upheld the order of the
A.O.

 

Before the
Tribunal the assessee contended that (a) services are professional in nature
and are not in the nature of managerial, technical or consultancy services to
fall within section 9(1)(vii); reliance was placed on section 194J to contend
that the Act consciously differentiates professional services and FTS; and (b)
under the DTAA, services falls within the Independent Personal Services (IPS)
article and unless the specified conditions are satisfied, exclusive taxing
right is with the resident state.

 

HELD

Scope
of FTS u/s 9(1)(vii)

  •   Professional services fall
    within the ambit of FTS.
  •   Section 194J is applicable
    to payments made to a resident. The distinction between professional services
    and FTS in section 194J has no relevance to determination of taxability of a
    non-resident.
  •   Section 9 includes income
    which is deemed to accrue or arise in India. It enlarges the scope for
    taxability of non-resident income.

 

Scope
of IPS article under DTAA

  •   Services falls within the
    IPS article of the DTAA. Payment will not be taxable in India if (a) the NR
    does not have fixed base in India, and (b) NR is not present in India for a
    specified number of days (exemption conditions).

 

Service
provider is specified person as per IPS Article1

  •   Services will not be
    taxable in India if the service provider satisfies exemption condition and he
    is a specified person as provided under the IPS article of the respective treaty.
    The treaties vary in terms of scope and applicability of persons to whom the
    IPS articles apply.
  •   Matter remanded to A.O. for
    verification of treaty residence and satisfaction of exemption conditions.

 

Service
provider is not specified person as per IPS Article2

  •   Service provider will not
    be entitled to benefit of the IPS Article under the DTAA.
  •   The Tribunal rejected the assessee’s argument
    of non-taxation of business profit in the absence of PE as in the view of the
    Tribunal, the DTAA has classified service recipient in two separate categories,
    viz., Article 7 and Article 15, for taxability of two types of income streams.
  •   Income continues to be professional service
    but does not satisfy the exemption condition of the IPS Article resulting in
    taxation in the source state.

 

Note: The decision has not dealt with the interplay of the FTS Article
with the IPS Article.

_________________________________________________________________________________________________

1   DTAA with countries Brazil, China, Czech
Republic, Japan, Philippines, Thailand and Vietnam covers within its scope
individual, company, partnership firm; DTAA with Australia covers individual,
partnership firm (other than company); DTAA with Korea covers only individuals

2   Norway, Denmark, Sri Lanka, Malaysia, Russia,
Luxembourg, Australia, Republic of Korea, South Africa, New Zealand, Mexico,
Indonesia, Colombia and Serbia cover only individuals. Other categories of taxpayers are not covered

 

Articles 11 and 7, India-Germany DTAA – Once entire interest was taxed on gross basis under Article 11, no taxation survived in respect of subsidiary and incident commitment fees and agency fees under article 7 as PE income even assuming the foreign bank had office which supported earning of such interest income – Once tax liability is discharged in respect of interest income under Article 11, the taxpayer is relieved of obligation to file ROI in terms of Article 11 read with section 115A(5)

 7. [2020] 122 taxmann.com 65 (Mum.)(Trib.) DZ Bank AG – India Representative Office vs. DCIT ITA No.: 1815 (Mum.) of 2018 A.Y.: 2014-15 Date of order: 4th
December, 2020

 

Articles 11 and 7, 
India-Germany DTAA  –  Once entire interest was taxed on gross basis
under Article 11, no taxation survived in respect of subsidiary and incident
commitment fees and agency fees under article 7 as PE income even assuming the
foreign bank had office which supported earning of such interest income – Once
tax liability is discharged in respect of interest income under Article 11, the
taxpayer is relieved of obligation to file ROI in terms of Article 11 read with
section 115A(5)

 

FACTS

The
assessee was a German banking company. It had set up a representative office
(‘RO’) in India after obtaining approval of the RBI, subject to the conditions
that: the RO will function only as a liaison office; it will not undertake
banking business; and all expenses of the RO will be met out of inward
remittances from the head office (‘HO’). The assessee had filed its return of
income in the name of the RO (apparently treating the RO and the HO as separate
entities) disclosing Nil income.

 

The A.O.
noticed that during the relevant previous year, the HO had provided foreign
currency loans to Indian companies from which payers had withheld tax. As
regards filing of returns, the assessee explained that as per section 115A(5)
of the Act a foreign company is exempt from furnishing return of income in
India if it only earns interest from foreign currency loans provided to Indian
companies. The A.O. asked the assessee to show cause why the RO should not be
considered as the PE of the HO in India and why interest and any other income
earned by the HO from operations in India should not be taxed @ 40%.

 

The
assessee argued that the RO did not constitute a PE of the HO under the basic
rule as no business activities were carried out from the RO. At best, the RO
was a fixed place of business engaged in ‘any
activity of preparatory or auxiliary character’, which
was excluded from the definition of PE, Article 5(4) of the India-Germany DTAA.
Besides, the RO cannot be said to be a dependent agent PE (‘DAPE’) as it had no
authority to conclude contracts on behalf of the HO or its other branches.

 

However,
after noting the activities undertaken by the RO on behalf of the HO, the A.O.
concluded that the business transactions of the HO with Indian clients could
not have been completed without the involvement of the RO. Thus, there was a
real relation between income-earning activity carried on by the assessee and
the activities of the RO which directly or indirectly contributed to earning of
income by the assessee. Therefore, income should be deemed to accrue / arise to
the assessee from ‘business connection’ in India.

 

Further,
‘auxiliary’ means helping, assisting or supporting the main activity.
Therefore, the issue was whether activities carried on by the RO only supported
the main business. Even if some functions of the RO might have been auxiliary,
the RO played a significant part in the lending business of the assessee in
India which could not be said to be auxiliary activity. Hence, the RO was a PE
of the assessee and profits attributable to the PE were deemed to accrue or
arise to the assessee.

 

The A.O.,
accordingly, taxed the entire interest income, commitment fees and agency fees
as income of the assessee as PE income on net basis, after allowing deduction
of expenses of the RO instead of gross basis of taxation suffered by the HO
under Article 11.

 

HELD

As
regards HO and RO being separate taxable entities under the Act

  •   The entire proceedings by
    the A.O. were on the premise that the HO and the RO were two distinct taxable
    entities. However, under the Act the taxable unit is a foreign company and not
    its branch or PE in India. The profit attributable to the PE is taxable in the
    hands of the HO. In     CIT vs. Hyundai Heavy
    Industries Co. Ltd. [(2007) 291 ITR 482 (SC)],     the
    Supreme Court observed that     ‘it is clear that under the
    Act a taxable unit is a foreign company and not its branch or PE in India’.
  •   The assessee filed the return
    in the name of the RO excluding interest received by the HO. Tax on interest
    was withheld and paid by payers under Article 11 of the India-Germany DTAA.
    Hence, there was no loss of revenue from such error. Further, the Department
    had also not objected. Hence, to avoid inconvenience to the assessee, a
    pragmatic view required to be adopted.

 

As regards taxability under Article 11 vis-à-vis Article
7

  •   Interest is taxable on
    gross basis under Article 11. It may be taxed on net basis under Article 7 if exception
    in Article 11(5) is triggered upon two conditions being fulfilled, namely, (a)
    the HO carries on business in the source state through a PE, and (ii) debt
    claim in respect of which interest was paid is effectively connected with such
    PE.
  •   There is a subtle
    distinction between     carrying on business
    of banking     vis-a-vis carrying on activities which
    contribute directly or indirectly to earning of income     from the business of banking.
  •   Even if an assessee
    maintains a fixed place of business, and even if there is a real relation
    between the business carried on by the assessee and the activities of the RO
    which directly or indirectly contribute to earning income, as observed by the
    A.O., that relationship     per se will
    not make that place a PE or activities taxable in India, if that place is so
    maintained solely for the purpose of the activity of preparatory or auxiliary
    character.

 

As
regards A.O. seeking to tax under Article 7

  •   The A.O. sought to tax
    income on net basis under Article 7. This income was already taxed on gross
    basis under Article 11.
  •   Further, the conditions
    stipulated for triggering the exception under article 11(5) for taxing interest
    under Article 7 on net basis were also not satisfied.
  •   Whether or not there was a
    PE, the debt claim in question could not be said to be effectively connected to
    the alleged PE. Therefore, exclusion of Article 11(5) could not have been
    triggered. Consequently, taxability under Article 7 could not have come into
    play.

 

As
regards ALP adjustment for service by the RO to the HO

  •   If the representative
    office of a foreign enterprise performs certain activities, suitable ALP
    adjustment for such activities could be in order.
  •   Even if RBI restricts the
    representative office of a foreign enterprise from transacting any banking
    business, such representative office does carry on economic activities. Hence,
    ALP adjustment for the same could be made.
  •   Once the entire revenue
    earned in India is taxed on gross basis under Article 11, no income survives
    for taxation under Article 7. In such a case, making any ALP adjustment will
    result in taxing previously taxed income. It will also result in taxable income
    being more than revenue in India.

 

As regards taxability of commitment fee and agency fee

  •   Commitment fee and agency
    fee were paid in connection with loan guarantee. Accordingly, they were not
    taxable under Article 11(3)(b) of the India-Germany DTAA.
  •   In Hindalco Industries Ltd.vs. ACIT [(2005) 94 ITD 242 (Mum.)],
    the Tribunal noted that     ‘…when principal transaction
    is such that it does not generally give rise to taxability in the source
    country, the transaction subsidiary and integral to such a transaction also
    does not give rise to taxability in the source country. In other words, the
    subsidiary and integral transactions have to take colour from the principal
    transaction itself and are not to be viewed in isolation’.
  •   Commitment charges and
    agency fees were, in fact, an integral part of the loan arrangements. They were
    relatable to the same loan and were part of consideration for the same loan. If
    the principal transaction (i.e., interest) did not result in taxable income in
    India, the subsidiary transaction (i.e., commitment fees and agency fees) could
    not result in taxable income in India.

 

As
regards filing return in India

  •   On the facts and in the circumstances of this
    case and in law, the assessee had no income other than interest from its
    clients in India.
  •   Tax liability on interest was already
    discharged under Article 11. Hence, the assessee had no obligation to file
    return of income under section 115A(5) of the Act.

 

THE CONUNDRUM OF ‘MAY BE TAXED’ IN A DTAA

INTRODUCTION

The liability to pay tax on global income of a resident assessee u/s 4 r/w/s 5 of the Income -tax Act, 1961 (the
Act) is subject to Double Taxation Avoidance Agreements (DTAA) entered into by
the Government with foreign countries u/s 90 of the Act.

 

As per section 90(1), the Government may enter into agreements with
foreign countries for (a) granting of relief in respect of income on which have
been paid both income-tax under the Act and income-tax in that country, (b) for
avoidance of double taxation of income, (c) for exchange of information for the
prevention of evasion or avoidance of income tax, and (d) for recovery of
income-tax under the Act and under the corresponding law in force in that
country.

 

In order to achieve the object of avoidance of double taxation, two
rules are generally adopted under a DTAA:

  •  Allocating taxing rights between contracting States with respect to
    various kinds of income, called distributive rule, and
  •  Obligating the State of residence to give either credit of taxes
    paid in the source State or to exempt the income taxed in the source
    State.

 

In this regard, DTAAs are found to use one or more of the following
phrases:

‘shall be taxable only’

‘may be taxed’

‘may also be taxed’.

 

The expression ‘shall be taxable only’ indicates that exclusive right
to tax is given to one contracting State. The expression ‘may also be taxed’
indicates that the right to tax is given to both contracting States.

 

As regards the expression ‘may be taxed’, it has been the subject
matter of interpretation as to whether it would mean the right to tax is given
only to the source State or to both contracting States.

 

In CIT vs. R.M. Muthaiah [1993] 292 ITR 508
(Kar.), the Honourable Karnataka High Court interpreting Article 6(1) of
the Indo-Malaysia DTAA which provides that ‘Income from immovable property may
be taxed in the contracting State in which such property is situated’ held that ‘when a power is specifically recognised as vesting in one,
exercise of such a power by others, is to be read as not available; such a
recognition of power with the Malaysian Government would take away the said
power from the Indian Government’. Thus, the Court held that as the immovable property is situated in
Malaysia, the power to tax income vested with the Malaysian Government and not
with the Indian Government.

 

The aforesaid decision is approved by the Supreme Court in UOI vs. Azadi Bachao Andolan [2003] 263 ITR 706
(SC) (see page 724).

 

In CIT vs. P.V.A.L. Kulandagan Chettiar [2004] 267 ITR 654 (SC), on the basis of the decision in Muthaiah (Supra), it was argued that the expression ‘may be taxed’ should be read as
‘shall only be taxed in the source State’. The Supreme Court held that when a
person resident in India is deemed to be a resident of Malaysia by virtue of his
personal and economic relations, his residence in India will become irrelevant
under the DTAA. The Court held that the assessee is
liable to tax only in Malaysia and not in India as his income from estate is not
attributable to a permanent establishment in India. Thus, the decision was
rendered on an altogether different ground. In fact, the residence of the assessee therein was never put to question before any
appellate authority / court including the Supreme Court. Although the Supreme
Court did not deliberate upon the phrase ‘may be taxed’, it did not upset the
decision in Muthaiah (Supra).

 

The decision of Kulandagan Chettiar (Supra) was understood [albeit incorrectly, if we may say so with utmost respect] by various Courts
as holding that the term ‘may be taxed’ has to be read as ‘shall be taxed only
in source State’. The following is the illustrative list of such
cases:

 

Dy. CIT vs. Turquoise Investment & Finance Ltd. [2006] 154 Taxman
80 (Madhya Pradesh) affirmed in Dy. CIT vs. Turquoise Investment & Finance Ltd. [2008] 168
Taxman 107 (SC);

Bank of India vs. Dy. CIT [2012] 27 taxmann.com 335 (Mum.)
upheld in CIT vs. Bank of India [2015] 64 taxmann.com 215 (Bom.);

Emirates Fertilizer Trading Co. WLL, In re [2005] 142 Taxman 127 (AAR);

Apollo Hospital Enterprises Ltd. vs. Dy. CIT [2012] 23 taxmann.com
168 (Chennai);

Daler Singh Mehndi vs. DCIT [2018] 91
taxmann.com 178 (Delhi-Trib.);

Ms Pooja Bhatt vs. CIT
2008-TIOL-558-ITAT-Mum.;

N.V. Srinivas vs. ITO [2014] 45 taxmann.com
421 (Hyderabad-Trib.).

 

The Legislature introduced sub-section (3) to section 90 by the
Finance Act, 2003 w.e.f. 1st April, 2004.
As per section 90(3), any term used but not defined in the Act or in the DTAA
shall, unless the context otherwise requires, and is not inconsistent with the
provisions of the Act or the DTAA, have the same meaning as assigned to it in
the Notification issued by the Central Government in the Official Gazette in
this behalf.

 

In exercise of powers under the aforesaid section, CBDT issued
Notification No. 91 of 2008 dated 28th August, 2008 wherein it
clarified that where the DTAA provides that any income of a resident of India
‘may be taxed’ in the other country, such income shall be included in his total
income chargeable to tax in India in accordance with the provisions of the Act
and relief shall be granted in accordance with the method for elimination or
avoidance of double taxation provided in such agreement.

 

In this article, an attempt is made to address the question whether
the decision in Muthaiah (Supra) is upset by the aforesaid Notification.

 

ANALYSIS

Analysis of Notification 91 of 2008

It may be noted that the scope of section 90(3) is to enable the
Central Government to only ‘define’ any term used but not defined in the Act or
in the DTAA. The memorandum to the Finance Bill, 2003 also clarifies that the
aforesaid provision is inserted to empower the Central Government to define such
terms by way of a Notification.

 

However, Notification No. 91 of 2008 does not define ‘may be taxed’.
It rather seeks to clarify the stand of the Government when such a phrase is
used. The said Notification in seeking to clarify the stand of the Government
has traversed beyond the scope of section 90(3). The words ‘may be taxed’ are at
best a phrase and not a term so that the definition of a phrase is not even in
the contemplation of section 90. Therefore, the validity of the aforesaid
Notification is open to challenge. Even if its validity is not put to challenge,
its enforceability may be doubted by the Courts.

Certain benches of the Tribunal have held that the legal position
understood as adumbrated in Kulandagan Chettiar (Supra) has undergone a sea change after the issue of the aforesaid
Notification and the words ‘may be taxed’ will not preclude the right of the
State of residence to tax such income. The following is the illustrative list of
such cases:

 

Essar Oil Limited vs. ACIT [2011] 13 taxmann.com 151
(Mumbai);

Essar Oil Ltd. vs. Addl. CIT [2014] 42 taxmann.com 21
(Mumbai);

Technimont (P) Ltd. vs. Asst. CIT [2020] 116 taxmann.com 996
(Mumbai-Trib.);

N.V. Srinivas vs. ITO [2014] 45 taxmann.com
421 (Hyderabad-Trib.)

 

As stated earlier, Kulandagan Chettiar did not lay down such principle. In fact, such principle was laid
down in Muthaiah which was approved in Azadi Bachao Andolan
(Supra). Further, as stated earlier, the principle of Muthaiah could not have been upset by the Notification No. 91 of 2008.
Therefore, it is trite to say that the principle of Muthaiah as approved in Azadi Bachao
Andolan holds the field as of date.

 

IMPACT OF MLI

India has signed Multi-Lateral Convention to Implement Tax
Treaty-Related Measures to Prevent Base Erosion and Profit Shifting
(‘Multi-Lateral Instrument’ or ‘MLI’).

 

MLI enables the contracting jurisdictions to modify their bilateral
tax treaties, i.e., DTAAs, to implement measures designed to address tax
avoidance. Therefore, the DTAAs have to be read along with the MLI.

 

MLI 11 deals with ‘Application of Tax Agreements to Restrict a
Party’s Right to Tax its Own Residents’. India has not reserved MLI
11.

 

The countries which have chosen MLI 11(1) with India (as on
29th September, 2020) are as under [source:
https://www.oecd.org/tax/beps/mli-matching-database.htm]:

Sl. No.

Name of countries

1

Armenia

2

Australia

3

Belgium

4

Colombia

5

Denmark

6

Fiji

7

Indonesia

8

Kenya

9

Mexico

10

New Zealand

11

Norway

12

Poland

13

Portugal

14

Romania

15

Russia

16

Slovak Republic

17

United Kingdom

 

As per MLI 11(1) a Covered Tax Agreement shall not affect the
taxation by a Contracting Jurisdiction of its residents, except with respect to
the benefits granted under provisions of the Covered Tax Agreement which are
listed in clauses (a) to (j).

 

Clause (j) deals with the provisions of DTAA which otherwise
expressly limit a Contracting Jurisdiction’s right to tax its own residents or
provide expressly that the Contracting Jurisdiction in which an item of income
arises has the exclusive right to tax that item of income.

 

For example, Article 7(1) of the Indo-Bangladesh DTAA provides that
‘The profits of an enterprise of a Contracting State shall be taxable
only in that State unless the enterprise carries on business in the other
Contracting State through a permanent establishment situated therein. If the
enterprise carries on business as aforesaid, then so much of the profits of the
enterprise as is attributable to that permanent establishment shall be taxable
only in that other Contracting State.’

 

The aforesaid article expressly takes away the right of the resident
country to levy tax on profits attributable to its PE.

 

Thus, in the absence of an express provision, the right of the
resident country to tax its residents cannot be taken away under the DTAA.
Therefore, the expression ‘may be taxed’ cannot be construed to mean ‘shall be
taxable only in the source state’, unless it is expressly stated. It may be
noted that the aforesaid proposition would apply only with respect to countries
which have opted for MLI 11 with India. It cannot be applied to countries which
have not chosen MLI 11 and which have not signed the MLI.

 

Now, the question that arises is whether the decision in Muthaiah would apply with respect to countries which have not chosen MLI 11
or countries which have not signed the MLI.

 

It may be noted that in certain DTAAs a clarification has been given
to the expression ‘may be taxed’ through protocols by stating that the said
expression should not be construed as preventing the resident country from
taxing the income. For example:

 

Indo-Malaysia DTAA: In paragraph 3 of the protocol signed on 9th May, 2012 it
has been stated that the term ‘may be taxed in the other State’ should not be construed as preventing the country of residence from
taxing the income.

 

Indo-South Africa DTAA: In paragraph 1 of the protocol signed on 26th July, 2013
it has been stated that wherever there is reference to ‘may be taxed in the other Contracting State’, it should be understood that income may, subject to the provisions
of Article 22 (Elimination of Double Taxation), also be taxed in the
first-mentioned Contracting State.

 

Indo-Slovenia DTAA: Under paragraph 2 of the protocol signed on 13th January,
2013 it has been stated that with reference to Article 6(1) and Article 13(1) it
is understood that in case of India income from immovable property and capital
gains on alienation of immovable property, respectively, may be taxed in both
Contracting States subject to the provisions of Article 23.

 

Thus, with respect to DTAAs like those above, the decision in
Muthaiah would not apply. With respect to the rest of the DTAAs, the decision
in Muthaiah would continue to apply.

 

CONCLUSION

With respect to countries which have adopted MLI 11, the right of
India to tax its residents cannot be taken away unless such right is expressly
taken away under a DTAA. This would mean that with respect to such cases the
decision in Muthaiah would not apply.

With respect to countries which have not adopted MLI 11 and which
have not signed MLI:

(a) India cannot tax its residents with respect to income derived
from source State, unless such right is expressly provided under the DTAA as in
the Indo-Malaysia DTAA, the Indo-South Africa DTAA, the Indo-Slovenia DTAA, etc.
This would mean that with respect to such cases the decision in Muthaiah would apply.

(b) Notification No. 91 of 2008 does not
apply as the said Notification has been issued beyond the scope of section
90(3).

 

TAXING THE DIGITAL ECONOMY – THE WAY FORWARD

The economy today is truly digital; from
business and entertainment, to food and travel, everything is accessible online.
To veterans in business, everything digital is a revolution and is often termed
Industry 4.0; to a school kid, it’s the way of life that they were born into.
Commerce and business is no longer limited by territorial
boundaries.

 

The digital economy is growing at an exponential rate while countries
are still debating mechanisms for taxation of the digital economy. On the
entertainment front, films moved from reels to disks and have now become content
that is streamed. Music moved from records to tapes to disks to downloads and is now streamed live. It is important to note
that while the modus of conducting business has changed, it is still the
same products and services that are supplied, albeit in a different
form.

 

Digital means of communication and social interaction are giving rise
to new businesses that did not exist very long ago. Many of these businesses
that have developed only in the last two decades have taken over a considerable
share of market segments and form a significant part of the economy and tax
base. Their growth in India has also reached proportions that make them
significant actors in the Indian economy1
.

 

Laws that are currently in place are at the behest of metrics that
were designed to tackle the then available modes of conducting business.
Developments in businesses with the aid of technology only means that they
function in a niche area where there is little or no governance and
countries have started expressing the view that they are not getting their fair
share of revenue and there is a demand for taxing rights across the
world.

 

Debates and deliberations on taxing the digital economy have been
taking place throughout the world; international organisations like the OECD and
the UN and even others that are meant for regional co-operation have involved
stakeholders and other key parties in the debates; they even adopted a
Multi-Lateral Instrument (MLI) – and yet, any consensus on arriving at a
suitable legal framework remains elusive.

Important and interesting questions are inevitable on who gets such
rights; or whether a number of nations who participate in the transactions
should pool such taxing rights; what would be the profits that would be
available for taxation, etc.– all these are questions in search of
answers.

 

When these questions are attempted to be answered, one realises that
the existing laws are woefully inadequate and the elusive consensus in the OECD,
the non-participation of the USA in the entire discussion and the new initiative
from the UN only amplify the cacophony of confusion. Unilateral initiatives such
as digital taxes, equalisation levies and cross-border wars have only made
things more difficult.

 

__________________________________________________________________________________________________________________________________

1   CBDT, Proposal for
Equalization Levy on Specified Transactions, Report of the Committee on
Taxation of E-Commerce (2016)

POSSIBLE SOLUTIONS

In this article, an attempt has been made to think out of the box and
explore new solutions based on some past tested practices, apart from ensuring
that taxing rights are adequately conferred without compromising the tax credit
through the DTAA.

 

Solution
No. I: Theory of
Presumptive Taxation – Payment for Digital Business

Presumptive taxation exists for certain businesses through provisions
in the domestic statutes. In India, section 44BB of the Income-tax Act, 1961
provides that where a non-resident provides services or facilities in connection
with or supplying plant and machinery used or to be used in prospecting,
extraction, or production of mineral oils, the profit and gains from such
business chargeable to tax shall be calculated at a sum equal to 10% of the
aggregate amounts paid or payable to such non-residents. This presumptive
taxation has been extended to the business of operating aircraft (section 44BBA)
and to civil construction and erection of plants under certain turnkey projects
(section 44BBB). An interesting feature of these presumptive taxation provisions
is that an assessee can claim lower profits than the
profits specified in the presumptive mechanism provided he maintains books of
accounts and other records and furnishes a tax audit report u/s
44AB.

 

This presumptive taxation can have the following
features:

(i)         It can be a
provision in the domestic statute and apply to non-residents who are engaged in
identified digital businesses which involve B2C transactions;

(ii)        The MLI route
should be adopted to ensure that the source State gets a right to tax digital
business in addition to the resident State without diluting the eligibility to
claim set-off of taxes in the said State;

(iii)       ‘Digital business’
can be defined to mean the activity of supply of goods or services over the
internet or electronic network either directly or through an online platform,
and includes supply of digital goods or digital services, digital data storage,
providing data or information retrievable or otherwise in electronic form. This
category should be a separate category apart from Fees for Technical Services
and Royalty;

(iv)       ‘Digital goods’ can
be defined to mean any software or other goods that are delivered or transferred
or accessed electronically, including via sound, images, data, information, or
combinations thereof, maintained in digital format where such software or other
goods are the principal object of the transaction as against the activity or
service performed or rendered to create such software or other
goods;

(v)        ‘Digital service’
can be defined to mean any service that is provided electronically, including
the provision of remote access to or use of digital goods, and includes
electronic provision of the digital service to the customer;

(vi)       The tax would be on
the deemed income which in turn would be a specified percentage of the payments.
A percentage of the amounts paid or payable by the customer to the overseas
supplier of digital goods or services can be identified as income deemed to
accrue or arise in a market jurisdiction;

(vii)      A clear definition
of the businesses covered in this segment would be required to ensure
transparency, compliance, ease of business, simplicity in tax administration,
etc.;

(viii)     While the tax would
remain a tax on income, there can be two models for collection:

  •             The first model
    would require the non-resident to obtain a special and simple registration in
    the source jurisdiction and pay tax at the presumptive rates;
  •             The second model
    would require that the tax be paid by the bank or financial institution or
    payment gateway or financial intermediary. This identified party shall pay the
    tax at the time of remittance of the payment itself. Assuming that USD 100 is
    payable for digital goods or services, that the presumed income is 10% and the
    tax rate 20%, the identified intermediary would be
    bound to release only USD 98 and remit USD 2 as taxes on behalf of the
    non-resident. This amount should be available as credit to the non-resident
    under the DTAA;

(ix)       It has to be ensured
that the payment by the identified intermediary is not in the nature of
withholding taxes but payment of taxes on behalf of the non-resident. This will
ensure that issues with reference to grossing up of payments are
avoided.

 

Solution No. II: Theory of Apportionment based on FARE

One of the methods that can be debated and examined in order to
arrive at a solution for taxing digital transactions would be based on the
theory of apportionment. Apportionment as a concept exists in many indirect tax
laws across the world. Typically, in GST input tax credit is apportioned in the
context of taxable and exempt supplies. While FAR is an established
principle which covers Functions, Assets and Risk, FARE would cover
Functions, Assets, Risk and Economic Presence.

 

In the context of property taxes, the Oregon Supreme Court in the
case of Alaska Airlines Inc. vs. Department of
Revenue2 upheld the position adopted by the Revenue
where the assessment was based on the presence, as reflected in air and ground
time, of aircraft property in that State. The taxes were proportionate to the
extent of the activities of the airlines’ units of aircraft properties within
the State. While engaging in these activities, the airlines enjoyed benefits,
opportunities and protection conferred or afforded by the State’s search and
rescue services, opportunities for further commerce and the protection of Oregon
criminal laws, and so could be made to bear a ‘just share of State tax burden’.
The taxes were fairly related to services provided by the State.

 

In the USA, questions arose as to the right of States in the context
of taxes and a four-pronged test was laid down by the US Supreme Court in the
case of Complete Auto Transit Co. vs. Brady3
wherein it was observed that this Court in a number of decisions has sustained a
tax against Commerce Clause challenge when

(i)         The tax is applied
to an activity with a substantial nexus with the taxing State,

(ii)        The tax is fairly
apportioned,

(iii)       The tax does not
discriminate against interstate commerce, and

(iv)       The tax is fairly
related to the services provided by the State.

 

This four-pronged test is an interesting test which can be the
starting point for working out provisions for taxing the digital economy.
The traditional concept of exclusive taxation by one State or double
taxation with credits which is established through DTAA may have to give way to
a new system wherein there will be a fair apportionment of tax between the
source State as well as the residence
State.

 

The challenges would be to identify a fair apportionment between the
countries. There could be complications where multiple countries are involved.
Insofar as the US is concerned, there are statutory apportionment formulae which
are based on property, payroll and sales.

 

The Functions, Asset, Risk (FAR) Test can be expanded to a Functions,
Asset, Risk, Economic Presence (FARE) Test. The Economic Presence could, of
course, mean Significant Economic Presence and would be a combination of revenue
thresholds and number of transactions. Accordingly, FARE would represent the
following.

 

  •  Functions can cover the access and penetration
    in the market;
  •  Assets deployed could cover the website, the
    artificial intelligence solutions, the technology platforms which are used in
    the transaction delivery mechanism to the market instead of focusing on their
    physical location;
  •  Risks inherent to digital businesses such as
    privacy, security, vulnerability of data, etc., can be given adequate
    weightage;
  •  Economic Presence could be based on threshold
    in terms of sales or volume of transactions.

 

In this model, countries will have to debate and arrive at a
consensus on what would constitute Significant Economic Presence. The solutions
so arrived at should be implemented through a Multi-Lateral Instrument
(MLI).

 

It may be possible to apply Solution No. II for B2B
transactions and Solution No. I for B2C
transactions. Further, B2C should not be confined merely to customers but
should be comprehensive enough to cover businesses that are
end-users.

 

Solution
No. III: Theory of
Access – ePE (Digital PE)

A building site or construction, installation or assembly project or
supervisory activities in connection therewith constitutes a PE under Article 5
based on breaching a period threshold. Similarly, an installation or structure
used for exploration or exploitation of natural resources constitutes a PE when
it breaches a particular period threshold. The period differs between the UN
Model and the OECD Model.

 

Where the number of days or months can be the basis for determination
of PE, it should be possible to arrive at a new concept of ePE (Digital PE) based on the number of users who have
accessed the goods or services provided by a non-resident through digital
means. In effect, this would seek to identify nexus to a market jurisdiction
based on access exercised by the customers in that jurisdiction through
electronic means for procurement of goods and services. A new definition or an
additional category to the existing Permanent Establishment definition will have
to be agreed upon and developed.

 

Care must be taken to ensure that a digital PE is clearly linked with
the breach of the number of users threshold. There must
not be any reporting requirements or compliance requirements from a user’s
perspective but a non-resident business which transacts in a market jurisdiction
digitally will have to report the number of users of its website linked with
transactions consummated. A customer-driven reporting may not work given the
fact that the customer can access the website through multiple devices and from
anywhere in the world. Once a PE is established the normal principles for
attribution of profits will come into play.

 

This is based on the premise that any supply of goods or services by
way of electronic commerce would necessarily involve intermediaries such as
banks, payment gateways, internet service providers, etc. The number of
transactions consummated in a particular jurisdiction can be easily identified
based on data provided by the various institutions. One of the key elements in a
transaction of procurement of goods or services through the internet is the
payment. This payment is also made online.

 

For example, if this logic is extended, one possible solution for
taxing digital entertainment in the country where it is downloaded or
viewed is to identify that the income arises or accrues or deems to arise or
accrue in the country in which the said digital content is downloaded or
streamed. Insofar as download or streaming of entertainment content is
concerned, there would be data points such as a customer having a registration;
having a user ID and password; network login details; payment for the content
and downloading / streaming data.

There are two challenges in this solution, namely,

(i)         Identification of
profits attributable to the country in which the content is downloaded or
streamed; this could be addressed by a deemed agreed percentage, and

(ii)        Illegal download or
streaming of content, payment through non-banking channels, payment through
unregulated virtual currencies, free services.

 

Solution
No. IV: OIDAR – The
Direct Tax Twin

Drawing an analogy from India’s GST provisions which identify OIDAR
(online information database access and retrieval) services that are supplied to
a non-taxable online recipient, or even the same model, can be emulated from a
direct tax perspective. Insofar as OIDAR services which are automated and
provided by a supplier who is a resident of another nation are concerned, the
said supplier can be required to pay income tax in the nation where the
recipient resides. Care should be taken to ensure that the levy retains the
character of direct tax and does not convert itself into a consumption tax. The
identification of taxability can be linked with the GST provisions but the tax
should be only on the profits. Nations can agree upon a certain percentage of
the receipts / payments on account of such supplies to be deemed as the income
accruing or arising in the recipient country. This would also meet the
requirement of nexus to the market jurisdiction. Tax credit has to be
ensured.

 

Solution
No. V: Tax
Collection at Source (TCS)

Section 206C provides that a seller at the time of debiting the
amount payable by the buyer to the account of the buyer, or at the time of
receipt of amounts from the buyer, whichever is earlier, has to collect as
income tax a specified percentage of the amount in respect of specified goods.
For example, a seller of scrap will have to collect 1% as TCS from the buyer.
The amount collected represents the income tax payable by the buyer. The buyer
will get the credit of tax so collected against his income-tax liability. This
model can be examined and modified in the following manner:

 

(i)         Any person who
facilitates payment for supply of digital goods or services shall be liable to
collect tax at source at a specified percentage. This tax shall be collected as
income-tax and should be available as credit to the non-resident supplier of
goods and services;

(ii)        Person facilitating
payment would mean the bank or financial institution or financial intermediary
or e-wallet service provider;

(iii)       To illustrate, if a
non-resident supplies digital content and the resident uses his credit card for
making payment of USD 100, the bank becomes responsible for making the payment
by way of TCS. Assuming that TCS is notified at the rate of 1%, the bank, at the
time of transfer of funds to the non-resident supplier, will deduct 1% being the
tax, apart from any other applicable transaction charges;

(iv)       The supplier will have
to obtain a simplified registration in the market jurisdiction and will have a
tax account which will reflect the payments by way of TCS;

(v)        The system should
automatically generate a certificate for payment by way of tax in the market
jurisdiction which would be available for claiming credit of taxes in the
country of residence under the treaty.

 

The
solutions referred to above are ideas which can be debated and developed into
effective and sustainable solutions. A solution to be effective has to be
certain and simple with uniform application. The aspirations of the market
jurisdiction in seeking taxing rights and the concerns of nations which are
worried about losing revenue will have to be balanced to ensure that the new
system that is created benefits one and all. At the end of the day, the levy of
taxes should not end up in scuttling new ideas and growth in the digital
environment.

Articles 8 and 24 of India-Singapore DTAA – Limitation of Relief (LOR) provisions (Article 24 of India-Singapore DTAA) are not applicable if (a) India does not have right to tax income pursuant to treaty provision, (b) income is taxed in Singapore under accrual basis. Accordingly, Article 24 is not applicable to shipping income earned by Singapore tax resident which is not taxable in India as per Article 8 of DTAA as also taxable on accrual basis in Singapore

6. [2020] 121 taxmann.com 165
(Chen.)(Trib.) Bengal Tiger Line (P) Ltd. vs. DCIT ITA No: 11/Chny/2020 A.Y.: 2015-16 Date of order: 6th November,
2020

 

Articles
8 and 24 of India-Singapore DTAA – Limitation of Relief (LOR) provisions
(Article 24 of India-Singapore DTAA) are not applicable if (a) India does not
have right to tax income pursuant to treaty provision, (b) income is taxed in
Singapore under accrual basis. Accordingly, Article 24 is not applicable to
shipping income earned by Singapore tax resident which is not taxable in India
as per Article 8 of DTAA as also taxable on accrual basis in Singapore

 

FACTS

The
assessee, a Singapore tax resident, was involved in the business of operation
of ships in international waters. It did not offer to tax income received from
shipping operations in India relying on Article 8 of the India-Singapore DTAA.
The A.O. denied Article 8 benefit invoking Article 24 of the India-Singapore
DTAA. In the view of the A.O., Limitation of Relief (LOR) provisions under
Article 24 apply since income from shipping operations is exempt under Singapore
tax laws.

 

The DRP
upheld the view of the A.O. Being aggrieved, the assessee appealed before the
Tribunal.

 

HELD

  •   Article 24 is applicable if
    (i) income is sourced in a Contracting State (India) and such income is exempt
    or taxed at a reduced rate by virtue of any Article under the India-Singapore
    DTAA, and (ii) income of the non-resident should be taxable on receipt basis in
    Singapore.
  •   The first condition of
    Article 24 is not satisfied as Article 8 of the India-Singapore DTAA provides
    exclusive right of taxation to Singapore. It does not provide for exemption or
    reduced rate of taxation of such income.
  •   Since India does not have
    right to tax shipping income, the satisfaction of other conditions of Article
    24, like exemption or reduced rate of tax, has no bearing on the taxability of
    shipping income.
  •   The second condition is not
    satisfied as the income of the shipping company is taxed on accrual basis in
    Singapore.
  •   Reliance was placed on the
    Singapore IRAS letter dated 17th September, 20182  wherein it was specifically stated that the
    provisions of Article 24 of the India-Singapore DTAA would not be applicable to
    shipping income.

______________________________________

2   Content
of letter is not extracted in decision

Explanation 7 to section 9(1)(i) – Small shareholder exemption introduced by this Explanation inserted by Finance Act, 2015 is retrospective in nature

5. [2020]
120 taxmann.com 325 (Del.)(Trib.) Augustus
Capital (P) Ltd. vs. DCIT ITA
No: 8084/Del/2018 A.Y.:
2015-16 Date
of order: 15th October, 2020

Explanation
7 to section 9(1)(i) – Small shareholder exemption introduced by this
Explanation inserted by Finance Act, 2015 is retrospective in nature

 

FACTS

The
assessee, a non-resident company, held shares in Singapore Company (SCO) which
in turn held shares in Indian company1. The assessee sold shares of
SCO to the Indian company. The Indian company withheld tax on the consideration
amount which was claimed as refund by the assessee.

 

During the
course of assessment proceedings, the assessee claimed that income is not
taxable in view of Explanation 7 to section 9(1)(i) which exempts the seller
from indirect transfer provisions if its interest in foreign company (which
derives substantial value from India) does not exceed 5%. The A.O. was of the
view that Explanation 7 inserted by Finance Act, 2015 is prospective, being
effective from 1st April, 2016 and, therefore, not applicable in the
year under consideration. The DRP upheld the view of the A.O.

 

1   Decision
does not mention total stake held by assessee in SCO. However, decision
proceeds on the basis that SCO derives substantial value from India and
aggregate stake of assessee is less than 5% in SCO

 

Being
aggrieved, the assessee appealed before the Tribunal.

 

HELD

  •   Explanation 5 to section
    9(1)(i) was introduced by the Finance Act of 2012 with retrospective effect
    from 1st April, 1962 to tax indirect transfers. The said provisions
    were inserted to obviate the decision of the Supreme Court in the case of Vodafone
    International Holdings B.V. 341 ITR 1 (SC)    .
  •   After the insertion of
    Explanation 5, the stakeholders were apprehensive about ambiguities surrounding
    the said Explanation and, therefore, representations were made to the
    Government of India which constituted the Shome Committee to look into the apprehensions
    / grievances of the stakeholders.
  •   On the recommendations of
    the Shome Committee, Explanations 6 and 7 were inserted by the Finance Act,
    2015. Explanations 6 and 7 have to be read with Explanation 5 to understand the
    provisions of section 9(1)(i). Since Explanation 5 has been given retrospective
    effect, Explanations 6 and 7, which further the object of the insertion of
    Explanation 5, have to be given retrospective effect.

TRANSFER PRICING – BENCHMARKING OF CAPITAL INVESTMENTS AND DEBTORS

1.   INTRODUCTION

Benchmarking of
financial transactions is an integral part of the Transfer Pricing Regulations
of India (TPR). The Finance Act, 2012 inserted an Explanation to section 92B of
the Income-tax, Act 1961 (the ‘Act’) with retrospective effect from 1st
April, 2002 dealing with the meaning of international transactions. Interestingly,
the Notes on Clauses of the Finance Bill, 2012 is silent on the intent and
purpose of inclusion of such transactions within the definition of
‘international transaction’. Clause (i)(c) of the said Explanation reads as
follows:

 

‘Explanation. –
For the removal of doubts, it is hereby clarified that –

(i) the
expression “international transaction” shall include –

(a) ….

(b) ….

(c) capital
financing, including any type of long-term or short-term borrowing, lending or
guarantee, purchase or sale of marketable securities or any type of advance,
payments or deferred payment or receivable or any other debt arising during the
course of business;

(d) ….

(e) ….’

 

Since financial
transactions are peculiar between two enterprises, it is hard to find comparables
in many cases. In this article we shall deal with some of the possible options
to benchmark some of these transactions to arrive at an arm’s length pricing
and / or discuss controversies surrounding them.

 

It may be noted
that Clause 16 of the Annexure to Form 3CEB requires the reporting of
particulars in respect of the purchase or sale of marketable securities, issue
and buyback of equity shares, optionally convertible / partially convertible /
compulsorily convertible debentures / preference shares. A relevant extract of
the Clause is reproduced herein below:

 

Particulars in respect of international
transactions of purchase or sale of marketable securities, issue and buyback of
equity shares, optionally convertible / partially convertible / compulsorily
convertible debentures / preference shares:

 

Has the
assessee entered into any international transaction(s) in respect of purchase
or sale of marketable securities or issue of equity shares including
transactions specified in Explanation (i)(c) below section 92B(2)?

 

If ‘yes’, provide the following details

(i) Name and address of the associated
enterprise with whom the international transaction has been entered into

(ii) Nature of the transaction

(a) Currency in which the transaction was
undertaken

(b) Consideration charged / paid in
respect of the transaction

(c) Method used for determining the arm’s
length price [See section 92C(1)]

 

It may be noted
that the Bombay High Court in the case of Vodafone India Services Pvt.
Ltd. vs. UOI [2014] 361 ITR 531 (Bom.) clearly stated that the issue of
shares at a premium is on capital account and gives rise to no income and,
therefore, Chapter X of the Act dealing with Transfer Pricing provisions do not
apply. (Please refer to detailed discussion in subsequent paragraphs.)

 

However, even after
the acceptance of the Bombay High Court judgment by the Government of India,
international transactions relating to marketable securities are still required
to be reported / justified in Form 3CEB. And therefore, we need to study this
aspect.

 

Of the various
financial transactions, this article focuses on Capital Investments and
Outstanding Receivables (Debtors). Other types of transactions will be covered
in due course.

2.   Benchmarking of capital
instruments under Transfer Pricing Regulations

2.1  Investments in share capital and CCDs

Cross-border
investment in capital instruments of an Associated Enterprise (AE), such as
equity shares, compulsory convertible debentures (CCDs), compulsory convertible
preference shares (CCPs) and other types of convertible instruments are covered
here.

     

Since CCDs and CCPs
are quasi-capital in nature, the same are grouped with capital
instruments. Even under FEMA, they are recognised as capital instruments.
Collectively, they are referred to as ‘Equity / Capital Instruments’ hereafter.

 

2.2. FEMA Regulations

(i)   Inbound investments – FDI or foreign
investments

Inbound investment
in India is regulated by the Foreign Exchange Management (Non-Debt Instruments)
Rules, 2019. The said Rules define ‘Capital Instruments’ as equity shares,
debentures, preference shares and share warrants issued by an Indian company.

 

‘FDI’ or
‘Foreign Direct Investment’ means investment through equity instruments by a
person resident outside India in an unlisted Indian company; or in ten per cent
or more of the post-issue paid-up equity capital on a fully-diluted basis of a
listed Indian company;

‘foreign
investment’ means any investment made by a person resident outside India on a
repatriable basis in equity instruments of an Indian company or to the capital
of an LLP;’

 

The NDI Rules define Foreign Portfolio Investment (FPI) as any investment
made by a person resident outside India through equity instruments where such
investment is less than 10% of the post-issue paid-up share capital on a
fully-diluted basis of a listed Indian company, or less than 10% of the paid-up value of each series of equity
instruments of a listed Indian company.

 

Since cross-border
investment of 26% or more in an entity would trigger the TPR [section 92
A(2)(a)], investments under FPI would not be subjected to benchmarking under
TPR. However, FDI and Foreign Investments in India would be required to be
benchmarked under TPR.

 

(ii)  Pricing guidelines for inbound investments

Rule 21 of the NDI
Rules provides pricing or valuation guidelines for FDI / foreign investments as
follows:

(a) For issue of equity instruments by a company to
a non-resident or transfer of shares from a resident person to a non-resident
person, it shall not be less than the price worked out as
follows:

For listed
securities ? the price at which a preferential allotment of shares can be made
under the Securities and Exchange Board of India (SEBI) Guidelines, as
applicable, in case of a listed Indian company, or in case of a company going
through a delisting process as per the Securities and Exchange Board of India
(Delisting of Equity Shares) Regulations, 2009;

For unlisted
securities ? the valuation of
equity instruments done as per any internationally-accepted pricing methodology
for valuation on an arm’s length basis duly certified by a Chartered
Accountant or a merchant banker registered with SEBI or a practising Cost
Accountant.

 

(b) For transfer of equity instruments from a
non-resident person to a person resident in India,it shall not exceed the
price worked out as mentioned in (a) above. The emphasis is on valuation as
per the provisions of the relevant SEBI guidelines and provisions of the
Companies Act, 2013 wherever applicable.

 

The interesting
point here is that the pricing guidelines under NDI rules emphasise on the
valuation of equity instruments based on an arm’s length principle.

 

The Rule provides
the guiding principle as ‘the person resident outside India is not
guaranteed any assured exit price at the time of making such investment or
agreement and shall exit at the price prevailing at the time of exit.’

 

(c)  In case of swap of equity
instruments, irrespective of the amount, valuation involved in the swap
arrangement shall have to be made by a merchant banker registered with SEBI or
an investment banker outside India registered with the appropriate regulatory
authority in the host country.

 

(d) Where shares in an Indian company are issued to
a person resident outside India in compliance with the provisions of the
Companies Act, 2013, by way of subscription to Memorandum of Association,
such investments shall be made at face value subject to entry route and
sectoral caps.

 

(e) In case of share warrants, their pricing and
the price or conversion formula shall be determined upfront, provided that
these pricing guidelines shall not be applicable for investment in equity
instruments by a person resident outside India on a non-repatriation basis.

(iii) Outbound investments      

Valuation norms for
outbound investments are as follows:

 

In case of partial
/ full acquisition of an existing foreign company where the investment is more
than USD five million, share valuation of the company has to be done by a
Category I merchant banker registered with SEBI or an investment banker /
merchant banker outside India registered with the appropriate regulatory
authority in the host country, and in all other cases by a Chartered Accountant
/ Certified Public Accountant.

 

However, in the
case of investment by acquisition of shares where the consideration is to be
paid fully or partly by issue of the Indian party’s shares (swap of shares),
irrespective of the amount, the valuation will have to be done by a Category I
merchant banker registered with SEBI or an investment banker/ merchant banker
outside India registered with the appropriate regulatory authority in the host
country.

 

In case of
additional overseas direct investments by the Indian party in its JV / WOS,
whether at premium or discount or face value, the concept of valuation, as
indicated above, shall be applicable.

 

As far as the
actual pricing is concerned, one must follow the guidelines mentioned at
paragraph (ii)(b) above, i.e., the transaction price should not exceed the
valuation arrived at by the valuer concerned.

 

2.3. Benchmarking of equity
instruments under transfer pricing

From the above discussion it is clear that for any cross-border capital
investments one has to follow the pricing guidelines under FEMA. However, as
mentioned in the NDI Rules, the valuation of equity / capital instruments must
be at arm’s length. Thus, the person valuing such investments has to bear in
mind the principles of arm’s length.

 

One more aspect that one has to bear in mind while doing valuation is to
use the internationally accepted pricing methodology. Pricing of an equity /
capital instrument is a subjective exercise and would depend upon a number of
assumptions and projections as to the future growth, cash flow, investments by
the company, etc. Therefore, the traditional methods of benchmarking as
prescribed in the TPR may not be appropriate for benchmarking investments in
equity / capital instruments.

2.4. Whether investments in
equity instruments require Benchmarking under TPR?

In this connection,
it would be interesting to examine the Bombay High Court’s decision in the case
of Vodafone India Services Pvt. Ltd. vs. Union of India(Supra).

     

Brief facts of the
case are as follows:

VISPL is a wholly-owned subsidiary of a non-resident company, Vodafone
Tele-Services (India) Holdings Limited (the holding company). VISPL required
funds for its telecommunication services project in India from its holding
company during the financial year 2008-09, i.e., A.Y. 2009-10. On 21st
August, 2008, VISPL issued 2,89,224 equity shares of the face value of Rs. 10
each at a premium of Rs. 8,509 per share to its holding company. This resulted
in VISPL receiving a total consideration of Rs. 246.38 crores from its holding
company on issue of shares between August and November, 2008. The fair market
value of the issue of equity shares at Rs. 8,519 per share was determined by
VISPL in accordance with the methodology prescribed by the Government of India
under the Capital Issues (Control) Act, 1947. However, according to the A.O.
and the Transfer Pricing Officer (TPO), VISPL ought to have valued each equity
share at Rs. 53,775 (based on Net Asset Value), as against the aforesaid
valuation done under the Capital Issues (Control) Act, 1947 at Rs. 8,519, and
on that basis the shortfall in premium to the extent of Rs. 45,256 per share
resulted in a total shortfall of Rs. 1,308.91 crores. Both the A.O. and the TPO
on application of the Transfer Pricing provisions in Chapter X of the Act held
that this amount of Rs. 1,308.91 crores is income. Further, as a consequence of
the above, this amount of Rs. 1,308.91 crores is required to be treated as a
deemed loan given by VISPL to its holding company and periodical interest
thereon is to be charged to tax as interest income of Rs. 88.35 crores in the
financial year 2008-09, i.e., A.Y. 2009-10.

 

The Bombay High
Court,while ruling on the petition filed by VISPL, among other things observed
as follows:

‘(i)   The tax can be charged only on income and in
the absence of any income arising, the issue of applying the measure of arm’s
length pricing to transactional value / consideration itself does not arise.

(ii)   If it’s income which is chargeable to tax,
under the normal provisions of the Act, then alone Chapter X of the Act could
be invoked. Sections 4 and 5 of the Act brings / charges to tax total income of
the previous year. This would take us to the meaning of the word income under
the Act as defined in section 2(24) of the Act. The amount received on issue of
shares is admittedly a capital account transaction not separately brought
within the definition of income, except in cases covered by section 56(2)(viib)
of the Act. Thus, such capital account cannot be brought to tax as already
discussed herein above while considering the challenge to the grounds as
mentioned in impugned order.

(iii)  The issue of shares at a premium is on capital
account and gives rise to no income. The submission on behalf of the Revenue
that the shortfall in the ALP as computed for the purposes of Chapter X of the
Act is misplaced. The ALP is meant to determine the real value of the
transaction entered into between AEs. It is a re-computation exercise to be
carried out only when income arises in case of an international transaction
between AEs. It does not warrant re-computation of a consideration received /
given on capital account.’

     

In an interesting
development thereafter, on 28th January, 2015, the Ministry of
Finance, Government of India, issued a press release through the Press
Information Bureau accepting the order of the Bombay High Court. Relevant
excerpts of the said press release are as follows:

 

‘Based on the
opinion of Chief Commissioner of Income-tax (International Taxation),
Chairperson (CBDT) and the Attorney-General of India, the Cabinet decided to:

i.)   accept the order of the High Court of Bombay
in WP No. 871 of 2014, dated 10th October, 2014 and not to file SLP
against it before the Supreme Court of India;

ii.)   accept orders of Courts / IT AT / DRP in cases
of other taxpayers where similar transfer pricing adjustments have been made
and the Courts / IT AT / DRP have decided /decide in favour of the taxpayer.

The Cabinet
decision will bring greater clarity and predictability for taxpayers as well as
tax authorities, thereby facilitating tax compliance and reducing litigation on
similar issues. This will also set at rest the uncertainty prevailing in the
minds of foreign investors and taxpayers in respect of possible transfer pricing
adjustments in India on transactions related to issuance of shares and thereby
improve the investment climate in the country. The Cabinet came to this view as
this is a transaction on the capital account and there is no income to be
chargeable to tax. So, applying any pricing formula is irrelevant.’

 

CBDT has also
issued Instruction No. 2/2015 dated 29th January, 2015 clarifying
that premium on shares issued was on account of capital account transaction and
does not give rise to income. The Board’s instruction is reproduced as follows:

‘Subject
Acceptance of the Order of the Hon’ble High Court of Bombay in the case of
Vodafone India Services Pvt. Ltd.-reg.

In reference to
the above cited subject, I am directed to draw your attention to the decision
of the High Court of Bombay in the case of Vodafone India Services Pvt. Ltd.
for AY 2009-10 (WP No. 871/2014), wherein the Court has held, inter alia, that the premium on share issue was on account of a
capital account transaction and does not give rise to income and, hence, not
liable to transfer pricing adjustment.

2. lt is hereby informed that the Board has
accepted the decision of the High Court of Bombay in the above-mentioned writ
petition. In view of the acceptance of the above judgment, it is directed that the
ratio decidendi of
the judgment must be adhered to by the field officers in all cases where this
issue is involved. This may also be brought to the notice of the ITAT, DRPs and
CslT(Appeals).’

 

The above decision
has been referred to in the following decisions:

 

On different facts,
the Supreme Court in case of G.S. Homes and Hotels P. Ltd. vs. DCIT
[Civil Appeal Nos. 7379-7380 of 2016 dated 9th August, 2016]
ruled that ‘we modify the order of the High Court by holding that the amount
(Rs. 45,84,000) on account of share capital received from the various
shareholders ought not to have been treated as business income.’ Thus, the Apex
Court reversed the order of the Karnataka High Court.

 

In ITO vs. Singhal General Traders Private Limited [ITA No.
4197/Mum/2017 (A.Y. 2012-13) dated 24th February, 2020],
following the decisions of the Bombay High Court in the case of VSIPL
(Supra) and the Apex Court in the case of G.S. Homes and
Hotels Ltd. (Supra), the Tribunal upheld the decision of the CIT(A) of
treating the receipt of share capital / premium as capital in nature and that
it cannot be brought to tax u/s 68 of the Act.

 

In light of the above discussion, the question arises, is it necessary to
benchmark the transactions of investments in capital / equity instruments? As
Form 3CEB still carries the reporting requirement, it is advisable to report
such transactions. One can use the valuation report to benchmark the
transaction under the category of ‘any other method’. This is out of abundant
precaution to avoid litigation. Ideally, the Form 3CEB should be amended to
bring it on par with the CBDT’s Instruction 2/2015 dated 29th
January, 2015 and the Government’s intention expressed through the press
release dated 28th January, 2015.

 

3.   Benchmarking of
outstanding receivables (debtors)

Debtors are
recorded in the books in respect of outstanding receivables for the exports
made to an AE. The underlying export transactions would have been benchmarked
in the relevant period and, therefore, is there any need to benchmark the
receivables arising out of the same transaction?

     

As mentioned in paragraph 1, the Explanation to section 92B dealing with
the meaning of international transactions was inserted, inter alia, to
include ‘receivable or any other debt arising during the course of business’
with retrospective effect from 1st
April, 2002. Therefore, apparently even the receivables need to be reported and
benchmarked.

 

 

However, recently
in the case of Bharti Airtel Services Ltd. vs. DCIT, the Delhi
ITAT [ITA No. 161/Del/2017 (A.Y. 2011-12) dated 6th October,
2020] ruled that outstanding debtors beyond an agreed period is a
separate international transaction of providing funds to its associated
enterprise for which the assessee must have been compensated at an arm’s
length. In the instant case there was a service agreement between Bharti Airtel
Services Ltd. and its overseas AE for payment of invoices within 15 days of
their receipt. However, the same remained outstanding beyond the stipulated
time of 15 days. The working capital adjustment was denied to the assessee in
the absence of any reliable data and therefore the same was not taken into
account while determining the arm’s length price of the international transaction
of provision of the services. On the facts and circumstances of the case, the
Tribunal held that outstanding debtors beyond an agreed period is a separate
international transaction of providing funds to its associated enterprise for
which the assessee must have been compensated in the form of interest at LIBOR
+ 300 BPS as held by CIT(A).

 

In this context the
Tribunal held as under:

‘9. Coming to the various decisions relied upon by
the learned authorised representative, we find that they are on different
facts. The decision of the honourable Delhi High Court in ITA number 765/2016
dated 24th April, 2017 in case of Kusum Healthcare Private Limited
(Supra), para number eight clearly shows that assessee has undertaken working
capital adjustment for the comparable companies selected in its transfer
pricing report which has not been disputed by the learned transfer pricing
officer and therefore the differential impact of working capital of the
assessee vis-à-vis
is comparable had already been factored in pricing profitability and therefore
the honourable High Court held that adjustment proposed by the learned TPO
deleted by the ITAT is proper. In the present case there is no working capital
adjustment made by the assessee as well as granted by the learned TPO. The
facts in the present case are distinguishable. Further, same are the facts in
case of Bechtel India where working capital adjustment was already granted. In
case of 91 taxmann.com 443 Motherson Sumi Infotech and Design Limited non-charging
of interest was due to business and commercial reasons and no interest was also
charged against outstanding beyond a specified period from non-related parties.
No such commercial or business reasons were shown before us. The facts of the
other decisions cited before us are also distinguishable. Therefore, reliance
on them is rejected.’

 

From the above
ruling it is clear that one must ensure the receipt of outstandings within a
stipulated time, else it would call for transfer pricing adjustment.

 

Benchmarking

Once it is
established that the receivables are beyond due date, the benchmarking has to
be done as if it is a loan transaction. Such a transaction needs to be
benchmarked using the Libor rate of the same currency in which the export
invoice is raised.

 

3.1. FEMA provisions for
receipt of outstanding receivables

It may be noted
that the time limit for realisation of export proceeds is the same for export
of goods as well as services.

 

The normal time
limit for realisation of exports is nine months from the date of exports.
However, it was extended to 15 months for exports made up to 31st
July, 2020 due to the Covid-19 pandemic [RBI/2019-20/206 A.P. (DIR Series)
Circular No. 27, dated 1st April, 2020].

 

Thus, ideally,
parties can provide mutual time limit for settlement of export invoices within
the overall time limit prescribed by RBI under FEMA.

 

4.   CONCLUSION

Benchmarking of financial transactions is an important aspect of
transfer pricing practice in India. Not much judicial / administrative guidance
is available for the two types of financial transactions referred to in this
article.

 

However,
detailed jurisprudence and guidance is available for benchmarking of financial
transactions in the nature of loans and guarantees. Readers may refer to the detailed articles published in the  May, 2014 and June, 2014 issues of the BCAJ dealing with benchmarking of
loans and guarantees, respectively.

Sections 195 and 201(1)/(1A) – Demurrage charges payable to non-resident shipping company were not liable to TDS u/s 195

4. TS-527-ITAT-2020-Ahd. Gokul Refoils &
Solvent Ltd. vs. DCIT ITA No:
2049/Ahd/2018 A.Y.: 2016-17 Date of order: 11th
September, 2020

 

Sections 195 and
201(1)/(1A) – Demurrage charges payable to non-resident shipping company were
not liable to TDS u/s 195

 

FACTS

The assessee paid
demurrage charges to a non-resident Singaporean company without deduction of
tax. The A.O. was of the view that the assessee was required to withhold tax
u/s 195 from the said payment. Since the assessee had not done so, the A.O.
held the Assessee in Default (AID) u/s 201 and levied interest u/s 201(1A).

 

On appeal, the
CIT(A) upheld this order. The aggrieved assessee appealed before the Tribunal.

 

HELD

i)   In the course of the assessment, the assessee
had submitted documentary evidence (comprising demurrage contract, letter to
bank for remittance, debit note, Form No. 15CA, Form No. 15CB, remittance
voucher, details of remittance, Form A2 under FEMA, and no PE declaration)
pertaining to reimbursement of expenses5.

ii)   The Tribunal relied on Circular No. 723 in
terms of which section 195 cannot be invoked if freight payment was made in
respect of a ship which was owned or chartered by a non-resident to which
section 172 (i.e., voyage-based special assessment scheme of the Act) applied.

iii) Accordingly, section 195
was not applicable in respect of demurrage charges paid to the non-resident
shipping company.

 

_________________________________________________________________________________________________

 

1   Other
grounds related to transfer pricing and disallowance of expenditure

2   328
ITR 81

3   Finance
Bill which respectively introduced and reintroduced DDT

4     382
ITR 114

5   Assessee
represented demurrage charges as reimbursement during
assessment proceedings. There is no independent finding of the Tribunal to the
effect that demurrage represents reimbursement

Article 10 of India-Germany DTAA – Section 115-O of the Act – Dividend Distribution Tax (DDT) payable by Indian company on dividend distributed to non-resident shareholder to be restricted to tax rate specified in DTAA

3. TS-522-ITAT-2020-Delhi Giesecke &
Devrient [India] Pvt. Ltd. vs. ACIT ITA No:
7075/Del/2017 A.Y: 2013-14 Date of order: 13th
October, 2020

 

Article 10 of
India-Germany DTAA – Section 115-O of the Act – Dividend Distribution Tax (DDT)
payable by Indian company on dividend distributed to non-resident shareholder
to be restricted to tax rate specified in DTAA

 

FACTS

The assessee was a
wholly-owned subsidiary of a German company (GCo). It paid dividend to GCo and
also paid DDT u/s 115-O.

 

During the appeal
proceedings before the Tribunal1, the assessee raised additional
grounds and contended that dividend was paid to a non-resident shareholder who
was qualified for benefit under the provisions of the India-Germany DTAA.
Accordingly, the DDT rate under the Act was to be restricted to the rate
specified under the India-Germany DTAA and the excess DDT refunded.

 

HELD

Interplay of DDT
with DTAA

(i)    For administrative convenience, while DDT is
collected from the company paying dividends, effectively, DDT is a tax on
dividend.

(ii)   In Godrej and Boyce Manufacturing
Company Ltd.2, the Bombay High Court held that DDT is a tax
on the company paying dividends and not on the shareholder.

(iii) The liability to pay DDT is on the Indian
company; DDT is a tax on income and income includes dividend.

(iv) The Tribunal perused the Memoranda to Finance
Bill, 1997 and the Finance Bill, 20033 and observed that
administrative convenience was the reason for the introduction of DDT. For all
intents and purposes, DDT was a charge on dividends. The burden of DDT falls on
shareholders rather than the company as the amount of dividend available for
distribution to shareholders stands reduced.

(v)   The income of a non-resident is to be
determined having regard to the provisions of the DTAA. The fact that liability
to pay DDT is on the Indian company was irrelevant for considering the rate for
tax on dividend under DTAA.

(vi) The India-Germany DTAA was notified in 1996,
i.e., prior to the introduction of DDT in 1997. In New Skies Satellite4
the Delhi High Court held that Parliament cannot amend DTAA by unilaterally
amending domestic law. Accordingly, the DDT rate cannot exceed the rate
prescribed on dividend under the India-Germany DTAA (namely, 10%).

(vii)       The Tribunal remitted the issue back to
the A.O. for limited verification of beneficial ownership and existence of PE
of GCO.

 

Note:

The Tribunal
admitted additional ground relying upon the jurisdictional Delhi High Court
decision in Maruti Suzuki India Ltd. WP(C) 1324/2019.

TRANSFER PRICING DATABASES – REQUIREMENT, USAGE AND REVIEW

This article is an attempt to understand
the purpose of transfer pricing software and to review the existing databases
based on certain parameters. But first a basic introduction to transfer pricing
will help us to appreciate the importance of these databases.

 

WHAT IS TRANSFER PRICING?

Transfer pricing (TP) refers to the pricing
of cross-border transactions between two related entities, referred to as
associated enterprises (AEs). When two AEs enter into any cross-border
transaction, the price at which they undertake the transaction is called
transfer price. Due to the special relationship between related companies, the
transfer price may be different from the price that would have been agreed to
between two unrelated companies. Thanks to their control over prices,
Multinational Enterprises (MNEs) have the flexibility to influence –

 

i)   Tax liabilities of individuals or a group of
persons / entities

ii)  Government tax targets

iii)  Cash flow requirements of the MNE group.

 

Every Government wants to prevent erosion
of its tax base and plug potential tax leakages, and hence there are TP regulations all over the world. In India, section 92 of the IT Act
was substituted by the Finance Act, 2001 with a set of new sections, 92 to 92F,
providing a detailed statutory framework for the determination of arm’s length
price (ALP) and maintenance of documentation.

 

TRANSFER PRICING DOCUMENTATION

As per Rule 10D(2) of the Income Tax Rules,
1962, when transactions with related parties cross the threshold of Rs. 1
crore, it is mandatory to keep and maintain information and documents as per
Rule 10D(1). TP Documentation also includes maintenance of proper records and
the process of how the ALP has been determined. The relevant extracts of Rule
10D which require proper documentation of process are reproduced below:

 

Rule

Description of the Rule 10D

10D(1)(h)

A record of the analysis performed to evaluate comparability
of uncontrolled transactions with the relevant international transaction

10D(1)(i)

A description of the methods considered for determining the
arm’s length price in relation to each international transaction or class of
transactions, the method selected as the most appropriate one along with
explanations as to why such method was selected and how such method was
applied in each case

10D(1)(j)

A record of the actual working carried out for determining
the ALP, including details of the comparable data and financial information
used in applying the most appropriate method and adjustments, if any, which
were made to account for the difference between international transactions,
or between the enterprises entering into such transactions

 

As per the rules, the entire analysis /
search process needs to be documented including the procedure being followed
and financial information of comparables. In such a case, the transfer pricing
database helps in the entire analysis and the working of documentation to a
great extent. This depends on which database is used and the features of each
database.

 

WHY A DATABASE IS REQUIRED

A TP database for determination of ALP can
be employed when the following methods are used:

(a)   Cost plus method (CPM)

(b)   Transactional net margin method (TNMM)

(c)   Resale price method (RPM) sometimes to
ascertain the gross margin earned by traders.

 

The above methods require a comparison of
the assessee’s gross / net margin with that of the industry.

 

A question that arises here is, how to
calculate the industry-wide margin. Can the assessee choose to pick companies
having similar transactions or competitors in their industry; ferret out their
financial information from the Ministry of Company Affairs (MCA) site; the BSE
/ NSE website; other private websites and then work out the industry margin?
Tribunals have generally held that the search process should be systematic and
consistent year on year. They have also held that cherry-picking of comparables
is not allowed. This approach will not only enable officers to only cherry-pick
companies having higher profitability but they can also reject the search
process and hence prove that the assessee’s transactions are not at ALP.
However, the ALP determined based on a detailed search process cannot be
rejected without any cogent reasons. Therefore, Transfer Pricing Databases are
used to remove the ambiguity involved and to bring standardisation in the
search process.

 

Apart from comparison margins, there are
some transaction-specific databases also available, such as Royalty Stat, Loan
Connector, OneSource, etc., which are used to benchmark specific transactions
like royalty and loan transactions and where the gross / net margins of
companies are not required.

 

GENERAL
SEARCH PROCEDURES IN A DATABASE

In general, a comparable search begins with
the identification of all companies appearing in the database in a particular
period in the relevant industry. Whenever the potential comparable is believed
to be spread over more than one industry, searches are supplemented by text
searches for business descriptions / products containing appropriate keywords.
Various filters (quantitative) are then applied in the database to arrive at a
set of reasonably comparable companies. Textual descriptions including the
background report and directors’ report identified by the database in the
initial screens are reviewed, along with the website details of certain
relevant companies (qualitative filters), first to eliminate companies that are
misclassified and then to narrow down the search to a reasonable number of the
most potentially comparable companies which can be selected.

 

A list of common filters (quantitative)
applied in the database is as follows:

1. Select companies in the same / similar industry
according to business activity and finished products produced / services
rendered. The first step is like creating a basket of similar companies.

2. Data Availability Filter to select companies
having data availability for the past three years. Companies for which the
latest financials are not available for the last three years are excluded
because their margin will not reflect the current trends.

3. Turnover Filter depending on the turnover of
your company as these companies would not be comparable to assess due to
differences in their scale of operations.

4. Net Worth Filter to select companies having net
worth > 0 because companies having negative net worth have a bankruptcy risk
and therefore margins may not be comparable to a normal company.

5. Select companies having manufacturing / sales
or services / sales ratio > X% depending on the industry in which the
company operates to restrict the list of selected companies with comparable
size and operations.

6. Select companies with related party transactions
< X% as a company having significant related party transactions would itself
be prone to incorrect transfer prices among related parties.

7. Other specific filters can be applied depending
on the facts of each case and the industry in which the company operates.

 

After applying all these filters, finally,
companies are accepted by applying Qualitative Filters. Qualitative Filters
include reviewing short business descriptions / directors’ report / annual
reports / generated from the database to ensure that their primary line of
business activities is matched with the assessee by excluding companies that

(a) were misclassified

(b) performed activities which involved
significantly different functions, assets and risks (FAR Analysis) as compared
to the assessee.

 

Having identified the comparable companies,
it is necessary to analyse the nature of these companies by performing a FAR
Analysis. A FAR Analysis identifies the functions undertaken by each party, the
risks each party assumes and the assets used by each party to the transaction.
It also assists in determining the economic value added by each relevant party.

 

Further, this analysis can help in
identifying specialised and critical business assets and activities that are
fundamental to the business. The CBDT emphasises the importance of the
functional analysis in determining the arm’s length price and identifying
suitable entities for comparison purposes.

 

Once the final companies are selected after
applying Qualitative Filters, the next step is to remove margins of companies
selected from the database / annual reports and compare the same with our
margin.

 

Adjustments, if any, can be made to the
margin of companies depending upon the difference, if any, in the FAR Analysis
of comparable companies. For example, Working Capital Adjustment, Risk
Adjustment, Idle Capacity Adjustment, etc.

 

DIFFERENT
TRANSFER PRICING DATABASES CHOSEN FOR DISCUSSION

We have analysed the three databases
mentioned below from the software available in India for transfer pricing
purposes. We have also identified certain objective parameters based on which
these databases can be evaluated.

 

(I)  Prowess1

  •   Developed by the Centre for Monitoring
    Indian Economy (CMIE) Private Limited.
  •   The service is only available for desktop version
    but the application can be downloaded on any number of desktops.

*    Number of Companies – Over 50,000

*    Unique Data fields – Over 3,500

*    Data Availability – from 1989

  •  Prowess as a software is extensively used
    in research projects and its usage is not restricted to only transfer pricing.
    Since it is not created specifically for transfer pricing, data collation and
    maintenance in the way that is required by Transfer Pricing Reports is a more
    cumbersome process. However, it also has an advantage over other databases
    based on the numbers of companies analysed and the years of experience in the
    statistical field.

 

(II) Ace-TP2

  •   Developed by Accord Fitch Private Limited.
  •    It is a web database-based browser
    application for comparing company financial information of Indian business
    entities. The service is available for both web-based and desktop versions.

*    Number of Companies – Over 38,000

*    Unique Data fields – Over 1,750

*    Data Availability – Past 15 years of
historical data

  •    Ace-TP was the first software which was
    specifically designed for TP and therefore has a very easy User Interface. It
    directly saves stepwise information and speeds up the documentation process.
    However, it is a relatively newer setup compared to the other software.

 

(III) Capitoline TP3

  •     Developed by Capital Markets Publishers
    India Pvt. Ltd.
  •  It is an
    internet web portal related to transfer pricing issues. The service is
    available for both web-based and desktop versions.

*    Number of Companies – Over 35,000

*    Unique Data fields – 1,250

Capitoline TP
Database has entered into an arrangement4 with ICAI wherein CA firms
would be charged a discounted rate.

 

  •    Capitoline TP is an extension of Capitoline
    Software which is extensively used for the stock market. Thanks to its arrangement
    with ICAI, its web version is one of the most used TP software by SME firms.

 

COMMON
FEATURES OF ABOVE DATABASES

#   Categorisation of companies based on industry,
sub-industry, NIC 2008 classification, business activities, products sold, raw
material consumed and various other factors. (Helpful in Search Procedure
Common Filter – Step 1 as mentioned above.)

#   Historical Data of Financials of company for
many years in easy-to-download Excel format. (Helpful in Search Procedure
Common Filter – Step 2 as mentioned above.)

#   Query Triggers and Formula Filters depending
on requirement of turnover, net worth, net profit and other parameters. Various
formulae can be clubbed together to derive more complex parameters. (Helpful
in Search Procedure Common Filter – Steps 3, 4, 5 and 6 as mentioned above.)

#   Data of both listed and unlisted companies.
Plus brief description / profile of companies and their business. (Helpful
in Search Procedure qualitative filters.)

#   Annual Report and financials of various companies
available in database. (Helpful in finding margins of comparable companies.)

#   Automation of filters applied for future use
by saving the process which is defined once.

  •    Database does not cover Proprietorship,
    Partnership and LLP.

 

Data is also compiled from notes of
accounts and aspects such as related party transactions, capacity utilisation,
export and import figures, etc.

 

__________________________________________________________________________________________________

1
As per website https://prowessiq.cmie.com/ and brochure shared by the company’s
representatives with the authors

*
Kindly review prices from vendors before taking a decision

2
http://www.acetp.com/

3
https://www.capitaline.com/Demo/tp.aspx and brochure shared by the company’s
representatives with the authors

4
https://www.icai.org/post/16361

* Kindly review
prices from vendors before taking decision


SELECTION
PARAMETER FOR ANY DATABASE

Many professionals use two databases for
getting a higher number of companies in the search process. However, the same
could also create duplication. With the above three options available, the
following major parameters can be kept in mind to select any one TP Database.

•    Number of companies available,

•    Pricing of the software,

•    User interface,

•    Training and customer support provided.

 

TP
DATABASE – CAN IT ONLY BE USED FOR TP?

TP Database contains various data points
for various companies for several years. These can also be used for various
other functions such as the following:

  •    Industry Peer and Trend Comparison –
    Some clients are interested in comparing their own companies’ financial health
    and growth with their competitors / industry leaders. These databases are a
    very effective tool to do the same.
  •   Due Diligence – If any of the
    companies on which due diligence needs to be conducted is presented in the
    database, it is easy to collate all the information and work upon it in a
    readily available manner. Even if the company is not available, these databases
    are an excellent tool to understand the industry dynamics.
  •    Stock Market – While investing in
    shares of a particular company / sector, a deep-dive analysis of a company /
    industry and its comparative peer set can be done in the database.
  •    Analysis of Business Ratios – Various
    ratios based on specific industry and specific companies can be collated
    instantly from these databases, thereby making them a very effective research
    tool.

 

Authors’ suggestions to database
companies based on our survey:

+ Instead of a yearly subscription, the
database should also be made available for short tenures. This will enable more
users to subscribe to them.

+ High pricing is the general concern of
respondents. They should target an increase in the number of users rather than
frequent increases in prices.

+ Users should be educated about the usage
of the database over and above transfer pricing. This will enable more
subscribers to join.

+ Companies can consider having a tie-up
with professional bodies for increasing awareness amongst users.

 

CONCLUSION

India is one of the fastest-growing
economies. A lot of businesses are being set up abroad by Indian MNC’s and many medium-sized companies are also expanding their footprints
globally. Besides, many foreign companies are setting up businesses in India. This
will lead to further increase in cross-border transactions between AEs.
Transfer Pricing Practice in India is about to step out of its teens. It’s
young, bubbling with energy and still shaping up. A more complex, granular and
widely covered yet affordable database will take this practice from the Metros
to Tier-II cities and can be a good practice area for budding chartered
accountants.

 

This article was an attempt to touch
base on the usage of the various databases available and to evaluate them in the
backdrop of various parameters. The user should assess or evaluate all the
databases before making any subscription decision.

 

 

Disclaimer: None of the authors is associated with / interested in any of the
databases and any relationship with them is purely restricted to the usage /
subscription of database licenses. All the information that is part of this
article has been gathered from the respective websites and brochures shared by
the databases with the authors.

 

 

ECONOMIC SUBSTANCE REQUIREMENTS REGULATIONS – AN OVERVIEW

1.0 
Introduction

‘Substance
over Form’ is an evergreen debate now tilting in favour of the former. Can a
legal form justify weak substance, or can a strong substance without a legal form be relevant or
practical? Does one score over the other? Are they interdependent or independent
of each other? How does one determine substance in a given transaction or
arrangement? Is it necessary to lift the corporate veil each time to examine
substance? Can a perfectly legal structure within the four corners of the law
be challenged and ignored for want of (or say, apparent lack of) substance? Is
every case of double non-taxation or lower taxation attributable to lack of
substance? There are a host of questions in this arena, some with answers, many
with grey areas and some without an answer. The easiest answer, perhaps, could
be that each case is fact-specific. However, in this uniqueness we need to have
certain rules and regulations and / or patterns to determine substance and give
tax certainty to businesses.

Recently, many jurisdictions introduced
Economic Substance Requirements Regulations (or ESR Regulations) for
enterprises carrying on business activities in / from that jurisdiction in any
form.

In this Article, we shall attempt to
understand what are the provisions of a typical ESR Regulations regime, their
significance and how does one comply with them.

 

2.0 
Genesis of substance requirements

Way back in 1998, OECD published a Report
on ‘Harmful Tax Competition: An Emerging Global Issue’ expressing
concern about the preferential regimes that lack in transparency and that are
being used by Multi-National Enterprises (MNEs) for artificial profit shifting.
OECD created the Forum on Harmful Tax Practices (FHTP) to review and monitor
compliances by preferential tax regimes with respect to transparency and other
aspects of tax structuring.

One of the twelve factors set out in the
1998 Report to determine whether a preferential regime is potentially harmful
or not was, ‘The regime encourages operations or arrangements that are purely
tax-driven and involve no substantial
activities’.

Fifteen Action Plans to prevent BEPS are
based on the following three main pillars:

(1) coherence of corporate tax at the
international level,

(2) realignment of taxation and substance,
and

(3) transparency, coupled with certainty
and predictability.

BEPS Action Plan 5 dealing with ‘Countering
Harmful Tax Practices More Effectively, Taking into Account Transparency and
Substance,’ intends to achieve the objectives of the second pillar of
realigning taxation with substance to ensure that taxable profits are not
artificially shifted away from countries where value is created. 

FHTP identified many harmful preferential
tax regimes that were providing an ideal atmosphere for profit-shifting with no
or low effective tax rates, lack of transparency and no effective exchange of
information.

To counter such harmful regimes more
effectively, BEPS Action Plan 5 requires FHTP to revamp the work on harmful tax
practices, with priority and renewed focus on requiring substantial activity
for any preferential regime and on improving transparency, including compulsory
spontaneous exchange on rulings related to preferential regimes1.

_____________________________________________________________

1 Paragraph 23 of the BEPS Action Plan 5


3.0 
FHTP’s approaches

FHTP has provided three approaches to
address the issue of substance in an Intellectual Property (IP) regime. They
are as follows:

(i)   Value Creation:
This approach requires taxpayers to undertake a set number of significant
development activities in the jurisdiction to claim tax benefits;

(ii)  Transfer Pricing:
This approach would require a taxpayer to undertake a set level of important
functions in the jurisdiction concerned to take advantage of lower tax regime.
These functions could include legal ownership of assets or bearing economic
risks of the assets, giving rise to the tax benefits.

(iii) Nexus Approach:
This approach has been agreed to by FHTP and endorsed by G20. It looks at
whether an IP regime makes its benefits conditional on the extent of R&D
activities of taxpayers in its jurisdiction. The Nexus Approach not only
enables the IP regime to provide benefits directly to the expenditures incurred
to create the IP, but also permits jurisdictions to provide benefits to the
income arising out of that IP, so long as there is a direct nexus between the
income receiving benefits and the expenditures contributing to that income.

In other words, when the Nexus Approach is
applied to an IP regime, substantial activity requirements establish a link
between expenditures, IP assets and IP income. The expenditure criterion acts
as a proxy for activities and IP assets are used to ensure that the income that
receives benefits does, in fact, arise from the expenditures incurred by the
qualifying taxpayer. The effect of this approach is therefore to link income and
activities.

Based on the above approach for the IP
regime, the Action Plan suggests applying this method to non-IP regimes as
well. Thus, a preferential regime should provide the substance requirement with
a clear link between income qualifying for benefits and core activities
necessary to earn the income.

What constitutes a Core Activity depends
upon the type of regime. However, the Action Plan has given certain indicative
Core Income Generating Activities (CIGA) for different types of preferential regimes,
such as Headquarters regimes, Distribution and service centre regimes,
Financing or leasing regimes, Fund management regimes, Banking and Insurance
regimes, Shipping regimes and Holding company regimes. (Paragraphs 74 to 87
of the BEPS Action Plan 5.) 

Under each of these regimes the Plan
identifies how preferential regimes give benefits and related concerns arising
from these regimes. Two common concerns under each regime are: (i)
‘Ring-fencing’, whereby foreign income is ring-fenced from domestic income to
provide tax exemption to the foreign-sourced income, and (ii) ‘Artificial
definition of the tax base’, whereby a certain fixed percentage or amount of
income is taxed, irrespective of the actual income of the taxpayer.

In order to address the above concerns, the
Action Plan provides CIGA in respect of each of the regimes mentioned above. A
taxpayer is expected to undertake CIGA commensurate with the nature and level
of activities. The idea underlying this is to tax income where value is
created. And value creation is determined by looking at the CIGA and also the
expenditure incurred to earn relevant income. 

Another major concern about preferential
regimes is lack of transparency. This concern is addressed through Automatic
Exchange of Information through Common Reporting Standard (CRS)2.
Besides this, when information is sought on request, the international standard
on information exchange covers the provision not only of exchange of
information, but also availability of information, including ownership,
banking, and account information. The Global Forum on Transparency and Exchange
of Information for Tax Purposes monitors implementation of international
standards on transparency and exchange of information for tax purposes and
reviews the effectiveness of their implementation in practice.

________________________________________________________________________________________________

2 The Common Reporting Standard (CRS), developed in response to the
G20 request and approved by the OECD Council on 15th July, 2014 calls
on jurisdictions to obtain information from their financial institutions and
automatically exchange that information with other jurisdictions on an annual
basis. It sets out the financial account information to be exchanged, the financial
institutions required to report, the different types of accounts and taxpayers
covered, as well as common due diligence procedures to be followed by
financial institutions. [Source: OECD (2017), Standard for Automatic Exchange
of Financial Account Information in Tax Matters]

 

4.0  Economic Substance Requirements Regulations
(ESR Regulations)

ESR Regulations require economic substance
in a jurisdiction where an entity reports relevant income. The underlying
objective of ESR Regulations is to ensure that entities report profits in a
jurisdiction where economic activities that generate them are carried out and
where value is created.

In December, 2017, the European Union Code
of Conduct Group (EU COCG) assessed preferential tax regimes with nil or only
nominal tax to identify harmful practices and enforce substance requirements.
The EU COCG also published a list of ‘non-co-operative jurisdictions for tax
purposes’ which were engaged in harmful tax practices such as ring-fencing
(through offshore tax regimes), artificial definition of tax base and lacked
transparency. Many countries promised to revamp their tax systems to curb
harmful tax practices and introduce substance requirements to avoid being
blacklisted. The work of EU COCG has been strengthened by BEPS Action Plan 5,
with similar objectives and wider applicability.

BEPS Action Plan 5 is also a Minimum
Standard which requires all G20 Nations and countries in the inclusive group
(over 135 countries) who are signatories of the BEPS Project to mandatorily
implement the same. 

To comply with the above, the following
countries enacted legislation to introduce the Economic Substance Regulations
for tax purposes with effect from 1st January, 2019 or an accounting
period commencing thereafter:

(i)    Bahamas

(ii)   Bermuda

(iii)  British Virgin Islands (BVI)

(iv)  Cayman Islands

(v)   Guernsey

(vi)  Jersey

(vii)  Isle of Man

(viii) Mauritius

(ix)  Seychelles

(x)   United Arab Emirates (UAE) (implemented with
amendments effective from 10th August, 2020).

In this Article we shall look closely at
the ESR Regulations as implemented in the UAE. However, it may be noted that
ESR Regulations as introduced by the above-mentioned countries are by and large
similar as they are based on the guidance and requirements issued by the EU as
well as by the OECD; the requirements of CIGA for different regimes are almost
identical. 

Broadly, ESR Regulations in every
jurisdiction would require resident entities to prove economic substance with
respect to the following criteria:

 

4.1 
Management test

The entity should be directed and managed
from the jurisdiction concerned. This can be proved by having physical board
meetings at regular frequency, maintaining minutes and accounts in the tax
jurisdiction concerned, directors having domain expertise of the activities of
the company, handling day-to-day operations and banking transactions, etc.

4.2 
CIGA test

The entity will have to clearly demonstrate
that Core Income Generating Activities are undertaken in the relevant
jurisdiction and such activities are commensurate with the level of income
generated therefrom. What is CIGA will depend upon the nature of income or the
regime. CIGA can be outsourced to a corporate service provider in the
jurisdiction, subject to oversight by the entity (e.g., monitoring and
control). In such cases, the relevant resources of the service providers will
be taken into account when determining whether the CIGA test is satisfied.

 

4.3 
Adequacy test

The entity will have to prove that it has
adequate number of qualified employees and infrastructure to carry out CIGA. It
has to also demonstrate that adequate expenditure is incurred to generate the
relevant income in that jurisdiction. ‘Adequacy’ of expenditure, employees or
infrastructure would depend upon the nature of the CIGA.

 

4.4  Summary of tests for Economic Substance
Requirements

1. The management and direction of the entity
should be located in the offshore jurisdiction concerned;

2. Core Income Generating Activities with respect to
the relevant activity must be undertaken in the offshore jurisdiction
concerned;

3. The entity should have a physical presence in
the offshore jurisdiction;

4. The entity should have full-time employees with
suitable qualifications in the jurisdiction concerned; and

5. The entity should have incurred operating
expenditure in the offshore jurisdiction concerned in relation to the relevant
activity.

 

5.0 
ESR Regulations in UAE

On 30th April, 2019, the Cabinet
of Ministers of the UAE issued Cabinet Resolution No. 31 of 2019 concerning
Economic Substance Requirements Regulations (Resolution 31). On 10th
August, 2020 amendments were introduced to Resolution 31 by the Cabinet of
Ministers by way of Resolution No. 57 of 2020 (ESR Regulations), which repealed
and replaced Resolution 31.

The UAE ESR Regulations contain 22
articles, a list of which is given below.

 

Article
No.

Description

1.

Definitions

2.

Objective of the Resolution

3.

Relevant Activity and Core Income Generating Activity

4.

Regulatory Authorities

5.

National Assessing Authority

6.

Requirement to meet Economic Substance Test

7.

Assessment of whether Economic Substance Test is met

8.

Requirement to provide Information

9.

Provision of Information by the Regulatory Authority

10.

Provision of Information by the National Assessing Authority

11.

Exchange of Information by Competent Authority

12.

Co-operation by other Governmental Authorities

13.

Offences and Penalties for failure to provide a Notification

14.

Offences and Penalties for failure to submit an Economic
Substance Report and for failure to meet the Economic Substance Test

15.

Offences and Penalties for providing inaccurate information

16.

Period for imposition of Administrative Penalty

17.

Right of Appeal against Administrative penalty

18.

Date of Payment of Administrative Penalties

19.

Power to enter Business Premises and Examine Business
Documents

20.

Executive Regulations

21.

Revocation

22.

Entry into Force
 

Ministerial Decision No. 100 for the year
2020 dated 19th August, 2020 is intended to provide further guidance
and direction to entities carrying out one or more Relevant Activities. An
entity subject to ESR Regulations shall have regard to this Decision for the
purposes of ensuring compliance with ESR Regulations.

           

5.1 
Basis of ESR Regulations

The basis of ESR Regulations in UAE as
stated in its ‘Ministerial Decision No. 100 for the year 2020 on the Issuance
of Directives for the implementation of the provisions of the Cabinet Decision
No. 57 of 2020 concerning Economic Substance Requirements’ (hereafter referred
to as ‘Ministerial Directives’) is as follows:

‘The ESR Regulations are issued pursuant
to the global standard set by the Organisation for Economic Cooperation and
Development (“OECD”) Forum on Harmful Tax Practices, which requires entities
undertaking geographically mobile business activities to have substantial
activities in a jurisdiction. In addition to the work of the OECD, the European
Union Code of Conduct Group (“EU COCG”) also adopted a resolution on a code of
conduct for business taxation which aims to curb harmful tax practices. The
Cabinet of Ministers enacted the ESR Regulations taking into account the
relevant standards developed by the OECD and the EU COCG.’

 

5.2 
Applicability

Article 3 of the Ministerial Directives
deals with the Licensees required to meet the Economic Substance test and
provides that ESR Regulations are applicable to Licensees. The term ‘Licensee’
is defined in Article 1 of the ESR Regulations to mean any of the following two
entities:

 

‘i. a juridical person (incorporated inside
or outside the State, i.e., UAE); or

ii. an Unincorporated Partnership;

registered in the State, including a Free
Zone and a Financial Free Zone and carries on a Relevant Activity.’

A juridical person is defined to mean a
corporate legal entity with a separate legal personality from its owners.

An Unincorporated Partnership is defined
under ESR Regulations to include those forms of partnerships that may operate
in the UAE without having a separate legal personality and are thereby
identified separately under the ESR Regulations. 

In other words, the regulations cover all
Licensees (natural and juridical person) having the commercial license,
certificate of incorporation, or any other form of permit necessarily taken
from the licensing authority to do business. Going by the spirit of the ESR
Regulations, it is interpreted that entities in Free Zone (including offshore
companies) would also be covered.

 

Branches

Branch of a foreign entity in the UAE

Since a licensee could be in the form of a
UAE branch of a foreign entity (juridical person incorporated outside UAE is
covered in the definition), Article 3 of the Ministerial Directives
specifically covers them for compliance of ESR Regulations. 

Similarly, a branch of a foreign entity
registered in the UAE that carries out a Relevant Activity is required to
comply with the ESR Regulations, unless the Relevant Income of such branch is
subject to tax in a jurisdiction outside the UAE.

Branch of a UAE entity outside UAE

Where a UAE entity carries on a Relevant
Activity through a branch registered outside the UAE, the UAE entity is not
required to consolidate the activities and income of the branch for purposes of
ESR Regulations, provided that the Relevant Income of the branch is subject to
tax in the foreign jurisdiction where the branch is located. In this context, a
branch can include a permanent establishment, or any other form of taxable
presence for corporate income tax purposes which is not a separate legal
entity.

 

5.3 Licensees exempted from ESR Regulations

The following entities which are registered
in the UAE and carry out a Relevant Activity are exempt from ESR Regulations:

(a)  an Investment Fund,

(b)  an entity that is tax resident in a
jurisdiction other than the UAE,

(c)  an entity wholly owned by UAE residents and
which meets the following conditions:

      (i)    the
entity is not part of an MNE Group;

      (ii)   all
of the entity’s activities are only carried out in the UAE;

(d)  a Licensee that is a branch of a foreign
entity, the Relevant Income of which is subject to tax in a jurisdiction other
than the UAE. 

 

(a) Investment Funds

The ESR Regulations define an Investment
Fund as ‘an entity whose principal business is the issuing of investment
interests to raise funds or pool investor funds with the aim of enabling a
holder of such an investment interest to benefit from the profits or gains from
the entity’s acquisition, holding, management or disposal of investments and
includes any entity through which an investment fund directly or indirectly
invests (but does not include an entity or entities in which the fund
invests).’

The above definition would include the
Investment Fund itself and any entity through which the Fund directly and indirectly
invests, but not the entity or entities in which the Fund ultimately invests.
It is clarified that the words ‘through which an investment fund directly or
indirectly invests’ refers to any UAE entity whose sole function is to
facilitate the investment made by the Investment Fund. The exemption for
Investment Funds is distinct from the Investment Fund Management Business as
regulated under ESR Regulations. The Investment Fund itself is not considered
an Investment Fund Management Business unless it is a self-managed fund (the
Investment Manager and the Investment Fund are part of the same entity).

 

(b) Tax resident in a jurisdiction other
than the State

An entity which is tax resident in a
jurisdiction outside the UAE need not comply with the ESR Regulations. However,
in order for such an entity to avail this exemption, the entity must be
subjected to corporate tax on all of its income from a Relevant Activity by
virtue of being a tax resident in a jurisdiction other than the UAE. It should
be noted that an entity that pays withholding tax in a foreign jurisdiction
will not be considered as tax resident in a foreign jurisdiction other than the
UAE solely on that basis.

 

(c) An entity wholly owned by UAE
residents

An entity that is ultimately wholly and
beneficially owned (directly or indirectly) by UAE residents is exempt from the
Economic Substance Test only where such entity is: (i) not part of an MNE
Group; (ii) all of its activities are exclusively carried out in the UAE; and
(iii) UAE resident owners of the entity reside in the UAE. The entity must
therefore not be engaged in any form of business outside the UAE. In this
context, ‘UAE residents’ means UAE citizens and individuals holding a valid UAE
residency permit, who reside in the UAE. 

(d) A
UAE branch of a foreign entity the Relevant Income of which is subject to tax
in a jurisdiction other than the State

An entity is not required to meet the
Economic Substance Test if such entity is a branch of a foreign entity and its
Relevant Income is subject to corporate tax in the jurisdiction where such
foreign entity is a tax resident. 

Evidence
to be submitted to claim exemption from ESR Regulations

A Licensee that claims to be exempt on the
basis of being a tax resident in a foreign jurisdiction is required to submit
one of the following documents along with its Notification in respect of each
relevant Financial Year:

(a)  Letter or certificate issued by the competent
authority of the foreign jurisdiction in which the entity claims to be a tax
resident stating that the entity is considered to be resident for corporate
income tax purposes in that jurisdiction; or

(b)  An assessment to corporate income tax on the
entity, a corporate income tax demand, evidence of payment of corporate income
tax, or any other document, issued by the competent authority of the foreign
jurisdiction in which the entity claims to be a tax resident.

It is further provided that where an entity
fails to provide sufficient evidence to substantiate its status as an Exempted
Licensee, the entity will be regarded as a Licensee for the purposes of ESR
Regulations and shall be subject to the requirements of ESR Regulations as
applicable to a Licensee, including the requirement to meet the Economic
Substance Test.

5.4 First reportable Financial Year

It is provided that all Licensees and
Exempted Licensees are subject to ESR Regulations from the earlier of (i) their
financial year commencing on 1st January, 2019, or (ii) the date on
which they commence carrying out a Relevant Activity (for a Financial Year
commencing after 1st January, 2019).

5.5 What are the Relevant Activities?

Article 3(1) of ESR Regulations identifies
any of the following activities to be a Relevant Activity: (i) Banking
Business, (ii) Insurance Business, (iii) Investment Fund Management Business,
(iv) Shipping Business, (v) Lease-Finance Business, (vi) Distribution and
Service Centre Business, (vii) Headquarters Business, (viii) Intellectual
Property Business, and (ix) Holding Company Business.

Entities are expected to use a ‘substance
over form’ approach to determine whether or not they undertake a Relevant
Activity and as a result will be considered Licensees for the purposes of ESR
Regulations, irrespective of whether such Relevant Activity is included in the
trade licence or permit of the entity. A Licensee may have undertaken more than
one Relevant Activity during the same financial period. In such a case, the
Licensee would be required to demonstrate economic substance in respect of each
Relevant Activity. 

Any form of passive income from a Relevant
Activity can also bring the entity within the scope of the ESR Regulations.

 

5.6 Relevant Income

The Economic Substance Test has to be
satisfied by a Licensee having regard to the level of Relevant Income derived
from any Relevant Activity. For the purposes of the ESR Regulations, ‘Relevant
Income’ means entity’s gross income from a Relevant Activity as recorded in its
books and records under applicable accounting standards, whether earned in the
UAE or outside, and irrespective of whether the entity has derived a profit or
loss from its activities. 

For the purposes of ‘Relevant Income’,
gross income means total income from all sources, including revenue from sales
of inventory and properties, services, royalties, interest, premiums, dividends
and any other amounts, and without deducting any type of costs or expenditure.
It appears that even capital gains are to be included while computing gross
income. 

In the context of income from sales or
services, gross income means gross revenues from sales or services without
deducting the cost of goods sold or the cost of services. It is further
clarified that gross income does not mean taxable or accounting income or
profit.

 

5.7
Liquidation or otherwise ceasing to carry on Relevant Activities

A Licensee and an Exempted Licensee shall
be subject to ESR Regulations as long as such an entity continues to exist.

 

5.8
The Economic Substance Test – How to substantiate economic substance in the
UAE?

In order for a Licensee to demonstrate that
it has adequate substance in the UAE in a given financial year, an entity must
meet the following tests:


(a) Core Income Generating Activities
(CIGA) Test

The Licensee
should conduct Core Income Generating Activities in the UAE. The CIGAs are
those activities that are of central importance to the Licensee for the
generation of the gross income earned from its Relevant Activity.

 

The CIGAs
depend upon the nature of the Relevant Activity. The list given in Article 3(2)
of the ESR Regulations is an indicative list and not exhaustive3. A
Licensee is not required to perform all of the CIGAs listed in the ESR
Regulations for a particular Relevant Activity. However, it must perform any of
the CIGAs that generate Relevant Income in the UAE. It is clarified that
activities that are not CIGAs can be undertaken outside the UAE.

 

(b) Directed and Managed Test

The ‘directed and managed’ test aims to
ensure that a Relevant Activity is directed and managed in the UAE and requires
that, inter alia, there are an adequate number of board meetings held
and attended in the UAE. A determination as to whether an adequate number of
board meetings are held and attended in the UAE will depend on the level of
Relevant Activity being carried out by a Licensee.

 

Consideration must also be given to more
onerous requirements in respect of board meetings prescribed under the applicable
law regulating the Licensee or as may be stipulated in the constitutional
documents of the Licensee.

 

The ‘directed and managed’ test further
requires that:

(i)   meetings are recorded in written minutes and
that such minutes are kept in the UAE;

(ii)  quorum for such meetings is met and those
attendees are physically present in the UAE; and

(iii) directors have the necessary knowledge and
expertise to discharge their duties and are not merely giving effect to
decisions being taken outside the UAE.

 

The minutes of the board meetings must
record all the strategic decisions taken in relation to Relevant Activities and
must be signed by the directors physically present. The quorum shall be
determined in accordance with the law applicable to the Licensee setting out
quorum requirements, or as may be set out in the constitutional documents of
the Licensee (or both).

 

It is clarified that for the purposes of
ESR Regulations the ‘directed and managed’ requirement does not prescribe that
board members (or equivalent) be resident in the UAE. Rather, the board members
(or equivalent) are required to be physically present in the UAE when taking
strategic decisions. In the event that the Licensee is managed by its
shareholders / owners / partners, an individual manager (e.g., general manager
or CEO), or more than one manager, the above requirements will apply to such
persons to the fullest extent possible.

 

(c) Expenditure Test


Having regard to the level of Relevant
Income earned from a Relevant Activity, the Licensee should ensure that it (i)
has an adequate number of qualified full-time (or equivalent) employees in
relation to the activity who are physically present in the UAE (whether or not
employed by the Licensee or by another entity and whether on temporary or long-term
contracts), (ii) incurs adequate operating expenditure by it in the UAE, and
(iii) has adequate physical assets (e.g. premises) in the UAE.

 

What is adequate or appropriate for each
Licensee will depend on the nature and level of Relevant Activity being carried
out by such Licensee. A Licensee will have to ensure that it maintains
sufficient records to demonstrate the adequacy and appropriateness of the
resources and assets utilised and expenditure incurred.

 

It is provided that the National Assessing
Authority shall review such records and other supporting documentation
submitted in assessing whether a Licensee has demonstrated the adequacy and
appropriateness of resources and assets utilised and expenditures incurred.

 

The requirement for adequate employees is
aimed at ensuring that there are a sufficient number of suitably qualified
employees carrying out the Relevant Activity. The requirement for adequate
physical assets is intended to ensure that a Licensee has procured appropriate
physical assets to carry out a Relevant Activity in the UAE. Physical assets
can include offices or other forms of business premises (such as warehouses or
facilities from which the Relevant Activity is being conducted) depending on
the nature of the Relevant Activity. Such premises may be owned or leased by
the Licensee, provided that the Licensee is able to produce the lease
agreement, etc., to prove the right to use the premises for the purposes of
carrying out the Relevant Activity.

 


__________________________________________________________________________________

3 The indicative list of CIGAs is based on the recommendations of the BEPS
Action Plan 5 (paragraphs 74 to 87).


5.9 Outsourcing

Article 6(2)
of the ESR Regulations provides that a Licensee may conduct all or part of its
CIGAs for a Relevant Activity through an Outsourcing Provider. For the purposes
of ESR Regulations, an Outsourcing Provider may include third parties or
related parties. The substance (e.g., employees and physical assets) of the
Outsourcing Provider in the UAE will be taken into account when determining the
substance of the Licensee for the purpose of the Economic Substance Test,
subject to certain conditions.

 

5.10 Notification Filings


Every Licensee and Exempted Licensee is
required to submit a Notification to their respective Regulatory Authorities
setting out the following for each relevant financial year:

i.   the nature of the Relevant Activity being
carried out;

ii.  whether it generates Relevant Income;

iii.  the date of the end of its financial year;

iv. any other information as may be requested by
the Regulatory Authority.

 

A Notification submitted by an Exempted
Licensee must be accompanied by sufficient evidence to substantiate the
Exempted Licensee’s status for each category in which it claims to be exempt.
Failure to provide sufficient evidence to this effect will result in the
Exempted Licensee not being able to avail itself of the exemption and having to
comply with the full requirements of the ESR Regulations, including meeting the
Economic Substance Test.

 

The time frames for compliance with the
requirement to submit a Notification are different from the time frames to
submit an Economic Substance Report as discussed in paragraph 5.11 below.

 

The Notification must be submitted within
six months from the end of the financial year of the Licensee or Exempted
Licensee. The Notification must be submitted electronically on the Ministry of
Finance Portal.

 

 

5.11 Submission of Economic
Substance Report

Every Licensee shall be required to meet
the applicable Economic Substance Test requirements and submit an Economic
Substance Report containing the requisite information and documentation
prescribed under the ESR Regulations within 12 months from the end of the
relevant financial year.

 

The Economic
Substance Report of the
Licensee will be assessed by the National Assessing Authority within a
period of six years from the end of the relevant financial year. The
National
Assessing Authority will issue its decision as to whether a Licensee has
met
the Economic Substance Test. This six-year limitation period shall not
apply if
the National Assessing Authority is not able to make a determination
during
this period due to gross negligence, fraud, or deliberate
misrepresentation by
the Licensee or any other person representing the Licensee.

 

5.12
Exchange of information with foreign authorities


The Competent Authority will spontaneously
exchange information with relevant Foreign Competent Authorities under the ESR
Regulations pursuant to an international agreement, treaty or similar
arrangement to which the UAE is a party in the following circumstances:

i)   where a Licensee fails to satisfy the
Economic Substance Test;

ii)  where a Licensee is a high-risk IP Licensee;

iii)  where an entity claims to be tax resident in a
jurisdiction outside the UAE; and

iv) where a branch of a foreign entity claims to be
subject to tax in a jurisdiction outside the UAE.

 

Every Licensee that is carrying out a
Relevant Activity must identify the jurisdiction in which the Parent Company,
Ultimate Parent Company and Ultimate Beneficial Owner claim to be tax resident.
An Exempted Licensee that is either (i) tax resident in a jurisdiction other
than the UAE; or (ii) a UAE branch of a foreign company of which all the income
of the UAE branch is subject to tax in a jurisdiction other than the UAE must,
in addition to identifying the foregoing, also identify the jurisdiction in
which such Exempted Licensee claims to be (a) a tax resident or (b) the
jurisdiction of the foreign company of the UAE branch (as may be relevant).

 

5.13 Penalties


Stringent penalties are prescribed for
non-compliance with ESR Regulations, which are as follows:

 

Article No.

Nature of offence

Penalty

Remarks

13

Failure to provide Notification

AED 20,000

 

14

Failure to submit Economic Substance Report and any other
information or documents in accordance with ESR Regulations or Failure to
meet the Economic Substance Test

AED 50,000

AED 4,00,000 for a repeat offence in the subsequent year

15

Providing inaccurate information

AED 50,000

 

 

5.14
Summary of the Relevant Activities, related CIGAs and the Regulatory Authority4


One may refer to the Text of ‘Schedule 1 –
Relevant Activities Guide’, of the Ministerial Directives referred to in
Paragraph 5.1 infra, for detailed explanations and examples.


Relevant Activity
pursuant to Article 3.1 of Cabinet Resolution No. (57) of 2020

Core Income
Generating Activities (non-exhaustive) Article 3.2 of Cabinet Resolution No.
(57) of 2020

Regulatory Authority
pursuant to Article 4 of Cabinet Resolution No. (57) of 2020

Banking Business

(a) Raising funds, managing risk
including credit, currency and interest risk.

(b) Taking hedging positions.

(c) Providing loans, credit or other
financial services to customers.

1. UAE Central Bank

2. The competent authority in the
Financial Free Zone for the Banking Businesses

Insurance Business

(a) Predicting and calculating risk.

(b) Insuring or re-insuring against risk
and providing Insurance Business services to clients.

(c) Underwriting insurance and
reinsurance.

1. Securities and Commodities Authority

2. The competent authority in the Free
Zone and Financial Free Zone for the Insurance Business

Investment Fund Management Business

(a) 
Taking decisions on the holding and selling of investments.

(b) Calculating risk and reserves.

(c) Taking decisions on currency or
interest fluctuations and hedging positions.

(d) Preparing reports to investors or
any government authority with functions relating to the supervision or
regulation of such business.

1. Securities and Commodities Authority

2. The competent authority in the Free
Zone and Financial Free Zone for the Investment Fund Management Business

Lease-Finance Business

(a) Agreeing funding terms.

(b) Identifying and acquiring assets to
be leased (in the case of leasing).

(c) Setting the terms and duration of
any financing or leasing.

(d) Monitoring and revising any
agreements.

(e) Managing any risks.

1. UAE Central Bank

2. The competent authority in the Free
Zone and Financial Free Zone for the Lease-Finance Business

 

Headquarter Business

(a) Taking relevant management
decisions.

(b) Incurring operating expenditures on
behalf of group entities.

(c) Coordinating group activities.

1. Ministry of Economy

2. The competent authority in the Free
Zone and Financial Free Zone for the Headquarter Business

Shipping Business

(a) Managing crew (including hiring,
paying and overseeing crew members).

(b) Overhauling and maintaining ships.

(c) 
Overseeing and tracking shipping.

(d) Determining what goods to order and
when to deliver them,

(e) Organising and overseeing voyages.

1. Ministry of Economy

2. The competent authority in the Free
Zone and Financial Free Zone for the Shipping Business

Holding Company Business

Activities related to a Holding Company Business.

1. Ministry of Economy

2. The competent authority in the Free
Zone and Financial
Free Zone for the Holding Company Business

Intellectual Property Business

Where the Intellectual Property Asset is
a

(a) Patent or similar Intellectual
Property Asset: Research and development.

(b) Marketing intangible or a similar
Intellectual Property Asset: Branding, marketing and distribution.

In exceptional cases, except where the
Licensee is a High-Risk IP Licensee, the Core Income Generating Activities
may include:

(i) taking strategic decisions and
managing (as well as bearing) the principal risks related to development and
subsequent exploitation of the intangible asset generating income.

(ii) taking the strategic decisions and
managing
(as well as bearing) the principal risks relating to acquisition by third
parties and subsequent exploitation and protection of the intangible asset.

(iii) carrying on the ancillary trading
activities through which the intangible assets are exploited leading to the
generation of income from third parties.

1. Ministry of Economy

2. The competent authority in the Free
Zone and Financial Free Zone for the Intellectual Property Business

Distribution and Service Centre Business

(a) Transporting and
storing component parts, materials or goods ready for sale.

(b) Managing inventories.

(c) Taking orders.

(d) Providing consulting or other
administrative services.

1. Ministry of Economy

2. The competent authority in the Free
Zone and Financial Free Zone for the Distribution and Service Centre Business

 

 

_____________________________________________________________________

4 Source:https://www.mof.gov.ae/en/StrategicPartnerships/Document/Economic%20Substance%20Relevant%20Activities%20Summary.pdf

                      5.15  Flow-chart of the Applicability of ESR
Regulations5

 

 

 ________________________________________________________________________

5.Source: https://www.mof.gov.ae/en/StrategicPartnerships/Pages/ESR.aspx



6.0.
Relevance of ESR Regulations for Indian Entities


Many Indian companies have their
subsidiaries, branches, project offices or other forms of entities operating in
the UAE. Every such entity needs to strictly follow the ESR Regulations as
stringent penalties are prescribed. The provisions of the ESR Regulations are
stricter than Limitation of Benefits under a Tax Treaty. Therefore, each structure
would need a reassessment, review and restructuring if need be. As the
Regulations are applicable to each type of Licensee, including Free Trade
Zones, Proprietorships, etc., even individual investments need to be examined
and should comply with ESR Regulations.


7.0 Epilogue


There is a well-known saying, ‘Don’t judge
a book by its cover’. It means, a beautiful cover cannot determine the worth of
a book. It can enhance its visual appeal but not the underlying (inherent)
value. In a lighter vein, an old Bollywood song also gives us some guidance… Dil
ko dekho, chehera na dekho, chehere ne lakhon ko loota… Dil sachcha aur chehera
jhutha.

 

So, there is no doubt that one needs to
have a substance and purpose in whatever structure one enacts, whichever
jurisdiction one chooses or whatever business activities / transactions one
undertakes. One has to justify every action from the perspective of non-tax
evasion, while one can always take benefits and advantages of favourable tax
treaties / regimes with good business substance.

 

It is equally important for Indian
entrepreneurs to bear in mind the ESR Regulations in different jurisdictions,
their reporting requirements while structuring or undertaking any outbound
investments / activities. They may also need to revisit their existing
structures to fall in line with the stringent substance requirements of various
jurisdictions. It may be noted that genuine businesses need not worry, but they
will have to prove their bona fides.

 

Article 12 of India-USA and India-Netherlands DTAAs – Testing and certification charges paid to US and Netherlands entities did not qualify as FTS since they did not satisfy ‘make available’ requirement Article 12 of India-China and India-Germany DTAAs – Testing and certification charges were FTS and taxable in India

2. [2020] 117
taxmann.com 983 (Delhi-Trib.) Havells India Ltd.
vs. ACIT ITA Nos.:
6072/Del./2010; 6073/Del./2010; 466/Del./2011 A.Ys.: 2004-05 and
2007-08 Date of order: 25th
August, 2020

 

Article 12 of
India-USA and India-Netherlands DTAAs – Testing and certification charges paid
to US and Netherlands entities did not qualify as FTS since they did not
satisfy ‘make available’ requirement

 

Article 12 of
India-China and India-Germany DTAAs – Testing and certification charges were
FTS and taxable in India

 

FACTS


The assessee was
engaged in the manufacture of electrical goods. It made payments to various
foreign entities in the USA, the Netherlands, China and Germany for testing and
certification of its products. The foreign entities had specialised knowledge
and facilities for undertaking testing and certification, which was required
for the manufacturing activity of the assessee. These were country-specific
certifications that were mandatory for sale in the respective countries.

 

The A.O. held that
the payments for testing fees were taxable u/s 9(1)(vii). As regards the
applicability of the DTAAs, the A.O. held that the services met the requirement
of ‘made available’ under the India-Netherlands and India-USA DTAAs. The A.O.
further held that the testing fees were in any case taxable under the
India-China and India-Germany DTAAs wherein the ‘make available’ clause was not
present.

 

The CIT(A) upheld
the order of the A.O.

 

Being aggrieved,
the assessee appealed before the Tribunal.

 

HELD


Payments to
US and Netherlands entities

Relying upon its
order in the assessee’s own case for A.Y. 2005-06 and A.Y. 2006-07 and
following orders for earlier years, the Tribunal held that the services
provided did not satisfy the ‘make available’ condition. Hence, the services
were not chargeable to tax in India.

 

Payment to
Chinese entity

(a) The assessee contended that in terms of Article
12 of the India-China DTAA, the meaning of FTS was restricted to only services
performed in India, based on ‘place of performance test’.

(b) Relying on the decision in Ashapura
Minichem Ltd.2 dealing with Article 12 of the India-China
DTAA, the Tribunal observed that: (i) FTS shall be deemed to accrue or arise in
the source country when the payer is resident of that country; (ii) it is the ‘provision
of services’, and not necessarily the ‘performance of services’ in the
source country which triggers taxability. The Tribunal observed that the
expression ‘provision for services’ used in the India-China DTAA is much wider
in scope than the expression ‘provision for rendering of services’
used in other DTAAs. Hence, rendition of services in India is not necessary for
taxability of FTS in India. It is sufficient that services were utilised in
India. Accordingly, under India-China DTAA, FTS was taxable in India.

(c) Relying on the above decision, the Tribunal
upheld disallowance u/s 40(a)(ia) for non-withholding of tax.

 

Payment to
German entity

In case of payments
made to the German entity, the Tribunal held that the services provided by it
were in the nature of technical services and hence were taxable under the
India-Germany DTAA.

 

Standard
services and machine-provided services

(i)  The assessee relied upon the Supreme Court
decision in Kotak Securities3 to contend that
technical services were standard services. However, the Tribunal held that
testing services were not standard services as they were for a specific
country, a specific product, and / or a specific manufactured lot of the
assessee, which was exported to that particular country and conformed to the
standards specified in that country.

(ii) The assessee also relied
on the decision of the Apex Court in Bharti Cellular Ltd.4
to contend that services were not FTS as they were provided by machines without
any human intervention. However, relying on the Supreme Court decision in Kotak
Securities (Supra), the Tribunal did not accept the contention of the
assessee. In the said decision, after taking note of the decision in Bharti
Cellular (Supra), the Court had observed that services could be
technical even in case of a fully-automated process which did not involve human
intervention.

_________________________________________________________________________________________________


2    (2010)
40 SOT 220 (Mum)

3    (2016)
383 ITR 1 (SC)

4    (2011)
330 ITR 239 (SC)

 

 

You can’t blame gravity for
falling in love

 — 
Albert Einstein

Article 5 of India-UK DTAA – Section 195 of the Act – Payment for production and delivery of film outside India is not taxable in India

1. [2020] 118
taxmann.com 314 (Mumbai-Trib.) Next Gen Films (P)
Ltd. vs. ITO ITA Nos.: 3782,
3783/Mum./2016 A.Ys.: 2011-12 to
2012-13 Date of order: 11th
August, 2020

 

Article 5 of
India-UK DTAA – Section 195 of the Act – Payment for production and delivery of
film outside India is not taxable in India

 

FACTS


The assessee and another Indian Company (E1) were co-producers of a
feature film. They entered into a commission agreement with D, a UK-based
company which was to provide production services like pre-production,
production, post-production and delivery of the feature film. Key terms of the
agreement were as follows:

(a) Based on the story concept provided by the
assessee, development of storyboards and screenplay, selection of locations and
special and visual effects services. D was to consult and take consent of the
assessee over important aspects like the identity of all key cast members, budget,
production schedule, delivery materials, cash flow, screenplay, production
services companies to be engaged, etc., to ensure that the film was produced
and delivered in accordance with the material requirement.

(b) Ownership of the film was solely and
exclusively with the assessee.

(c) As a consideration for the
aforesaid services, D was paid 100% of the budget. This amount was to be
reduced by the amount of UK Tax Credit advance, any underspent amount, interest
accrued on monies held in the production account and any realisable value from
equipment / materials sale at the end of production of the film.

 

To execute the
Indian leg of the project, D entered into a production service agreement with
E2 (a subsidiary of the parent of E1). The services of E2 were subject to the
direction and control of D. The A.O. was of the view that D had a place of
management in India. He further held that the assessee, D and E2 were
associated enterprises in terms of Article 10. Accordingly, E2 had also created
a service PE of D in India. Since the assessee had not withheld tax on
remittance, the A.O. deemed it as ‘assessee in default’ and initiated
proceedings u/s 201/201(1A) of the Act.

 

In appeal, the
CIT(A) held against the assessee who, being aggrieved, appealed before the
Tribunal.

 

HELD


Associated
enterprise

+ The contract
between the assessee and D was on a principal-to-principal basis which required
D to produce the film in accordance with the specifications laid down by the
assessee.

+ D carried out its
activities in consultation with the assessee to ensure that the film was
produced as per specifications and in keeping with the storyline.

+ D acted
independently and was free to take decisions and also engage other service
providers.

+ D had borrowed
against expected UK tax credit1. Thus, it could not be said that D
was dependent upon the assessee for its financial requirement.

+ D also recorded
revenue received from the assessee and consequential loss in its books of
accounts.

 

Thus, it could not
be said that the assessee participated directly or indirectly in the
management, control or capital of D.

 

Permanent
Establishment

* The agreement
between D and E2 was that between a principal and an agent. E2 had provided
limited production services for a lump sum consideration of Rs. 3 crores.

* The gross
receipts of E2 were Rs. 133.55 crores (A.Y. 2011-12) and Rs. 76.27 crores (A.Y.
2012-13), respectively, as compared to the fees of Rs. 3 crores received from
D. Therefore, E2 was an agent of independent status. Consequently, D did not
create a PE in India.

 

Thus, D and E2 were
not associated enterprises in terms of Article 10 of the DTAA.


_________________________________________________________________________________________________

1    Decision
does not mention nature or conditions qualifying for tax credit in UK

 

TAXABILITY OF A PROJECT OFFICE OR BRANCH OFFICE OF A FOREIGN ENTERPRISE IN INDIA

In our last article
published in the August, 2020 issue of the BCAJ, we discussed various
aspects relating to taxability of a Liaison Office (LO) in India, including the
recent decision of the Supreme Court in the case of the U.A.E. Exchange Centre.

In addition to a Liaison
Office (LO), Project Offices (PO) and Branch Offices (BO) of foreign
enterprises have also been important modes of doing business in India for many
foreign entities.

Issues have arisen for
quite some time as to under what circumstances a PO / BO has to be considered
as a Permanent Establishment (PE) of a foreign enterprise in India and then be
subjected to tax here.

In this article, we
discuss various aspects relating to taxability of a PO / BO in India, including
the recent decision of the Supreme Court in the case of Samsung Heavy
Industries Ltd.

 

BACKGROUND


The determination of tax
liability of a foreign enterprise has been a contentious subject in the Indian
tax regime for a very long time. And whether a foreign enterprise has a PE in
India has been a highly debatable issue, though it is very fact-intensive. The
ITAT and the courts have been taking different views based on the facts of each
case.

 

A Project Office means a
place of business in India to represent the interests of the foreign company
executing a project in India but excludes a Liaison Office. A Site Office means a
sub-office of the Project Office established at the site of a project but does
not include a Liaison Office.

 

A foreign company may open
project office(s) in India provided it has secured from an Indian company a
contract to execute a project in India, and (i) the project is funded directly
by inward remittance from abroad; or (ii) the project is funded by a bilateral
or multilateral international financing agency; or (iii) the project has been
cleared by an appropriate authority; or (iv) a company or entity in India
awarding the contract has been granted term loan by a public financial
institution or a bank in India for the project.

 

A Branch Office in
relation to a company means any establishment described as such by the company.

 

As per Schedule I read
with Regulation 4(b) of the FEM (Establishment in India of a Branch Office or a
Liaison Office or a Project Office or any Other Place of Business) Regulations,
2016 [(FEMA 22(R)], a BO in India of a person resident outside India is
permitted to carry out the following activities:

(i)  Export / import of goods.

(ii) Rendering
professional or consultancy services.

(iii) Carrying out
research work in which the parent company is engaged.

(iv) Promoting technical
or financial collaborations between Indian companies and parent or overseas
group company.

(v) Representing the
parent company in India and acting as buying / selling agent in India.

(vi) Rendering services in
Information Technology and development of software in India.

(vii) Rendering technical
support to the products supplied by parent / group companies.

(viii) Representing a
foreign airline / shipping company.

 

Normally, a branch office
should be engaged in the same activity as the parent company. There is a
difference between the PO / BO and LO, both in terms of their models and, more
importantly, their permitted activities. As per the FEMA 22(R), an LO is
permitted to carry out very limited activities and can only act as a
communication channel between the source state and the Head Office; whereas a
PO / BO is permitted to carry out commercial activities, but only those
specified activities as per the RBI Regulations.

 

Thus, under FEMA 22(R) a PO
is allowed to play a larger role as compared to an LO in India. Further, the
scope of permitted activities of a BO provided in Schedule I of FEMA 22(R) is
much larger than the scope of permitted activities of an LO provided in
Schedule II of FEMA 22(R).

 

In National
Petroleum Construction Company vs. DIT (IT) [2016] 66 taxmann.com 16 (Delhi),
the Delhi High Court, after referring to the definitions of LO and PO in the
Foreign Exchange Management (Establishment in India of Branch or Office or
Other Place of Business) Regulations, 2000, held that ‘It is apparent from
the plain reading of the aforesaid definitions that whereas a liaison office
can act as a channel of communication between the principal place of business
and the entities in India and cannot undertake any commercial trading or
industrial activity, a project office can play a much wider role. Regulation (6)(ii)
of the aforesaid regulations mandates that a “project office” shall not
undertake or carry on any other activity other than the “activity relating
and incidental to execution of the project”. Thus, a project office can
undertake all activities that relate to the execution of the project and its
function is not limited only to act as a channel of communication.’

 

WHETHER A PO / BO CONSTITUTES A PE IN INDIA?


As mentioned above, as per
the prevailing FEMA regulations a PO / BO can carry out activities which may
not be limited to acting as a communication channel between the parent company
and Indian companies.

 

An issue that arises for
consideration is whether just because the scope of the permitted activities of
a PO / BO is much wider as compared to an LO under FEMA 22(R), would that be an
important consideration in determining the existence of a PE of a foreign
enterprise in India?

 

Due to the difference in
scope of activities to be carried out by an LO and a PO / BO, the assessing
officers many a times take a stand that the PO / BO is a PE of a foreign
enterprise as they are permitted to carry out commercial activities as compared
to an LO. This perception leads to the conclusion of a PO / BO being a PE in
India.

 

In order to decide whether
a PO / BO constitutes a PE in the source state, the actual activities carried
out by them in India need to be minutely analysed irrespective of the fact
whether such activities were carried out in violation of FEMA regulations and
RBI approval.

 

RELEVANT
PROVISIONS OF THE INCOME-TAX ACT, 1961 (the ITA) and the (DTAAs) relating to
PEs


Definition
under the ITA


Section 92F(iiia) defines
a PE as follows: ‘permanent establishment’, referred to in clause (iii),
includes a fixed place of business through which the business of the
enterprise is wholly or partly carried on.’

 

Section 94B defines a PE
as a ‘permanent establishment’ and includes a fixed place of business
through which the business of the enterprise is wholly or partly carried on.

 

Similarly, Explanation (b)
to section 9(1)(v), Explanation (c) to sections 44DA, 94A(6)(ii) and 286(9)(i)
defines a PE by referring to the definition given in section 92F(iiia).

 

It is important to note
that under the ITA a PE is defined in an inclusive manner. It has two limbs,
i.e. (a) it has to be a fixed place of business, and (b) through such fixed
place the business of the enterprise is wholly or partly carried on.

 

Definition of
Fixed Place PE and exceptions under the OECD Model Conventions


Since the publication of
the first ambulatory version of the OECD Model Convention in 1992, the Model
Convention was updated ten times. The last such update which was adopted in
2017 included a large number of changes resulting from the OECD / G20 Base
Erosion and Profit Shifting (BEPS) Project and, in particular, from the final
reports on Actions 2 (Neutralising the Effects of Hybrid Mismatch
Arrangements), 6 (Preventing the Granting of Treaty Benefits in
Inappropriate Circumstances), 7 (Preventing the Artificial Avoidance
of Permanent Establishment Status), and 14 (Making Dispute
Resolution Mechanisms More Effective), produced as part of that project.

 

Article 5(1) of the OECD
Model Convention 2017 update defines the term ‘permanent establishment’ as
follows:

 

‘1. For the purposes of
this Convention, the term ‘‘permanent establishment’’ means a fixed
place of business through which the business of an enterprise is wholly
or partly carried on.

 

Article 5(2) of the OECD
Model Convention 2017 provides that the term ‘permanent establishment’
includes, especially, (a) a place of management; (b) a branch; (c) an
office; (d) a factory; (e) a workshop; and (f) a mine, an oil or gas well,
a quarry or any other place of extraction of natural resources.

 

Thus, on a plain reading
of Articles 5(1) and 5(2), a branch or an office is normally considered as a PE
under a DTAA.

 

The updated Article 5(4)
provides that the term PE shall be deemed not to include:

(a) the use of facilities
solely for the purpose of storage, display or delivery of goods or
merchandise belonging to the enterprise;

(b) the maintenance of a
stock of goods or merchandise belonging to the enterprise solely for the
purpose of storage, display or delivery;

(c) the maintenance of a
stock of goods or merchandise belonging to the enterprise solely for the
purpose of processing by another enterprise;

(d) the maintenance of a
fixed place of business solely for the purpose of purchasing goods or
merchandise or of collecting information for the enterprise;

(e) the maintenance of a
fixed place of business solely for the purpose of carrying on, for the
enterprise, any other activity;

(f) the maintenance of a
fixed place of business solely for any combination of activities mentioned
in sub-paragraphs (a) to (e), provided that such activity or, in the
case of sub-paragraph (f), the overall activity of the fixed place of
business is of a preparatory or auxiliary character.

 

Paragraph 4.1 of Article 5
provides for exception to paragraph 4 as under:

‘4.1 Paragraph 4 shall not
apply to a fixed place of business that is used or maintained by an
enterprise if the same enterprise or a closely related enterprise
carries on business activities at the same place or at another place in
the same Contracting State, and

(A) that place or other
place constitutes a permanent establishment for the enterprise or the
closely related enterprise under the provisions of this Article, or

(B) the overall
activity resulting from the combination of the activities carried on by the
two enterprises at the same place, or by the same enterprise or closely related
enterprises at the two places, is not of a preparatory or auxiliary
character, provided that the business activities carried on by the two
enterprises at the same place, or by the same enterprise or closely related
enterprises at the two places, constitute complementary functions that are
part of a cohesive business operation.’

 

It is important to note
that the UN Model Convention 2017 contains a modified version of Article 5 to
prevent the avoidance of PE status which is on the same lines as Articles 5(4)
and 5(4.1) of the OECD MC mentioned above, except that in Articles 5(4)(a) and
5(4)(b) of the UN MC 2017, the word ‘delivery’ is missing. This is due to the
fact that the UN MC does not consider activity of ‘delivery’ of goods as of
preparatory or auxiliary character.

 

Determination
of existence of PE in cases of non-carrying on of ‘business’ or ‘core business’
of the assessee


On a proper reading and
analysis of Article 5(1), it would be observed that it contains two limbs and
to fall within the definition of a fixed place PE both the limbs have to be
satisfied. Therefore, in case of a PO / BO, normally the first limb is
satisfied, i.e., there is a ‘fixed place of business’ in India but if the second
limb ‘through which the business of an enterprise is wholly or partly
carried on’ is not satisfied, then a fixed place PE cannot be said to be in
existence.

 

The Tribunal and courts
have, based on the facts of each case, often held that if the actual activities
of a PO / BO did not tantamount to carrying on the business of an enterprise
wholly or partly, then a fixed place PE cannot be said to have come into
existence.

 

Recently, the Supreme
Court in the case of DIT vs. Samsung Heavy Industries Limited (SHIL)
[2020] 117 taxmann.com 870 (SC) after in-depth analysis of the facts
held that the Mumbai Project Office of SHIL cannot be said to be a fixed place
of business through which the ‘core business’ of the assessee was wholly or
partly carried on. Relying on a number of judicial precedents of the Supreme
Court in the cases of CIT vs. Hyundai Heavy Industries Co. Ltd., [2007] 7
SCC 422; DIT (IT) vs. Morgan Stanley & Co. Inc., [2007] 7 SCC 1;
Ishikawajima-Harima Heavy Industries Ltd. vs. DIT, [2007] 3 SCC 481;
and ADIT vs. E-Funds IT Solution Inc. [2018] 13 SCC 294, the
Court in paragraphs 23 and 28 held as follows:

 

‘23. A reading of the aforesaid judgments makes it clear that
when it comes to “fixed place” permanent establishments under double
taxation avoidance treaties, the condition precedent for applicability of
Article 5(1) of the double taxation treaty and the ascertainment of a
“permanent establishment” is that it should be an establishment
“through which the business of an enterprise” is wholly or partly
carried on. Further, the profits of the foreign enterprise are taxable only where the said enterprise carries on its core
business through a permanent establishment. What is equally clear is
that the maintenance of a fixed place of business which is of a preparatory or
auxiliary character in the trade or business of the enterprise would not be
considered to be a permanent establishment under Article 5. Also, it is
only so much of the profits of the enterprise that may be taxed in the other
State as is attributable to that permanent establishment.

 

28. Though it was pointed out to the ITAT that there were
only two persons working in the Mumbai office, neither of whom was qualified to
perform any core activity of the assessee, the ITAT chose to ignore the
same. This being the case, it is clear, therefore, that no permanent
establishment has been set up within the meaning of Article 5(1) of the DTAA, as
the Mumbai Project Office cannot be said to be a fixed place of business
through which the core business of the assessee was wholly or partly carried
on. Also, as correctly argued by Shri Ganesh, the Mumbai Project Office,
on the facts of the present case, would fall within Article 5(4)(e) of the
DTAA, inasmuch as the office is solely an auxiliary office, meant to act as a
liaison office between the assessee and ONGC. This being the case, it is
not necessary to go into any of the other questions that have been argued
before us.’

 

In the context of a fixed
place PE, in the SHIL case the Supreme Court mentioned and summarised the
aforesaid aspect in the decision in the case of Morgan Stanley & Co.
Inc. (Supra) as under:

 

‘17. Some of the judgments of this Court have dealt with
similar double taxation avoidance treaty provisions and therefore need to be
mentioned at this juncture. In Morgan Stanley & Co. Inc. (Supra),
the Double Taxation Avoidance Agreement (1990) between India and the United
States of America was construed. …..Tackling the question as to whether a
“fixed place” permanent establishment existed on the facts of that
case under Article 5 of the India-US treaty – which is similar to Article 5 of
the present DTAA – this Court held:

 

“10. In our view, the second requirement of Article 5(1) of DTAA is not
satisfied as regards back office functions. We have examined the
terms of the Agreement along with the advance ruling application made by MSCo
inviting AAR to give its ruling. It is clear from reading of the above
Agreement / application that MSAS in India would be engaged in supporting the
front office functions of MSCo in fixed income and equity research and in
providing IT-enabled services such as data processing support centre and
technical services, as also reconciliation of accounts. In order to
decide whether a PE stood constituted one has to undertake what is called as a
functional and factual analysis of each of the activities to be undertaken by
an establishment. It is from that point of view we are in agreement with the
ruling of AAR that in the present case Article 5(1) is not applicable as the
said MSAS would be performing in India only back office operations. Therefore
to the extent of the above back office functions the second part of Article
5(1) is not attracted.”

 

14. There is one more
aspect which needs to be discussed, namely, exclusion of PE under Article 5(3).
Under Article 5(3)(e) activities which are preparatory or auxiliary in
character which are carried out at a fixed place of business will not
constitute a PE. Article 5(3) commences with a non obstante clause. It states that notwithstanding what is stated in
Article 5(1) or
under Article 5(2) the term PE shall not include maintenance of a fixed place
of business solely for advertisement, scientific research or for activities
which are preparatory or auxiliary in character. In the present case we are
of the view that the abovementioned back office functions proposed to be
performed by MSAS in India falls under Article 5(3)(e) of the DTAA. Therefore,
in our view in the present case MSAS would not constitute a fixed place PE
under Article 5(1) of the DTAA as regards its back office operations.’

 

The Supreme Court further
mentioned about the decision in the case of E-Funds IT Solution Inc. (Supra)
as follows:

 

‘22. Dealing with “support services” rendered by an Indian
Company to American Companies, it was held that the outsourcing of such
services to India would not amount to a fixed place permanent establishment
under Article 5 of the aforesaid treaty, as follows:

 

“22. This report
would show that no part of the main business
and revenue-earning activity of the two American companies is carried on
through a fixed business place in India which has been put at their
disposal. It is clear from the above that the Indian company only renders
support services which enable the assessees in turn to render services to their
clients abroad. This outsourcing of work to India would not give rise to a
fixed place PE and the High Court judgment is, therefore, correct on this
score.”’

 

In view of above
discussion, to constitute a fixed place PE it is particularly important to
determine what constitutes the ‘Business’, ‘Core Business’ or the ‘Main
business’, as referred to by the Supreme Court, of the assessee foreign
enterprise. This determination is going to be purely based on the facts and
hence an in-depth functional and factual analysis of the activities being
actually performed by the PO / BO would be required to be carried out in each
case.

 

The term ‘business’ is
defined in an inclusive manner in section 2(13) of the ITA as follows:
‘Business’ includes any trade, commerce, manufacture or any adventure or
concern in the nature of trade, commerce or manufacture.

 

Article 3(1)(h) of the
OECD MC provides that the term ‘business’ includes the performance of
professional services and of other activities of an independent character.

 

From
an overall analysis of the decisions, it appears that if the activities of the
PO / BO are purely in the nature of back office activities or support services
which enables the assessee foreign enterprise in turn to render services to
their clients abroad or performing mere coordination and executing delivery of
documents, etc., then the same would not be considered as the core or main
business of the assessee, and accordingly a PO / BO performing such activities
would not constitute a fixed place PE in India.

 

It is not quite clear as
to whether to constitute Core or Main business of the assessee foreign
enterprise there has to be revenue-earning activity in India, i.e., having
customers or clients in India to whom goods are sold or for whom services are
rendered, invoiced and revenue generated in India, is necessary for the same to
be constituting a fixed place PE in India and consequently be taxable in India.

 

RELIANCE OF RELEVANT DOCUMENTS


Since the determination of
a fixed place PE is predominantly an in-depth fact-based exercise, the ITAT and
the courts have to rely on various relevant documents.

 

It has been observed that
in the application to the Reserve Bank of India (RBI) for obtaining approval of
PO / BO, the relevant Board resolution of the foreign enterprise to open a PO /
BO, the approval given by the RBI, the accounts maintained by the PO / BO in
India, etc., are very relevant for arriving at the determination of the
existence of a PE in India.

 

The ITAT in SHIL vs.
ADIT IT [2011] 13 taxmann.com 14 (Delhi), largely relied upon (a)
SHIL’s application to RBI for opening the PO; (b) SHIL’s Board Resolution for
opening the PO; and (c) RBI’s approval for opening the PO. In respect of the
Board Resolution, the ITAT focused on its first paragraph alone and in
paragraph 71 of the order observed as follows:

 

‘71. There is a force in the contention of Learned DR that
the words “That the Company hereby open one project office in Mumbai,
India for co-ordination and execution of Vasai East Development Project for Oil
and Natural Gas Corporation Limited (ONGC), India” used by the assessee company
in its resolution of Board of Directors meeting dated 3-4-2006 makes it
amply clear that the project office was opened for coordination and execution
of the impugned project. In the absence of any restriction put by the assessee
in the application moved by it to the RBI, in the resolutions passed by the
assessee company for the opening of the project office at Mumbai and the
permission given by RBI, it cannot be said that Mumbai project office was not a
fixed place of business of the assessee in India to carry out wholly or partly
the impugned contract in India within the meaning of Article 5.1 of DTAA.
These documents make it clear that all the activities to be carried out in
respect of impugned contract will be routed through the project office only.’

 

All these gave a prima
facie impression that the PO was opened for coordination and execution of
the entire project and was thus involved in the core business activity of SHIL
in India.

 

However, the Supreme Court
delved deeper and looked at various other factors which the ITAT had ignored or
dismissed. In paragraphs 27 and 28, the Court, relying on the second paragraph
of the Board Resolution which clarified that the PO was established for
coordinating and executing delivery of certain documents, and not for the
entire project, the fact that the accounts of the PO showed no expenditure
incurred in relation to execution of the contract and that the only two people
employed in the PO were not qualified to carry out any core activity of SHIL,
concluded that no fixed place PE has been set up within the meaning of Article
5(1) read with Article 5(4)(e) of the India-Korea DTAA.

 

The
above indicates that the determination of the existence of a fixed place PE of
a foreign enterprise in India requires a deep factual and functional analysis
and the same cannot be determined on mere prima facie satisfaction.

 

Even in the case of Union
of India vs. U.A.E. Exchange Centre [2020] 116 taxmann.com 379 (SC)
dealing with the question relating to a Liaison Office being considered as a
fixed place PE in India, the Court relied on the approval letter given by the
RBI. In paragraph 9 of the judgment. the Supreme Court mentioned that ‘keeping
in mind the limited permission and the onerous stipulations specified by the
RBI, it could be safely concluded, as opined by the High Court, that the
activities in question of the liaison office(s) of the respondent in India are
circumscribed by the permission given by the RBI and are in the nature of
preparatory or auxiliary character. That finding reached by the High Court is
unexceptionable.’

 

In Hitachi High
Technologies Singapore Pte Ltd. vs. DCIT [2020] 113 taxmann.com 327
(Delhi-Trib.) the ITAT held that whether the assessee violated the
conditions of RBI or FEMA is not relevant in determining the LO as a PE under
the I.T. Act.

 

It appears
that there is an increasing reliance by the ITAT and courts, inter alia, on the application and related documents
and the approval of the RBI in considering whether an LO / PO / BO can
constitute a fixed place PE in India.

 

INITIAL ONUS REGARDING EXISTENCE OF A FIXED PLACE PE IN
INDIA


An important question
arises as to whether the onus is on the assessee or the tax authorities to
first show that a PO / BO is a fixed place PE in India.

 

The ITAT in the SHIL
case (Supra) held that the initial onus was on the assessee and not the
Revenue. However, the Supreme Court in the SHIL case reiterated the fact
that the initial onus lies on the Indian Revenue, and not the assessee, to
prove that there is a PE of the foreign enterprise in India before moving
further to determine the Indian tax liability of that enterprise. While
reversing the finding of the ITAT, the Supreme Court stated that ‘Equally
the finding that the onus is on the Assessee and not on the Tax Authorities to
first show that the project office at Mumbai is a permanent establishment is
again in the teeth of our judgment in E-Funds IT Solution Inc. (Supra).’

 

The Supreme Court in E-Funds
IT Solution Inc. (Supra) stated that the burden of proving the fact
that a foreign assessee has a PE in India and must, therefore, suffer tax from
the business generated from such PE, is initially on the Revenue. The
Court observed as follows:

 

‘16. The Income-tax Act,
in particular Section 90 thereof, does not speak of the concept of a PE. This
is a creation only of the DTAA. By virtue of Article 7(1) of the DTAA, the
business income of companies which are incorporated in the US will be taxable
only in the US, unless it is found that they were PEs in India, in which event
their business income, to the extent to which it is attributable to such PEs,
would be taxable in India. Article 5 of the DTAA set out hereinabove provides
for three distinct types of PEs with which we are concerned in the present
case: fixed place of business PE under Articles 5(1) and 5(2)(a) to 5(2)(k);
service PE under Article 5(2)(l) and agency PE under Article 5(4). Specific and
detailed criteria are set out in the aforesaid provisions in order to fulfil
the conditions of these PEs existing in India. The burden of proving the
fact that a foreign assessee has a PE in India and must, therefore, suffer tax
from the business generated from such PE is initially on the Revenue. With
these prefatory remarks, let us analyse whether the respondents can be brought
within any of the sub-clauses of Article 5.’

 

In view of above referred
two Supreme Court decisions, it can be said that the initial onus is on the
Revenue and not on the assessee.

 

PREPARATORY OR AUXILIARY ACTIVITIES TEST


As mentioned above,
Article 5(4) of the OECD MC provides exclusionary clauses in respect of a fixed
place PE provided the activities of a PE, or in case of a combination of
activities the overall activities, are of a preparatory or auxiliary
character. In this connection, the readers may refer to extracts of the
OECD Commentary in this regard discussed in paragraph 4 of the article
published in the BCAJ of August, 2020 in respect of Taxability of the
Liaison Office of a Foreign Enterprise in India.

 

Further, in the context of
activities of an ‘auxiliary’ character, in National Petroleum
Construction Company vs. DIT (IT) (Supra) the Delhi High Court in paragraph
28 explained as follows:

 

‘28. The Black’s Law Dictionary defines the word “auxiliary”
to mean as “aiding or supporting, subsidiary”. The word “auxiliary”
owes its origin to the Latin word “auxiliarius” (from auxilium meaning help).
The Oxford Dictionary defines the word auxiliary to mean “providing
supplementary or additional help and support”. In the context of Article
5(3)(e) of the DTAA, the expression would necessarily mean carrying on
activities, other than the main business functions, that aid and support the
Assessee. In the context of the contracts in question, where the main
business is fabrication and installation of platforms, acting as a
communication channel would clearly qualify as an activity of auxiliary
character – an activity which aids and supports the Assessee in carrying on its
main business.’

 

BEPS Report on Action 7 – Preventing
the Artificial Avoidance of Permanent Establishment Status


When the exceptions to the
definition of PE that are found in Article 5(4) of the OECD Model Tax
Convention were first introduced, the activities covered by these exceptions
were generally considered to be of a preparatory or auxiliary nature.

 

Since the introduction of
these exceptions, however, there have been dramatic changes in the way that
business is conducted. Many such challenges of a digitalised economy are
outlined in detail in the Report on Action 1, Addressing the Tax Challenges
of the Digital Economy. Depending on the circumstances, activities
previously considered to be merely preparatory or auxiliary in nature may nowadays
correspond to core business activities. In order to ensure that profits derived
from core activities performed in a country can be taxed in that country,
Article 5(4) is modified to ensure that each of the exceptions included therein
is restricted to activities that are otherwise of a ‘preparatory or auxiliary’
character.

 

BEPS concerns related to
Article 5(4) also arose from what is typically referred to as the
‘fragmentation of activities’. Given the ease with which multinational
enterprises may alter their structures to obtain tax advantages, it was
important to clarify that it is not possible to avoid PE status by fragmenting
a cohesive operating business into several small operations in order to argue
that each part is merely engaged in preparatory or auxiliary activities that
benefit from the exceptions of Article 5(4).

 

Article 13 of
Multilateral Instrument (MLI) – Artificial avoidance of Permanent Establishment
status through the Specific Activity Exemptions


MLI has become effective
in India from 1st April, 2020 and it will affect many Indian DTAAs
post MLI because, wherever applicable, MLI will impact the covered tax
agreements. Article 13 of MLI deals with the artificial avoidance of PE through
specific activity exemptions, i.e., activities which are preparatory or
auxiliary in nature, and provides two options, i.e. ‘Option A’ and ‘Option B’.

 

India
has opted for ‘Option A’, which continues with the existing list of exempted
activities from (a) to (e) in Article 5(4), but has added one more sub-clause
(f) which states that the maintenance of a fixed place of business solely for
any combination of activities mentioned in sub-paragraphs (a) to (e) is covered
in the exempt activities, provided all the activities mentioned in sub-clauses
(a) to (e) or a combination of these activities must be preparatory or
auxiliary in nature. Therefore, as per modified Article 5(4), in order to be
exempt from fixed place PE, each activity on a standalone basis as well as a
combination of activities should qualify as preparatory or auxiliary activity
test.

 

INDIAN JUDICIAL PRECEDENTS


On the issue of whether a
PO / BO constitutes a fixed place PE in India, there are mixed judicial
precedents, primarily based on the facts of each case. In addition to various Supreme
Court cases mentioned and discussed above, there are many other judicial
precedents in this regard.

 

BO Cases


In a few cases, based on
the peculiar facts of each case, the Tribunals and courts have held that a BO
does not constitute a fixed place PE in India. In this regard, useful reference
can be made to the following case: Whirlpool India Holdings Ltd. vs. DDIT
IT [2011] 10 taxmann.com 31 (Delhi).

 

However, in the following
case it has been held that a BO constitutes a fixed place PE in India: Hitachi
High Technologies Singapore Pte Ltd. vs. DCIT [2020] 113 taxmann.com 327
(Delhi-Trib.).

 

In the case of Wellinx
Inc. vs. ADIT IT [2013] 35 taxmann.com 420 (Hyderabad-Trib.), where it
was contended by the assessee that the income of the BO is not taxable in
India, the ITAT held that services performed by a branch office are on account
of outsourcing of commercial activities by its head office, and income arising
out of such services rendered would be taxable under article 7(3) of the
India-USA DTAA.

 

PO Cases


Similarly, in the case of
POs, based on the factual matrix the following cases have been decided in
favour of assessees as well as the Revenue:

 

In favour of the
assessees:

Sumitomo
Corporation vs. DCIT [2014] 43 taxmann.com 2 (Delhi-Trib.);

National
Petroleum Construction Company vs. DIT (IT) [2016] 66 taxmann.com 16 (Delhi);

HITT Holland
Institute of Traffic Technology B.V. vs. DDIT (IT) [2017] 78 taxmann.com 101
(Kolkata-Trib.).

 

In favour of the Revenue:

Voith Paper
GmbH vs. DDIT [2020] 116 taxmann.com 127 (Delhi-Trib.);

Orpak Systems
Ltd. vs. ADIT (IT) [2017] 85 taxmann.com 235 (Mumbai-Trib.).

 

KEY POINTS OF JUDGMENT OF THE SUPREME COURT IN SHIL


The Supreme Court in this
case has clearly established that facts are important in deciding about the
existence of a fixed place PE in India, while principles of interpretations
more or less remain constant. It is imperative that one must minutely look into
the facts and actual activities to decide existence of a fixed place PE in case
of a PO / BO.

 

The key points of this
judgment can be summarised as under:

  •  In deciding whether a
    project office constitutes a fixed place PE, the entire set of documentation
    including the relevant Board resolutions, application to RBI and approval of
    the RBI, should be read minutely and understood in their entirety.
  •  The detailed factual and
    functional analysis of the actual activities and role of PO / BO in India is
    crucial in determining a PE. It would be necessary to determine whether the PO
    / BO carries on business / core business or the main business of the foreign
    enterprise in India.
  • The nature of expenses
    debited in the accounts of the PO / BO throws light and cannot be brushed aside
    on the ground that the accounts are entirely in the hands of the assessee. They
    do have relevance in determining the issue in totality.
  •  It reiterates that the
    initial onus is on the Revenue to prove the existence of a fixed placed PE in
    India.

 

Even post-MLI, the Supreme
Court ruling in SHIL’s case should help in interpretation on a fixed place PE
issue.

 

CONCLUSION


The issue of existence of
a fixed place PE in case of a PO / BO has been a subject matter of debate
before the ITAT and courts for long. The ruling of the Supreme Court in SHIL’s case
endorses the settled principles on fixed place PE in the context of a PO of a
turnkey project. The Supreme Court reiterated that a fixed place PE emerges
only when ‘core business’ activities are carried on in India. The Court brings
forth more clarity on the existence of a fixed place PE or otherwise in case of
a PO / BO and should instil confidence in multinationals to do business in
India and bring much needed certainty in this regard.  

 

Article 11(3)(c) of the India-Mauritius DTAA – Interest income earned from India by a Mauritian company engaged in the banking business is exempt under Article 11(3)(c) of the India-Mauritius DTAA; in terms of Circular No 789, TRC issued by Mauritius tax authority is valid proof of residence as well as beneficial ownership

18. [2020] 117 taxmann.com 750 (Mumbai-Trib.) DCIT vs. HSBC Bank
(Mauritius) Ltd. ITA No: 1320/ Mum/2019 A.Y.: 2015-16 Date of order: 8th
July, 2020

 

Article 11(3)(c) of the India-Mauritius DTAA
– Interest income earned from India by a Mauritian company engaged in the
banking business is exempt under Article 11(3)(c) of the India-Mauritius DTAA;
in terms of Circular No 789, TRC issued by Mauritius tax authority is valid
proof of residence as well as beneficial ownership

 

FACTS

The assessee, a resident of Mauritius, carried on banking business as a
licensed bank in Mauritius. The assessee was also registered as an FII with
SEBI. Article 11(3)(c) of the India-Mauritius DTAA exempts interest income from
tax in India if: (i) the interest is derived and beneficially owned by the
assessee; and (ii) the assessee is a bank carrying on bona fide banking
business in Mauritius. The assessee had received interest income from
securities and loans to Indian tax residents. According to the assessee, being
a tax resident of Mauritius, it qualified for exemption under Article 11(3)(c)
of the DTAA and hence, interest earned by it was not chargeable to tax in
India. To support its beneficial ownership and residential status, the assessee
placed reliance on the Certificate of Residency (TRC) issued by Mauritius tax
authorities and also Circular No 7896.

 

The A.O., however, did not grant exemption on the ground that the banking
activities carried out by the assessee in Mauritius were minuscule and were
only for namesake purpose. Further, Circular No. 789 dealt with taxation of
dividends and capital gains under the India-Mauritius DTAA and did not apply in
case of interest. Accordingly, the A.O. charged tax on interest @ 5% u/s 115AD
of the Act, read with section 194LD.

 

On appeal, relying upon the orders of the Tribunal in favour of the
assessee in earlier years7, the CIT(A) concluded in favour of the
assessee.

 

Being aggrieved, the Tax Department filed an appeal before the Tribunal
where it contended that the earlier years’ orders did not deal with the Tax
Department’s objection that the assessee was not a beneficial owner of the
interest and was a conduit company.

 

HELD

  • The following observations from the orders of earlier years8
    in the case of the assessee are relevant:

  • As per Circular 789, wherever a Certificate of Residency is issued by
    the Mauritius tax authority, such Certificate will constitute sufficient
    evidence for accepting residential status as well as beneficial ownership for
    application of the India-Mauritius DTAA.
  •  Circular 789 equally applies to taxability of interest in terms of
    Article 11(3)(c) of the DTAA.
  • Thus, having regard to the Tax Residency Certificate issued by the
    Mauritius tax authority, the assessee is ‘beneficial owner’ of interest income.
  • Accordingly, interest earned by the assessee is exempt in terms of
    Article 11(3)(c) of the India-Mauritius treaty.

 

Note: The decision is in the context of the India-Mauritius DTAA prior
to its amendment with effect from 1st April, 2017. Post-amendment,
Article 11(3A) reads as follows: 

‘Interest arising in a Contracting State shall be exempt from tax in
that State provided it is derived and beneficially owned by any bank resident
of the other Contracting State carrying on bona fide
banking business. However, this exemption shall apply only if such interest
arises from debt-claims existing on or before 31st March, 2017.’

 

_________________________________________________________________________________________________

6  Circular No 789 provides that TRC will
constitute sufficient evidence in respect of tax residence as well as
beneficial ownership for application of DTAA

7  A.Y. 2009-10 (ITA No. 1086/Mum/2018), A.Y.
2010-11 (ITA No. 1087/Mum/2018) and A.Y. 2011-12 (ITA No. 1708/Mum/2016)

8  A.Y. 2014-15 (ITA No. 1319/Mum/2019)

 





Article12 of the India-Ireland DTAA – Consideration received by the assessee for supply / distribution of its copyrighted software products was not chargeable to tax in India as royalty under Article 12 of India-Ireland DTAA

17. [2020] 117 taxmann.com 983 (Delhi – Trib.) Mentor Graphics Ireland
Ltd. vs. ACIT ITA No. 3966/Del/2017 A.Y.: 2014-15 Date of order: 9th
July, 2020

 

Article12 of the India-Ireland DTAA – Consideration received by the
assessee for supply / distribution of its copyrighted software products was not
chargeable to tax in India as royalty under Article 12 of India-Ireland DTAA

 

FACTS

The assessee, an Ireland resident company, received consideration for
sale of software and provision of support services. According to the assessee,
it had received consideration for sale of copyrighted product and not for sale
of copyright and hence, in terms of Article 12 of the India-Ireland DTAA, such
consideration was not chargeable to tax in India. However, it offered income
from support services to tax.

 

Relying upon the Karnataka High Court decisions in the case of Samsung
Electronics Company Ltd2 and Synopsis International
Old Ltd.3, the A.O. and the DRP held that the consideration
received by the assessee for supply / distribution of copyrighted software
products was for grant of ‘right to use’ of the copyright in the software and
hence it qualified as ‘royalty’.

 

Being aggrieved, the assessee appealed before the Tribunal.

 

HELD

  •  In
    earlier years, on an identical issue in the assessee’s case4,
    the Tribunal had ruled in favour of the assessee.

 

  •  Further,
    in DIT vs. Infrasoft Ltd.5 , the jurisdictional
    High Court had held that receipt from sale of software by the assessee in
    that case was not royalty under Article 12 of the India-Ireland DTAA.

 

  •  Accordingly,
    income from sale of software was not in the nature of ‘royalty’ under
    Article 12 of the India-Ireland DTAA and was not taxable in India.

 


———————————————————————-

2   
345 ITR 494 (Kar)

3  212 Taxman 454 (Kar)

4  ITA No. 6693/Del/2016 relating to Assessment
Year 2013-14

5  [2013] 220 Taxman 273 (Del.)

Article 12 of India-Singapore DTAA; Section 9 of the Act – Provision for IT infrastructure management and mailbox / website hosting services were not in nature of royalty, whether under the Act or Article 12 of DTAA; fees for management services (such as sales support, financial advisory and human resources assistance) and fees for referral services did not satisfy the requirement of ‘make available’ under Article 12 of DTAA

16. [2020] 118
taxmann.com 2 (Mumbai-Trib.) Edenred (P) Ltd.
vs. DDIT ITA Nos.
1718/Mum/2014; 254/Mum/2015 A.Ys.: 2010-11 to
2012-13 Date of order: 20th
July, 2020

 

Article 12 of
India-Singapore DTAA; Section 9 of the Act – Provision for IT infrastructure
management and mailbox / website hosting services were not in nature of
royalty, whether under the Act or Article 12 of DTAA; fees for management
services (such as sales support, financial advisory and human resources
assistance) and fees for referral services did not satisfy the requirement of
‘make available’ under Article 12 of DTAA

 

FACTS

The assessee was a
Singapore tax resident company. It entered into certain agreements with its
group companies in India for rendering the following services:

Infrastructure Data Centre (IDC) services

Management services

Referral services

  •  Administration and supervision of central infrastructure
  •  Mailbox hosting services
  •  Website hosting services

  •  Sales support activities
  •  Legal services
  •  Financial advisory services
  •  Human resource assistance

  •  Support services1 to serve clients in India that
    were referred by assessee

 

 

Relying upon
Article 12 of the India-Singapore DTAA, the assessee contended that income
received from the aforesaid agreements was not taxable in India. The A.O. as
well as the DRP rejected this contention of the assessee. The following is a
summary of the conclusions of the A.O. and of the DRP:

 

Services

Draft A.O. order

Draft DRP direction

Final assessment order

IDC charges

Taxable as royalty under Act and DTAA

Management services

Taxable as FTS under Act and DTAA

Referral fees

Taxable as royalty under Act and DTAA

Taxable as royalty and FTS under Act and DTAA

 

Being aggrieved,
the assessee appealed to the Tribunal.

 

HELD

IDC Charges

  •  Facts pertaining
    to IDC agreement are as follows:
  •  The assessee
    had an infrastructure data centre and not an information centre in Singapore.
  •  The Indian
    group companies did not access or use the CPU of the assessee; the IDC
    agreement did not permit such use / access to group companies of the assessee
    nor had the assessee provided any system which enabled group companies such use
    / access.
  •  The assessee
    did not maintain any centralised data; IDC did not have any capability in
    respect of information analytics, data management.
  •  The assessee
    provided IDC service using its own hardware / security devices / personnel;
    Indian group companies received standard IDC services without use of any
    software; the assessee had used bandwidth and networking infrastructure for
    rendering IDC services; Indian companies only received output generated by the
    assessee using bandwidth and network but not the use of underlying
    infrastructure.
  •  Consideration
    paid by group companies was for IDC services and not for any specific
    programme. Besides, the assessee had not developed any embedded / secret
    software which was used by group companies.
  •  Having regard to
    the case law relied upon by the assessee and the Tax Department, since the
    assessee had merely provided IDC services, such as administration and
    supervision of central infrastructure, mailbox hosting services and website
    hosting services, income from IDC services was not in the nature of ‘royalty’,
    whether under the Act or under the DTAA.

 

Management
Services

  •  The assessee had
    provided management services to support Indian group companies in carrying on
    their business efficiently and running the business in line with the business
    model, policies and best practices uniformly followed by companies of the
    assessee group.
  •  Services did not
    ‘make available’ any technical knowledge, skill, know-how or processes to
    Indian group companies.
  •  Hence,
    consideration received by the assessee for management services was not in the
    nature of ‘fees for technical services’ under the DTAA.

 

Referral Fees

  •  The fees
    received by the assessee in consideration for referral services did not ‘make
    available’ any technical knowledge, skill, know-how or processes to Indian
    group companies because there was no transmission of the technical knowledge,
    experience, skill, etc. by the assessee to the group company or its clients.
  •  Hence, the
    consideration received by the assessee for referral services was not in the
    nature of ‘fees for technical services’, whether under the Act or under the
    DTAA.

 __________________________________

1   
Decision does not describe nature of services in detail

Articles 5 and 12 of India-Singapore DTAA – Seconded employee working under control and supervision of Indian company did not constitute service PE – Service PE under Article 5(6) and taxability as FTS under Article 12 cannot co-exist – Services provided did not fulfil ‘make available’ requirement under Article 12 of India-Singapore DTAA

15.
TS–336–ITAT–2020 (Del.) DDIT vs. Yum
Restaurants Asia Pte Ltd. ITA No.
6018/Del/2012 A.Y.: 2008-09 Date of order: 16th
July, 2020

 

Articles 5 and 12 of India-Singapore DTAA – Seconded employee working
under control and supervision of Indian company did not constitute service PE –
Service PE under Article 5(6) and taxability as FTS under Article 12 cannot
co-exist – Services provided did not fulfil ‘make available’ requirement under
Article 12 of India-Singapore DTAA

 

FACTS

The assessee, a
resident of Singapore, was engaged in franchising of certain restaurant brands
in the Asia Pacific region (including India). It entered into a technology
license agreement with its Indian AE (I Co) for operation of restaurant
outlets. I Co in turn appointed a number of franchisees for operating restaurants
in India under brand names KFC and Pizza Hut.

 

Mr. V was an
employee of the assessee who had been deputed to India to work under the
control and supervision of I Co. Mr. V was working solely for I Co. However,
the assessee continued to pay remuneration to Mr. V. I Co reimbursed the amount
equivalent to the remuneration of Mr. V (after deducting tax) to the assessee.

 

The A.O. concluded
that Mr. V constituted service PE of the assessee in India. Hence, the amount
reimbursed by I Co to the assessee was in the nature of FTS and taxable in
India. The A.O. further concluded that the assessee had agency PE in India.

 

In the appeal,
after referring to relevant clauses of the Deputation Agreement and the
evidence furnished by the assessee, the CIT(A) held that Mr. V was not an
employee of the assessee. Hence, he did not have any right / lien over his
employment. Consequently, there was no service PE of the assessee.

 

HELD

Service PE

  •  The deputation
    agreement between the assessee and I Co mentioned that the assessee was not
    responsible for, or assumed the risk of, the work of assignees; assignees would
    work under the control, direction and supervision of I Co; and the assessee
    released assignees from all rights and obligations, including lien on employment,
    if any.
  •  CIT(A) had given
    the following findings:
  •  An employee of I
    Co leading the business development team had resigned. Mr. V was deputed to
    India as his substitute. Upon expiry of the deputation period, Mr. V was
    inducted as an employee of I Co.
  •  During the
    deputation period, I Co had reimbursed the remuneration paid by the assessee on
    cost-to-cost basis. I Co had also deducted the applicable tax. Mr. V had paid
    tax in India on his remuneration.
  •  All the facts and
    circumstances indicate that Mr. V was an employee of I Co and the assessee had
    merely acted as a conduit for payment of remuneration to Mr. V in Singapore
    since his family was in Singapore.
  •  Other evidence,
    such as attending board meetings of I Co, signing financial statements of I Co
    as its director, etc., also showed that Mr. V was involved in the day-to-day
    management of I Co.
  •  Revenue had also
    not controverted the findings of the CIT(A). Thus, the deputation of Mr. V did
    not constitute service PE of the assessee in India.
  •  Even if a service
    PE of the assessee in India was constituted, no income can be attributed to the
    service PE because for computing profit attributable to PE, expenses incurred
    (in this case, remuneration paid to Mr. V) should be deducted. Having regard to
    reimbursement of remuneration on cost-to-cost basis, the income of the PE would
    be ‘Nil’.

 

FTS
taxability

  •  Having regard to
    provisions of Article 5(6) read with Article 12 of the India-Singapore DTAA,
    service PE and taxability as FTS cannot co-exist.
  •  Even otherwise,
    services did not fulfil the ‘make available’ condition under Article 12 of the
    India-Singapore DTAA.
  •  Mr. V worked as
    an employee of I Co and paid taxes on his remuneration. Taxing the same again
    as FTS would result in double taxation of the same income.

 

Agency PE

  •  The A.O. did not
    establish under which limb of definition of agency PE in Article 5(8) of
    India-Singapore DTAA the agency PE of the assessee was constituted in India.

 

Note: The Tribunal distinguished the Delhi High
Court decision in the case of Centrica India Offshore Pvt. Ltd. [2014] 364 ITR 336 as not applicable to the facts under
consideration. The exact basis of this conclusion is not clear. 

Articles 11, 12 of India-Netherlands DTAA; section 9 of the Act – Guarantee charges paid by Indian company to non-resident AE were not: ‘interest’ under Article 11 as there was no debt and income was not ‘from debt-claim’; FTS under Article 12(5) as although provision of guarantee was a financial service, it was not consultancy service contemplated in Article 12(5

14. [2020] 117
taxmann.com 343 (Delhi-Trib.) Lease Plan India
(P) Ltd. vs. DCIT ITA Nos. 6461 &
6462/Del/2015 A.Ys.: 2009-10
& 2010-11 Date of order: 15th June, 2020

 

Articles 11, 12 of
India-Netherlands DTAA; section 9 of the Act – Guarantee charges paid by Indian
company to non-resident AE were not: ‘interest’ under Article 11 as there was
no debt and income was not ‘from debt-claim’; FTS under Article 12(5) as
although provision of guarantee was a financial service, it was not consultancy
service contemplated in Article 12(5)

 

FACTS

The assessee was
engaged in the business of leasing motor vehicles, financial services and fleet
management. It intended to borrow funds for its business from banks in India.
It had an AE in Netherlands (Dutch Co) with which it entered into an agreement
for provision of guarantee to banks in India. On the strength of such
guarantee, banks lent funds to the assessee. As per the agreement, the assessee
paid guarantee charges to Dutch Co.

 

Before the A.O.,
the assessee contended that the payment being reimbursement of actual expenses,
it was not chargeable to tax in India and hence the tax was not deductible. The
A.O. concluded that since payment was made to a non-resident for rendering
services, it was covered u/s 9(1)(vii) as FTS. As the assessee had not deducted
tax, the A.O. invoked section 40(a)(i) and disallowed the entire amount.

 

In appeal, the
CIT(A) confirmed the order.

 

HELD

Whether
guarantee charges interest?

  •  It was undisputed
    that guarantee charges paid by the assessee to Dutch Co were chargeable to tax
    in India. However, it was to be examined whether it was in the nature of
    ‘interest’ in terms of Article 11 of the India-Netherlands DTAA.
  •  2Any
    income can be characterised as ‘interest’ if it is ‘from debt-claim’.
    Thus, two criteria are required to be satisfied. First, capital in the form of
    debt (which can be claimed) should have been provided. This predicates the
    existence of a debtor-creditor (or lender-borrower) relationship. Second,
    income should be from such debt.
  •  In this case,
    Dutch Co had promised the lenders to pay the amount of loan if the assessee
    failed to do so. The assessee paid guarantee charges in consideration for that.
    As Dutch Co had not provided any capital to the assessee, there was neither
    lender-borrower relationship, nor did Dutch Co earn any income from the debt
    claim.
  •  Accordingly,
    guarantee charges paid by the assessee to Dutch Co were not in the nature of
    ‘interest’ in terms of Article 11 of the India-Netherlands DTAA.
  •  This view is also
    supported by the decision in Container Corporation vs. Commissioner of
    Internal Revenue of US Tax Court Report [134 T.C. 122 (U.S.T.C. 2010) 134 T.C.
    5]     wherein the Court held that guarantee is more analogous to service
    and hence guarantee fee cannot be considered as interest.

 

2   Tribunal
noted that though another Bench had set aside orders for A.Ys. 2007-08 to
2009-10 for considering additional evidence submitted by the assessee, that
option was not open to it because for the years under consideration, CIT(A) had
decided after considering all the documents


Whether
guarantee charges FTS?

  •  Article 12(5) of
    the India-Netherlands DTAA defines FTS as payment of any kind to any person in
    consideration for the rendering of any technical or consultancy services
    (including through the provision of services of technical or other personnel).
    Article 12(5) further stipulates that such services should either be ancillary
    to grant of license for intellectual property rights (IPRs) or should make
    available technical knowledge, etc.
  •  The provision of
    guarantee was a service. Indeed, it was a financial service. However, there was
    no way it could be termed ‘consultancy service’. Even otherwise, Dutch Co had
    neither provided services which were ancillary to grant of license for IPRs nor
    had it ‘made available’ technical knowledge, etc. Hence, payment for such
    services was not FTS.
  •     Since Dutch Co did not have any PE in India,
    in terms of Article 7 of the India-Netherlands DTAA, payments were not
    chargeable to tax in India.
 

Sections 9, 195, 201(1A) of the Act – On facts, since non-resident supplier had ‘business connection’ in India, the resident payer was required to withhold tax u/s 195

13. [2020] 117 taxmann.com
322 (Indore-Trib.) Sanghvi Foods (P.)
Ltd. vs. ITO ITA Nos. 743 &
744/Ind/2018 A.Ys.: 2015-16
& 2016-17 Date of order: 3rd
June, 2020

 

Sections 9, 195,
201(1A) of the Act – On facts, since non-resident supplier had ‘business
connection’ in India, the resident payer was required to withhold tax u/s 195

 

FACTS

 

The assessee was an
Indian company engaged in the business of manufacturing plants. It had
purchased spare parts for its machinery from a company in Switzerland (Swiss
Co) for which it made payments during F.Ys. 2014-15 and 2015-16. The assessee
did not withhold tax from the payments on the basis that the purchase was
directly made from a non-resident and that, too, for purchase of capital goods.

 

The Swiss Co had a
wholly-owned subsidiary in India (I Co)
which was primarily engaged in the manufacture and trading of food processing
machinery, spares and components, and also providing repair, maintenance and
engineering services, etc. In addition, it provided marketing support services
to its group companies, including Swiss Co.

 

In the course of
his examination, the A.O. found the following:

  •  While the
    assessee had contended that it was not aware whether Swiss Co had any
    representative in India, it had extensive email communication with I Co. Such
    communication showed:
  •  The assessee had
    placed an order on Swiss Co on the basis of the quotation received from I Co;
  •  I Co was
    authorised to negotiate, issue quotation, revise quotation and also confirm the
    order;
  •  The assessee
    confirmed the order on Swiss Co through I Co;
  •  While I Co had an
    active role in concluding the contract, Swiss Co had raised only the final
    invoice.

 

The A.O. had issued
notice u/s 133(6) of the Act to I Co. In response, I Co provided information
and communication between it and the assessee which supported the findings of
the A.O.

 

Accordingly, the
A.O. concluded that Swiss Co had ‘business connection’ in India through I Co.
Consequently, the profits arising from the sales to the assessee were subject
to withholding of tax u/s 195 of the Act. Therefore, the A.O. determined 10% of
the amount remitted as net profit and calculated tax @ 41.2% on a gross basis
in respect of both the payments.

 

In his order, the
CIT(A) observed that the functions performed by I Co proved that it was not a
mere business-sourcing agent but was concluding contracts on behalf of Swiss
Co. This resulted in a business connection in India. He further observed that
irrespective of whether the payment was for the purchase of capital goods, the
payer was obliged to withhold tax once the business connection was established.

 

HELD

The investigation
of the A.O. and the findings of the CIT(A) show that the role of I Co could not
be ignored at any stage. I Co was involved since the beginning when the assessee
was looking for suppliers of spares. The reply of I Co u/s 133(6) of the Act
further supported this finding.

 

The activities
performed by I Co for Swiss Co were squarely covered within clauses (a),
(b) and (c) of the definition of ‘business connection’ in Explanation
2 to section 9(1) of the Act.

 

Based on the facts
and findings on record, Swiss Co had a ‘business connection’ in India through I
Co.

 

Accordingly, the transaction was subject to section 9(1) and the income
of Swiss Co was deemed to accrue or arise in India. Consequently, in terms of
section 195, the payer was required to withhold tax from the payment 1.

1   It
appears that both the CIT(A) and the Tribunal have discussed only the issue of
‘business connection’ and have not made any observations on the quantum of
profit determined by the A.O.

Section 92A(2)(c) of the Act – Loan given by each enterprise should be considered independently and an enterprise can be deemed to be an AE only if loan given by it exceeds 51% of book value of total assets – Business advances cannot be construed as loan to determine AE

10. Soveresign Safeship Management Pvt. Ltd. vs.
ITO ITA No. 2070/Mum/2016 A.Y.: 2011-12 Date of order: 5th March, 2020

 

Section 92A(2)(c) of the Act – Loan given
by each enterprise should be considered independently and an enterprise can be
deemed to be an AE only if loan given by it exceeds 51% of book value of total
assets – Business advances cannot be construed as loan to determine AE

 

FACTS

The assessee was
engaged in providing ship management and consultancy services. In Form 3CEB it
had considered two group companies as AEs (Associated Enterprises) and reported
international transactions by way of advances received in the course of
business from these entities. The assessee was providing ship management and
consultancy services to one of the entities from which it had received business
advances.

 

Before the TPO, the
assessee contended that though the said entities were not AEs, it had
inadvertently disclosed them in Form 3CEB as AEs. The TPO deemed the two group
entities as AEs u/s 92A(2)(m) on the basis that there was a relationship of
mutual interest between the taxpayer and the two group entities.

 

The DRP observed
that business advances received were separately reported and included within
‘sundry creditors’. The assessee had not rendered any service to the entities
for which it had received advances. Hence, advances received by the assessee
from the said entities were to be treated as loans taken from the AEs. The DRP
further observed that since the aggregate loans taken from the two entities
exceeded 51% of the book value of the total assets of the assessee, u/s
92A(2)(c) of the Act they were AEs of the assessee.

 

Being aggrieved,
the assessee appealed before the Tribunal.

 

HELD

(A) In terms of section 92A(2)(c),
an enterprise will be deemed to be an AE if ‘loan advanced by one enterprise
to the other enterprise constitutes not less than fifty-one per cent of the
book value of the total assets of the other enterprise’. As the language of
the section is unambiguous, only lending enterprises which had advanced loan
exceeding 51% of the book value of the total assets could be deemed as AEs.

 

(B) Advances received by the assessee from one of
the entities were towards ship management and consultancy services rendered by
it to the said entity. Business advances cannot be construed as loans.
Accordingly, such advances should be excluded while determining AE
relationship.

 

(C)       The tax authority could not rely merely on
self-disclosure of AEs by the assessee in Form 3CEB when the facts in the
financial statements of the assessee were clear and the language of the statute
was unambiguous.

 

 

 

 

Article 12 of India-Korea DTAA, section 9(1)(vii) of the Act – Fees paid to foreign company for providing shortlist of candidates as per job description, were not in the nature of FTS u/s 9(1)(vii) of the Act

9. TS-141-TAT-2020 (Ind) D&H Secheron Electrodes Pvt. Ltd. vs.
ITO ITA No. 104/Ind/2018 A.Y.: 2016-17 Date of order: 6th March, 2020

 

Article 12 of India-Korea DTAA, section
9(1)(vii) of the Act – Fees paid to foreign company for providing shortlist of
candidates as per job description, were not in the nature of FTS u/s 9(1)(vii)
of the Act

 

FACTS

The assessee was
engaged in the business of manufacture of welding electrodes and was looking
for engineers for development of certain products. Hence, it entered into an
agreement with a Korean company (‘Kor Co’) for providing a list of engineers
matching the job description provided by it. On the basis of the list provided,
the assessee interviewed the candidates and recruited them if found suitable.
For its service, the assessee made payments to Kor Co without withholding tax.

 

According to the A.O., since the said services were technical in nature,
the assessee was liable to withhold tax. Therefore, the A.O. treated the
assessee as ‘assessee in default’ and initiated proceedings u/s 201 and u/s
201(1A) of the Act. The CIT(A) upheld the view of the
A.O.

 

Being aggrieved,
the assessee filed an appeal before the Tribunal.

 

HELD

(1) In the contract between the
assessee and Kor Co, the assessee had not sought any technical expertise from
the latter.

(2) The process involved in the services provided
by Kor Co was as follows:

(a) Assessee provided detailed job description to
Kor Co;

(b) After matching the job description with the
profile of candidates available in its database, Kor Co shortlisted candidates
for the assessee and had merely provided the list of such candidates to the
assessee;

(c) Kor Co had guaranteed that if the appointed
candidate were to voluntarily leave the job within the first 90 days of
employment, Kor Co would provide suitable replacement at no cost to the
assessee.

(3) The assessee had evaluated the
shortlisted candidates on its own by interviewing them and taking tests. The
decision whether the relevant candidates were suitable as per its requirements
was solely that of the assessee and Kor Co had not provided any inputs for the
same.

(4) Having regard to the nature of
the services provided by Kor Co, the payments made by the assessee to Kor Co
were not in the nature of ‘fees for technical services’ as defined in
Explanation 2 to section 9(1)(vii). Accordingly, the assessee was not required
to withhold tax from such payments.

 

Note: Apparently, though the assessee had also
referred to Article 12 of the India-Korea DTAA, the Tribunal concluded only in
the context of section 9(1)(vii) of the Act.

Section 9(1)(vi) and section 194J of the Act – Payments made to telecom operators for providing toll-free number service were in nature of ‘royalty’ u/s 9(1)(vi) and, consequently, tax was required to be withheld

8. [2020] 116
taxmann.com 250 (Bang.)(Trib.) Vidal Health
Insurance TPA (P) Ltd. vs. JCIT ITA Nos. 736 &
1213 to 1215 (Bang.) of 2018 A.Ys.: 2011-12 to
2014-15 Date of order: 26th
February, 2020

 

Section 9(1)(vi)
and section 194J of the Act – Payments made to telecom operators for providing
toll-free number service were in nature of ‘royalty’ u/s 9(1)(vi) and,
consequently, tax was required to be withheld

 

FACTS

The assessee was
licensed by IRDA for providing TPA services to insurance companies. It engaged
telecom operators (‘telcos’) for allotting toll-free numbers and providing
toll-free telephone services to policy-holders of insurance companies such that
the charges for calls made by policy-holders to the toll-free number were borne
by the assessee and not the policy-holders. The assessee did not deduct tax
from the payments made to the telcos.

 

According to the
A.O., the payments were in the nature of royalty u/s 9(1)(vi) of the Act, read
with Explanation 6 thereto. Accordingly, he disallowed the payments u/s
40(a)(ia) of the Act.

 

The CIT(A) held
that since the payments were made by the assessee for voice / data services,
they were in the nature of royalty.

 

Being aggrieved,
the assessee appealed before the Tribunal. The assessee’s principal argument
was that section 194J deals with deduction of tax from payment of ‘royalty’. As
per Explanation (ba) in section 194J, the meaning of ‘royalty’ should be
construed as per Explanation 2 to section 9(1)(vi) of the Act. Explanation 6 to
section 9(1)(vi) of the Act defines ‘process’. Since section 194J has nowhere
referred to Explanation 6 to section 9(1)(vi) of the Act, it could not be
considered.

 

HELD

Royalty
characterisation

(i)   A toll-free number involves providing
dedicated private circuit lines to the assessee.

 

(ii) The consideration paid by the assessee was
towards provision of bandwidth / telecommunication services and further, for
‘the use of’ or ‘right to use equipment’. The assessee was provided assured
bandwidth through which it was guaranteed transmission of data and voice. Such
transmission involved ‘process’, thus satisfying the definition of ‘royalty’ in
Explanation 2 to section 9(1)(vi) of the Act.

 

Royalty definition
u/s 194J

(a) Explanation 6 to section 9(1)(vi) defines the
expression ‘process’, which is included in the definition of ‘royalty’ in
Explanation 2.

 

(b) Since Explanation 2 does not define ‘process’,
the definition of ‘process’ in Explanation 6 must be read into Explanation 2 to
analyse whether a particular service comprised ‘process’ and consequently
consideration paid for the same was ‘royalty’.

 

Article 7 of India-US DTAA – Explanation (a) to section 9(1)(v)(c) of the Act – Interest paid by an Indian branch of a foreign bank to its head office / overseas branches was not taxable under the Act – Explanation (a) to section 9(1)(v)(c) deeming such interest as income is prospective in nature

19. JP Morgan Chase Bank N.A. vs. DCIT
ITA No. 3747/Mum/2018 & 363/Mum/2019
A.Ys.: 2011-12 and 2012-13

Date of order: 30th December, 2019

Article 7 of India-US DTAA – Explanation (a) to section 9(1)(v)(c) of the Act – Interest paid by an Indian branch of a foreign bank to its head office / overseas branches was not taxable under the Act – Explanation (a) to section 9(1)(v)(c) deeming such interest as income is prospective in nature

FACTS

The assessee, an Indian branch (BO) of a US banking company, paid interest to its head office (HO) and sister branches abroad. The HO contended that the payment by the BO to the HO was payment to self and was covered under the principle of mutuality. Hence, interest received by it was not taxable in India. The AO accepted the contention of the assessee and completed the assessment on that basis.
Administrative CIT exercises power u/s 263 of the Act. According to the CIT, under the India-USA DTAA, interest is taxable in the source country. Since the assessee had its PE in India (i.e., the BO), interest was taxable in India. He further held that since the assessee had opted to be governed under beneficial provisions of the DTAA, the single entity approach under the Act gave way to the distinct and independent entity or separate entity approach under the DTAA. Hence, the BO and the HO were two separate entities. The CIT further referred to Explanation (a) to section 9(1)(v)(c) of the Act which was effective from 1st April, 2016 and mentioned that since the amendment was clarificatory in nature, it applied retrospectively. He also referred to the CBDT Circular No. 740 dated 17th April, 1996 mentioning that a branch of a foreign company in India is a separate entity for taxation under the Act. The CIT distinguished the Tribunal Special Bench decision in Sumitomo Mitsui Banking Corporation vs. DDIT [2012] 19 taxmann. com 364 (Mum.) on the ground that the Tribunal had no occasion to consider the reasoning mentioned by him in the context of the DTAA. The CIT concluded that interest received by the HO and other branches abroad was taxable in India.
Aggrieved, the assessee filed an appeal with the Tribunal.
HELD
The Special Bench of the Tribunal in the case of Sumitomo Mitsui Banking Corporation vs. DCIT1 held that since the interest paid by the BO to the HO is in the nature of payment made to self, it will be governed by the principle of mutuality. Hence, it was not taxable under the Act. Applying the same principle, interest received by the HO (and other branches) from the BO was not taxable in India.
Explanation (a) to section 9(1)(v)(c) of the Act, which deems that interest paid by the BO of a bank to its HO is taxable in India, applies prospectively from 1st April, 2016 and cannot be invoked to tax interest of any earlier financial year.

Article 12 of India-Singapore DTAA – Receipt from Indian group companies towards information technology and business support services did not qualify as royalty / FTS under India- Singapore DTAA

18. ACIT vs. M/s FCI Asia Pte. Ltd.
ITA Nos. 2588 & 2589/Del/2015
A.Ys.: 2009-10 and 2010-11

Date of order: 6th January, 2020

Article 12 of India-Singapore DTAA – Receipt from Indian group companies towards information technology and business support services did not qualify as royalty / FTS under India- Singapore DTAA

FACTS
The assessee, a Singapore company, was engaged in providing IT support services as well as business support services to its affiliates in India. The IT support services included services such as centralised data centre, disaster recovery management and backup storage. The business support services included common services towards purchasing, communications and international relationship matters, legal and insurance
support services.
The assessee contended that the services rendered by it were standardised IT-related services. Although the affiliates were provided access to IT infrastructure, they were not conferred with any use or right to use the equipment which remained under the control of the assessee. Thus, payment for such services did not amount to royalty under the Act as well as the India- Singapore DTAA. Besides, the IT support services as well as business support services did not enable the affiliates to apply technical knowledge independently or to perform such services independently without any recourse to the assessee. Hence, in the absence of a ‘make available’ clause under the India-Singapore DTAA being satisfied, such services did not qualify as Fees for Technical services under the India-Singapore DTAA.
However, the AO contended that in the course of rendering services, the assessee granted a right to its affiliates to access the data centre / storage capacity maintained by
it. Thus, payments made by the affiliates were towards the use of, or the right to use, industrial, commercial and scientific equipment. Hence, the payments were in the nature of royalty under the Act as well as under Article 12 of the India-Singapore DTAA.
Aggrieved, the assessee appealed before CIT(A) who ruled in his favour. The aggrieved AO preferred an appeal before the Tribunal.
HELD
The services rendered by the assessee in relation to the centralised data centre, WAN bandwidth management, disaster recovery management, backup and offsite storage management and security management merely involved provision of a ‘facility’ and not a right to use the equipment. Hence, the payment received for such services did not qualify as royalty.
Support services such as purchasing, communications and international relationship matters, legal and insurance support services did not enable the service recipient to make use of the said technical or managerial services independently. Further, there was no training involved under the agreement. Thus, consideration for such services did not qualify as FTS.


Article 12 of India-Finland DTAA – Consideration for distribution, updation and maintenance of software, without right of exploitation of intellectual property, was not in nature of royaltyunder India-Finland DTAA

17. TS-810-ITAT-2019 (Mum.)
Trimble Solutions Corporation vs. DCIT
ITA No. 6481/Mum/2017; 6482/Mum/2017
A.Y.: 2011-12

Date of order: 16th December, 2019

Article 12 of India-Finland DTAA – Consideration for distribution, updation and maintenance of software, without right of exploitation of intellectual property, was not in nature of royaltyunder India-Finland DTAA

FACTS

The assessee, a company incorporated in Finland, was engaged in the business of developing and marketing specialised off-the-shelf software products. The assessee appointed non-exclusive distributors for the distribution of the software to end-customers in India. In addition, the assessee also provided software upgrades, maintenance and support services with regard to such software.
During the year under consideration, the assessee received income from the sale of software as well as payments for maintenance and support services from the distributors in India. The assessee contended that the software was provided to its distributors for the purpose of resale / distribution to the end-customers for use as copyrighted article but no right was granted to use copyright in software. Further, the payments received for software upgrades, maintenance and support services with regard to software were also not for transfer of any right in copyright of a copyrighted article. Thus, payments received from distributors cannot be characterised as royalty under the India-Finland DTAA.
The AO, however, was of the view that distribution of software to end-customers through distributors resulted in transfer or use of copyright in software. In any case, postinsertion of Explanations 4 and 5 to section 9(1)(vi), grant of a license was also ‘royalty’. The AO read the definition of royalty under the Act into the India-Finland DTAA and held that payments received from distributors would qualify as royalty even under the India-Finland DTAA. The AO further held that payments received for maintenance and support services (including upgrades) were part of, and inextricably linked to, supply and use of software. Hence, payment for such services was also in the nature of royalty.
Aggrieved, the assessee approached the Dispute Resolution Panel (DRP), which rejected the objections of the assessee.
Aggrieved, the assessee filed an appeal before the Tribunal.

HELD

  •  Article 12 of the India-Finland DTAA envisages consideration for the use of, or the right to use, certain specific works which could include intellectual properties (such as copyright, patents, etc.) by the owner of such intellectual properties from any other person.
  •  The Tribunal noted the following factors from the agreement entered into between the assessee and the distributors:
• Distributors were granted non-exclusive license to market and distribute software products developed by the assessee;
• Distributors did not have the right to use the source code of such software products;
• Distributors were not permitted to modify, translate or recompile, add to, or in any way alter software products (including its documentation);
• Distributors were not permitted to create source code of software products supplied under the agreements;
• Distributors were not expressly permitted to reproduce or make copies of software products under the agreements (except backup copy as required by the customer);
• Distributors were not vested with rights of any nature in intellectual property developed and owned by the assessee in software products;
• All trademarks and trade names which distributors used in connection with products supplied, remained the exclusive property of the assessee. At all times, the assessee had title to all rights to intellectual property, software and proprietary information, including all components, additions, modifications and updates.
The assessee had granted only the right to distribute software products and not the right to reproduce or make copies of software. Thus, in the absence of vesting of any right of commercial exploitation of intellectual property contained in copyrighted article (i.e., software product), the amount received by the assessee from its distributors was in the nature of business income.
In terms of Article 3(2) of the India-Finland DTAA, the definition of a term under domestic law can be applied only if it is not defined in the DTAA. Royalty is defined in the India-Finland DTAA. Hence, amendment of its definition under domestic law had no bearing on the definition under the DTAA. Therefore, the contention of the AO / DRP that the definition of ‘royalty’ under the Act was to be read into the DTAA was incorrect.
Accordingly, payments received by the assessee from distributors were not in the nature of royalty under Article 12 of the DTAA.

Article 15 of India-Korea DTAA – Technical advisory services provided by non-resident individual to Indian company were in nature of IPS under Article 15 of India-Korea DTAA which, in absence of fixed base in India, were not taxable in India

16. TS-803-ITAT-2019 (Ahm.)
J. Korin Spinning Pvt. Ltd. vs. ITO
ITA No. 2734/Ahm/2016
A.Y.: 2015-16
Date of order: 13th December, 2019

Article 15 of India-Korea DTAA – Technical advisory services provided by non-resident individual to Indian company were in nature of IPS under Article 15 of India-Korea DTAA which, in absence of fixed base in India, were not taxable in India
FACTS
The assessee, an Indian company, entered into an agreement with Mr. L, a resident of  South Korea, under which he was required to act as technical adviser and provide technical advice in relation to certain aspects of the production process of the assessee. The assessee paid a consideration to Mr. L for the said services.
According to the assessee, the services provided by Mr. L were in the nature of Independent Personal Services (IPS) in terms of Article 15 of the India-Korea DTAA. Since Mr. L did not have a fixed base available to him in India, consideration for the  services was not taxable in India. Hence, the assessee did not withhold tax u/s 195 from the payments made to him.
The AO, however, contended that the services rendered by Mr. L were industrial in ature since they related to setting up of the assessee’s factory and cannot be categorised as IPS. Hence, they qualified as fee for technical services (FTS) u/s 9(1)(vii) as well as Article 13 (Royalties and FTS) of the DTAA.
The CIT(A) dismissed the assessee’s appeal. Aggrieved, the assessee filed an appeal before the Tribunal.

HELD

  •  Mr. L was a technical expert in certain fields of textiles. He was engaged by the assessee to provide technical advice on some aspects of the assessee’s production process.
  •  Mr. L was an individual and resident of Korea.
  •  The agreement was between the assessee and Mr. L individually and not with any ‘firm’ or ‘company’.
  •  The agreement mentioned Mr. L as ‘Technical Adviser’ to the assessee. Hence, the services rendered by him qualified as IPS.
  •  Mr. L and his technical team were required to fly to India on need basis for rendering services to the assessee. This indicated that Mr. L did not have a fixed base in India.
  •  Since Mr. L did not have a fixed base in India, the consideration received by him was not taxable in India as per Article 15 of the India-Korea DTAA.

Article 13(4) of India-Mauritius DTAA – Capital gains exemption under pre-amended India-Mauritius DTAA is not available to shareholder Mauritius SPV upon transfer of shares of Indian company, as Mauritius SPV was set up as a tax-avoidance device, interposed solely for obtaining treaty benefit

4.       [2020]
114 taxmann.com 434 (AAR-Mum.)

Bid Services Division (Mauritius) Ltd., In re.

AAR No. 1270 of 2011

A.Y.: 2012-13

Date of order: 10th February, 2020

 

Article 13(4) of India-Mauritius DTAA – Capital gains
exemption under pre-amended India-Mauritius DTAA is not available to
shareholder Mauritius SPV upon transfer of shares of Indian company, as
Mauritius SPV was set up as a tax-avoidance device, interposed solely for
obtaining treaty benefit

 

FACTS

The Airports Authority of India (AAI)
undertook an international bidding process for the purpose of inviting bids to
acquire 74% stake in an Indian joint venture company (JV Co.) proposed to be
formed for the purpose of undertaking development, operation and maintenance of
airports at Mumbai and Delhi.

 

A South African entity (SA Co.),
together with other independent entities, formed a consortium and was
successful in acquiring the contract with AAI. The other two entities which
participated with SA Co. were incorporated in India and SA.

 

During the entire bidding process, it
was understood that SA Co. would be a direct investor in the shares of JV Co.
However, ten days prior to submission of final bids, SA Co., through its
wholly-owned subsidiary in South Africa, incorporated an entity in Mauritius
(Mau Co. / Applicant) and invested the funds in JV Co. through Mau Co. The
other two entities in the consortium also invested vide their group entities,
without change in jurisdiction of the entities, i.e., vide entities located in
India (I Co) and SA (SA Co. 2).

 

After a period of approximately five
years of holding, during the A.Y. 2012-13, Mau Co. transferred JV Co.’s shares
to the extent of 13.5% to another existing shareholder of JV Co. while
retaining the balance 13.5% of shares. Mau Co. earned capital gains upon such transfer.

 

A diagrammatic depiction of JV Co.’s
shareholding is as follows:

 

 

Mau Co. claimed that the amount of
capital gains arising from such transfer was not taxable in India by virtue of
exemption granted under Article 13(4) of the India-Mauritius DTAA (treaty).

 

The issue before the AAR was whether
Mau Co. was eligible to claim the capital gains exemption provided under the
treaty.

 

HELD

The AAR held that Mau Co. was not
entitled to treaty benefit as it was a device employed to carry out tax avoidance,
without any commercial substance.

 

®  Mau
Co. was set up close to the project being finalised and was not in existence
from the very start of the bidding process. The other joint venture parties
(including from SA and India) also did investments through their group
concerns, but there was no change in jurisdiction of the principal entities and
the investor entities, being SA Co. 2 and I Co., were from the same
jurisdiction, i.e., SA and India, respectively, unlike SA Co. which interposed
Mau Co. and there was a change in jurisdiction from SA to Mauritius;

®  Mau
Co. did not have any fiscal independence, i.e., no independent source of funds,
and it relied on its holding entity for the same. Further, Mau Co. had no
independent collaterals to secure the funds from third parties;

®  Mau
Co. did not have any independent source of income;

®  Mau
Co. did not have any tangible assets, employees, office space, etc.;

®  While SA Co. as a member of the consortium was to
provide strategic input, advice on various aspects such as structured finance,
ancillary services, corporate governance and cargo and logistics development
services, Mau Co., as its substitution, did not even employ any management
experts or financial advisers to carry out the same tasks;

®  Mau
Co. was not involved in the decision-making process w.r.t the development
process of the project or for resolving the implementation issues that were
encountered;

®  Mau
Co. was set up only to hold the investments in the JV Co.;

®  Mau
Co. merely endorsed the decisions taken by the SA Co.;

®  Mau Co. did not provide any value addition in the
JV Co.

The AAR also held that even if
investments were proposed to be carried out by the SA Co. vide setting up of an
individual SPV, commercially, it could have been set up in South Africa or
India, rather than a third jurisdiction, Mauritius, which was neither a
financial hub nor a provider of low-cost capital.

 

The AAR applied the doctrine of
‘substance over form’ and followed the observations of the Apex Court in the
case of Vodafone International Holdings BV (2012) 341 ITR 1 which
state that treaty benefits should be denied, if a non-resident achieves
indirect transfer through abuse of legal form and without reasonable business
purpose, which results in tax avoidance. In such a case, the tax authority can
re-characterise the equity transfer as per its economic substance and impose
tax directly on the non-resident rather than the interposed entity.

 

Accordingly, the AAR held that Mau Co. was
merely set up as a tax-avoidance device by the SA Co. without having any
independent infrastructure or resources and interposed for the dominant purpose
of avoiding tax in India; thus it cannot be granted any treaty benefits.

Article 12 and Article 5 read with Protocol of India-Swiss DTAA – Tax in India cannot exceed 10% even if Swiss Co has service PE in India

3.       [2020]
114 taxmann.com 51 (Mum.)

AGT International GmbH vs. DCIT

ITA No. 7465/Mum/2018

A.Y.: 2015-16

Date of order: 31st January, 2020

 

Article 12 and Article 5 read with Protocol of India-Swiss
DTAA – Tax in India cannot exceed 10% even if Swiss Co has service PE in India

 

FACTS

The assessee, a tax resident of
Switzerland, received fees for technical services from an Indian company and
offered the said income to tax @ 10% on gross basis under Article 12(2) of the
India-Swiss DTAA.

 

The Indian company had withheld tax @
42.024% on the entire amount.

 

The A.O. was of the view that the
services rendered by the assessee (by rendering services in India) did not
amount to fees for technical services as defined in Article 12 and that the
assessee had a Service PE in India. The A.O. computed the income by allowing
expenditure @ 40% on estimated basis and taxed the remaining 60% amount at the
normal income tax rates applicable to foreign companies. As against 10%, the
assessee was assessed effectively at 24% (being 40% of 60).

 

Aggrieved by the stand taken by the
A.O., the assessee raised objections before the DRP but without any success.
Being aggrieved, the assessee filed an appeal before the Tribunal.

 

HELD

The Tribunal referred to the Protocol
of the India-Swiss Treaty which states that furnishing of services covered by
sub-paragraph (l) of paragraph 2 (i.e., Service PE) shall be taxed according to
Article 7 or, on request of the enterprise, according to the rates provided for
in paragraph 2 of Article 12.

In light of the said Protocol, the Tribunal held
that the assessee has a choice to be taxed on gross basis at the rates provided
under article 12(2) or on net basis under article 7. A combined reading of the
above provision of article 5(2)(l) along with the related Protocol clause is
that on Service PE being triggered on account of rendition of services by a
Swiss entity in India, or vice versa, it can never make the assessee
worse off so far as the tax liability in source jurisdiction is concerned.
Unless the assessee has a lower tax on PE profits on net basis under article 7 vis-à-vis
taxability of FTS on gross basis under article 12(2), the PE trigger does not
trigger higher tax.

Article 13 of India-Belgium DTAA – Gain arising on indirect transfer of shares of Indian company not taxable in India as per Article 13(6) of India-Belgium DTAA

2.       TS-129-ITAT-2020

Sofina S.A. vs. ACIT

ITA No. 7241/Mum/2018

A.Y.: 2015-16

Date of order: 5th March, 2020

 

Article 13 of India-Belgium DTAA – Gain arising on indirect
transfer of shares of Indian company not taxable in India as per Article 13(6)
of India-Belgium DTAA

 

FACTS

The assessee is a tax resident of
Belgium and is a venture capital investor who invested in Startups in India
such as Myntra, Freecharge, etc.

 

The assessee owned 11.34% stake in
preference shares of Sing Co, a company tax resident of Singapore. In turn,
Sing Co held 99.99% shares in an Indian company (ICO). The assessee sold its
entire 11.34% stake in Sing Co to J, an unrelated Indian company. J, while
making the payment, deducted TDS u/s 195 of the Act. The assessee claimed refund
of TDS in its return of income relying on Article 13(6) of the India-Belgium
DTAA as per which gains arising from the alienation of shares of Sing Co are
taxable in the contracting state of which the alienator is a resident, i.e.,
Belgium.

 

The
A.O. held that the assessee carried out an indirect transfer of shares which is
taxable in India. As per Explanation 5 to section 9(1)(i) of the Act, shares of
Sing Co derived value substantially from ICO and therefore the shares of Sing
Co are deemed to be situated in India. The A.O. imported the Explanation 5 to
section 9(1)(i) in order to deem Sing Co as a company resident in India.
Accordingly, in his view, the transfer of shares of Sing Co was covered under
Article 13(5) and was taxable in India.

 

On appeal, the DRP approved the view
of the A.O. Being aggrieved, the assessee filed an appeal before the Tribunal.

 

HELD

Article 13(5) of the India-Belgium
Tax Treaty applies if the following two conditions are cumulatively satisfied:
(i) the transfer of shares should represent the participation of at least 10%
in the capital stock of the company; and (ii) the company whose shares are
transferred should be a resident of a contracting state. As the assessee
transferred shares of a Singapore resident company, the second condition is not
satisfied and, accordingly, Article 13(5) is not applicable.

 

Unlike Explanation 5 to section
9(1)(i) and Article 13(4) (providing for indirect transfer tax of company
deriving value from immovable property in India), Article 13(5) of the
India-Belgium Tax Treaty did not adopt a see-through approach. It does not
refer to ‘direct or indirect transfer’. Accordingly, the transfer of the shares
of Sing Co cannot be regarded as shares of its subsidiary ICO.

 

Explanation 5 to section 9(1)(i) of
the Act does not define residence of a person and only deems shares of a
foreign company to be located in India. In the absence of any provision for
deeming a Singapore resident company as a treaty resident of India either in
the DTAA between India and Singapore, or in the DTAA between India and Belgium,
Sing Co cannot be held to be a company resident of India so as to get covered
by Article 13(5).

 

The Tribunal upheld the assessee’s contention
that the transfer will be governed by residuary clause Article 13(6) and will
be taxable in the state of the alienator, i.e., Belgium.

Article 12 of India-US DTAA – Deputation of skilled employee results in making technology available and satisfies FIS article under India-US DTAA

1.      
[2020] 115 taxmann.com 129 (Mum.)

General Motors Overseas Corporation
vs. ACIT

ITA Nos. 1282 of 2009; 1986, 2787 of
2014; 381 (Mum.) of 2018

A.Ys: 2004-05, 2008-09 to 2010-11

Date of order: 6th March,
2020

 

Article 12 of India-US DTAA –
Deputation of skilled employee results in making technology available and
satisfies FIS article under India-US DTAA

 

FACTS

The assessee, a US resident company,
entered into a Management Provision Agreement (MPA) with its Indian group
company G engaged in the business of manufacture, assembly, marketing and sale
of motor vehicles and other products in India. Under the MPA, the assessee
agreed to provide executive personnel to assist G in its activities of
development of general management, finance, purchasing, sales, service,
marketing and assembly / manufacturing. Further, the assessee agreed to charge
salary and other direct expenses related to such personnel from G.

 

Past proceedings before AAR

The assessee had made an application
to AAR in the past to ascertain the tax liability of the amount received under
MPA. In the circumstances and on the basis of the facts on record, AAR had
concluded that the services are ‘managerial’ and not ‘technical or consultancy’
in nature and accordingly are not within the scope of charge of Article 12. AAR
had, however, indicated that the amount received by G may trigger taxation if
the assessee has a Permanent Establishment (PE) in India and accordingly the
receipts may constitute business profits. AAR had, however, caveated
(conditioned) its ruling by stating that it had no information or material to
indicate that the employees were rendering services of a nature falling beyond
the terms of the MPA and whether, in fact, there was a PE trigger. AAR also
clarified that the tax authorities can examine the factual position and take
appropriate action if they find the factual situation to be otherwise.

 

Assessment and appeal proceedings

During the course of assessment, the
facts noted by the A.O. were as follows:

(i)   The
assessee had deputed two employees, viz., (i) Mr. A – President and MD of G and
responsible for overall management and direction of G operations; and (ii) Mr.
S – Vice-President (Manufacturing), responsible for overall management of G
facilities to manufacture and assemble products of G according to required
standards;

(ii)   The
A.O. also called for a copy of the service agreement of the deputationists
which the assessee failed to produce. The A.O. held that the services rendered
by Mr. S satisfied the make-available requirement and constituted FIS;

(iii)
Seeking to follow the AAR ruling, the
A.O. concluded that the assessee had a PE in India and computed its business
profit by taxing gross receipt at 20% u/s 44D r.w.s. 115A without providing
deduction for any expenses;

(iv) On
appeal, the CIT(A) upheld the A.O.’s order. Being aggrieved, the assessee
preferred an appeal before the Tribunal.

 

HELD

Services rendered by Mr. A

It was not disputed by the parties
that the services rendered by Mr. A were managerial in nature and in the
absence of charge for managerial service in the FIS Article of the India-US
Treaty, the said payment did not constitute FIS and hence was not chargeable to
tax in India.

 

Services rendered by Mr. S

The ruling given by the AAR, although
binding on the Commissioner and income tax authorities subordinate to the
Commissioner, is, however, not binding on the Tribunal and only has a
persuasive value for the reason that the Tribunal is not an authority coming
under the Commissioner. However, the dispute can reach the Tribunal when the
authorities bound by the ruling do not follow the ruling for valid or invalid
reasons. Hence, the Tribunal is required to examine the reasons given by the
authorities for not following the AAR ruling.

 

The caveat portion of the AAR ruling
makes it clear that this ruling was not an absolute and unqualified one. The
AAR ruling on the services rendered by Mr. S was a general, non-conclusive
finding. The power was given to the tax authorities to examine the transaction
/ actual conduct of parties. In the absence of the assessee providing the
service agreement or other documents showing the actual services rendered by
Mr. S, the A.O. had no other option but to examine the MPA and determine the
scope of services provided by Mr. S.

 

Mr. S, Vice-President
(Manufacturing), was working with the assessee before being sent as an employee
to India. It was obvious that Mr. S had sufficient knowledge and experience of
the technology and its standards used by the assessee in the US. In the
automobile industry, assembly of products and the standards of the company are
patented / protected technology and the owner of the technology charges royalty
for the same. But in the present case no royalty had been charged by the
assessee from G because the assessee had sent its employee to India. This
person was an expert in the technology, experienced in the assembly of products
and well aware of the standards of the company.

 

The
technology / expertise lay in the technical mind of an employee/s and if key
employee/s having the requisite knowledge, experience and expertise of
technology are transferred from one tax jurisdiction to another tax
jurisdiction, then it is transfer of technology. By sending Mr. S, technology
was made available in India by the assessee.

 

Computation of income

As regards computation of business profits, the
Tribunal on a co-joint reading of Article 7(3) and section 44D, ruled that
profits need to be taxed at 20% on gross basis as section 44D prohibits
deduction for any expenses.

Article 12 of India-USA DTAA; Section 9(1)(vi), (vii) of the Act – Payment received by American company for provision of cloud hosting services to Indian customers was not royalty or fees for included services within meaning of Article 12 since the assessee was in physical control or possession over, and operating and managing, equipment without having granted its lease to customers – Since the assessee did not have PE in India, income could also not be taxed as business profits

22 [2020] 113 taxmann.com 382 (Mum.)(Trib.) Rackspace, US Inc. vs. DCIT ITA Nos. 4920 & 6195 (Mum.) of 2018 A.Ys.: 2010-11 & 2015-16 Date of order: 28th November,
2019

 

Article 12 of
India-USA DTAA; Section 9(1)(vi), (vii) of the Act – Payment received by
American company for provision of cloud hosting services to Indian customers
was not royalty or fees for included services within meaning of Article 12
since the assessee was in physical control or possession over, and operating
and managing, equipment without having granted its lease to customers – Since
the assessee did not have PE in India, income could also not be taxed as
business profits

 

FACTS

The assessee was a
company incorporated in, and a tax resident of, the USA. During the relevant
year, the assessee had earned income from provision of cloud services (cloud
hosting and other supporting and ancillary services) to Indian customers. The
assessee had not filed return of its income.

 

The A.O. issued
notice u/s 148 of the Act. In response, the assessee filed the return of its
income and contended that cloud hosting services were not taxable as
‘royalties’ under Article 12 of the India-USA DTAA because of the following
reasons:

 

  •     The customers do not
    operate the equipment and do not have physical access to or control over the
    equipment used by the assessee to provide cloud support services.
  •     The assessee does not ‘make
    available’ technical knowledge, experience, skill, know-how, etc. to its
    customers. Further, the cloud support services are not in the nature of
    managerial, technical or consultancy services. Consequently, they do not
    constitute included services under Article 12 of the India-USA DTAA.
  •     Hence, income from cloud
    hosting services was business profits. Since the assessee did not have a PE in
    India under Article 5 of India-USA DTAA, the income was not taxable in India
    under the provisions of Article 7(1) of the India-USA DTAA.

 

However, in
accordance with the direction of the DRP, income from cloud services was
treated as ‘Royalty’ and taxed @ 10% under the India-USA DTAA.

 

HELD

  •     Customers of the assessee
    had only availed hosting services. They had not used, possessed or controlled
    equipment (which was owned and controlled by the assessee) used for providing
    hosting services. Hence, the payment for hosting services made by Indian
    customers did not fall within the ambit of the definition of royalty in
    Explanation 2 to section 9(1)(vi) of the Act.
  •     Amendment to the said
    definition by the Finance Act, 2012 clarified that irrespective of possession
    or control of equipment with payer, or use by payer, or location of equipment
    in India, any payment made for ‘use of equipment’ would be classified as
    ‘royalties’.
  •     Since the assessee was a
    tax resident of the USA, it qualified for beneficial provisions under the
    India-USA DTAA.
  •     The definition of royalties under Article
    12(3) of the India-USA DTAA is in pari materia with the pre-amendment
    definition of royalty under the Act. The definition under the India-USA DTAA
    being exhaustive and not inclusive, its meaning should be only that given in
    the Article.
  •     The assessee was providing
    hosting services to Indian customers. The data centre and infrastructure
    therein which was used to provide services belonged to, and was operated and
    managed by, only the assessee.
  •     The term ‘use’ or ‘right to
    use’ in the context of the DTAA contemplates that the payer has possession /
    control over the property or the property is at its disposal. However, the
    assessee did not give any equipment to the customers nor did it allow them to
    have control over equipment. Customers did not have physical control or
    possession over servers and other equipment used to provide cloud hosting
    services. Customers did not even know the location of either the data centre or
    the location of the server in the data centre.
  •     The assessee had provided
    cloud hosting services which were standard services provided to customers.
    Agreement between the assessee and its customers was only a service level
    agreement for providing hosting and other ancillary services simpliciter
    to customers and not for use, or hire, or lease, of any equipment.
  •       Accordingly,
    payments received by the assessee could not be said to be royalty within the
    meaning of Explanation (2) to section 9(1)(vi) of the Act and also Article
    12(3)(b) of the India-USA DTAA. Besides, in the absence of a PE of the assessee
    in India, in terms of the India-USA DTAA its income could not be taxed as
    business profits in India.

 

Articles 7, 14 and 23 of India-Spain DTAA – As gains from hedging were covered under Article 7 or 14 (though not taxable under those Articles), Article 23 is not applicable Article 14 of India-Spain DTAA – Merely because companies are engaged in real estate development, it could not be concluded that their assets ‘principally’ consist of immovable properties; therefore, capital gain earned on sale of shares of such companies not taxable under Article 14

21 [2019] 112
taxmann.com 119 (Mum.)(Trib.) JCIT vs. Merrill
Lynch Capital Market Espana SA SV ITA No. 6109 (Mum.)
of 2018 A.Y.: 2013-14 Date of order: 11th
October, 2019

 

Articles 7, 14 and
23 of India-Spain DTAA – As gains from hedging were covered under Article 7 or
14 (though not taxable under those Articles), Article 23 is not applicable

 

Article 14 of
India-Spain DTAA – Merely because companies are engaged in real estate
development, it could not be concluded that their assets ‘principally’ consist
of immovable properties; therefore, capital gain earned on sale of shares of
such companies not taxable under Article 14

 

FACTS I

The assessee was a
company incorporated in, and tax resident of, Spain. It was registered as a
Foreign Institutional Investor (FII) in India. During the relevant year, the
assessee had undertaken certain transactions to hedge its exposure in foreign
exchange on Indian investments and earned gains therefrom.

 

During the course
of assessment proceedings, the A.O. noticed that the assessee had earned gain
from hedging which it had claimed was exempt under Article 14 of the
India-Spain DTAA. The A.O. observed that being an investor, the assessee could
not carry on any business activity. Accordingly, the A.O. held that the receipt
was in the nature of other income, which was taxable in India in terms of
Article 23(3) of the India-Spain DTAA.

 

In appeal, the
CIT(A) followed the orders of his predecessors in the assessee’s own case.
Further, the CIT(A) also relied on the decision in Citicorp Banking
Corpn., Bahrain vs. ACIT (IT Appeal No. 6625/{Mum.} of [2009]). Accordingly,
the CIT(A) observed that hedging contracts had nexus with the investment in
India because forex transactions were to hedge investment in securities. Hence,
gains from hedging were capital gains. As investment income of the FII was not
taxable in India in terms of Article 14(6) of the India-Spain DTAA, gains from
hedging were also not taxable in India.

 

HELD I

  •     Article 23 comes into play
    only if an item of income is ‘not expressly dealt with’ in the preceding
    articles (i.e. Articles 6 to 22) of the DTAA. The Revenue has not contended
    that as the gains are not covered by Article 7 (Business Income) or Article 14
    (Capital Gain), they should be taxable under Article 23 (Other Income) which
    gives residuary taxation rights to source jurisdiction.
  •     Income cannot be brought
    within the ambit of Article 23 only because it cannot be taxed as the
    conditions for taxability in source jurisdiction were not fulfilled. However,
    income which is otherwise not covered under Articles 6 to 22 (such as alimony,
    income from chance, lottery or gambling, rent paid by resident of a contracting
    state for the use of an immovable property in a third state, and damages which
    do not pertain to loss of income covered by Articles 6 to 22, etc.) only will be
    covered by Article 23.
  •     Income from gains from
    hedging was covered by Article 7 or Article 14. It was taxable if conditions
    were satisfied. Hence, Article 23 would not have any application.
  •     If hedging contracts were
    entered into in the course of business, notwithstanding regulatory
    permissibility, such contracts could either be revenue or capital in nature.
  •     If gains were capital in
    nature, they will be capital gains and would be subject to Article 14 of the
    India-Spain DTAA. A perusal of Article 14(1) to 14(5) shows that none of the
    clauses could be invoked. Accordingly, in terms of Article 14(6), the gains
    were not taxable in source jurisdiction.
  •     If gains were revenue in
    nature, they will be business profits and would be subject to Article 7. They could
    be taxed in source jurisdiction only if the assessee has a PE in India. Article
    7 of the India-Spain DTAA merely mentions ‘profits of an enterprise’. The A.O.
    has mentioned that ‘as an investor, the assessee cannot carry out any business
    activity’ and, therefore, it cannot be said to be a business activity. However,
    Article 7 does not even remotely suggest compliance with regulatory conditions
    for qualifying under the DTAA. Whether with regulatory approval or without
    regulatory approval, and whether legal or illegal, business profits are taxable
    nevertheless.
  •     Even if these were not
    hedging contracts but the assessee was dealing in forward exchange contracts simplicter,
    by itself it could not make gains taxable under Article 7 if the assessee did
    not have a PE in India, or under Article 14 if the gains were not covered in
    Article 14(1) to 14(5). Merely because gains though covered under Article 7 or
    14 but not taxable, would not be covered by Article 23. Hence, gains from
    hedging could not be taxed as non-business income.
  •     Accordingly, the assessee
    was not liable to tax on gains under the India-Spain DTAA.

 

FACTS II

The assessee had invested in shares of certain companies engaged in
development of real estate. Shares of these companies were listed on the stock
exchange (and the taxpayer held them as portfolio investment such that the
holding in each company was less than 7%). During the relevant year, the
assessee earned capital gains on sale of these shares. In India, such gain
could be taxed in terms of the India-Spain DTAA only if the property of such
company, directly or indirectly, consisted of immoveable properties in India
and the shares of such company derived their value principally from such
immovable properties.

 

The A.O. observed that these companies were in the real estate sector,
including development of residential and commercial properties, and further,
the value of the shares of the companies was derived from the value of
immovable properties held by them.

 

Accordingly, the A.O. concluded that capital gain on the sale of their
shares was taxable in India under Article 14(4) of the India-Spain DTAA.

 

In appeal, the
CIT(A) observed that the assessee had minuscule shareholding which could not
have given any right, either in stock-in-trade of those companies, or to occupy
immovable properties of those companies. The CIT(A) further observed that
Article 14(4) was meant to cover cases of indirect transfer of immovable
properties through transfer of shares of companies holding properties. It would
not cover cases where commercial investments were made in shares of companies
engaged in the real estate sector. Hence, the CIT(A) held that gains on the
sale of shares were not taxable in India in terms of Article 14(6) of the
India-Spain DTAA.

 

HELD II

  •     The assessee had sold no
    more than 2% shares in any of the six realty companies. It did not hold any
    controlling interest or even significant interest in these companies which
    could provide any right to occupy properties. All the companies were engaged in
    the business of real estate development and not in holding of real estate per
    se    .
  •     Under Article 14(1), gains
    from immovable property may be taxed in source state. The purpose of Article
    14(4) is to cover gains from shares of a company holding immovable property
    which would not have been covered in Article 14(1).
  •     The India-Spain DTAA does
    not specifically define the expression ‘principally’. From clarifications in
    model convention commentaries, in the absence of anything to suggest a
    different intention, the threshold test should be 50% of total assets. Only
    such companies where holding of immovable property directly or indirectly
    comprises at least 50% of aggregate assets are covered.
  •     Merely because a company is
    engaged in real estate development it would not imply that over 50% of its
    aggregate assets consist of immovable properties. Apparently, the A.O. has
    presumed that just because these companies are dealing in real estate
    development the assets of these companies ‘principally’ consist of immovable
    properties.
  •     Accordingly, the CIT(A) had
    correctly held that cases where commercial investments were made in shares of
    companies engaged in the real estate sector were not covered. Hence, gains on
    sale of shares were not taxable in India in terms of Article 14(6) of the
    India-Spain DTAA.

 

Article 11 of India-Mauritius DTAA; sections 4, 92 of the Act – As per Article 11(1), interest can be taxed only if twin conditions of ‘arising’ (i.e., accrual) and ‘paid’ (i.e., actual receipt) are fulfilled – Transfer pricing provisions cannot apply to tax an amount which had neither accrued to, nor was received by, the taxpayer

20 [2020] 113 taxmann.com 79 (Mum.)(Trib.) Gurgaon Investment Ltd. vs. DCIT ITA Nos. 1499 (Mum.) of 2014, 7359 (Mum.) of
2016 & 6821 (Mum.) of 2017 A.Y.: 2008-09, 2011-12 & 2012-13 Date of order: 15th November,
2019

 

Article 11 of India-Mauritius DTAA;
sections 4, 92 of the Act – As per Article 11(1), interest can be taxed only if
twin conditions of ‘arising’ (i.e., accrual) and ‘paid’ (i.e., actual receipt)
are fulfilled – Transfer pricing provisions cannot apply to tax an amount which
had neither accrued to, nor was received by, the taxpayer

 

FACTS

The assessee was a
non-resident company incorporated in Mauritius. It was engaged in the business
of holding of investments. It was a member company of an international group of
financial management and advisory companies. The assessee had purchased
compulsorily convertible debentures (CCDs) of an Indian company (I Co) from its
AE based in Mauritius.

 

In course of transfer pricing proceedings, the assessee furnished
details of interest on debentures due from I Co. The assessee submitted that it
had waived interest that was due from I Co and I Co had also not claimed
deduction of interest on CCDs. Therefore, no income had accrued to the
assessee. The TPO observed that the assessee had waived interest to help its
AE. Therefore, such interest was to be reduced from the income of the assessee.

 

CIT(A) upheld the
transfer pricing adjustment made.

 

HELD

  •     Article 11(1) of the
    India-Mauritius DTAA reads: ‘Interest arising in a Contracting State and
    paid to a resident of the other Contracting State may be taxed in that other
    State.’
  •     The expression ‘paid’ has
    been used in several other DTAAs, in similar as well as different contexts.
    Several judicial authorities have interpreted the expression ‘paid’ and held1  that in such cases the relevant income is to
    be taxed on paid basis and not accrual basis.
  •     Article 11(1) of the India-Mauritius DTAA
    requires fulfilment of the twin conditions of ‘arising’ (i.e., accrual) and
    ‘paid’ (i.e., actual receipt) for taxability of interest. Unless both
    conditions are fulfilled, interest will not be taxable.
  •     Once interest is not
    taxable as per Article 11(1) of the DTAA, section 4 of the Act will have no
    application. Section 92 and other provisions in Chapter X are in the nature of
    machinery provisions, which are subject to charging provision in section 4 of
    the Act. If a particular item of income does not come within the purview of the
    charging provision, the machinery provisions would not be applicable.
  •     Chapter X containing TP
    provisions is in the nature of anti-avoidance provisions applicable in case of
    transactions between related parties. However, when income itself is not
    chargeable to tax because of DTAA provisions, there is no question of tax
    avoidance / evasion being applicable.
  •     It was only because of
    difficulties in the real estate sector that investee companies had requested
    for waiver of interest.
  •     For taxing interest, it was
    necessary to satisfy the twin conditions of accrual and payment. However, the
    TPO / A.O. had sought to tax what the assessee was supposed to
    receive     (but, factually had not received).
  •     Transfer pricing adjustment
    was made on this hypothetical amount. In Vodafone India Services (P.)
    Ltd. vs. Union of India [2014] 50 taxmann.com 30 (Bom.)    , the Bombay
    High Court held that even income arising from an international transaction must
    satisfy the test of income under the Act and must find its home in one of the
    charging provisions. The TPO / A.O. had not established that notional interest
    satisfied the test of income arising or received under the charging provision
    of the Act. Transfer pricing adjustment in respect of interest which was
    neither received by, nor had accrued to, the assessee could not be made.

_________________________________________________________________

 

1 DIT vs. Siemens Aktiengesellscharft, [IT Appeal No.
124 of 2010, dated 22nd October, 2012]
[India-Germany DTAA];
Johnson & Johnson vs. Asstt. DIT; Johnson & Johnson vs. ADIT [2013] 32 taxmann.com
102 (Mum.)(Trib.) [India- USA DTAA]; Pramerica ASPF 11 Cyprus Holding Ltd. vs.
Dy. CIT [2016] 67 taxmann.com 368 (Mum.)(Trib.) [India-Cyprus DTAA].

Explanations 6 and 7 to section 9(1)(i) of the Act – Indirect transfer tests of 50% threshold of ‘substantial value’ (Explanation 6) and small shareholder (Explanation 7) are to be applied retrospectively

12. AAR No. 1555 to 1564 of 2013 A to J, In Re

 

Explanations 6 and 7 to section 9(1)(i) of
the Act – Indirect transfer tests of 50% threshold of ‘substantial value’
(Explanation 6) and small shareholder (Explanation 7) are to be applied
retrospectively

 

FACTS

In F.Y. 2013-14,
Applicant 1 (buyer, a Jersey-based company) and Applicant 2 (sellers /
shareholders based in the US, UK, Hong Kong and Cayman Islands) entered into a
transaction for sale of 100% shares of a British Virgin Islands-based company
(BVI Co). Individually, each seller had less than 5% shareholding in BVI Co.

 

BVI Co was a
multinational company and had subsidiaries across the globe. It indirectly held
100% shares in an Indian company (I Co) through a Mauritian company (Mau Co).
The sellers submitted the valuation report of the shares of BVI Co, as per
which the value derived directly or indirectly from assets located in India was
26.38%. The applicants approached AAR in December, 2013 with respect to
taxability arising in India as regards the transfer of the shares of BVI Co.

 

Indirect transfer
provisions were introduced in the Act in 2012. These were amended in 2015 by
introducing Explanation 6 and Explanation 7 to section 9(1)(i). The amended
provisions provided the following benchmarks:

  •     50%
    value threshold to ascertain substantial value of foreign shares or interest,
    from assets in India (50% threshold).
  •     Proportionate
    tax (i.e., to the extent of value of assets in India).
  •     Indirect
    provisions not to apply to shareholders having less than 5% shareholding, or
    voting power, or interest in foreign company or entity, if they have not
    participated in management and control during the 12-month period preceding the
    date of transfer (small shareholder exemption).

 

The question before
the AAR was whether amendments made in 2015 could be applied to a transaction
retrospectively?

 

HELD

  •     From
    2012 to 2015, the term ‘substantially’ was statutorily not defined, though it
    was interpreted by the High Court1 
    and the AAR2. Both rulings held that the term ‘substantially’
    would only include a case where shares of a foreign company derived at least
    50% of their value from assets in India.
  •     The
    provision inserted in 2015 begins with the expression ‘for the purposes of
    this clause, it is hereby declared…’.     Relying on the principles of
    statutory interpretation dealing with declaratory states3, AAR held
    that declaratory or curative amendments made ‘to explain’ an earlier provision
    of law should be given retrospective effect.
  •     Explanation
    6 pertaining to 50% threshold is clarificatory in nature. Similarly,
    Explanation 7 pertaining to small shareholder exemption is inserted to address
    genuine concerns of small shareholders. Hence, both should apply
    retrospectively to give a true meaning and make the indirect provisions
    workable.

 

The AAR concluded
on principles and did not adjudicate on valuation. It held that tax authorities
could scrutinise the valuation report to ascertain whether it met the 50%
threshold and satisfied the conditions of small shareholders exemption. 

______________________________________________

1   DIT
vs. Copal Research Ltd., Mauritius [2014] 49 taxmann.com 125 (Delhi)

2     GEA Refrigeration Technologies GmbH, In
re [2018] 89 taxmann.com 220 (AAR – New Delhi)

 

3   Principles
of Statutory Interpretation by Justice G.P. Singh (Sixth Edition 1996)

 

 

MFN CLAUSE: RELEVANCE OF INTERPRETATION BY FOREIGN COURTS

BACKGROUND

A tax treaty is usually bilateral in nature and is limited to two
countries: Resident country and Source country. When two bilateral treaties are
compared, there ought to be substantial or minor differences on account of the
different strategies and the negotiation power of the competent authorities of
the respective countries. The question is whether the taxpayer can rely on
another bilateral tax treaty, one that is not applicable to him. The answer is
clearly ‘No’.

 

The taxpayer relies on the tax treaty entered into by his resident
country for the income that has arisen in the source country. For his
taxability, the taxpayer is restricted to the applicable tax treaty only.
However, the tax treaty mechanism is such that, if expressly provided for in
his treaty, the taxpayer is permitted to enforce the beneficial provisions of
another bilateral tax treaty, though subject to conditions. This is widely termed
as the Most Favoured Nation clause (MFN clause). It prevents discrimination
amongst the OECD member states. Its application cannot be implicit but has to
be expressly provided for. If not expressed, a tax treaty cannot oblige another
tax treaty to apply its beneficial provisions (whether in terms of scope or tax
rate).

 

In the Indian context, the MFN clause is usually found in the Protocol to
its tax treaties, for example, the Protocol to the India-Netherlands TT, the
India-France TT, the India-Sweden TT, etc. For instance, article  12(3)(b) of the India-Sweden Tax Treaty
defines the Fees for Technical Services (FTS) as ‘(b) The term “fees for
technical services” means payment of any kind in consideration for the
rendering of any managerial, technical or consultancy services, including the
provision of services by technical or other personnel but does not include
payment for services mentioned in articles 14 and 15 of this Convention’.

 

If the Indian taxpayer is making payment for commercial service, the
payment would primarily be covered under this FTS article. It would be interesting to then look into the Protocol
to the India-Sweden DTA that reads as under:

 

‘In respect of
Articles 10 (Dividends), 11 (Interest) and 12 (Royalties and fees for technical
services) if under any Convention, Agreement or Protocol between India and a
third State which is a member of the OECD, India limits its taxation at source
on dividends, interest, royalties, or fees for technical services to a rate
lower or a scope more restricted than the rate or scope provided for in this
Convention on the said items of income, the same rate or scope as provided for
in that Convention, Agreement or Protocol on the said items of income shall
also apply under this Convention.’

 

Taking benefit of
the FTS clause (or Fees for Included Services) in the India-USA tax treaty or
the India-UK tax treaty, where USA is the OECD member state, the scope for FTS
in the India-Sweden tax treaty would be reduced to make-available
technical services. Where the FTS is not make-available, the FTS would
be subject to tax only when the taxpayer has a permanent establishment in India
in accordance with Article 7 of that treaty. In other words, if the taxpayer
has no permanent establishment, the FTS income that is not make-available
service would not be taxed in India. This is how the MFN clause would apply and
be beneficial to the taxpayer.

 

FOREIGN
COURT DECISION

In this context,
the author has discussed a recent foreign court decision on the MFN clause. It
is significant in terms of the manner in which this clause should be applied.
The decision articulates the importance of the phrase ‘limits its taxation at
source’, in respect of interpreting the phrase ‘a rate lower or a scope more
restricted’. It looks into the resultant tax effect, rather than the rate or
scope prescribed in another Tax Treaty (referred to as TT). The decision is
explained in detail below:

 

South Africa

Tax Court in
Cape Town

ABC Proprietary Limited vs. Commissioner (No.
14287)

Date of Order:
12th June, 2019

(i)   FACTS

The taxpayer is a
South African tax resident company and a shareholder of a Dutch company. The
Dutch company declared dividend to the South African taxpayer in respect of
which it withheld dividend tax at the rate of 5% and paid it to the Dutch Tax
Authorities. The taxpayer subsequently requested a refund of the dividend tax
paid to the Dutch Tax Authorities on account of the MFN clause in the
Netherlands-South Africa Tax Treaty (NL-SA TT). It contended as follows:

 

(a) NL-SA TT
provides for 5% withholding tax;

(b) MFN of NL-SA TT
referred to the South Africa-Sweden Tax Treaty (SA-SW TT) that also provides
for 10% withholding tax; but the second MFN of the SA-SW TT provides for an
effective withholding tax rate of 0% after referring to the South Africa-Kuwait
Tax Treaty (SA-Kuwait TT).

 

The peculiarity of
this decision is the extent to which the second MFN influences the effective
withholding tax rate in the NL-SA DTA. Coincidentally, the recent judgment of
the Dutch Supreme Court on 18th January, 2019 in case number
17/04584 is on similar facts with a similar outcome. Both the decisions are
discussed together.

 

(ii) TT ANALYSIS

To understand the
importance of this decision, it is equally important to have the extract of the
relevant clauses for our benefit.

 

NL-SA TT

Article 10 of the
NL-SA TT provides for a 5% dividend withholding tax on distribution of
dividends if the beneficial owner is a company holding at least 10% of the
capital in the company paying the dividends. The MFN clause in article 10(10)
is given as under:

 

(10) If under
any convention for the avoidance of double taxation concluded after the date of
conclusion of this Convention between the Republic of South Africa and a third
country, South Africa limits its taxation on dividends as contemplated in
sub-paragraph (a) of paragraph 2 of this Article to a rate lower, including
exemption from taxation or taxation on a reduced taxable base, than the rate
provided for in sub-paragraph (a) of paragraph 2 of this Article, the same
rate, the same exemption or the same reduced taxable base as provided for in
the convention with that third State shall automatically apply in both
Contracting States under this Convention as from the date of the entry into
force of the convention with that third State.

 

It can be observed from the above that the MFN clause of the NL-SA TT
has a time limitation to its applicability. Only the OECD member state DTAs,
that are concluded by South Africa after the signing of the NL-SA TT, would be
looked into. Once applied, the beneficial tax rate or scope for taxation of FTS
in third state TTs would also apply in the NL-SA TT. Accordingly, the SA-SW DTA
satisfied the condition. The analysis of the SA-SW DTA is discussed below.

 

SA-SW TT

Originally, the
SA-SW TT was concluded prior to the conclusion of the NL-SA TT, however, the
Protocol, wherein the 10% dividend withholding tax rate and the second MFN
clause was provided for, was concluded after the conclusion of the NL-SA TT.
The Court and the tax authority did not think that this would be an issue and
both concluded that since the Protocol was concluded after the date of
conclusion of the NL-SA TT, the SA-SW TT would continue to apply.

 

Article 10 of the
SA-SW TT read with the Protocol did not provide for any concession in the tax
rate (i.e. 5% withholding tax rate in the NL-SA TT; whereas it was 15% in the
SA-SW TT). However, the Protocol introduced Article 10(6) to the SA-SW TT and
read as follows:

 

(6) If any
agreement or convention between South Africa and a third state provides that
South Africa shall exempt from tax dividends (either generally or in respect of
specific categories of dividends) arising in South Africa, or limit the tax
charged in South Africa on such dividends (either generally or in respect of
specific categories of dividends) to a rate lower than that provided for in
sub-paragraph (a) of paragraph 2, such exemption or lower rate shall
automatically apply to dividends (either generally or in respect of those
specific categories of dividends) arising in South Africa and beneficially
owned by a resident of Sweden and dividends (either generally or in respect of
those specific categories of dividends) arising in Sweden and beneficially
owned by a resident of South Africa, under the same conditions as if such
exemption or lower rate had been specified in that sub-paragraph.

 

It can be observed from the above that the time limitation present in
the NL-SA TT is not present in the SA-SW TT. Hence, in the absence of any
limitation, the MFN clause of the SA-SW TT is open to all member states (no
time limitation and no OECD member state limitation). This is where the
SA-Kuwait TT was applied wherein the dividend withholding tax rate is 0% when
dividends arise in South Africa.

 

SA-Kuwait TT

Article 10(1) of
the SA-Kuwait TT provides that the ‘Dividends paid by a company which is a
resident of a Contracting State to a resident of the other Contracting State
who is the beneficial owner of such dividends shall be taxable only in that
other Contracting State.’ In other words, the dividend paid by the South
African company would be exempt from withholding tax. Kuwait is a non-OECD
member and the SA-Kuwait TT was concluded prior to the date of conclusion of
the NL-SA TT and hence direct reference to this TT was not possible.

 

(iii)       TAX AUTHORITIES’ CONTENTION

The tax authorities
denied the benefit of exemption for various reasons: (a) the benefit of the
SA-Kuwait TT is not available directly to the NL-SA DTA; (b) the purpose of the
MFN clause is to provide additional benefit and bring parity with other OECD
member states. The clause should be read literally and not be open to
interpretation on the basis of another MFN in another DTA, i.e., the SA-SW TT;
and (c) the intention of the MFN clause is to look into the tax rates as
specified in other DTAs, without considering any other MFN clause or other
influence. The MFN clause should be interpreted to bring parity with the
‘specified’ tax rate, rather than the ‘applied’ / ‘effective’ tax rate. The tax
authorities refused to exempt the withholding tax rate.

 

(iv) ISSUE

Whether the
dividend withholding tax rate is exempt under the NL-SA TT, by virtue of the
MFN clause in that TT and in the SA-SW TT?

 

(v)   DECISION

The Tax Court of
South Africa gave its judgment in favour of the taxpayer that dividends arising
from South Africa would be exempt from withholding tax. It is identical to the
one given by the Hon’ble Supreme Court of the Netherlands. It gave the
following reasons:

(a)   The MFN clause to be interpreted based on its
plain meaning. It cannot be contended that the MFN clause is not intended to be
triggered by MFN clauses in treaties concluded thereafter.

(b) The South African tax authorities had in
practice exempted the withholding tax on dividends arising from South Africa;
when the SA-SW TT, read with the SA-Kuwait TT, was applied.

(c)   From the perspective of the NL-SA TT, the real
tax effect has to be seen while contemplating the beneficial effects of the MFN
clause.

(d) Accordingly, once it was clear that the SA-SW
TT is a qualified TT, the effective / resultant withholding tax rate would
apply to the NL-SA TT. The indirect effect of the SA-Kuwait TT, that was
concluded prior to the NL-SA TT, is purely coincidental.

 

IN AN INDIAN CONTEXT

From an Indian perspective, we do not have judgments on any similar
issue. Hence, it becomes imperative to analyse the above decision from the
perspective of Indian tax treaties. Let’s take an example of payments being
made by an Indian resident to a Dutch company in the nature of Fees for
Technical Services. We have considered the India-Netherlands Tax Treaty (Ind-NL
TT), the India-Sweden Tax Treaty (Ind-SW TT) and the India-Greece Tax Treaty
(Ind-Gr TT).

 

Ind-NL TT

Article 12 of the Ind-NL TT provides for a 20% withholding tax rate and
defines FTS as: The term ‘fees for technical services’ as used in this
Article means payments of any kind to any person, other than payments to an
employee of the person making the payments and to any individual for
independent personal services mentioned in Article 14, in consideration for
services of a managerial, technical or consultancy nature.

 

The extract of the Protocol to the Ind-NL TT is given below:

 

If after the signature of this Convention under any
Convention or Agreement between India and a third State, which is a member of
the OECD, India should limit its taxation at source on dividends, interest,
royalties, fees for technical services or payments for the use of equipment to
a rate lower or a scope more restricted than the rate or scope provided for in
this Convention on the said items of income, then, as from the date on which
the relevant India Convention or Agreement enters into force, the same rate or
scope as provided for in that Convention or Agreement on the said items of
income shall also apply under this Convention.

 

It can be observed that, like the NL-SA TT, the Ind-NL TT provides for a
time limitation and the OECD member-state condition for applicability of the
MFN clause.

 

Ind-SW TT

The Ind-SW TT
(conclusion date: 24th June, 1997) was concluded after the date of
conclusion of the Ind-NL TT (conclusion date: 30th July, 1988);
accordingly, Ind-SW is a qualified TT for application of the MFN clause.

 

Article 12 of the
Ind-SW TT provides for a 10% withholding tax rate and defines FTS as: The
term ‘fees for technical services’ means payment of any kind in consideration
for the rendering of any managerial, technical or consultancy services,
including the provision of services by technical or other personnel, but does
not include payments for services mentioned in Articles 14 and 15 of this
Convention.

 

The extract of the Protocol to the Ind-SW TT is given below:

 

In respect of
Articles 10 (Dividends), 11 (Interest) and 12 (Royalties and fees for technical
services), if under any Convention, Agreement or Protocol between India and a
third State which is a member of the OECD, India limits its taxation at source
on dividends, interest, royalties or fees for technical services to a rate
lower than or a scope more restricted than the rate or scope provided for in
this Convention on the said items of income, the same rate or scope as provided
for in that Convention, Agreement or Protocol on the said items of income shall
also apply under this Convention.

 

It can be observed that,
like the SA-SW TT, the Ind-SW TT also does not provide for any time limitation,
although it does specify an OECD member-state condition.

 

Ind-Gr TT

The Ind-Gr TT was concluded on 11th February, 1965, that is,
prior to the date of conclusion of the Ind-NL TT dated 30th July,
1988 and hence, like the above decision, direct reference to this TT was not
possible. But Greece is an OECD member state and, thus, satisfied the MFN
clause of the Ind-SW TT. The Ind-Gr TT does not have the FTS article and hence
the income from performance of services would be taxable under Article 3 for
industrial or commercial services, or under Article 14 for professional
services. The threshold requirements in Article 3 and Article 14 would
accordingly apply in the present case. These provide for a reduced scope that
is ‘more restricted’, resulting in limiting India’s right to tax FTS and,
hence, could be read into the Ind-SW TT and thereafter into the Ind-NL TT.

 

Another argument that can also come up for analysis is whether the ‘scope
more restricted’ in the Ind-SW TT takes into account a complete absence of the
FTS article or takes into account a mere tax effect on FTS? Reliance can be
placed on another foreign court decision by the Supreme Court of Kazakhstan in
the case of The Kazmunai Services (Case No. 3??-77-16), dated 3rd
February, 2016, wherein the taxpayer applied the MFN clause of
the Kazakhstan-India DTA and wanted to benefit from the missing FTS article in
the Kazakhstan-Germany DTA, the Kazakhstan-UK DTA and the Kazakhstan-Russia
DTA. The Supreme Court denied the benefit of the MFN clause without discussing
its applicability and the issue about the absent FTS article.

 

In response, it could be stated that the MFN clause refers to the nature
of income (FTS), rather than the FTS article in itself. The phrase used in the
MFN clause of the Ind-SW TT is ‘India limits its taxation at source on
dividends, interest, royalties or fees for technical services to a
rate lower or a scope more restricted than the rate or scope provided for in
this Convention [emphasis] on the said items of income’.
Therefore, in the case of complete absence of FTS, the MFN clause could still
apply when the comparative TT provides for a reduced taxing right on FTS, and
thereby affecting the Source State’s right to ‘taxation at source’.

 

CONCLUSION

The MFN clause, when applied through the Protocol, is assumed to have an
automatic application, i.e., without the need for a formal approval from tax
authorities1, similar to the MFN clause in the SA-SW TT above. The
past decisions on the MFN clause2 
are usually from the perspective of the scope of FTS, wherein, the scope
for FTS is reduced to either ‘make-available’ technical services or removing
managerial service from FTS, or from the perspective of reducing the tax rate
on FTS; all to the extent of the scope or tax rate as ‘specified’ in the
qualifying TT. None of the Indian decisions goes past the ‘specified’ scope or
tax rate in the qualified TT. The objective of this article is to be aware of
its possibility and its planning opportunities.

 

Observing the similarities between the above foreign decision and the
above example, the MFN clause in the Ind-NL TT refers to two important terms,
‘limits its taxation at source’ and ‘a rate lower or scope more restricted’.
It highlights the resultant scope or resultant rate that limits India’s taxation at source. We
know that the TT merely provides for an allocation of taxing rights between the
resident and the source country. If another TT with another OECD member state
provides for a reduced scope or a lower rate, and thereby limiting India’s
right to ‘taxation at source’, the MFN clause of the Ind-SW TT will get
triggered. India’s right to taxation at
source is determined after taking into account the final tax rate
and provides for an observation to the resulting tax outcome. The scope of the
MFN clause needs to be seen from the perspective of the net result. Whether we
can derive the same result before the Indian judiciary as in the above foreign
decision, only time will tell.

 

TAXABILITY OF THE LIAISON OFFICE OF A FOREIGN ENTERPRISE IN INDIA

A liaison
office (LO) has been an important mode of entry into India of many foreign entities
wishing to do business and make investments here.

A dispute
has been going on for quite some time about whether an LO has to be considered
as a Permanent Establishment (PE) of the non-resident in India and be subjected
to tax.

In this
article we have discussed various aspects relating to the taxability of an LO
in India, including the recent decision of the Supreme Court in the case of the
U.A.E. Exchange Centre.

 

1. BACKGROUND

In many
cases, an enterprise usually tests the waters outside its domestic jurisdiction
in an endeavour to expand business. In the initial phase of establishment of
business in the host country, a multinational corporation (MNC) conducts market
research, develops strategies to explore the foreign market, formulates plans, maintains
liaison with the government officials, etc. After such preliminary activities,
it commences operations in the foreign market, controlled or managed either
from the home country or in the foreign host country.

 

To undertake
such exploratory or precursory activities, MNCs establish an LO in the host
country. The RBI
also permits this, subject to the condition that it is venturing into certain
limited areas of permitted activities only. Undertaking any activity beyond the
rigours of the permitted activities requires an application for conversion of
such LO into a Branch Office or Project Office, or any other body corporate, as
the case may be.

 

Thus, an MNC
/ foreign company can do business in India either by opening an LO or a branch
office, or a limited liability partnership ?rm, or a subsidiary or wholly-owned
subsidiary, depending upon its business requirements in India. Each of the
above modes of setting up business presence in India is governed by the Foreign
Exchange Management Regulations.

 

As per
Schedule II read with Regulation 4(b) of the FEM (Establishment in India of a
Branch Office or a Liaison Office or a Project Office or any Other Place of
Business) Regulations, 2016 [FEMA 22(R)], an LO in India of a person resident
outside India is permitted to carry out the following limited activities:

(i)  Representing the parent company / group
companies in India.

(ii)  Promoting export / import from / to India.

(iii)
Promoting technical / financial collaborations between parent / group companies
and companies in India.

(iv) Acting
as a communication channel between the parent company and Indian companies.

 

Thus, an LO
is not permitted to carry out, directly or indirectly, any trading or
commercial or industrial activity in India. The LO can operate only out of
inward remittance received from the parent company in India. When a foreign
company operates through an LO in India, there is no income that is taxable in
India as it is not permitted to earn any income here. The activities mentioned
above are essentially of a preparatory or auxiliary nature.

 

2. WHETHER AN LO CONSTITUTES A PE IN INDIA?

As mentioned
above, as per the prevailing FEMA regulations, an LO cannot carry on any
activity in India other than activities permitted as per FEMA 22(R). However,
in practice it is observed in some cases that LOs carry out activities which
may not be limited to acting as a communication channel between the parent
company and Indian companies.

 

Thus, time
and again doubts arise in respect of the business activities carried out by a
foreign company in India through an LO and whether the said activities can be
taxable in India. The actual activities could vary from case to case. It may be
difficult to presume that an LO will not constitute a PE merely because RBI has
given permission for setting up an LO in India on specific terms and
conditions.

 

To determine
whether an LO constitutes a PE and consequent taxability of the same in India,
it is very important to examine whether it is carrying out an important part of
the business activities of the foreign company, or only the preparatory and
auxiliary activities as permitted under FEMA 22(R).

 

3. RELEVANT PROVISIONS OF THE INCOME-TAX ACT, 1961 AND
THE DOUBLE TAXATION AVOIDANCE AGREEMENTS (DTAAs)

Section 9 of
the ITA, 1961 contains provisions relating to income deemed to accrue or arise
in India and includes all income accruing or arising, whether directly or
indirectly, through or from any business connection in India. Explanation 1(a)
to section 9(1)(i) provides that in case of a business of which all the
operations are not carried out in India, the income of the business deemed u/s
9(1)(i) to accrue or arise in India shall be only such part of the income as is
reasonably attributable to the operations carried out in India.

 

Further,
Explanation 1(b) to section 9(1)(i) provides that in the case of a
non-resident, no income shall be deemed to accrue or arise in India to him
through or from operations which are confined to the purchase of goods in India
for the purposes of export.

 

Under
Article 5(1) and (2) of the DTAAs, an LO may be treated as ‘fixed place of
business’ and accordingly a PE in India. However, relief is provided under
Article 5(4) to exclude the activities which are ‘preparatory or auxiliary’ in
nature.

 

4. PREPARATORY OR AUXILIARY ACTIVITIES TEST – OECD
COMMENTARY

The terms
‘preparatory’ or ‘auxiliary’ have not been defined under the ITA or under the
DTAAs. Various judicial decisions have attempted to define the same. The term
‘preparatory’ has been explained to mean something done before or for the
preparation of the
main task. Similarly, the term ‘auxiliary’ has been interpreted to mean an
activity ‘aiding’ or supporting the main activity.

 

The OECD
Commentary on the Model Tax Convention on Income and on Capital dated 21st
November, 2017 in relevant paragraphs 59, 60 and 71 deals with various aspects
of preparatory auxiliary activities. The said paragraphs read as under:

 

‘59.  It is often difficult to distinguish between
activities which have a preparatory or auxiliary character and those which have
not. The decisive criterion is whether or not
the activity of the fixed place of business in itself forms an essential and
significant part of the activity of the enterprise as a whole. Each individual
case will have to be examined on its own merits. In any case, a fixed place of
business whose general purpose is one which is identical to the general purpose
of the whole enterprise does not exercise a preparatory or auxiliary activity.

           

60.  As a general rule, an activity that has a
preparatory character is one that is carried on in contemplation of the
carrying on of what constitutes the essential and significant part of the
activity of the enterprise as a whole. Since a preparatory activity
precedes another activity, it will often be carried on during a relatively
short period, the duration of that period being determined by the nature of the
core activities of the enterprise. This, however, will not always be the case
as it is possible to carry on an activity at a given place for a substantial
period of time in preparation for activities that take place somewhere else.
Where, for example, a construction enterprise trains its employees at one place
before these employees are sent to work at remote work sites located in other
countries, the training that takes place at the first location constitutes a
preparatory activity for that enterprise. An activity that has an auxiliary
character, on the other hand, generally corresponds to an activity that is
carried on to support, without being part of, the essential and significant
part of the activity of the enterprise as a whole. It is unlikely that an
activity that requires a significant proportion of the assets or employees of
the enterprise could be considered as having an auxiliary character.

 

71. Examples
of places of business covered by sub-paragraph e) are fixed places of business
used solely for the purpose of advertising or for the supply of information or
for scientific research or for the servicing of a patent or a know-how
contract, if such activities have a preparatory or auxiliary character.
Paragraph 4 would not apply, however, if a fixed place of business used for the
supply of information would not only give information but would also furnish
plans, etc. specially developed for the purposes of the individual customer.
Nor would it apply if a research establishment were to concern itself with
manufacture. Similarly, where the servicing of patents and know-how is the
purpose of an enterprise, a fixed place of business of such enterprise
exercising such an activity cannot get the benefits of paragraph 4. A fixed
place of business which has the function of managing an enterprise or even only
a part of an enterprise or of a group of the concern cannot be regarded as
doing a preparatory or auxiliary activity, for such a managerial activity
exceeds this level. If an enterprise with international ramifications
establishes a so-called “management office” in a State in which it maintains
subsidiaries, permanent establishments, agents or licensees, such office having
supervisory and coordinating functions for all departments of the enterprise
located within the region concerned, sub-paragraph e) will not apply to that
“management office” because the function of managing an enterprise, even if it
only covers a certain area of the operations of the concern, constitutes an
essential part of the business operations of the enterprise and therefore can
in no way be regarded as an activity which has a preparatory or auxiliary
character within the meaning of paragraph 4.’

 

In order to
determine whether an LO of an MNC constitutes its PE in India, an in-depth
analysis is required to be done based on the factual information available, for
example, considering the nature of the activities undertaken by the LO, the
business of the MNC and the overall facts and circumstances of the case. In
this it is very important to consider the various judicial precedents on the
subject.

 

5. INDIAN JUDICIAL PRECEDENTS

On the issue
of whether an LO constitutes a PE in India, there are mixed judicial
precedents, primarily based on the facts of each case.

 

In a few
cases, the Tribunals and Courts have held that an LO does not constitute a
fixed place PE in India because the LO was carrying on activities / operations
within the framework of permitted activities by the RBI, i.e. preparatory or
auxiliary activities. In this regard, useful reference can be made
to the following cases:

• IAC vs.
Mitsui & Co. Ltd. [1991] 39 ITD 59 (Delhi)(SB);

• Motorola
Inc. vs. DCIT [2005] 95 ITD 269 (Delhi)(SB);

• Western
Union Financial Services Inc. vs. ADIT [2007] 104 ITD 40 (Delhi)

• Sumitomo
Corporation vs. DCIT [2008] 114 ITD 61 (Delhi);

• Metal One
Corporation vs. DDIT [2012] 52 SOT 304 (Delhi);

• DIT vs.
Mitsui & Co. Ltd. [2018] 96 taxmann.com 371 (Delhi);

• Nagase
& Co. Ltd. vs. DDIT [2019] 109 taxmann.com 288 (Mumbai-Trib.);

• Kawasaki
Heavy Industries Ltd. vs. ACIT [2016] 67 taxmann.com 47 (Delhi-Trib.).

 

However, in
a few other cases, Tribunals / Courts have, based on the specific facts of the
cases, held that an LO constitutes a fixed place PE in India because it was
carrying on certain activities which were in the nature of commercial / core
activities of the taxpayer. A list of such cases is
given below:

• U.A.E.
Exchange Centre [2004] 139 Taxman 82 (AAR);

• Columbia
Sportswear Co. (AAR) [2011] 12 taxmann.com 349 (AAR);

• Jebon
Corporation India vs. CIT(IT) [2012] 19 taxmann.com 119 (Karnataka);

• Brown
& Sharpe Inc. vs. ACIT [2014] 41 taxmann.com 345 (Delhi-Trib.) affirmed in
Brown & Sharpe Inc. vs. CIT [2014] 51 taxmann.com 327 (All.);

• GE Energy
Parts Inc. vs. CIT(IT) [2019] 101 taxmann.com 142 (Delhi);

• Hitachi
High Technologies Singapore Pte Ltd. vs. DCIT [2020] 113 taxmann.com 327
(Delhi-Trib.).

 

Some other
relevant judicial precedents in this regard are as under:

• Gutal
Trading Est., In re [2005] 278 ITR 643 (AAR);

• Angel
Garment Ltd., In re [2006] 287 ITR 341(AAR);

• Cargo
Community Network PTE Ltd., In re [2007] 289 ITR 355 (AAR);

• Sojitz
Corporation vs. ADIT [2008] 117 TTJ 792 (Kol.);

• Mitsui
& Co. Ltd. vs. ACIT [2008] 114 TTJ 903 (Delhi);

• K.T.
Corpn. [2009] 181 Taxman 94 (AAR);

• IKEA
Trading (Hong Kong) Ltd. [2009] 308 ITR 422 (AAR);

• Mondial
Orient Ltd. vs. ACIT [2010] 42 SOT 359 (Bang.);

• M.
Fabricant & Sons Inc. vs. DDIT [2011] 48 SOT 576 (Mum.);

• Nike Inc.
vs. ACIT [2013] 125 ITD 35 (Bang.);

• Linmark
International (Hong Kong) Ltd. vs. DDIT (IT) [2011] 10 taxmann.com 184 (Delhi);

• CIT vs.
Interra Software India (P.) Ltd. [2011] 11 taxmann.com 82 (Delhi).

 

6. A BRIEF ANALYSIS OF SOME OF THE DECISIONS based on the nature of the activities of the
LOs is given below to understand the judicial thinking on the subject.

(A) Routine
functions of LO

Earlier, the
ITAT, Mumbai considering the specific facts in the case of Micoperi Spa
Milano vs. DCIT [2002] 82 ITD 369 (Mum.) had held that maintenance of a
project office in India and incurring expenses for maintaining such office,
cost of postage, telex, etc., indicates that the MNC has a PE in India.

 

However,
where routine functions are performed by the LO in India and for the purposes
of performing such routine functions the LO has been given limited powers, it
cannot be held that a MNC has a PE in India in the form of its LO.

 

In Kawasaki
Heavy Industries Ltd. vs. ACIT [2016] 67 taxmann.com 47 (Delhi- rib.),
the ITAT held that:

(a) The
powers / rights granted by an MNC to its LO in India such as (i) Signing of
documents for renting of premises, equipment, services with any person,
including Municipal bodies, governments, etc., as may be required for the
operation of the LO; (ii) Execution of contracts for purchase of items for
operation of the LO, etc. are specific to the operations of the LO and the
stand of the A.O., that the power of attorney is an ‘open document’ giving
unfettered powers to the LO, would be outside the scope of the initial approval
granted by the RBI.

(b) Prima
facie, a reading of the power of attorney does not demonstrate that the
employees of the assessee at the LO are authorised to do core business activity
or to sign and execute contracts, etc.

(c) The A.O.
has not brought on record any material, other than his interpretation of the
terms of the power of attorney, to demonstrate that the LO is carrying on core
business activity warranting his conclusion that the assessee has a PE in
India.

 

Thus, in
respect of routine functions of the LO, the same may not be considered as
constituting a PE in India.

 

(B)  Purchase activities for the purposes of
exports

Under
Explanation 1(b) of section 9(1)(i), purchase
functions or a part thereof, performed by an LO in India has been consistently
held as outside the purview of such LO having any taxable income in India.

 

In Ikea
Trading (Hong Kong) Ltd. [2009] 308 ITR 422 (AAR), the AAR has held that
where the LO’s activities are confined only to facilitate the purchase of goods
in India for the purposes of export outside India, such activities are covered
by restriction / relief provided under Explanation 1(b) to section 9(1)(i) of
the Act and, accordingly, no income is deemed to accrue or arise in India with
respect to the operations carried out by the LO in India. A similar view has
been taken in ADIT (IT) vs. Tesco International Sourcing Ltd. [2015] 58
taxmann.com 133 (Bang.-Trib.).

 

The Karnataka
High Court in Columbia Sportswear Co. vs. DIT (IT) [2015] 62 taxmann.com
240, reversing the decision of the AAR in Columbia Sportswear Co.
[2011] 12 taxmann.com 349 (AAR), held that all the activities
undertaken by the LO of an MNC such as designing, manufacturing, identifying
vendors, negotiating with vendors, ensuring quality control of the products
manufactured by vendors, quality assurance, on-time delivery, acting as a
conduit or ‘go between’ between the vendors in India / Egypt / Bangladesh and the
MNC situated outside India, are ‘activities necessary’ for carrying out a
purchase function in India, as otherwise the goods purchased from India would
not find any customer outside India. Accordingly, such activities are not the
‘activities other than sale of goods’ as held by AAR, rather, they are an
extension / necessary part of the purchase function itself, so carried out by
the LO in India. Accordingly, appropriate relief as provided under Explanation
1(b) to section 9(1)(i) of the Act is required to be extended to the taxpayer.

 

(C) Information collection, research and
aiding activities

Initial
research, information collection and preliminary advertising undertaken by an
LO in India has been held to be in the nature of ‘preparatory’ or ‘auxiliary’
activity, and thus it has been held that the LO does not constitute the PE of
its MNC in India.

 

The AAR in
the case of K.T. Corporation [2009] 181 Taxman 94 (AAR) held that
the activities in the nature of:

(i)   Holding seminars, conferences;

(ii)
Receiving trade inquiries from the customers;

(iii)
Advertising about the technology being used by the MNC in its products /
services and answering the queries of the customers;

(iv)
Collecting feedback from the customers / prospective customers, trade
organisations and not playing any role in pre-bid survey, etc., before entering
into the agreement with its customers, nor involving itself in the technical
analysis of the products / services, are in aid or support of the ‘core
business activity’ of the MNC and, thus, fall under the exclusionary clauses
(e) and (f) of Article 5(4) of the DTAA between India and Korea. It is
pertinent to note that the AAR also noted that the LO is confined to carrying
out preparatory or auxiliary activities only.

 

The AAR also
said, ‘However, we may add here that if the activities of the liaison office
are enlarged beyond the parameters fixed by RBI or if the Department lays its
hands on any concrete materials which substantially impact on the veracity of
the applicant’s version of facts, it is open to the Department to take
appropriate steps under law. But, at this stage, we proceed to give ruling on
the basis of facts stated by the applicant which cannot be treated as ex
facie untrue.’

 

Similarly,
the Delhi High Court in the case of Nortel Networks India International
Inc. vs. DIT [2016] 69 taxmann.com 47 held that where the Indian
subsidiary of the MNC negotiated and entered into contracts with the customers
of the MNC, the LO of the same MNC could not be held to be a PE of the MNC in
India, especially when the tax authorities had not brought on record any
evidence that the LO had participated in the negotiation of the contracts.

 

The ITAT,
Mumbai in the case of Nagase & Co. Ltd. vs. DDIT [2018] 96
taxmann.com 504 (Mum.-Trib.) held that in the absence of any material
or evidence brought on record by the Revenue authorities to the effect that the
LO was executing business or contracts independently with the customers in
India, the plea of the assessee that it was engaged in carrying out only
preparatory or auxiliary activities needs to be accepted and, accordingly, the
taxpayer’s LO in India did not constitute its PE in India.

 

(D)
Marketing activities

Where the LO
undertakes the preliminary activities of advertising, identification of customers,
attending to queries of customers, such activities would fall within the ambit
of preparatory / auxiliary activities and, accordingly, the LO would not
qualify as a PE of the MNC in India.

 

However,
where such activities cross the ‘thin-line’ of preparatory / auxiliary
activities and venture into performing income-generating activities, such
activities would require the LO to be treated as the PE of the MNC in India.

 

The
Karnataka High Court in the case of Jabon Corporation India vs. CIT (IT)
[2012] 19 taxmann.com 119 (Karnataka), while upholding the decision of
ITAT, Bangalore in the case of DDIT (IT) vs. Jebon Corpn. India [2010]
125 ITD 340 (Bang.-Trib.) that the LO has to be treated as the PE of
the Korean parent, held as follows:

 

‘10. It is on the basis of the aforesaid material, the Tribunal held that
the activities carried on by the liaison office are not confined only to the
liaison work. They are actually carrying on the commercial activities of
procuring purchase orders, identifying the buyers, negotiating with the buyers,
agreeing to the price, thereafter, requesting them to place a purchase order
and then the said purchase order is forwarded to the Head Office and then the
material is dispatched to the customers and they follow up regarding the
payments from the customers and also offer after-sales support. Therefore,
it is clear that merely because the buyers place orders directly with the Head
Office and make payment directly to the Head Office and it is the Head Office
which directly sends goods to the buyers, would not be sufficient to hold that
the work done by the liaison office is only liaison and it does not constitute
a permanent establishment as defined in Article 5 of DTAA. In fact, the
Assessing Officer has clearly set out that what was discovered during the
investigation and the same has been properly appreciated by the Tribunal and it
came to the conclusion that though the liaison office was set up in Bangalore
with the permission of the RBI and in spite of the conditions being
stipulated in the said permission preventing the liaison office from carrying
on commercial activities, they have been carrying on commercial activities.

 

11. It was further contended that the RBI has not taken any action and
therefore such interference is not justified. Once the material on record
clearly establishes that the liaison office is undertaking an activity of
trading and therefore entering into business contracts, fixing price for sale
of goods and merely because, the officials of the liaison office are not
signing any written contract would not absolve them from liability. Now that
the investigation has revealed the facts, we are sure that the same will be
forwarded to the RBI for appropriate action in the matter in accordance with
law. But merely because no action is initiated by RBI till today would not
render the findings recorded by the authorities under the Income-tax Act as
erroneous or illegal.

 

12. We are satisfied from the material on record that the finding recorded by
the Tribunal is based on legal evidence and that the finding that the liaison
office is a permanent establishment as defined under Article 5 of the DTAA and
therefore, the business profits earned in India through this liaison office is
liable for tax is established.’

 

The
Allahabad High Court in the case of Brown & Sharpe Inc. vs. CIT
[2014] 51 taxmann.com 327 (All.) held that the activities such as:

(i)
Explaining the products to the buyers in India;

(ii)
Furnishing information in accordance with the requirements of the buyers;

(iii)
Discussions on the commercial issues pertaining to the contract through the
technical representative, after which an order was placed by the Indian buyer directly to the Korean HO,
would be something more than ‘preparatory’ or ‘auxiliary’ activities and, accordingly, the LO was a PE
of the MNC in India. Further, the incentive plan designed for remuneration of the employees of the LO indicated
that the LO was undertaking not just the ‘advertising’ activities, rather such activities traversed the actual
marketing of products of the MNC in India as it was only on the basis of the
orders generated that an incentive was envisaged / organised for the employees.

 

In GE
Energy Parts Inc. vs. CIT (IT) [2019] 101 taxmann.com 142 (Delhi), the
Delhi High Court held that the LO of GE Energy Parts Inc. (GE US), established
to act as a communication channel, was carrying out core activity of marketing
and selling highly-sophisticated equipments of the US company, and hence the LO
was a fixed place PE of the assessee company in India. The GE LO was a fixed
place PE of GE due to the fact that (a) There was a fixed place of business;
(b) The fixed place of business was at the disposal of the employees of the LO,
more so when GE had not contested that activities of ‘some form’ were not
carried out from such premises and thus it was reasonable to assume that the
activities were carried through such premises; (c) Though the final word with
respect to the pricing of the products was with the HO, however, that won’t mean
that the LO was for mute data collection / information dissemination. The LO
discharged the vital responsibilities or at least had a prominent role in
contract finalisation, viz., extensive negotiations with its customers,
customisation of the products with respect to the requirements of the
customers, negotiating the financial parameters of the products and not
allowing the overseas entity to alter such terms without the consent of GE
India, etc. Accordingly, the LO was not performing merely liaising activities.
Defining the terms preparatory or auxiliary activities as ‘something remote
from the actual realisation of the profits’, the Court held that the
activities performed by the LO would not fall within the exception provided
under Article 5(3)(e) of the India-USA DTAA.

 

The Court
also held that GE’s overseas entity had agency PE for the following reasons:
(a) Where the expatriates / employees performed activities for different
entities of the same group, then it could not be construed that activities had
been performed for a single enterprise. Accordingly, the GE India (through the
employees of the LO and Indian subsidiary), constituted a dependent agent of GE
overseas MNC; (b) Relying on the decision of the Italian Court it held that the
active and major participation / involvement of the employees / representatives
in the negotiations / meetings with the customers indicated that the agents had
‘authority to conclude contracts’, even if final contracts were concluded by
the GE HO.

 

7. FUND REMITTANCE SERVICES – Decision of the Supreme Court in the case of
Union of India vs. U.A.E. Exchange Centre

In respect
of fund remittance services, the Supreme Court in Union of India vs.
U.A.E. Exchange Centre [2020] 116 taxmann.com 379 (SC) held that an
Indian LO of a United Arab Emirates (UAE) company did not constitute a PE in
India.

 

U.A.E.
Exchange Centre (the assessee), a company incorporated in the UAE, is engaged, inter
alia, in providing to non-resident Indians in UAE the service of remitting
funds to India. For its India-centric business, the assessee had set up four
LOs in Chennai, New Delhi, Mumbai and Jalandhar after obtaining prior approval
from the RBI u/s 29(1)(a) of the erstwhile Foreign Exchange Regulation Act,
1973.

 

As per the
business practice followed by the assessee, the funds collected from the NRI
remitters are remitted to India by either of the following two modes:

(i)
Telegraphic transfer: Under this mode the amount is remitted telegraphically by
transferring directly from the UAE through normal banking channels to the
beneficiaries in India and the LOs have no role to play except attending to
complaints regarding fraud, etc.

(ii)
Physical dispatch of instruments: Under this mode, on a request from the NRI
remitter, the assessee sends instruments such as cheques / drafts through its
LOs to beneficiaries in India. For this purpose, the LOs download the
particulars of the remittance (while staying connected to the server in the
UAE), and print and courier the instruments to beneficiaries in India.

 

In this
case, the contract pursuant to which the funds are remitted to India is entered
into between the assessee and the NRI remitter in the UAE. Moreover, the funds
for remittance as well as the commission are collected in the UAE.

 

From A.Y.
1998-99 to 2003-04, the assessee was filing Nil returns in India on the basis
that no income had accrued or deemed to have been accrued in India under the
ITA or the India-UAE DTAA. However, owing to some doubt expressed by the
Revenue, the assessee filed an application for advance ruling before the
Authority for Advance Rulings (AAR) in 2003 seeking a ruling on ‘whether any
income is accrued / deemed to be accrued in India from the activities carried
out by the company in India’.

 

AAR decision

The AAR
ruled that the income of the assessee was deemed to have accrued in India on
the basis that it had a ‘business connection’ in terms of section 9(1) of the
ITA insofar as activities concerning physical dispatch of instruments was
concerned. The AAR observed that without the activities of the Indian LOs, the
transaction of remittance would not be complete. Further, the commission earned
by the assessee covers not only the activities carried out in the UAE, but also
the activities carried out by the LOs in India.

 

The AAR also
held that the ‘preparatory or auxiliary’ exception to formation of a PE under
the India-UAE DTAA would not be applicable in respect of physical dispatch of
instruments. This was on the basis that a transaction for remittance would not
be completed without the activities of the Indian LOs. Specifically, the AAR
noted that the role of the LOs’ physical dispatch of instruments is ‘nothing
short of performing the contract of remitting the amounts at least in part.’

 

Delhi High
Court decision

The assessee
challenged the AAR ruling by way of a writ petition in the Delhi High Court.
The High Court noted that the AAR’s discussions and findings on the ‘business
connection’ test under domestic law were unnecessary, considering the scope of
section 90 of the ITA which allows for tax treaties to override domestic law
provisions. Accordingly, the High Court restricted its analysis to the
applicable provisions of the India-UAE DTAA, i.e., Articles 5 and 7.

 

The Court
held that although an LO comes within the inclusive list of fixed places of
business under Article 5(2)(c), it is subject to exclusions under Article 5(3),
including fixed places of business maintained solely for carrying out
activities which are ‘preparatory or auxiliary’ in nature. While relying on the
common meaning of the terms ‘preparatory or auxiliary’ under Black’s law
dictionary (i.e., activities which aid / support the main activity), the Court
concluded that the activities performed in respect of physical dispatch of
instruments were merely ‘preparatory or auxiliary’ in nature. It observed that
the error committed by the AAR was to read the test of ‘preparatory or
auxiliary’ which permits making a value judgment on whether the transaction
would or would not have been completed without the activities of the LOs and
were, therefore, significant activities. The Court indicated that the test of ‘preparatory
or auxiliary’ is not a function only of whether the activities under
consideration led to completion of the transaction.

 

In arriving
at its conclusion, the High Court applied the judgment of the SC in DIT
(IT) vs. Morgan Stanley & Co. [2007] 162 Taxman 165 (SC) and
accorded a liberal and wide interpretation to the exclusionary clause of PE.
The reason for this was that by invoking clauses of PE, income which otherwise
neither accrues / arises in India becomes taxable in India by virtue of a ‘deeming
fiction.’

 

Supreme
Court judgment

An SLP was
filed by the Revenue against the High Court decision. The core issue before the
Apex Court was whether the activities carried out by the LOs in India would
qualify the expression ‘of preparatory or auxiliary character’ as mentioned in
Article 5(3)(e) of the India-UAE DTAA.

 

In
confirming the finding of the High Court that the activities conducted by the
LOs were ‘preparatory or auxiliary’ and hence excludable from the purview of
PE, the Supreme Court also referred to the limited permission granted by the
RBI under FERA to the assessee regarding the activities to be conducted by the
LOs.

 

The Supreme
Court noted that as per the nature of activities allowed for under the RBI
permission, the LOs were only allowed to provide incidental service of delivery
of cheques / drafts drawn on a bank in India. They were not allowed to perform
business activities such as (i) entering into a contract with any party in
India; (ii) rendering consultancy or any other service directly or indirectly
with or without consideration to anyone in India; (iii) borrowing or lending
any money from or to any person in India without RBI’s permission. Thus, it was
amply clear that the LOs in India were not to undertake any other activity of
trading (commercial or industrial) or enter into any business contracts in its
own name in India. On this basis, the Supreme Court concluded that the nature
of activities conducted by the LOs as circumscribed by the RBI constituted
‘preparatory or auxiliary’ in character, and hence outside the purview of PE.

 

The Court
noted further that through the LOs the assessee was not carrying on any
business activity in India, but only dispensing with the remittances by
downloading the information from the UAE server and printing the cheques /
drafts. The LOs could not even charge commission / fee for their services.
Therefore, no income actually accrued to the LOs u/s 2(24) of the ITA.

 

The Supreme
Court further held that the activities of the LO of the taxpayer in India are
limited activities which are circumscribed by the permission given by the RBI
and are of preparatory or auxiliary character and, therefore, covered by
Article 5(3)(e). As a result, the ?xed place used by the respondent as LO in
India would not qualify the de?nition of PE in terms of Articles 5(1) and 5(2)
of the DTAA on account of non-obstante and deeming clause in Article
5(3) of the DTAA. Hence, no tax can be levied or collected from the LO of the
taxpayer in India in respect of the primary business activities concluded by
the taxpayer in the UAE.

 

The Supreme
Court also observed that after the enactment of the Finance Act, 2003,
Explanation 2 to section 9(1)(i) of the Act was inserted which de?ned business
connection as business activity carried out by a person on behalf of a
non-resident. In this regard, the Court held that even if the stated activities
of the LO of the taxpayer in India are regarded as business activity, the same
being ‘of preparatory or auxiliary character’, by virtue of Article 5(3)(e) of
the DTAA, the LO of the taxpayer in India which would otherwise be a PE, is
deemed to be expressly excluded from being so. Since, by a legal ?ction, it is
deemed not to be a PE of the taxpayer in India, it is not amenable to tax
liability in terms of Article 7 of the DTAA.

 

At present,
there are few precedents which provide guidelines for the ‘preparatory or
auxiliary’ test such as (i) to check whether the activities performed in the
fixed place of business form an essential and significant part of the
enterprise as a whole as held in Western Union Financial Services Inc.
vs. ADIT [2007] 104 ITD 40 (Delhi); (ii) whether the activities
performed in the fixed place of business form part of the core business
activities of the enterprise, as held in Angel Garments Ltd. [2006] 287
ITR 341 (AAR).

 

After
analysing the facts, the Supreme Court held the activities of the LOs to be of
‘preparatory or auxiliary’ nature without setting out guidelines for the
application of the ‘preparatory or auxiliary’ test. It would have been
extremely helpful if the Supreme Court would have laid down detailed guidelines
for the application of the ‘preparatory or auxiliary’ test.

 

The above
ruling is quite relevant for money remittance companies and potentially other businesses
which are primarily operated from outside India with some preparatory or
auxiliary activities in India.

 

It is to be
noted though that India has introduced an equalisation levy of 2% on certain
non-resident service providers providing services to customers in India, and
its application with respect to the specific facts may need evaluation.

 

Further, the
above decision is a welcome decision, wherein along with providing comments on
the meaning of ‘preparatory or auxiliary character’, the Court has re-affirmed
the guiding principle of ‘treaty override’ which forms the pillar of the
international tax law in India.

 

The Supreme
Court has laid emphasis on bringing out the characteristics of what can be
termed as ‘of preparatory or auxiliary character’ which shall be relevant for
future cases. Further, the Court has de?ned the rationale of taxability due to
which the judgment shall hold persuasive value for similar cases.

 

The decision
seems to lay down a broad guideline that where the activities of an LO are
restricted to the approvals granted by the RBI, such activities should qualify
as preparatory or auxiliary in nature and should not constitute a PE in India.

 

8. PRECAUTIONS REGARDING LOs FOR NOT BEING
CONSIDERED AS PEs

The
important point here would be to restrict the activities of the LO to
preparatory or auxiliary work only. Further, the LO should not venture into or
towards activities which could be viewed as commercial or core activities
undertaken on behalf of the foreign entity or its group entity. If it does so,
not only could the LO trigger a PE risk in India, but it could also be seen as
going beyond the domain of the activity permissions granted by the RBI.
Further, appropriate documentation should be maintained to prove that the
activities of the LO are preparatory or auxiliary in nature such as, for
instance, the RBI approval letter in the case of the U.A.E. Exchange Centre,
which reflected that the activities of the LO were mere support services to the
foreign parent entity.

 

In our view,
one should not presume that an LO or place of business will not constitute a PE
merely because the RBI or a government body has given permission for its
establishment in India. To determine the Indian tax implications, it is
critical to examine whether the LO is carrying out an important part of the
business activity of the foreign company (i.e., a commercial activity which is
core income-generating), or whether it is merely aiding or supporting
activities of the main business.

 

9. BEPS ACTION 7 AND MULTI-LATERAL INSTRUMENT (MLI)

While
analysing the ‘preparatory or auxiliary’ activities, one may additionally need
to be mindful of the BEPS Action Plan 7 and Article 13 of the MLI which deal
with the issue of artificial fragmentation of activities between various group
companies to avail the benefit of ‘preparatory or auxiliary’ activities.

 

Specific
activity exemption

In relation
to tax treaties to which the provisions of MLI regarding specific
activity-based exemption apply, it will become important to demonstrate that
the stated activity in the exclusion clause (advertising, storage, delivery,
etc.) is indeed ‘preparatory or auxiliary’ in nature. As the world moves
towards complex and innovative business models which rely on limited physical
presence in the country where the customers reside, foreign players must
assess, based on the facts, whether their Indian presence can still be said to
be merely aiding the core business in order to avail exemption under the
respective tax treaty.

 

Anti-fragmentation
rules

Article 13
is incorporated in the MLI with a view to address the issue of artificial
avoidance of the PE status through fragmentation of activities between
closely-related enterprises. Thus, businesses carrying out more than one
activity in a country which earlier individually were getting covered under the
term ‘preparatory or auxiliary character’ and hence were not forming a PE in
India, could be subject to the provision of Article 13 of the MLI. Accordingly,
such activities may thus form a PE in India if the activities performed when
seen cumulatively exceed what can be considered as of ‘preparatory or auxiliary
character’.

 

However, one
would have to first check whether Article 13 of the MLI applies to the relevant
DTAA in question.

 

With MLI
coming into force and India being a signatory thereto, going forward the
business models would need to be independently examined under the provisions of
the MLI for ascertaining whether or not a PE is established. Now, with
implementation of BEPS and signing of MLIs, litigation on this issue may
further intensify as the Indian tax authorities would now have additional
ammunition to target the LOs.

 

India has
opted for Option A and anti-fragmentation rules. Accordingly, in India no
specific exemption would be available unless the activities are preparatory or
auxiliary in nature and also there should not be artificial fragmentation of
activities within the group.

 

10. CONCLUSION

Whether or
not the activities of LOs constitute a PE of the non-resident entity is a very fact-speci?c
and vexed issue. In the past, where an LO has exceeded its scope of permitted
activities, courts have held that such an LO can constitute the PE of the
foreign entity in India. Therefore, it is important to ensure at all times that
an LO in India operates within the limits set out by RBI.

 

The
determination of the question as to whether any activities of an LO qualify as
preparatory or auxiliary in nature would depend upon the facts of each case and
the nature of business of the taxpayer. In order to decide the status of the
LO, a functional and factual analysis of the activities performed by it needs
to be undertaken.

 

It is very important to
keep in mind that all the aforementioned judicial precedents should be
critically analysed in the light of BEPS Action Plan 7, MLI and changes in the
OECD Commentary, before applying the same on the factual matrix of a particular
case.

 

Whether in sorrow or in happiness,
a friend is always a friend’s support.

— (Valmiki Raamaayan 4.8.40)

OECD’S ‘GloBE’ PROPOSAL – PILLAR TWO (Tax Challenges of the Digitalisation of the Economy – Part II)

The current international tax
architecture is being exploited with the help of digitalised business models by
the Multinational Enterprises (MNEs) to save / avoid tax through BEPS. To
counter this, the existing tax rules require reconsideration and updation on
the lines of the digitalised economy. Many countries have introduced unilateral
measures to tackle the challenges in taxation arising from digitalisation which
restricted global trade and economy.

 

Now, OECD has set the deadline of
end-2020 to come out with a consensus-based solution to taxation of
cross-border transactions driven by digitalisation. For this, OECD has
published two public consultation documents, namely (i) ‘Unified Approach under
Pillar One’ dealing with Re-allocation of profit and revised nexus rules, and
(ii) ‘Global Anti-Base Erosion Proposal (GloBE) – Pillar Two’. It is important
to understand these documents because once modified, accepted and implemented
by various jurisdictions, they will change the global landscape of international
taxation in respect of the digitalised economy.

 

Part I of this article on ‘Pillar
One’ appeared in the January, 2020 issue of the BCAJ. This, the second
article, offers a discussion on the document dealing with GloBE under ‘Pillar
Two’.

 

1.0 BACKGROUND

Thanks to advances in technology,
the way businesses were hitherto conducted is being transformed rapidly. In
this era of E-commerce, revenue authorities are facing a lot of challenges to
tax Multinational Enterprises (MNEs) who are part of the digital economy. To
address various tax challenges of the digitalisation of the economy, OECD in
its BEPS Action Plan 1 in 2015 had identified many such challenges as one of
the important areas to focus upon. Since there could not be any consensus on
the methodology for taxation, the Action Plan recommended a consensus-based
solution to counter these challenges. OECD has targeted to develop such a
solution by the end of 2020 after taking into account suggestions from the
various stakeholders. Meanwhile, on the premise of the options as examined by
the Task Force on the Digital Economy (TFDE), the BEPS Action Plan 1 suggested
three options to counter the challenges of taxation of the digitalised economy
which could be incorporated in the domestic laws of the countries. It is
provided that the measures to tackle the challenges of taxing digitalised
economy shall not be incompatible with any obligation under any tax treaty or
any bilateral treaty. They shall be complementary to the current international
legal commitments.

 

OECD issued an interim report in
March, 2018 which examines the new business framework as per the current
digitalised economy and its impact on the international tax system. In January,
2019 the Inclusive Framework group came up with a policy note to address the
issues of taxation of digitalised economy into two complementary ‘pillars’ as
mentioned below:

 

Pillar 1 – Re-allocation of
Profits and the Revised Nexus Rules

Pillar 2 – Global Anti-Base
Erosion Mechanism

 

The three proposals suggested under
Pillar 1 are as follows:

(i) New Nexus Rules – Allocation based on sales rather than physical
presence in market / user jurisdiction;

(ii) New Profit Allocation Rules – Attribution of profits based on
sales even in case of unrelated distributors (in other words, allocation of
profits beyond arm’s length pricing, which may continue concurrently between
two associated enterprises);

(iii) Tax certainty via a three-tier mechanism for profit allocation:

(a) Amount A: Profit allocated to market jurisdiction in absence of
physical presence.

(b) Amount B: Fixed returns varying by industry or region for certain
‘baseline’ or ‘routine’ marketing and distributing activities taking place (by
a PE or a subsidiary) in a market jurisdiction.

(c) Amount C: Profit in excess of fixed return contemplated under
Amount B, which is attributable to marketing and distribution activities taking
place in marketing jurisdiction or any other activities. Example: Expenses on
brand building or advertising, marketing and promotions (beyond routine in
nature).

 

Thus, it highlights potential
solutions to determine where the tax should be paid and the basis on which it
should be paid.

 

Let us look at the proposals
under Pillar Two in more detail.

 

2.0 PILLAR TWO – GLOBAL
ANTI-BASE EROSION PROPOSAL (‘GloBE’)

The public consultation document
has recognised the need to evolve new taxing rules to stop base erosion and
profit shifting into low / no tax jurisdictions through virtual business
structures in a digitalised economy. According to the document, ‘This Pillar
seeks to comprehensively address remaining BEPS challenges by ensuring that the
profits of internationally operating businesses are subject to a minimum rate
of tax. A minimum tax rate on all income reduces the incentive for taxpayers to
engage in profit shifting and establishes a floor for tax competition among
jurisdictions.’

 

The harmful race to the bottom on
corporate taxes and uncoordinated and unilateral efforts to protect the tax
base has led to the increased risk of BEPS, leading to a lose-lose situation
for all jurisdictions in totality. Therefore, the GloBE proposal is an attempt
to shield the tax base of jurisdictions and lessen the risk of BEPS.

 

Broadly, the GloBE proposal aims
to have a solution based on the following key features:

 

(i) Anti-Base Erosion and Profit Shifting

It not only aims to eliminate
BEPS, but also addresses peripheral issues relating to design simplicity,
minimise compliance and administration costs and avoiding the risk of double
taxation. Taxing the entities subject to a minimum tax rate globally will seek
to comprehensively address the issue of BEPS. Such a proposal under Pillar Two
will cover the downside risk of the tax revenue of the MNEs globally by
charging a minimum tax rate, which otherwise would lead to a lose-lose
situation for various jurisdictions.

(ii) New taxing rules through four component parts of the GloBE proposal

The four component parts of the
GloBE proposal, proposed to be incorporated by way of changes into the domestic
laws and tax treaties, are as follows:

 

(a) Income inclusion rule

Under this rule, the income of a
foreign branch or a controlled entity if that income was subject to tax at an
effective rate that is below a minimum rate, will be included and taxed in the
group’s total income.

 

For example, the profits of the
overseas branch in UAE of a Hong Kong1  (HK) company will be included in the taxable
income in HK, as the UAE branch is not subjected to tax at the minimum rate,
say 15%. But for this rule, profits of the overseas branch of an HK company
would not have been taxed in HK. Of course, HK may have to amend its domestic
law to provide for such taxability.

 

Example 1 – Accelerated taxable
income (as given in the public consultation document). In our
opinion, this example throws light on the income inclusion rule.

 

Application of income inclusion
rule

Example 1

Year 1

Year 2

Inclusion rule (Book)

Inclusion rule (Book)

Country B (Tax)

Inclusion rule (Book)

Country

B (Tax)

Income

50

100

50

0

Expenses

(10)

(20)

(10)

(0)

Net income

40

80

40

(0)

Tax paid

(16)

(16)

0

0

Minimum tax (15% x net income)

(6)

 

(6)

 

Excess tax (= Tax paid – Minimum tax)

10

 

0

 

Tentative inclusion rule tax

–

 

6

 

Excess tax carry-forward
used

–

 

(6)

 

Inclusion rule tax

–

 

0

 

Remaining excess tax
carry-forward

10

 

4

 

 

(b) Undertaxed payments rule

It would operate by way of denial
of a deduction or imposition of source-based taxation (including withholding tax)
for a payment to a related party, if that payment was not subject to tax at or
above a minimum rate.

(c) Switch-over rule

It is to be introduced into tax
treaties such that it would permit a residence jurisdiction to switch from an
exemption to a credit method where the profits attributable to a Permanent
Establishment (PE) or derived from immovable property (which is not part of a
PE) are subject to an effective rate below the minimum rate.

(d) Subject to tax rule

It would complement the
under-taxed payment rule by subjecting a payment to withholding or other taxes
at source and adjusting eligibility for treaty benefits on certain items of
income where the payment is not subject to tax at a minimum rate.

 

The GloBE proposal recognises the
need for amendment of the domestic tax laws and tax treaties to implement the
above four rules. However, it also cautions for coordinated efforts amongst
countries to avoid double taxation.

 

3.0  DETERMINATION OF TAX
BASE

The first step towards applying a
minimum tax rate on MNEs is to determine the tax base on which it can be
applied. It emphasises the use of financial accounts as a starting point for
the tax base determination, as well as different mechanisms to address timing
differences.

 

3.1 Importance of consistent tax base

One of the simple methods to
start determining the tax base is to start with the financial accounting rules
of the MNE subject to certain agreed adjustments as necessary. The choice of
accounting standards to be applied will be subject to the GloBe proposal. The
first choice to be made is between the accounting standards applicable to the
parent entity or the subsidiary’s local GAAP. The next choice is which of the
accounting standards will be acceptable for the purposes of the GloBE proposal.

 

As per the public document, it is
suggested to determine the tax base as per the CFC Rules or, in absence of CFC
rules, as per the Corporate Income Tax Rules of the MNE’s jurisdiction. Such an
approach will overcome the limitation of the inclusion of only certain narrow
types of passive income. However, it would mean that all entities of an MNE
will need to recalculate their income and tax base each year in accordance with
the rules and regulations of the ultimate parent entity’s jurisdiction. There
can be differences in accounting standards between the subsidiary’s
jurisdiction and the ultimate parent entity’s jurisdiction, and to address the
same the public document recommends that the MNE groups shall prepare the
consolidated financial statements and compute the income of their subsidiaries
using the financial accounting standards applicable to the ultimate parent
entity of the group as part of the consolidation process.

 

Accounting standards which are
accepted globally can serve as a starting point for determining the GloBE tax
base.

 

3.2 Adjustments

Financial accounting takes into
account all the income and expenses of an enterprise, whereas accounting for
tax purposes can be different. Relying on the unadjusted figures in accounts
could mean that an entity’s net profits may be overstated or understated when
compared to the amount reported for tax purposes. Most of the differences among
the accounting standards will be timing differences and some of the differences
may be permanent differences or temporary differences that require further
consideration, and some of the timing differences may be so significant that
they warrant the same consideration as permanent differences.

 

3.2.1  Permanent differences

Permanent differences are
differences in the annual income computation under financial accounting and tax
rules that will not reverse in the future. Permanent differences arise for a
variety of reasons. The need to adjust the tax base may depend upon the level
of blending ultimately adopted in the GloBE proposal. Inclusions and exclusions
of certain types of income and expenses in domestic tax policy may lead to
permanent differences. Thus, consideration for such differences is of utmost
importance while determining the tax base.

 

Examples of permanent differences

Dividends received from foreign
corporations and gains on sale of corporate stocks may be excluded from income
to eliminate potential double taxation. Under the worldwide blending approach,
the consolidated financial statements should eliminate dividends and stock
gains in respect of entities of the consolidated group. However, under a
jurisdictional or entity blending approach, the financial accounts of the group
entities in different jurisdictions would be prepared on a separate company
basis and dividends received from a ‘separate’ corporation would be included in
the shareholder’s financial accounting income.

Permanent difference also arises
due to disallowance of certain deductions under the domestic tax laws of a
particular jurisdiction, such as entertainment expenses, payment of bribes and
fines, etc.

 

3.2.2  Temporary differences

Temporary differences are
differences in the time for taking into account income and expenses that are
expected to reverse in the future. It can lead to a low cash effective tax rate
at the beginning of a period and high cash effective tax rate at the end of a
period, or vice versa. A separate blending approach may lead to
difference volatility in the ETR from one period to another. Temporary
differences are very important in determination of the tax base and also affect
the choice of blending.

 

Approaches to addressing
temporary differences

The public consultation document
on Pillar Two lists three basic approaches to addressing the problem of
temporary differences, namely,

(i) carry-forward of excess taxes and tax attributes,

(ii) deferred tax accounting, and

(iii) a multi-year average effective tax rate.

 

It also provides that these basic
approaches could be tailored and elements of the different approaches could be
combined to better or more efficiently address specific problems.

 

4.0 BLENDING OF HIGH-TAX
AND LOW-TAX INCOME FROM ALL SOURCES

According to the public
consultation document, ‘Because the GloBE proposal is based on an effective
tax rate (“ETR”) test it must include rules that stipulate the extent to which
the taxpayer can mix low-tax and high-tax income within the same entity or
across different entities within the same group. The Programme of Work refers
to this mixing of income from different sources as “blending.”’

 

Blending means the process of mixing
of the high-tax and low-tax income of an MNE from all the sources of all the
entities in the group. Blending will help to calculate the ETR on which the
GloBE proposal is based. It can be done on a limited basis or a comprehensive
basis, from a complete prohibition on blending to all-inclusive blending.
Limited basis will lead to no or less blending (mixing) of income and taxes of
all different entities and jurisdictions. This would restrict the ability of an
MNE to reduce charge of tax applied on all entities across all jurisdictions
through mixing the high-tax and low-tax income.

 

It is suggested to apply the
GloBE proposal (minimum tax rate rule) in the following manner:

First Step: Determine
the tax base of an MNE and then calculate the Effective (blended) Tax Rate
[ETR] of the MNE on the basis of tax paid.

Second Step: Compare
the ETR with the Minimum Tax Rate prescribed according to the relevant blending
approach.

Third and the final Step: Use any
of the four components as specified in the GloBE proposal to the income which
is taxed below the minimum tax rate prescribed. [The four components as
discussed above are: (i) Income inclusion rule, (ii) Under-taxed payments rule,
(iii) Switch-over rule and (iv) Subject to tax rule].

 

Determining the Effective
(blended) Tax Rate [ETR] of the MNEs forms the second step in applying a
minimum tax rate rule. It throws light on the level of blending under the GloBE
proposal, i.e., the extent to which an MNE can combine high-tax and low-tax
income from different sources taking into account the relevant taxes on such
income in determining the ETR on such income.

 

There are three approaches to
blending:

4.1   Worldwide blending approach

4.2   Jurisdictional blending approach

4.3   Entity blending approach.

 

The above three different
blending approaches are explained in brief below:

4.1 Worldwide blending approach

In this case, total foreign
income from all jurisdictions and tax charged on it are mixed. An MNE will be
taxed under such an approach if the total tax charged on such foreign income of
an MNE is below a prescribed minimum rate. The additional tax charged on such
income will be the liability of an MNE to bring the total tax charged to the
prescribed minimum rate of tax.

4.2 Jurisdictional blending approach

In this case, blending of foreign
income and tax charged on such income will be done jurisdiction-wise. The
liability of additional tax would arise when the income earned from all the
entities in a particular jurisdiction is below the minimum rate, i.e., if an
MNE has been charged lower tax on the income from a particular jurisdiction
than the minimum rate of tax. The sum of the additional taxes of all the
jurisdictions will be the tax liability of an MNE.

4.3 Entity blending approach

Under this approach blending is
done of income from all sources and tax charged on such income in respect of
each entity in the group. Additional tax will be levied on an MNE whenever any
foreign entity in a group is charged with tax below the minimum tax rate
prescribed for that foreign entity.

 

All three approaches have the
goal congruence of charging MNEs a minimum rate of tax globally with different
policy choices.

 

In addition, in respect of
blending, the public consultation document on Pillar Two also explains in
detail the following:

(1)   Effect of blending on volatility

(2)   Use of consolidated financial accounting information

(3)   Allocating income between branch and head office

(4)   Allocating income of a tax-transparent entity

(5)   Crediting taxes that arise in another jurisdiction

(6)   Treatment of dividends and other distributions.

 

5.0 CARVE-OUTS

Implementation of the GloBE
proposal is fraught with many challenges and therefore, to reduce the
complexity and restrict the application, the Programme of Work2,
through its public consultation document, calls for the exploration of possible
carve-outs as well as thresholds and exclusions. These carve-outs / thresholds
/ exclusions will ensure that small MNEs are not burdened with global
compliances. They would also provide relief to specific sectors / industries.

 

The Programme of Work calls for
the exploration of carve-outs, including for:

(a) Regimes compliant with the standards of BEPS Action 5 on harmful tax
practices and other substance-based carve-outs, noting, however, that such
carve-outs would undermine the policy intent and effectiveness of the proposal.

(b) A return on tangible assets.

(c) Controlled corporations with related party transactions below a
certain threshold.

 

The Programme of Work also calls
for the exploration of options and issues in connection with the design of
thresholds and carve-outs to restrict application of the rules under the GloBE
proposal, including:

(i)   Thresholds based on the turnover or other indications of the size
of the group.

(ii) De minimis thresholds to exclude transactions or entities
with small amounts of profit or related party transactions.

(iii) The appropriateness of carve-outs for specific sectors or industries.

 

6.0 OPEN ISSUES

There are several open issues in
the proposed document, some of which are listed below:

 

6.1 Appropriate Accounting Standards

Determination of tax base is the
starting point to apply measures given in the GloBE proposal. Thus, the use of
financial accounting is the basis to determine the tax base. Hence, the issue
could be, which of the accounting standards would be appropriate and
recommended for determining the tax base across various jurisdictions?

 

6.2 Non-preparation of consolidated accounts by smaller MNEs

There can be some instances when
smaller MNEs are not required to prepare consolidated accounts by the statute
for any purpose. In such a case where the information is not consolidated, how
will the tax base be determined?

 

6.3 Compliance cost and economic effects

The blending process,
irrespective of the policy approach, will have a lot of compliance costs which
may even exceed the economic benefit out of the process. How does the GloBE
proposal deal with this?

 

6.4 Changes in ETR due to tax assessments in subsequent years

MNEs operate in different
jurisdictions and each jurisdiction may have different tax years, assessment
procedures and so on. It is very likely that tax determined for a particular
year based on self-assessment may undergo significant change post-assessment or
audit by tax authorities. This may change the very basis for benchmarking of
ETR with a minimum tax rate. There should be a mechanism to make adjustments
beyond a tolerable limit of variance.

 

7.0 CONCLUSION

OECD had asked for public
comments on its document on GloBE not later than 2nd December, 2020.
However, there are several areas yet to be addressed which are ambiguous and to
find solutions to them within a short span of time till December, 2020 is
indeed a daunting task. However, it is also a fact that in the absence of
consensus and delay in a universally acceptable solution, more and more
countries are resorting to unilateral measures to tax MNEs sourcing income from
their jurisdictions.

 

In this context, it is important
to note that vide Finance Act, 2016 India introduced a unilateral
measure of taxing certain specified digitalised transactions by way of
Equalisation Levy (EL) @ 6%. The scope of EL is expanded significantly by the
Finance Act, 2020 by providing that E-commerce operators, including
facilitators, shall be liable to pay EL @ 2% on the consideration received
towards supply of goods and services.

 

Determination
of a tax base globally on the basis of consolidated profits is a very complex
process. To give effect to all the permanent and temporary differences while
determining the tax base along with blending of income from different sources
from all jurisdictions will be a challenging task for the MNEs. It is to be seen
how effectively the four components of the GloBE proposal, individually and in
totality, will be practically implemented. The success of the GloBE proposal
also depends upon the required changes in the domestic tax laws by the
countries concerned. The cost of compliance and uncertainty may also need to be
addressed. A higher threshold of revenue could take care of affordability of
cost of compliance by MNEs, whereas clear and objective rules may take care of
uncertainty.

 

All
in all, we are heading for a very complex global tax scenario.

COVID-19 AND TRANSFER PRICING – TOP 5 IMPACT AREAS

Starting December, 2019, the
world has witnessed the once-in-a-generation pandemic. Multinational
Enterprises will have to consider the effect of COVID 19 on their transfer
pricing policies due to large scale economic disruption. It will be imperative,
especially in this economic environment, to adhere to and demonstrate arms
length behaviour. Many MNEs have started revisiting transfer pricing policies,
inter company agreements, and documentation standards.

 

This article highlights the top
five transfer pricing impact areas arising out of Covid-19:

 

  • Supply chain restructuring
  • Renegotiation of pricing and other terms
  • Cash optimisation
  • Balancing business uncertainty with tax
    certainty
  • Benchmarking

 

Towards the end of the article,
some recommendations have also been outlined for consideration of the
government authorities to make it easier for taxpayers to demonstrate
compliance with arm’s length principles.

 

1.  Supply chain restructuring

MNE groups with geographically
diverse supply chains are affected severely due to the pandemic. Any disruption
to any part of the supply chain tends to impact the entire group, though the
extent of the impact depends on the importance of the part of the supply chain
which has been disrupted and the availability of alternatives.

 

Many MNE groups have discovered
the fragility in their value chains as a result of the disruption caused by the
pandemic. They are faced with one or more of the following situations:

  • Longer than needed supply chain involving
    various countries
  • Overdependence on a particular supplier /
    set of suppliers / region / country for materials / services / manufacturing /
    market
  • Affiliate(s) finding it difficult to sustain
    their businesses owing to disruption caused by the pandemic
  • Unviable non-core businesses.

 

MNE groups could consider this as
an opportunity to revisit their existing supply chains and also potentially
restructure the supply chain to achieve one or more of the following:

  • Shorter supply chains involving lesser
    number of geographical locations
  • Creation of alternate sourcing destinations
    for materials and services
  • Setting up of manufacturing / service
    facilities in alternate destinations
  • Closure and / or monetisation of non-core
    businesses / entities.

 

These restructuring transactions
could raise multiple transfer pricing issues, including:

  • Exit charges for that affiliate which will
    be eliminated from the supply chain / will get reduced business because of
    creation of an alternate destination
  • New transfer pricing agreements, policies
    and benchmarks to be developed in case of setting up of affiliates in new /
    alternate jurisdictions
  • Valuation issues in case non-core assets are
    transferred to affiliates
  • Issues relating to bearing of closure costs
    in case some group entities or part of their businesses face insolvency /
    closure
  • Issues around identification and valuation
    of intangibles involved in the restructuring exercise
  • Appropriate articulation of restructuring
    transactions in the local files of the entities concerned and the Master File
    of the group.

 

2.  Renegotiation of pricing and other terms

In arm’s length dealings,
businesses are in fact renegotiating prices as well as other terms, mainly with
their vendors.

 

In the case
of many MNEs it would be perfectly arm’s length behaviour for different
entities within the group to start discussions and re-negotiations regarding
prices and other terms of their inter-company transactions. In fact, in many
cases it might be non-arm’s length for companies to not renegotiate with their
affiliates. In almost all cases, it would be arm’s length behaviour to have
inter-company agreements which mirror agreements that would have been entered
into between third parties.

 

Renegotiations of existing
arrangements / agreements could be of at least the following types:

 

2.1. Compensation for limited
risk entities in the group

Many MNEs
have entities which operate as limited risk entities, such as captive service
providers, contract manufacturers, limited risk distributors, etc. As a general
rule, these limited risk entities are eligible for a stable income, all
residual profits or losses being attributed to the Principal affiliate.
However, in today’s dynamic business environment, no-risk entities do not exist
and limited risk entities also bear some risks. For example, limited risks
captive service providers or contract manufacturers have a significant single
customer risk; therefore any adverse disruption to that single customer will
adversely impact the captive as well.

 

In times of disruption like this,
exceptions to the general rule may be warranted and compensation for limited
risk activities may need to be revisited, depending, inter alia, on the
type of activity performed, type of disruption faced and the control and decision-making
capabilities of each of the parties involved.

 

In third party situations the
service provider would be better off to agree to reduced income (or even losses
in the short term) from the Principal, especially if the Principal itself is
facing challenges relating to its own survival. Accordingly, on a case-to-case
basis, certain MNEs may have the ability / necessity to revisit their
arrangements with their captive entities for the short to medium term. The
revision in the inter-company agreements could take several forms. For
instance, such revised agreements may provide for compensation for only costs
(without a mark-up), reduced mark-up, compensation for only ‘normal’ costs
(with or without mark-up), etc.

 

2.2.  Renegotiations of other terms

It is common for entities in an
MNE group to negotiate prices of their inter-company transactions from time to
time in line with the prevailing business dynamics. However, in emergencies
like these certain other terms of the agreements between affiliates may also
need to be renegotiated. For example, the commitment relating to quantities
which a manufacturer will purchase from the related raw material supplier may
undergo a significant renegotiation. Given the non-recovery of fixed costs due
to the resulting idle capacity, the raw material cost per unit may increase
which the supplier may want to pass on to the manufacturer. A higher per unit
cost, on the other hand, may make the related supplier uneconomical for the
manufacturer. In the interest of the long-term commercial relationship, the
parties may agree to an in-between pricing mechanism, as is likely to be the
case in third-party dealings. Which party would bear which types of costs would
depend on the characterisation of the parties, the decision-making evidenced
through capabilities of the persons involved, and the options realistically
available to the parties involved.

 

3. Cash optimisation

Cash optimisation is currently
one of the most important considerations of businesses across the world.

 

Many MNE groups facing a cash
crunch have started looking at the cash position with different group entities
and trying to optimise the cash available with them. This could lead to some
new funding-related transactions and benchmarking issues such as those relating
to interest and guarantee fees transactions between affiliates.

 

In some situations, taxpayers
that have borrowed funds from their affiliates and are not in a position to
honour their interest / principal repayment commitments could approach their
affiliate lenders to negotiate for a reduction in interest rate / interest
waiver / moratorium at least for some period of time. On the other hand, the
lender affiliate may want to balance the moratorium with a revision in the
interest rate. Significant movements in exchange rates of currencies primarily
attributable to the pandemic could make this negotiation even more dynamic. Any
kind of negotiation should take into account the perspectives of both parties
and options realistically available to them.

 

Similarly, payment terms for
goods or services purchased from or sold to AEs or other inter-company
transactions, such as royalties, could also be renegotiated at least for the
short term, to enable different entities within the MNE group to manage their
working capital cycle more efficiently.

 

4. Balancing business uncertainty with tax certainty

4.1. Advance Pricing Agreements (APAs)

Globally, APAs have been an
effective tool for taxpayers and tax authorities to achieve tax certainty.
However, in times like these businesses go through unprecedented levels of
uncertainty. Therefore, many taxpayers may find it against their interest to be
bound by the terms of the APAs, especially where these provide for a minimum
level of tax profits to be reported by the taxpayer.

 

If their circumstances warrant
it, taxpayers who have already entered into an APA may consider applying for
revision of the same. The law provides that an APA may be revised if, inter
alia, there is a change in the underlying critical assumptions1.  Most Indian APAs have a critical assumption
of the business environment being normal through the term of the APA. In times
like these, a request for revision may be warranted if the business environment
for the taxpayer is considered to be abnormal based on the specific facts and
circumstances of its case and the impact of the uncertainty on the transaction
under consideration.

 

If the taxpayer and the
authorities do not agree to the revision, the taxpayer may potentially also
request for cancellation of the agreement2. On the other hand, in
case the tax authorities believe that cancellation of the agreement is
warranted due to failure on the part of the taxpayer to comply with its terms,
the taxpayer should utilise the opportunity provided to it to explain the
pandemic-related impact on the APA and the related reason for its failure to
comply with the terms of the agreement.

 

For taxpayers who are in the
process of negotiating for their APAs, and for whom the business impact is very
uncertain right now, it may be prudent to wait to get some more clarity
regarding the full impact of the pandemic on their business before actually
concluding the APA.

 

Alternatively,
taxpayers should request for an APA for a shorter term, say a period of up to
Financial Year (F.Y.) 2019-20, even if it means entering into the APA for, say
three or four years. Another APA could then be applied for, starting F.Y.
2021-22, based on the scenario prevailing then.

 

4.2. Safe harbours

The government has not yet
pronounced the safe harbours for the F.Y. 2019-20. Once these are pronounced,
depending on their industry, extent of business disruption, expected loss of
business / margins and the safe harbours provided for F.Y. 2019-20 and onwards,
taxpayers should evaluate whether or not to opt for safe harbours at least for
the F.Y.s 2019-20 and 2020-21.

5. Benchmarking

The current economic situation is
likely to create some unique benchmarking issues which should be borne in mind.
While some of these issues are common to taxpayers globally, a few issues are
specific to India given the specific language of the Indian transfer pricing
regulations.

 

5.1. Justification of losses / low margins

Taxpayers are facing several
business challenges including cost escalations / revenue reductions which are
not related to their transactions with affiliates. Taxpayers in several sectors
have recorded sharp declines in revenues due to lockdowns in various parts of
the world, including India. Some taxpayers are faced with the double whammy of
escalated costs even in times of reduced revenues. Escalated costs could
include, for example, additional costs relating to factory personnel who are
provided daily meals and other essentials, additional transportation costs
incurred to arrange special transport for essentials owing to most fleet
operators not plying, etc.

 

It is pertinent for taxpayers to
identify and record these expenses separately from the expenses incurred in the
regular course of business (preferably using separate accounting codes in the
accounting system). Depending on the transfer pricing method and comparables
selected, taxpayers should explore the possibility of presenting their
profitability statements excluding the impact of these additional costs /
reduced revenues.

 

Another alternative available to
taxpayers is to justify their transfer prices considering alternative profit
level indicators (PLIs).

 

In any case, given the fact that
a lot of information about comparable benchmarks is not available in the public
domain currently, business plans, industry reports, business estimates, etc.,
prepared / approved by the management of the organisation should be maintained in
the documentation file and presented to the transfer pricing authorities if
called for.

 

5.2.  Loss-Making Comparables

During times of emergency like
these, for many businesses the focus shifts from growth / profitability to
survival. Therefore, many businesses could try operating at marginal costing
levels to recover committed costs / utilise idle capacity. Therefore, businesses
operating at net operating losses could be a normal event at least in times
like these. Secondly, even the taxpayer could have been pushed into losses
because of completely commercial reasons and even such losses could be arm’s
length and commercially justifiable.

 

From the
perspective of transfer pricing benchmarking, persistently loss-making
companies are typically rejected as comparables mainly because they do not
represent the normal economic assumption that businesses operate to make
profits. However, in times when business losses are normal events, benchmarking
a loss-making taxpayer with only profit-making comparables would lead to
artificial benchmarks and, potentially, unwarranted transfer pricing additions
in the hands of taxpayers.

 

In case loss-making comparables
are indeed rejected, it could be more prudent to reject companies making losses
at a gross level.

 

5.3.  Unintended comparables

The current
focus of many businesses is survival. Businesses which have created capacities
to cater to their affiliates may find it difficult to sustain if the impact of
the pandemic lasts longer than a few months. For example, consider the case of
an Indian manufacturer whose manufacturing capacities are created based on
demand projections and confirmed orders from its affiliates. Since the
capacities are completely used up in catering to demand from its affiliates,
the manufacturer does not cater to unrelated parties. In case there is a
disruption in the demand from such affiliates expected in the medium term, in
order to sustain in the short to medium term, the Indian manufacturer could
start using its manufacturing set-up for other potential (unrelated) customers
also. While this appears to be a purely rational business decision by the
Indian manufacturer, a question arises whether such third-party dealings will
be considered as comparable transactions for dealings with affiliates. The
Indian manufacturer in this case would need to be able to document the business
justification for entering into these transactions with unrelated parties and
whether these are economically and commercially different from the routine
related party transactions. Similar issues could arise in respect of other
transactions such as temporary local procurement, local funding, etc.


5.4.  Mismatch in years and adjustments

The Indian transfer pricing
regulations provide for the use of three years’ data of comparables to iron out
the impact of cyclical events from the benchmarking analysis. However, data of
the last two years may not be representative of the conditions prevailing in
the current year (in this context, current year could be F.Y. 2019-20 as well
as 2020-21, both years being impacted to different extents due to the
pandemic).

 

Since the financial data of a lot
of comparables is not available up to the due date of transfer pricing
compliance, this mismatch may lead to a situation where normal business years
of comparables are compared with the pandemic-affected years of taxpayers – a
situation which is very likely to give skewed results.

 

Adjustments are regularly made to
minimise the impact of certain differences between a tested party (say,
taxpayer) and the comparable benchmarks. Depending on the industry in which the
taxpayer operates and the manner in which its affiliates are impacted,
taxpayers may need to make adjustments, including some unique adjustments, to
more aptly reflect the arm’s length nature of inter-company prices.

 

However, in the Indian context
the law does not provide for the making 
of adjustments to the tested party and the adjustments are to be
necessarily made to comparable data3. Given the lack of reliable
data for making adjustments, the reliability of the adjustments themselves may
be questioned.

 

It must be borne in mind that the
principle which necessitates downward adjustments to comparables’ margins
currently being made to normal years will also require upward adjustments to
comparables’ margins in respect of pandemic-affected years going forward. This
situation is simplistically illustrated in Table 1 below. For the purpose of
the illustration, it is assumed that:

 

  • F.Y. 2017-18 and 2018-19 are considered as
    normal business years
  • F.Y. 2019-20 is impacted by the pandemic,
    but to a lesser degree
  • F.Y. 2020-21 is impacted severely by the
    pandemic
  • F.Y. 2021-22 is a normal business year
  • At the time of conducting the benchmarking
    analysis, comparables’ data is available for only the last two years.

 

 

Table 1 – Year-wise comparability4
and adjustments5

 

Tested
Financial Year

Comparable
Financial Years

Adjustments
Required (say, adjustments to margins)

Remarks

2019-20

2018-19, 2017-18

Downward

Downward adjustment due to loss of business
compared to normal years (2018-19, 2017-18)

2020-21

2019-20, 2018-19

Downward

Downward adjustment due to loss of business
compared to normal / less impacted years (2019-20, 2018-19)

2021-22

2020-21, 2019-20

Upward

Upward adjustment due to normal business compared
to impacted years (2020-21, 2019-20)

 

 

6.  Recommendations to government authorities

Government authorities could
consider the following recommendations by way of amendments to the law to relax
adherence to transfer pricing regulations for taxpayers, especially for F.Y.s
2019-20 and 2020-21, i.e., the impacted years:

 

  • Expansion of arm’s length range –
    Since different industries and different companies in the same industry will
    respond to the pandemic in different ways, the margins of comparables over the
    next two years could be extremely varied. Therefore, for the impacted years the
    arm’s length range may be expanded from the current 35th to 65th
    percentile to a full range, or inter-quartile range (25th to 75th
    percentile), as is used globally. Similarly, the applicable tolerance band
    could be appropriately increased from the current 1% / 3%.
  • Extending compliance deadline – In
    case the deadline for companies to file their financial statements for F.Y.
    2019-20 with the Registrar of Companies (RoC) is extended, the deadline for
    transfer pricing compliance should also be extended, to give the taxpayers
    their best chance to use comparable data for F.Y. 2019-20.
  • Extending deadlines for Master File
    compliance     – It is expected that companies will take time to be able to
    fully assess the impact of the pandemic on their business models, value chains,
    profit drivers, etc., and then appropriately document the same in their Master
    File. Therefore, the due date for Master File compliances may be extended at
    least for F.Y. 2019-20.
  • Adjustment to taxpayer data – At
    least for the impacted years, the law could be amended to provide an option to
    the taxpayer to adjust its own financial data since the taxpayer will have a
    better level of information regarding its own financial indicators.
  • Multiple year tested party data – As
    discussed earlier, the Indian transfer pricing regulations currently provide
    for using multiple year data of the comparables as benchmarks for current year
    data of the tested party. For F.Y.s 2019-20 and 2020-21, use of multiple year
    data could be allowed even for the tested party to average out the impact of
    the pandemic to a certain extent.
  • Safe harbours relaxation – Safe
    harbours for F.Y. starting 2019-20 are currently pending announcement. The
    authorities could use this opportunity to rationalise these safe harbours to
    levels representative of the current business realities and reduce the safe
    harbour margins expected of Indian taxpayers. Safe harbours which are
    representative of the current business scenario will be very helpful to
    taxpayers potentially facing benchmarking issues discussed earlier in the
    article.
  • Relaxation in time period for
    repatriation of excess money (secondary adjustment)     – Given the cash crunch
    being faced by MNEs worldwide, the time period for repatriation of excess money6  could be extended from the current period of
    only 90 days7.

 

CLOSING REMARKS

While the pandemic has impacted
almost every business in some way or the other in the short term and in many
inconceivable ways in the long term, just this claim alone will not be enough
from a transfer pricing perspective. Taxpayers will need to analyse the exact
impact of the pandemic on their entire supply chain and to the extent possible
also quantify the impact for their specific business. The impact of the
pandemic, steps taken by the management to mitigate the adverse impact,
negotiations / renegotiation (with third parties as well as affiliates),
business plans and business strategies, government policies and interventions
are some of the key factors which will together determine the transfer pricing
impact of the pandemic on the taxpayer.

 

The pandemic has brought to the
fore the importance of having robust agreements. While the current discussion
revolves mostly around force majeure clauses in third-party agreements,
inter-company agreements are equally important in the context of transfer
prices between the entities of an MNE group. Going forward, for new
transactions with affiliates or at the time of renewal of agreements relating
to existing transactions, care should be taken to draft / revise inter-company
agreements specifically outlining emergency-like situations and the
relationship between the parties in such times. Which party will be responsible
for which functions and would bear what type of risks and costs should be
clarified in detail. Agreements could potentially also include appropriate
price adjustment clauses. MNEs could consider entering into shorter term
agreements till the time the impact of the pandemic is reasonably clear. Having
said that, even if the agreement permits price adjustments, any pricing / price
adjustment decisions taken should also consider the economic situation and the
implication of such decisions under other applicable laws, including transfer
pricing laws of the other country/ies impacted by such decisions.

 

 

These times require businesses to
act fast and address several aspects of their business, and often, to keep the
business floating in the near term. Needless to say, taxpayers should
adequately document the commercial considerations dictating these decisions on
a real time basis and be able to present the same to transfer pricing
authorities in case of a transfer pricing scrutiny. Further, in the Master File
taxpayers should include a detailed industry analysis and a description of
business strategies as well as the corporate philosophy in combating the
financial impact of Covid-19, including the relationships with employees,
suppliers, customers / clients and lenders.

 

Governments and
inter-governmental organisations around the world are closely monitoring the
economic situation caused by the pandemic. Organisations such as OECD are also
monitoring various tax and non-tax measures taken by government authorities to
combat the impact of Covid-198. Taxpayers would do well to
continuously monitor the developments (including issuance of specific transfer
pricing guidelines relevant to this pandemic) at the level of organisations
such as OECD and UN, and also look out for guidance from the government
authorities.  

____________________________________________________________

 

1   Refer Rule 10Q of Income Tax Rules, 1962

2   Refer Rule 10Q of
Income Tax Rules, 1962

3   Refer Rule 10B of Income Tax Rules, 1962

4   Refer Rule 10CA of Income Tax Rules, 1962

5   Refer Rule 10B of
Income Tax Rules, 1962

6   Refer section 92CE of Income-tax Act, 1961

7   Refer Rule 10CB of Income-tax Rules, 1962

8   For instance, the OECD has recently published a report on tax and
fiscal policy in response to the coronavirus crisis. The OECD has also compiled
and published data relating to country-wise tax policy measures. Both, the
report as well as the country-wise data, can be accessed at www.oecd.org/tax

THE IMPACT OF COVID-19 ON INTERNATIONAL TAXATION

The rapid
outbreak of Covid-19 has had a significant commercial impact globally. As
globalisation has led to the world becoming one market (reducing borders and
increasing economic interdependence), the virus knows no borders and the impact
is being experienced by all of us.

 

Nearly 162 countries and their
governments are enforcing lockdowns and travel restrictions and taking other
measures to control further spread of the virus. The business community across
the world is operating in fear of an impending collapse of the global financial
markets and recession. This situation, clubbed with sluggish economic growth in
the previous year, especially in a developing country like India, is leading to
extremely volatile market conditions. In fact, 94% of the Fortune 1000
companies are already seeing Covid-19 disruptions1.

 

Amongst many tax issues (covered
separately in this Journal), this article focuses on cross-border elements in
the new equations. Such cross-border elements include unintended Permanent
Establishment exposure, incidental (and / or accidental) tax residency,
taxation issues relating to cross-border workers and so on. Transfer Pricing
issues have been covered separately in this Journal. In such a background, this
article attempts to throw some light on the impact of the Covid-19 outbreak on
these aspects.

 

IMPACT
ON CREATION OF PERMANENT ESTABLISHMENT

As the work scenario has changed
across the world due to Covid-19, with most employees working from their homes
while others may have got stuck in foreign countries because of the lockdown,
it has created several questions for companies as to the existence of their
Permanent Establishments in such countries.

 

The various treaties provide for
several types of PEs such as Fixed Place PE, Agency PE, Construction PE and
Service PE.

Fixed Permanent Establishment
(‘Fixed Place PE’)

 

 

A Permanent Establishment is ‘a
fixed place of business through which the business of an enterprise is wholly
or partly carried on’. This is commonly referred to as ‘basic rule of PE’, or
fixed place PE. A fixed place PE exists if the business of the enterprise is
carried out at a fixed place within a jurisdiction, typically for a substantial
period depicting permanence.

 

For a home office to be
considered the PE of an enterprise, the home office must be used on a
continuous basis for carrying on its business and the enterprise must require
the individual to use that location to carry on the said business.

 

It is worthwhile to note that the
Hon’ble Apex Court recently in the case of E-funds IT Solutions Inc2
which also relied on the ruling in the case of Formula One3,
held that ‘a Fixed Place PE can be created only if all the tests for the
constitution of a Fixed Place PE are satisfied, i.e., there is a “fixed place
at the disposal of the foreign enterprise”, with some “degree of permanence”,
from which the “business is carried on”’.

 

The OECD in its Secretariat
Analysis of Tax Treaties and the Impact of the Covid-19 Crisis4  in paragraphs 5, 8 and 9 provides that under existing
treaty principles it is unlikely that a business will be considered to have a
fixed place PE in a jurisdiction as a result of the temporary presence of its
employees during the Covid-19 crisis. It has stated that ‘individuals who
stay at home to work remotely are typically doing so as a result of government
directives; it is force majeure, not an enterprise’s requirement.
Therefore, considering the extraordinary nature of the Covid-19 crisis, and to
the extent that it does not become the new norm over time, teleworking from
home (i.e., the home office) would not create a PE for the business / employer,
either because such activity lacks a sufficient degree of permanency or
continuity, or because, except through that one employee, the enterprise has no
access or control over the home office’.

 

A typical
remote work from home scenario in the present crisis is a result of force
majeure, i.e., government travel restrictions or work from home directives
which have been imposed during the pandemic and as such should not result in
the creation of a Fixed Place PE in a foreign jurisdiction. However, time is of
the essence to show how courts and tax authorities interpret Fixed Place PEs
under Covid-19.

 

Agency Permanent Establishment

The concept of PE has taken birth
in the context of two tax principles, i.e. the residence and source principles
of taxation. As per the source principle, if a tax resident of a particular
country earns income through another person (a separate legal entity) in
another country and where such other person can conclude contracts, then such
person creates an Agency PE in the latter country. The issue which needs to be
addressed is whether the activities of an individual temporarily working from
home for a non-resident employer during the present pandemic could give rise to
a dependent Agent PE.

 

In the case
of Reuters Limited vs. Deputy Commissioner of Income Tax (ITA No. 7895/Mum/2011)
the concept of Agency PE was discussed in detail wherein it was held that ‘A
qualified character of an agency is providing authorisation to act on behalf of
somebody else as to conclude the contracts’. This means that the presence
which an enterprise maintains in a country should be more than merely
transitory if the enterprise is to be regarded as maintaining a PE, and thus a
taxable presence, in that country.

 

OECD in its Secretariat Analysis
of Tax Treaties and the Impact of the Covid-19 Crisis has stated that ‘an
employee’s or agent’s activity in a State is unlikely to be regarded as
habitual if he or she is only working at home in that State for a short period
because of force majeure and / or government directives extraordinarily
impacting his or her normal routine’.

 

Construction Permanent
Establishment

The concept of Construction PE
provides that profits generated from construction works will be taxed in the
country in which the permanent establishment (construction site) is placed or located.

 

In general, a construction site
will constitute a PE if it lasts more than 12 months under the OECD Model, or
more than six months under the UN Model. However, the threshold may vary in
different tax treaties. It appears that many activities on construction sites
are being temporarily interrupted by the Covid-19 crisis.

 

In this regard, it has been seen
that the Indian tax authorities do not assume that interruptions of works at
site are to be excluded from the project period. OECD in its Secretariat
Analysis of Tax Treaties and the Impact of the Covid-19 Crisis has stated that ‘it
appears that many activities on construction sites are being temporarily
interrupted by the Covid-19 crisis. The duration of such an interruption of
activities should however be included in determining the life of a site and
therefore will affect the determination, whether a construction site
constitutes a PE. Paragraph 55 of the Commentary on Article 5(3) of the OECD
Model explains that a site should not be regarded as ceasing to exist when work
is temporarily discontinued (temporary interruptions should be included in
determining the duration of a site).’

 

However, it is questionable
whether this case can be applied to the current pandemic situation which was
simply unpredictable. It is a natural event, but not seasonal. It is not even
predictable with a sufficient probability, as in bad weather. It is simply not
calculable; it is a classic force majeure scenario.

 

Service Permanent Establishment

Globalisation has led Multinational
Enterprises (MNEs) to increase cross-border secondment of technical, managerial
and other employees to their subsidiaries located in low-cost jurisdictions
such as India. The rationale behind seconding such employees is sometimes to
help the subsidiaries avail the benefit of the skill and expertise of the
seconded employees in their respective fields, and sometimes to exercise
control.

 

Secondment of employees has
become a really significant area, given that some bank staff or companies’
staff on assignments or secondments may be trapped in their non-native country
due to the travel restrictions, while others may have come back earlier than
expected; such situations might create a Service Permanent Establishment
(Service PE) for the companies.

 

Forced quarantine may delay the
intended secondment of an employee abroad or make a person employed on a
foreign contract decide to return to India due to reasons beyond control. In
this case, work for a foreign employer will be performed from India. This may
result in the creation of taxability of the employee’s income in India and in
some cases may even create risk of a permanent establishment. It is pertinent
to note, of course, that each case should be analysed on its own merits.

 

The concept of PE has been
defined extensively in various places but the interpretation of the same
continues to be complex and subjective. The distinct nature of each transaction
makes the interpretation of the law and the judicial precedents worth noting.
There can be no thumb rule which can be inferred from the jurisprudence or OECD
guidelines at present to the current crisis. Whether the virus-induced duration
of interruption would be included in the deadline in individual cases will
depend upon the specific circumstances.

 

We have
experienced in the recent past that India has been the frontrunner in
implementing the recommendations of OECD G-20 nations which are being discussed
under the initiative of BEPS Action Plans. Examples of this are introduction of
the concept of Significant Economic Presence (SEP) and Equalisation Levy (EL)
in the statute. However, it is important to see whether the same enthusiasm is
shown while implementing the recommendations on Covid-19-related aspects.

 

IMPACT
ON RESIDENTIAL STATUS OF A COMPANY (PLACE OF EFFECTIVE MANAGEMENT)

A company is generally tax
resident in the country where it is incorporated or where it has its ‘Place of
Effective Management’ (‘POEM’). The residential status of a company dictates
where a company will be taxed on its worldwide profits.

 

The OECD MC has defined POEM as ‘the
place where key management and commercial decisions that are necessary for the
conduct of the business as a whole are in substance made and that all relevant
facts must be examined to determine POEM’.

 

In India,
POEM has been recognised by amendment in section 6(3) of the Income-tax Act,
1961 under the Finance Act, 2015 which states that a company is said to be
resident in India in any previous year, if it is an Indian company, or its
place of effective management in that year is in India. The Explanation to
section 6(3) provides that POEM means a place where key management and
commercial decisions that are necessary for the conduct of the business of an
entity as a whole are, in substance, made. POEM is also an internationally
recognised residency concept and adopted in the tie-breaker rule in many Indian
treaties for corporate dual residents and is also adopted in many jurisdictions
in their domestic tax laws.

 

Due to Covid-19, management
personnel / CEO may not be able to travel to the habitual workplace on account
of restrictions and may have to attend Board meetings via telephone or video
conferencing which will create a concern as to the place / jurisdiction from
which decisions are being taken.

 

It is pertinent
to note that the Central Board of Direct Taxes (‘CBDT’) had issued POEM
guidelines vide Circular No. 06 dated 24th January, 2017. In
the context of cases where the company is not engaged in active business
outside India, the Guidelines state that the location of the company’s head
office is one of the key determinant factors.

 

In this connection, CBDT has
considered a situation where senior management participates in meetings via
telephone or video-conferencing. In such a situation, CBDT states that the head
office would normally be the location where the highest level of management
(e.g., the Managing Director / Financial Director) and their direct support
staff are located.

 

OECD in its Secretariat Analysis
of Tax Treaties and the Impact of Covid-19 states that ‘it is unlikely that
the Covid-19 situation will create any changes to an entity’s residence status
under a tax treaty. A temporary change in location of the Chief Executive
Officers and other senior executives is an extraordinary and temporary
situation due to the Covid-19 crisis and such change of location should not
trigger a change in residency, especially once the tie breaker rule contained
in tax treaties is applied’.

 

Although the OECD Guidance
provides relief in this respect, however, taxpayers should be mindful of the
specific clarifications issued by respective tax jurisdictions on this aspect.
Recently, the US IRS has announced5 cross-border tax guidance
related to travel disruptions arising from the Covid-19 emergency. In the
guidance, IRS stated that ‘U.S. business activities conducted by a
non-resident alien or foreign corporation will not be counted for up to 60
consecutive calendar days in determining whether the individual or entity is
engaged in a U.S. trade or business or has a U.S. permanent establishment, but
only if those activities would not have been conducted in the United States but
for travel disruptions arising from the Covid-19 emergency’.

 

 

Similarly, jurisdictions such as
Ireland, UK and Jersey, Australia have issued guidance providing various
relaxations to foreign companies in view of Covid-19.

 

While the OECD Secretariat has
done an analysis on treaty impact, it may be worthwhile exploring a
multilateral instrument (on the lines of MLI) for avoiding conflict of
positions while granting treaty benefit to the taxpayers.

 

IMPACT ON RESIDENTIAL STATUS OF AN
INDIVIDUAL

Generally, number of days
presence is considered as a threshold (the total number of days that an
individual is present in a particular jurisdiction) for determining individual
tax residency. An exception to this principle is where citizens are taxed
irrespective of their presence.

 

Due to the Covid-19 outbreak,
travel is restricted, which gives rise to two main situations:

i. A
person is temporarily away from his home (perhaps on holiday, perhaps to work
for a few weeks) and gets stranded in the host country because of the Covid-19
crisis and attains domestic law residence there.

ii. A person/s is working in a country (the ‘current home country’)
and has acquired residence status there, but they temporarily return to their
‘previous home country’ or are unable to return to their current home country
because of the Covid-19 situation.

 

According to
the OECD, in the first scenario it is unlikely that the person would acquire
residence status in the country where he is temporarily staying because of
extraordinary circumstances. There are, however, rules in domestic legislation
considering a person to be a resident if he or she is present in the country
for a certain number of days. But even if the person becomes a resident under
such rules, if a tax treaty is applicable, the person would not be a resident
of that country for purposes of the tax treaty. Such a temporary dislocation
should therefore have no tax implications.

 

In the second scenario, it is
again unlikely that the person would regain residence status for being
temporarily and exceptionally in the previous home country. But even if the
person is or becomes a resident under such rules, if a tax treaty is
applicable, the person would not become a resident of that country under the
tax treaty due to such temporary dislocation.

However, in litigious countries
like India, and in the context of recent legislative amendments where NRIs have
been targeted for ?managing’ their period of stay in India, the very thought of
having to substantiate to the authorities that as per any tie-breaker test, a
person is non-resident in India is daunting.

 

With a view to remove genuine
hardships to individuals, CBDT has issued a clarification through Circular No.
11 of 2020 dated 8th May, 2020 in respect of determination of
residency u/s 6 due to Covid-19. The circular is applicable to individuals who
came on visit to India on or before 22nd March, 2020 and have
continued to be in India in different scenarios. This circular applies only for
determination of residency for FY 2019-2020.

 

Accordingly, in case of
individuals who have come on a visit to India on or before 22nd
March, 2020 and are falling under the following categories, relaxation will be
provided while determining their number of days’ presence in India for the
purpose of section 6 for FY 2019-20, as explained hereunder:

 

a. Scenario 1: where an
individual (who is on a visit to India) is unable to leave India before 31st
March, 2020 – the period of stay between 22nd and 31st
March, 2020 (both inclusive) shall not be counted for determining presence in
India.

 

b. Scenario 2: where an individual
has been quarantined in India on account of Covid-19 on or after 1st
March, 2020 and such individual has departed on an evacuation flight before 31st
March, 2020 or is unable to depart – the period starting from the start
of the quarantine period up to 31st March, 2020 or date of actual
departure shall not be counted for determining presence in India.

 

c. Scenario 3: where an
individual (who is on a visit to India) has departed on an evacuation flight
before 31st March, 2020 – the period of stay between 22nd
March, 2020 and date of his departure shall not be counted for determining
presence in India.

 

It has also
been stated that another circular will be issued in due course for determining
residency for FY 2020-2021. These pro-active clarifications bring relief to
many individuals facing difficulties in determining their residential status
amidst the measures taken by various governments to contain the impact of
Covid-19. It should be noted that this circular provides relief only from the
residence test u/s 6 of the Act. The issue of an individual’s forced stay in
India playing a role in constituting residence for a foreign company, HUF,
etc.; or determination of a business connection or Permanent Establishment of a
non-resident in India; and other such implications are not covered in the
circular. The US has recently issued a clarification which states that up to 60
consecutive calendar days of presence in the USA that are presumed to arise from
travel disruption caused by Covid-19 will not be counted for purposes of
determining US tax residency.

 

IMPACT ON CROSS-BORDER WORKERS

Cross-border
workers are persons who commute to work in one state but live in another state
where they are resident.

 

As per the
Income from Employment Article of the DTAAs, income from employment is taxable
only in a person’s state of residence unless the ‘employment is exercised’ in
the other state. However, there are certain conditions for not taxing
employment income in a state where employment is exercised (presence of employee
in that state not exceeding 183 days; and remuneration is paid by an employer
who is not a tax resident of that state; and such remuneration is not borne by
the employer’s PE in that state).

 

The issue which will come up here
is the taxation of wages and salaries received by such cross-border workers in
cases where they cross the threshold of 183 days due to travel restrictions.

OECD in the Secretariat Analysis
of Tax Treaties and the Impact of Covid-19 has stated that income should be
attributable to the state where they used to work before the crisis.

 

THE WAY FORWARD

The issues discussed above are
some of the common issues on which clarification / guidance should be issued by
the respective tax jurisdictions in order to protect taxpayers from unnecessary
hardship. We expect that CBDT will also consider these issues and come out with
relevant relief measures. Though the OECD guidelines have a persuasive value,
they are not binding in any manner, especially to non-OECD member countries. In
fact, taxpayers may have certain other issues on which they may need
clarifications; therefore, a mechanism should be put in place where they can
describe the facts and get redressal from the tax authorities. It is
recommended that companies / individuals must maintain robust documentation
capturing the sequence of facts and circumstances of the relevant presence
inside or outside of India during the Covid-19 crisis to substantiate the bona
fides of their case before the tax authorities if and when they arise in
future.

 

‘Presume not that I am the thing
I was’ – Shakespeare‘Come what come may, time and the hour run
through the roughest day’ – Shakespeare  



____________________________________________

1   https://fortune.com/2020/02/21/fortune-1000-coronavirus-china-supply-chain-impact/
dated 21st February, 2020

2   ADIT vs. E-funds IT Solution Inc. (Civil Appeal No. 6802 of 2015
SC)

3   Formula One World Championship Ltd. vs. CIT (IT) [2016] 76
taxmann.com 6/390 ITR 199 (Delhi)(SC)

4   https://read.oecd-ilibrary.org/view/?ref=127_127237-vsdagpp2t3&title=OECD-Secretariat-analysis-of-tax-treaties-and-the-impact-of-the-COVID-19-Crisis

5   https://www.irs.gov/newsroom/treasury-irs-announce-cross-border-tax-guidance-related-to-travel-disruptions-arising-from-the-covid-19-emergency

Section 9(1)(vii)(b) of Act – On facts, since payments made by assessee to foreign attorneys for registration of IPs abroad were not for services utilised in profession carried on outside India, or for making or earning any income from any source outside India, FTS was sourced in India and not covered by exception carved out in section 9(1)(vii)

7. [2020] TS-117-ITAT-(Kol.)

ACIT vs. Sri Subhatosh Majumder

ITA No. 2006/Kol/2017

A.Y.: 2011-12

Date of order: 26th February, 2020

 

Section 9(1)(vii)(b) of Act – On facts, since payments made
by assessee to foreign attorneys for registration of IPs abroad were not for
services utilised in profession carried on outside India, or for making or
earning any income from any source outside India, FTS was sourced in India and
not covered by exception carved out in section 9(1)(vii)

 

FACTS

The assessee (resident in
India) was a patent attorney who provided IP registration services to its
clients in India. For registration of the IP of his clients abroad, the
assessee had made payments to foreign lawyers and attorneys. According to the
assessee, services were performed abroad and hence the payments were not
chargeable to tax in India. Therefore, the assessee did not withhold tax from
these payments.

 

But according to the A.O.,
the assessee had obtained technical information or consultancy services from
foreign attorneys. And although services were rendered outside India, they were
essentially connected with the profession carried on by the assessee in India.
Therefore, the payments were in the nature of FTS in terms of section
9(1)(vii), read with Explanation 2 thereto. Accordingly, the A.O. disallowed
the expenses u/s 40(a)(i).

 

On an appeal, following the
earlier years’ order in the assessee’s case5, the CIT(A) deleted the
addition by the A.O.

 

Being aggrieved, the tax
authority appealed before the Tribunal.

 

HELD

(1) Foreign attorneys were appointed for
registration of IP under patent laws of foreign countries where products were
sold. They had specialised knowledge and experience of foreign IP laws and
procedures for IPR registrations. Only because of the advice of foreign
attorneys the assessee and / or his clients could prepare the requisite,
technically intricate documentation necessary for preparing IP rights
registration applications in foreign countries. Foreign attorneys also
represented the clients of the assessee before the IP authorities abroad and
provided clarifications and explanations necessary for registrations.

(2) The following facts did not
support the contention of the assessee that he had merely acted as a
pass-through facilitating the payment to foreign attorneys or as an agent:

(a) Perusal of the documents furnished by the assessee did not show the
existence of direct and proximate nexus or direct contact between clients and
foreign attorneys.

(b) Clients had not issued any letters which showed that the appointment
of the foreign attorneys was made by the assessee on their specific
instructions or request.

(c) Perusal of the engagement letter issued by a client showed that it
had engaged the services of the assessee for registration of trade marks in
several foreign countries. It nowhere suggested engaging the services of, or
coordinating with, any particular foreign attorney. The manner of performance
was also left to the sole discretion of the assessee. The contractual terms did
not mention reimbursement of costs by the client.

(d) Copies of invoices raised by foreign attorneys showed that privity
of work was between the assessee and the foreign attorneys who performed their
work in terms of the appointment made by the assessee.

 

(3) Thus,
the foreign attorneys were engaged by the assessee. Payments to them were also
made by him. Such engagement was in the performance of professional services by
the assessee in India. The source of income of the assessee was solely located
in India. The assessee had engaged the services of foreign attorneys for
earning income from sources in India. Accordingly, the services rendered by the
foreign attorneys were in the nature of FTS in terms of section 9(1)(vii)(b)
and were not covered in the exception carved out therein.

_______________________________________________________________

5              Said
order pertained to years prior to amendment made vide Finance Act, 2010

Section 9(1)(i) of Act – As appearance of non-resident celebrity for promotional event outside India was for the benefit of the business in India, there was significant business connection in India and hence appearance fee paid was taxable in India

6. [2020] 115 taxmann.com 386 (Mum.)(Trib.)

Volkswagen Finance (P) Ltd. vs. ITO

ITA No. 2195/Mum/2017

A.Y.: 2015-16

Date of order: 19th March, 2020

 

Section 9(1)(i) of Act –
As appearance of non-resident celebrity for promotional event outside India was
for the benefit of the business in India, there was significant business
connection in India and hence appearance fee paid was taxable in India

 

FACTS

The assessee was an Indian
member-company of a global automobile group. It organised a promotion event in
Dubai jointly with another Indian member-company of the group for the launch of
a car in India. For this purpose, the assessee paid appearance fees to a
non-resident (NR) international celebrity outside India. In consideration, the
assessee and its group company had full rights to use all the event footage /
material / films / stills / interviews, etc. (event material) for its business
promotion.

The assessee contended before the A.O. that the event took place in
Dubai; the NR made his appearance in Dubai; the NR or his agent had not
undertaken any activity in India in relation to the appearance fee; and hence,
appearance fee could not be treated as accruing or arising in India, or deemed
to be accruing or arising in India. Therefore, the income was not taxable under
the Act. Consequently, no tax was required to be withheld. Accordingly, there
was no question of claiming any DTAA benefit.

 

But the A.O. held that the
payment was in the nature of royalty u/s 9(1)(vi) and further, Article 12 of
the India-USA DTAA also did not provide any relief. Hence, the assessee was
liable to withhold tax.

 

On appeal, the CIT(A)
confirmed the conclusion of the A.O. and further held that the sole purpose of
organising the event in Dubai was to avoid attracting section 9(1)(i) relating
to Business Connection in India. Being aggrieved, the assessee filed an appeal
before the Tribunal.

 

HELD

(i) The Tribunal relied upon the Supreme Court’s observations in the
R.D. Agarwal case4  to hold
that business connection is not only a tangible thing (like people, businesses,
etc.), but also a relationship. From the following facts it was apparent that
the event in Dubai and the business of the assessee in India had a
relationship.

 

(a) The event was India-centric and the benefits thereof were to accrue
to the assessee and its group company in India because the target audience was
in India.

(b) The assessee and its group company were permitted non-exclusive use
of the event material.

(c) Both the assessee and its group company had business operations only
in India.

(d) The claim of entire expenses of the event by the assessee and its
group company showed that they had treated the same as ‘wholly and
exclusively for the purposes of business’.

 

(ii) As a consequence of the relationship between the event in Dubai and
the business of the assessee in India, income had accrued to the NR. In this
case, the business connection was intangible since it was a ‘relationship’ and
not an object. However, it was a significant business connection without which
the appearance fee would not have been paid.

Accordingly, the NR had
business connection in India. Hence, the payment made to the NR was taxable in
India. Consequently, the assessee was required to withhold tax.

 

______________________________

3   Decision
does not mention particulars of circumstantial evidence provided by the
assessee for proving residency

4   (1965)
56 ITR 20 (SC)

Article 15(1) of India-Austria DTAA – Sections 6(1), 90(4) of the Act – Notwithstanding section 90(4), submission of TRC is not mandatory to claim DTAA benefit if assessee otherwise provides sufficient circumstantial evidence

5. [2020] TS-15 -ITAT-(Hyd.)

Sreenivasa Reddy
Cheemalamarri vs. ITO

ITA No. 1463/Hyd/2018

A.Y.: 2014-15

Date of order: 5th
March. 2020

 

Article 15(1) of
India-Austria DTAA – Sections 6(1), 90(4) of the Act – Notwithstanding section
90(4), submission of TRC is not mandatory to claim DTAA benefit if assessee
otherwise provides sufficient circumstantial evidence

 

FACTS

The assessee was deputed by
his employer in India to Austria. He was paid certain foreign allowance outside
India on which the employer had deducted tax in India. The assessee contended
that since he was in India for less than 60 days, he was a non-resident (NR).
Further, he was a tax resident of Austria. Hence, in terms of Article 15(1) of
the India-Austria DTAA, the salary earned by a tax resident of Austria was
taxable only in Austria. Accordingly, he filed a NIL return as an NR in India.
The assessee also expressed his inability to furnish the Tax Residency
Certificate (TRC) on the ground that the issuance of a TRC was dependent upon
the Austrian tax authority.

  

Therefore, relying on section
90(4)1  of the Act, the A.O.
denied DTAA benefit on the ground that the assessee could not furnish the TRC.
The assessee preferred an appeal before the CIT(A). Agreeing with the view of
the A.O., the CIT(A) dismissed the appeal. The assessee then filed an appeal before
the Tribunal.

 

HELD

(i) If, in spite of his best possible efforts, the assessee could not
procure the TRC from the country of residence, the situation may be treated as
impossibility of performance2. In such circumstances, the assessee
cannot be obligated to do an impossible task and be penalised for the same.

 

(ii) If the assessee provides sufficient circumstantial3 evidence
for proving residency, the requirement of section 90(4) ought to be relaxed.

 

(iii) In case of conflict between the DTAA and the Act, DTAA would prevail
over the Act. In terms of the DTAA, the assessee was liable to tax in Austria
for services rendered in Austria. Therefore, notwithstanding the Act requiring
a TRC for proving residency, not providing the same to the tax authorities
cannot be the only reason for denial of DTAA benefit to the assessee.

 

Note: In the absence of
any such specific mention, it is not clear whether the Tribunal read down
section 90(4) of the Act, impliedly treating it as a case of ‘treaty override’.

____________________________________________________________________________________________

1   Section
90(4) provides that an NR assessee will be entitled to claim relief under DTAA
only if he has obtained a TRC from the government of that country

2      Decision does not mention particulars of
‘best possible efforts’ of assessee or basis on which ITAT considered the
situation to be that of ‘impossibility of performance’. Decision merely
mentions that ‘normally it is a herculean task to obtain certificates from
alien countries for compliance of domestic statutory obligations’

RESIDENTIAL STATUS OF NRIs AS AMENDED BY THE FINANCE ACT, 2020

1.0  BACKGROUND

The
government presented the Union Budget 2020 in the month of February this year
in the midst of an economic slowdown. The Budget was based on the twin pillars
of social and economic reforms to boost the Indian economy. The Finance Bill,
2020 got the President’s assent on 27th March, 2020, getting
converted into the Finance Act, 2020 which has brought in a lot of structural
changes such as (a) giving an option to the taxpayers to shift to the new slabs
of income-tax; (b) introducing the Vivad se Vishvas scheme; (c) reducing
the corporate tax rate; and (d) changes in taxation of dividends and many other
proposals.

 

Apart from
the above, one of the significant amendments made by the Finance Act, 2020
pertains to a change in the rules for determining the residential status of an
individual.

 

Let us study
these amendments in detail. It may be noted that the amendments to section 6 of
the Income-tax Act, 1961 (the Act) are applicable with effect from 1st
April, 2020 corresponding to the A.Y. 2020-21 onwards.

 

2.0  SIGNIFICANCE OF RESIDENTIAL STATUS

A person is
taxed in a jurisdiction based on ‘residence’ link or a ‘source’ link. However,
the comprehensive tax liability is invariably linked to the residential status,
barring a few exceptions such as taxation based on citizenship (e.g., USA) or
in case of territorial tax regimes (such as Hong Kong).

 

In India,
section 6 of the Act determines the residential status of a person. Section 5
defines the scope of total income and section 9 expands the scope of total
income in case of non-residents by certain deeming provisions.

 

Along with
the incidence of tax, residential status is also important to claim relief
under a particular tax treaty, as being a resident of either of the contracting
states is a prerequisite for the same. Therefore, Article 4 on ‘Residence’ is
considered to be the gateway to the tax treaty. Once a person is a resident of
a contracting state, he gets a Tax Residency Certificate which enables him to
claim treaty benefits.

 

3.0  PROVISIONS OF SECTION 6 OF THE ACT POST
AMENDMENT

The highlighted
portion is the insertion by the Finance Act, 2020. The provisions relating
to residential status under the Act are as follows:

 

Residence in
India

‘6.
For the purposes of this Act,

(1)
An individual is said to be resident in India in any previous year, if he

(a)
is in India in that year for a period or periods amounting in all to one
hundred and eighty-two days or more; or

(b)
[***]

(c)
having within the four years preceding that year been in India for a period or
periods amounting in all to three hundred and sixty-five days or more, is in
India for a period or periods amounting in all to sixty days or more in that
year.

 

Explanation
1 – In the case of an individual,

(a)
being a citizen of India, who leaves India in any previous year as a member of
the crew of an Indian ship as defined in clause (18) of section 3 of the
Merchant Shipping Act, 1958 (44 of 1958), or for the purposes of employment
outside India, the provisions of sub-clause (c) shall apply in relation
to that year as if for the words ‘sixty days’ occurring therein, the words ‘one
hundred and eighty-two days’ had been substituted;

(b)
being a citizen of India, or a person of Indian origin within the meaning of Explanation
to clause (e) of section 115C who, being outside India, comes on a visit
to India in any previous year, the provisions of sub-clause (c) shall
apply in relation to that year as if for the words ‘sixty days’, occurring
therein, the words ‘one hundred and eighty-two days’ had been substituted
and in case of the citizen or person of Indian origin having total income,
other than the income from foreign sources, exceeding fifteen lakh rupees
during the previous year, for the words ‘sixty days’, occurring therein, the
words ‘one hundred and twenty days’.

     

Clause (1A)
of Section 6

(1A)
Notwithstanding anything contained in clause (1), an individual, being a
citizen of India, having total income, other than the income from foreign
sources, exceeding fifteen lakh rupees during the previous year, shall be
deemed to be resident in India in that previous year, if he is not liable to
tax in any other country or territory by reason of his domicile or residence or
any other criteria of similar nature.

 

Explanation
2 – For the purposes of this clause, in the case of an individual,
being a citizen of India and a member of the crew of a foreign-bound ship
leaving India, the period or periods of stay in India shall, in respect of such
voyage, be determined in the manner and subject to such conditions as may be
prescribed.

 

(2) A
Hindu undivided family, firm or other association of persons is said to be
resident in India in any previous year in every case except where during that
year the control and management of its affairs is situated wholly outside
India.

 

(3) A
company is said to be a resident in India in any previous year if—

(i)
it is an Indian company; or

(ii)
its place of effective management, in that year, is in India.

 

Explanation
– For the purposes of this clause ‘place of effective management’ means a place
where key management and commercial decisions that are necessary for the
conduct of business of an entity as a whole are in substance made.

 

(4)
Every other person is said to be resident in India in any previous year in
every case, except where during that year the control and management of his
affairs is situated wholly outside India.

 

(5)
If a person is resident in India in a previous year relevant to an assessment
year in respect of any source of income, he shall be deemed to be resident in
India in the previous year relevant to the assessment year in respect of each
of his other sources of income.

 

(6) A
person is said to be ‘not ordinarily resident’ in India in any previous year if
such person is,

(a)
an individual who has been a non-resident in India in nine out of the ten
previous years preceding that year, or has during the seven previous years
preceding that year been in India for a period of, or periods amounting in all
to, seven hundred and twenty-nine days or less; or

(b) a
Hindu undivided family whose manager has been a non-resident in India in nine
out of the ten previous years preceding that year, or has during the seven
previous years preceding that year been in India for a period of, or periods
amounting in all to, seven hundred and twenty-nine days or less, or

(c)
a citizen of India, or a person of Indian origin, having total income, other
than the income from foreign sources, exceeding fifteen lakh rupees during the
previous year, as referred to in clause (b) of Explanation 1 to clause (1), who
has been in India for a period or periods amounting in all to one hundred and
twenty days or more but less than one hundred and eighty-two days; or

(d)
a citizen of India who is deemed to be resident in India under clause (1A).

Explanation
– For the purposes of this section, the expression ‘income from foreign
sources’ means income which accrues or arises outside India (except income
derived from a business controlled in or a profession set up in India).

 

4.0  DETERMINING THE SCOPE OF TAXABILITY (SECTION
5)

All over the world an individual is categorised as either a Resident or
a Non-resident. However, India has an intermediary status known as ‘Resident
but Not Ordinarily Resident’ (RNOR). This status provides breathing space to a
person from being taxed on a worldwide income, in that such a person is not
subjected to Indian tax on passive foreign income, i.e. foreign-sourced income
earned without business controlled from or a profession set up in India.

 

Thus, an
individual is subjected to worldwide taxation in India only if he is ‘Resident
and Ordinarily Resident’ (ROR).

 

Therefore,
an individual who is a resident of India is further classified into (a) ROR and
(b) RNOR (Refer paragraph 3 herein above).

The scope of
total income, based on the residential status, is defined in section 5 of the
Act which can be summarised as follows:

 

 

Sources of Income

ROR

RNOR

NR

i

Income received or is deemed to be received
in India

Taxable

Taxable

Taxable

ii

Income accrues or arises or is deemed to accrue
or arise in India

Taxable

Taxable

Taxable

iii

Income accrues or arises outside India, but it is
derived from a business controlled in or a profession set up in India

Taxable

Taxable

Not Taxable

iv

Income accrues or arises outside India other than
derived from a business controlled in or a profession set up in India

Taxable

Not Taxable

Not Taxable

 

 

5.0  NON-RESIDENT

According to
section 2(30) of the Act, ‘non-resident means a person who is not a
“resident”, and for the purposes of sections 92, 93 and 168 includes
a person who is not ordinarily resident within the meaning of clause (6)
of section 6.’

 

Section 92
deals with transfer pricing, section 93 deals with avoidance of income tax by
transactions resulting in transfer of income to non-residents and section 168
deals with residency of executors of the estate of a deceased person.
‘Executor’ for the purposes of section 168 includes an administrator or other
person administering the estate of a deceased person.

 

Thus, in
view of the amendments in section 6, a change in the classification of
residential status from that of a non-resident to an RNOR may lead to change in
the scope of taxability in respect of the above sections, viz., 92, 93 and 168.

 

6.0  RATIONALE FOR CHANGE IN THE DEFINITION OF
RESIDENTIAL STATUS

Clause (c)
of section 6(1) provides that an individual who is in India in any previous
year for a period of 60 days or more, coupled with 365 days or more in the
immediately preceding four years to that previous year, then he would be
considered a resident of India. The period of 60 days is very short, therefore
Indians staying abroad demanded some relaxations. The government also
acknowledged the fact that Indian citizens or Persons of Indian Origin (PIO)
who stay outside India often maintain strong ties with India and visit India to
take care of their assets, families or for a variety of other reasons.
Therefore, relaxation has been provided to Indian citizens / PIOs, allowing
them to visit India for longer a duration of 182 days since 1995, without losing
their non-resident status.

 

However, it
was found that this relaxation was misused by many visiting Indian citizens or
PIOs, by carrying on substantial economic activities in India and yet not
paying any tax in India. They managed to stay in India almost for a year by
splitting their stay in two financial years and yet escape from taxation in
India, even if their global affairs / businesses were controlled from India. In
order to prevent such misuse, the Finance Act, 2020 has reduced the period of stay
in India from 182 days to 120 days in case of those individuals whose
Indian-sourced income1 
exceeds Rs. 15 lakhs.

 

There is no
change in case of a person whose Indian-sourced income is less than Rs. 15
lakhs.

 

7.0 IMPACT OF THE AMENDMENTS

7.1  Residential status of Indian citizens / PIOs
on a visit to India

The amended
provision of section 6(1)(c) read with clause (b) of Explanation 1 now
provides as follows:

 

An Indian
citizen or a Person of Indian Origin, having total income other than income from
foreign sources exceeding Rs. 15 lakhs, who being outside India comes on a
visit to India, shall be deemed to be resident in India in a financial year if…

(i)    he is in India for 182 days or more during
the year; or

(ii)   he has been in India for 365 days or more
during the four immediately preceding previous years and for 120 days or more
during that previous year.

 

7.2  Amendment to the definition of
R but NOR u/s 6(6)

As mentioned
earlier, section 6(6) provides an intermediary status to an individual (even
HUF through its manager) returning to India, namely, RNOR.

 

Clause (d)
is inserted in section 6(6) to provide that an Indian citizen / PIO who becomes
a resident of India by virtue of clause (c) to section 6(1) with the 120 days’
rule (as mentioned above) will always be treated as an RNOR. The impact is that
their foreign passive income would not be taxed in India.

_______________________________________________________________

1   The amendment uses the term ‘Income from
foreign sources’ which means income which accrues or arises outside India
(except income derived from a business controlled in or a profession set up in
India). In this Article, the term ‘Indian-sourced income’ is used as a synonym
for the term ‘income other than income from foreign sources’.

 

 

Let us
understand the conditions of residential status with the help of a flowchart (as
depicted below).

 

Assuming
that an Indian citizen has satisfied one of the two conditions of clause (c) to
section 6(1), namely, stay of 365 days in India during the preceding four
financial years, the following are the possible outcomes:

 

It may be noted that a person becoming a resident by virtue of the 120
days’ criterion would automatically be regarded as an RNOR, whereas a person
becoming resident by virtue of the 182 days’ criterion would become an RNOR
only if he further satisfies one of the additional conditions prescribed in
clause (a) of section 6(6) of the Act, namely, that he has been a non-resident
in nine out of the ten years preceding the relevant previous year, or he was in
India for a period or periods in aggregate of 729 days or less in seven years
preceding the relevant previous year.

 

The impact
of the amendment is that an individual who is on a visit to India may become a
resident by virtue of the reduced number of days criterion, but would still be
regarded as an RNOR, which gives much-needed relief as he would not be taxed on
foreign income, unless it is earned from a business or profession controlled /
set up in India.

 

8.0  DEEMED RESIDENTIAL STATUS FOR INDIAN CITIZENS

Traditionally,
in India income tax is levied based on the residential status of the
individual. It was felt that in the residence-based scheme of taxation there
was scope for abuse of the provisions. It was possible for a high net-worth
individual to arrange his affairs in a manner whereby he is not considered as a
resident of any country of the world for tax purposes. In order to prevent such
abuse a new Clause 1A has been inserted to section 6 of the Act vide the
Finance Act, 2020 whereby an individual being a citizen of India having total
income, other than the income from foreign sources, exceeding fifteen lakh
rupees during the previous year, shall be deemed to be resident in India in
that previous year, if he is not liable to tax in any other country or
territory by reason of his domicile or residence, or any other criterion of
similar nature. However, this provision is not applicable to Overseas Citizens
of India (OCI) card-holders as they are not the citizens of India.

 

In other
words, an individual is deemed to be a resident of India only if all the
following conditions are satisfied:

(i)    He is a citizen of India;

(ii)   His Indian-sourced total income exceeds Rs. 15
lakhs; and

(iii) He is not liable to tax in any other country or
territory by reason of his domicile or residence or any other criterion of
similar nature.

 

By virtue of the above deemed residential status, many NRIs living
abroad and possessing Indian citizenship could have been taxed in India on their
worldwide income. In order to provide relief, clause (d) has been inserted in
section 6(6) to provide that a citizen who is deemed a resident of India by
virtue of clause 1A to section 6 of the Act, would be regarded as an RNOR. The
advantage of this provision is that his foreign passive income would not be
taxed in India.

 

The above
amendment can be presented in the form of a flow chart (Refer Flow Chart 2,
on the next page):

 

 9.0 ISSUES

9.1  What is the meaning of the term ‘liable to
tax’ in the context of determination of ‘deemed residential status’?

 

 

As per the
amended provision of section 6(1A) of the Act, an Indian citizen who is not
liable to tax in any country or territory by reason of his domicile or
residence or any other criterion of similar nature would be regarded as deemed
resident of India. However, the term ‘liable to tax’ is not defined in the Act.
This term has been a matter of debate for many years. Contrary decisions are in
place in respect of residents of the UAE where there is no income tax for
individuals.

 

Whether liability to tax includes ‘potential liability to tax’, in that
the individuals are today exempt from tax in the UAE by way of a decree2
, but they can be brought to tax any time. For that matter, any sovereign
country which is not levying tax on individuals at present always has an
inherent right to tax its citizens. Therefore,
can one say that residents of any country are always potentially liable to tax
by reason of their residence or domicile, etc.?

 

In the M.A.
Rafik case, In re [1995] 213 ITR 317, the AAR held that ‘liability to
tax’ includes potential liability to tax and, therefore, benefit of the
India-UAE Tax Treaty was available to a UAE resident. However, in the case of Cyril
Pereira the AAR held otherwise and refused to grant the benefit of the
India-UAE DTAA as there was no tax in the UAE. The Hon’ble Supreme Court, in
the case of Azadi Bachao Andolan [2003] 263 ITR 706, after
referring to the ruling of Cyril Pereira and after elaborate
discussions on the various aspects of this issue, concluded that ‘it is… not
possible for us to accept the contentions so strenuously urged by the
respondents that the avoidance of double taxation can arise only when tax is
actually paid in one of the contracting states.’

 

_______________________________________________________________

2   The UAE federal government has exclusive
jurisdiction to legislate in relation to UAE taxes. However, no federal tax
laws have been established to date. Instead, most of the Emirates enacted their
own general income ‘tax decrees’ in the late 1960s. In practice, however, the
tax decrees have not been enforced to date for personal taxation. [Source:
https://oxfordbusinessgroup.com/overview/full-disclosure-summary-general-and-new-tax-regulations]

 

 

The Hon’ble
Supreme Court in this case (Azadi Bachao Andolan, Supra), further
quoted excerpts from Prof. Klaus Vogel’s commentary on ‘Double Taxation’, where
it is clearly mentioned that ‘Thus, it is said that the treaty prevents not
only “current” but also merely “potential” double taxation.’

 

In Green
Emirate Shipping & Travels [2006] 100 ITD 203 (Mum.), the Mumbai
Tribunal after refusing to be persuaded by the decision of the AAR in the case
of Abdul Razak A. Menon, In re [2005] 276 ITR 306 held that
‘being “liable to tax” in the contracting state does not necessarily imply that
the person should actually be liable to tax in that contracting state by virtue
of an existing legal provision but would also cover the cases where that other
contracting state has the right to tax such persons – irrespective of whether
or not such a right is exercised by the contracting state. In our humble
understanding, this is the legal position emerging out of Hon’ble Supreme
Court’s judgment in Azadi Bachao Andolan case.’

 

In ITO (IT) vs. Rameshkumar Goenka, 39 SOT 132, the Mumbai
Tribunal, following the decision in Green Emirates (Supra), held
that the ‘expression “liable to tax” in that contracting state as used in
Article 4(1) of the Indo-UAE DTAA does not necessarily imply that the person
should actually be liable to tax in that contracting state and that it is
enough if the other contracting state has the right to tax such person, whether
or not such a right is exercised.’

 

In the case
of DDIT vs. Mushtaq Ahmad Vakil, the Delhi Tribunal, relying on the
decisions of Green Emirates (Supra), Meera Bhatia, Mumbai ITAT, 38 SOT 95,
and Ramesh Kumar Goenka (Supra) ruled in favour of the assessee
to give the benefit of the India-UAE Tax Treaty.

 

Thus, we
find that various judicial precedents in India are in favour of granting tax
treaty benefits to the residents of even those contracting states where there
is no actual liability to tax at present. Therefore, one may take a view that
in the context of Indian tax treaties ‘liability to tax’ includes ‘potential liability
to tax’, except where there is an express provision to the contrary in the tax
treaty concerned.

 

9.2  Can a deemed resident person avail treaty
benefit?

The benefit
of a tax treaty is available to a person who is a resident of either of the
contracting states which are party to the said treaty. Article 3 of the tax
treaties defines ‘person’ to include the individual who is treated as a taxable
entity in the respective contracting state (e.g. India’s tax treaties with the
USA and the UK). However, Article 4 of the India-UK Tax Treaty dealing with
‘Fiscal Domicile’ provides that the term ‘resident of a contracting state’
means any person who, under the law of that state, is liable to taxation
therein by reason of his domicile, residence, place of management or any other
criterion of a similar nature. This provision is similar in both the
UN and the OECD Model Conventions as well as most of the Indian tax treaties.
Here the question arises as to whether a person who is a deemed resident of
India (by virtue of clause 1A to section 6 of the Act), will be able to access
a treaty based on the wordings of Article 4? Article 4 requires him to be a
resident of a contracting state based on the criteria of domicile, residence or
any other criterion of similar nature, which does not include citizenship.
Although citizenship is one of the decisive criteria while applying
tie-breaking tests mentioned in paragraph 2 of Article 4, but first one must
enter the treaty by virtue of paragraph 1.

 

When we look
at the provisions of the India-US Tax Treaty, we find that citizenship is one
of the criteria mentioned in paragraph 1 of Article 4 on residence as mentioned
below:

 

‘ARTICLE 4 –
Residence – 1. For the purposes of this Convention, the term “resident of a
Contracting State” means any person who, under the laws of that State, is
liable to tax therein by reason of his domicile, residence, citizenship,
place of management, place of incorporation, or any other criterion of a
similar nature.’

 

Therefore,
in case of the India-US Tax Treaty there is no doubt about the availability of
tax benefits to an individual who is deemed to be a resident of India because
of his citizenship.

 

9.3  What is the status of Indian workers working
in UAE who are invariably citizens of India?

Article 4 of
the India-UAE Tax Treaty reads as follows:

 

ARTICLE 4 RESIDENT

1.    For the purposes of this Agreement the
term ‘resident of a Contracting State’ means:

(a) ?in the case of India: any person who, under
the laws of India, is liable to tax therein by reason of his domicile,
residence, place of management or any other criterion of a similar nature. This
term, however, does not include any person who is liable to tax in India in
respect only of income from sources in India; and

(b) in the case of the United Arab Emirates: an
individual who is present in the UAE for a period or periods totalling in the
aggregate at least 183 days in the calendar year concerned, and a company which
is incorporated in the UAE and which is managed and controlled wholly in UAE.’

 

As per the
above provision, a person who stays in the UAE for 183 days or more in a
calendar year would be regarded as a resident of the UAE and therefore eligible
to get the treaty benefit.

 

The CBDT
issued a Press Release on 2nd February, 2020 clarifying that ‘the
new provision is not intended to include in tax net those Indian citizens who
are bona fide workers in other countries. In some sections of the media
the new provision is being interpreted to create an impression that those
Indians who are bona fide workers in other countries, including in
Middle East, and who are not liable to tax in these countries,
will be taxed in India on the income that they have earned there. This
interpretation is not correct.

 

In order to
avoid any misinterpretation, it is clarified that in case of an Indian citizen
who becomes deemed resident of India under this proposed provision, income
earned outside India by him shall not be taxed in India unless it is derived
from an Indian business or profession.’ (Emphasis supplied.)

 

The above
clarification is significant as it clearly provides that even though Indian
citizens in the UAE or in other countries are not liable to tax therein, their
foreign-sourced income will not be taxed in India unless it is derived from an
Indian business or profession.

 

However,
this clarification does not change the position for determination of deemed
residential status of such workers. In other words, all workers in the UAE or
other countries who are citizens of India may be still be regarded as deemed
residents of India if their Indian-sourced income exceeds Rs. 15 lakhs in a year.
The Press Release only says that their foreign income may not be taxed in
India, if the conditions are satisfied.

 

9.4  What is the impact of Covid-19 on
determination of residential status?

The CBDT
Circular No. 11 of 2020 dated 8th May, 2020 grants relief to
taxpayers by excluding the period of their forced stay in India from the 22nd
to the 31st of March, 2020 in computation of their residential
status in India for Financial Year 2019-20. The relevant extract of the said
Circular is reproduced below:

 

‘3. In
order to avoid genuine hardship in such cases, the Board, in exercise of powers
conferred under section 119 of the Act, has decided that for the purpose of
determining the residential status under section 6 of the Act during the
previous year 2019-20 in respect of an individual who has come to India on a
visit before 22nd March, 2020 and:

(a) has been
unable to leave India on or before 31st March, 2020, his period of
stay in India from 22nd March, 2020 to 31st March, 2020
shall not be taken into account; or

(b) has been quarantined in India on account of Novel Corona Virus
(Covid-19) on or after 1st March, 2020 and has departed on an
evacuation flight on or before 31st March, 2020 or has been unable
to leave India on or before 31st March, 2020, his period of stay
from the beginning of his quarantine to his date of departure or 31st
March, 2020, as the case may be, shall not be taken into account; or

(c) has departed on an evacuation flight on or before 31st
March, 2020, his period of stay in India from 22nd March, 2020 to
his date of departure shall not be taken into account.’

The above
Circular deals with the period up to 31st March, 2020. The Finance
Minister has assured similar relief for the Financial Year 2020-21. As the
operations on international flights have not resumed fully, a suitable
relaxation may be announced in future when the situation normalises.

 

10.0 EPILOGUE

The
amendments to section 6 are in the nature of anti-abuse provisions. However, in
view of the pandemic Covid-19, it is desirable that these amendments are
deferred for at least two to three years. More than half of the world is under
lockdown. India is also under lockdown for over two months now. International
flights are still not operative. Only Air India is operating international
flights under the ‘Vande Bharat’ mission to bring back or take out the
stranded passengers. This is an unprecedented situation which calls for
unprecedented measures. Today, India is considered safer than many other
countries in the world and therefore many NRIs may like to spend more time with
their families in their motherland. Under the circumstances, the amendment
relating to reduction of the number of days’ stay from 182 to 120 should be
reconsidered.

 

 

Article 13 of India-Mauritius DTAA; section 245R of the Act – As gain on sale of shares by a Mauritius company in a Singapore company which derived substantial value from assets in India was, prima facie, designed for avoidance of tax, applications were to be rejected under clause (iii) to proviso to section 245R(2) of the Act

11. [2020] 116
taxmann.com 878 (AAR-N. Del.) Tiger Global
International II Holdings, In re Date of order: 26th
March, 2020

 

Article 13 of
India-Mauritius DTAA; section 245R of the Act – As gain on sale of shares by a
Mauritius company in a Singapore company which derived substantial value from
assets in India was, prima facie, designed for avoidance of tax, applications
were to be rejected under clause (iii) to proviso to section 245R(2) of
the Act

 

FACTS

The applicants were
three Mauritius companies (Mau Cos), which were tax resident of Mauritius. They
were member companies of a private equity fund based in USA. Mau Cos
collectively invested in shares of a Singapore Company (Sing Co). Sing Co, in
turn, invested in multiple Indian companies. Sing Co derived substantial value
from assets located in India. All investments were made prior to 31st
March, 2017. The Mau Cos transferred their shares in Sing Co to an unrelated
Luxembourg buyer pursuant to contracts executed outside India.

 

Before executing
the transfer of shares, the applicants applied to tax authorities for nil
withholding certificate u/s 197. The applications were rejected on the ground
that the applicants did not qualify for benefit under the India-Mauritius DTAA.

 

The applicants
subsequently approached the AAR to determine the chargeability of share
transfer transaction to income tax in India. The tax authorities objected to
the admission of the application.

 

 

HELD

Pending
proceedings

  •     Proceedings relating to
    issue of nil withholding certificate are concluded when the certificate was
    issued by the tax authority.
  •     Even if the tax withholding
    certificate was applicable for the entire financial year and could have been
    modified, it could not be given effect to after the transaction was closed and
    payment was made.
  •     Accordingly, there was no
    pending proceeding on the date of making the application to the AAR.

 

Application
before AAR was concerned only with chargeability to tax and question of
determination of FMV did not arise

  •     The applications pertained
    only to determination of taxability of transfer of shares.
  •     Tax authority can undertake
    valuation of shares and computation of capital gains arising from shares only
    after the transaction is found to be exigible to tax. Therefore, the
    application cannot be rejected on this ground.

 

Prima facie avoidance
of tax

  •     At the stage of admission
    of the application before the AAR, there is no requirement to conclusively
    establish tax avoidance; rather, it only needs to be demonstrated that prime
    facie     the transaction was designed for avoidance of tax.
  •     The following factors
    established that the control and management of the Mau Cos was not in
    Mauritius:

•    Authorisation to operate bank account above
US $250,000 was with Mr. C who was not a Director of the Mau Co but was the
ultimate owner of the PE Fund.

•    Since the applicants were located in
Mauritius, logically a Mauritius resident should have been authorised to sign
cheques and operate bank accounts. However, the applicants could not justify
why Mr. C was authorised to do so.

•    Since Mr. C was the beneficial owner of the parent
company of the applicants and also the sole director of the ultimate holding
company, the authorisation given to him was not coincidental. This fact
established that the funds were controlled by Mr. C.

•    Further, Mr. S (US resident general counsel
of the PE fund) was present in all the Board meetings where decisions on
investment and sale of securities were taken. Despite this, decisions in
respect of any transaction over US $250,000 were taken by Mr. C. This suggested
that notwithstanding that decisions were undertaken by the Board of Directors
of the applicants, these were ultimately under the control of Mr. C because of
his power to operate bank accounts.

•    Thus, the real management and control of the
applicants was not with the Board of Directors, but with Mr. C who was the
beneficial owner of the group. The Mau Cos were only pass-through entities set
up to avail the benefits of the India-Mauritius DTAA.

  •     Hence, prima facie, the transaction
    was designed for avoidance of tax and, accordingly, it could not be admitted.

 

Applicability
of India-Mauritius DTAA

•    The Mau Cos derived gains from transfer of
shares of the Sing Co and not those of the I Cos. The India-Mauritius DTAA
(post-2016 amendment), as also Circular No. 682 dated 30th March,
1994 suggest that the intent of the DTAA is only to protect gains from transfer
of shares of an Indian company and not transfer of shares of a Singapore
company. Exemption from capital gains tax on sale of shares of a company not
resident in India was never intended under the original or the amended DTAA
between India and Mauritius.

 

TAX CHALLENGES OF THE DIGITALISATION OF ECONOMY

With the advent of computers and internet,
the modes of business transactions have undergone significant changes. The
distinction between doing business ‘with’ a country and ‘in’ a country is
increasingly becoming blurred. Virtual presence has overtaken physical
presence. Naturally, under the changed circumstances, traditional concepts of
PE and taxing rules are just not sufficient to tax cross-border transactions.
OECD identified these challenges arising out of the digitalisation of the
economy as one of the main areas of focus in its 2015 BEPS Action Plan 1.

 

However, taxing transactions in the
digitised economy is fraught with many challenges, as traditional source vs.
residence principles and globally accepted and settled transfer pricing
regulations (especially, the principle of ‘arm’s length price’) are being
challenged and need to be tweaked or revisited. At the same time, not
addressing these issues is leaving gaps in taxation to the advantage of
Multi-National Enterprises (MNEs), who are able to save / avoid considerable
tax through Base Erosion and Profit Shifting (BEPS). Not merely that, many
countries have introduced unilateral measures (for example, India introduced
Equalisation Levy to tax online advertisements) which are resulting in double
taxation and hampering global trade and economy. Therefore, OECD has set the
deadline of end-2020 to come out with a consensus-based solution to taxation of
cross-border transactions driven by digitalisation.

 

OECD has published two public consultation
documents, namely, (i) a ‘Unified Approach under Pillar One’ dealing with reallocation
of profit and revised nexus rules, and (ii) ‘Global Anti-Base Erosion
Proposal (GloBE) – Pillar Two’. It is important to understand these documents,
because once accepted, they will change the global landscape of international
taxation.

 

This article discusses the first document
dealing with ‘Unified Approach under Pillar One’.

1.0    Background

Tax challenges of the digitalisation of
economy was identified as one of the main areas of focus in the BEPS Action
Plan 1 in 2015; however, no consensus could be reached on a methodology for
taxation. The Action Plan 1 suggested the development of a consensus-based
solution to the taxation of digitalised economy by the end of 2020 after due
consultation with all stakeholders and undertaking further work on this dynamic
subject. In the meanwhile, however, based on the options analysed by the Task
Force on the Digital Economy (TFDE), the BEPS Action Plan 1 recommended three
options for countries to incorporate in their domestic tax laws to address the
challenges of BEPS. However, countries were well advised to ensure that any of
the measures adopted did not in any way vitiate their obligation under a tax
treaty or any bilateral treaty obligation. It also provided that these options
may be calibrated or adapted in such a way as to ensure existing international
legal commitments.

 

Three options to
tax digitised transactions, as mentioned in BEPS Action Plan 1, are as follows:

(i)     New nexus in the form of Significant
Economic Presence;

(ii)    A withholding tax on certain types of digital
transactions; and

(iii)    Equalisation Levy.

 

Pending implementation of the BEPS Action
Plan till the end of 2020, India chose to introduce unilateral measures as recommended
above. Accordingly, section 9 of the Income-tax Act, 1961 was amended to expand
the scope of deemed income to include income based on Significant Presence of a
non-resident in India.

 

The new Explanation 2A was added to
section 9(1) vide the Finance Act, 2018 and provides as follows:

Significant Economic Presence shall
mean

(a) Any transaction in respect of any
goods, services or property carried out by a non-resident in India including
provision of download of data or software in India if the aggregate of payments
arising from such transaction or transactions during the previous year exceeds
the amount as may be prescribed; or

(b)
Systematic and continuous soliciting of its business activities or engaging in
interaction with such number of users as may be prescribed, in India through
digital means.

 

Provided that the transactions or activities shall constitute Significant
Economic Presence in India, whether or not

(i)    the agreement for such transactions or
activities is entered in India; or

(ii)   the non-resident has a residence or place of
business in India; or

(iii) the non-resident renders services in India.

 

Provided, further, that only so much of income as is attributable to the
transactions or activities referred to in clause (a) or clause (b) shall be
deemed to accrue or arise in India.

 

However, it may be noted that in the absence
of rules and prescription of transaction threshold, the provision has remained
infructuous.

 

Equalisation Levy (EL) was introduced in
India vide the Finance Act, 2016 whereby certain specified transactions
or payments in respect of online advertisements are subject to a levy of 6% on
a gross basis. However, EL was introduced as a separate levy and not as part of
the Income-tax Act, and hence there are issues in claiming its credit in
overseas jurisdictions.

 

OECD continued further work on this aspect
and that led to an interim report in March, 2018 analysing the impact of
digitalisation of various business models and the relevance of the same to the
international income tax system. In January, 2019, the Inclusive Framework (it
refers to the expanded group of 137 countries involved in the BEPS project
which was originally started by G20 nations) issued a short Policy Note which
grouped the proposals for addressing the challenges of digitised economy into
two pillars as mentioned below.

 

Pillar 1 Reallocation of profit and revised nexus rules

It was felt that the traditional nexus of
physical presence is not sufficient to tax the profits arising in market
jurisdiction (source state) and therefore new nexus rules are essential. This
pillar will explore potential solutions for determining new nexus-based profits
taxation and attribution based on clients or user base or both. In other words,
this Pillar deals with two significant aspects of the taxation of the
digitalised transactions, namely, nexus rules and profit allocation. Thus,
Pillar One comprises ‘User Participation’, ‘Marketing Intangibles’ and
‘Significant Economic Presence’ proposals.

 

Pillar 2 Global Anti-base Erosion Mechanism

Proposals under this Pillar go beyond
digitised economy, as it proposes to tax MNEs at a minimum level of tax. Thus,
it in its true sense addresses the BEPS challenge. It has proposed four broad
rules to ensure minimum level of taxation by MNEs. These are discussed at
length subsequently.

 

Let us look at proposals under Pillar One in
more detail.

 

2.0    Pillar One – Unified Approach towards
reallocation of profit and revised nexus rules

The public consultation document has
recognised the need to evolve new nexus rules to allocate profits arising in
digitalised economy. According to the document ‘the need to revise the rules
on profit allocation (arises) as the traditional income allocation rules would
today allocate zero profit to any nexus not based on physical presence, thus
rendering changes to nexus pointless and invalidating the policy intent. That
in turn requires a change to the nexus and profit allocation rules not just for
situations where there is no physical presence, but also for those where there
is’.

 

Thus, we can see that the new nexus approach
would recognise the contribution of the market jurisdiction or a consumer base
without a physical presence. Broadly, the Unified Approach aims to have a
solution based on the following key features:

 

(a)  Wider Scope: It not only aims to cover highly digitalised
businesses, but also to cover other businesses that are more consumer focussed.
Consumer-facing businesses are broadly defined as businesses that generate
revenue from supplying consumer products or providing digital services that
have a consumer facing element.

 

The following carve-outs are expected from
the scope of new nexus:

(i)     Extractive industries

(ii)    Commodities

(iii)   Financial services

(iv)   Sales below specified revenue threshold [e.g.,
Euro 750 million threshold for Country by Country Reporting (CbCR)].

(b) New Nexus: The new nexus of taxation would be largely based on sales, rather
than physical presence. The thresholds of sales may even be country-specific
such that even the smaller economies benefit (for example, it could be a lower
sales threshold for small and developing countries, a higher threshold for
developed countries).

 

(c) New Profit Allocation Rules: For the first time, profit allocation rules contemplate attribution
of profits even in a scenario of sales via unrelated distributors. To this
extent these rules will go beyond the arm’s length principle (ALP). ALP will
continue to apply for in-country marketing or distribution presence (through a
Permanent Establishment or a separate subsidiary), but for attribution of
profits in another scenario, a formula-based solution may be developed.

 

(d) Tax certainty via a three-tier
mechanism for profit allocation

The Unified Approach aims at tax certainty
for both taxpayers and tax administrations and proposes a three-tier profit
allocation mechanism as follows:

 

Amount A:
Profit allocated to market jurisdiction in absence of physical presence.

Amount B:
Fixed returns varying by industry or region for certain ‘baseline’ or ‘routine’
marketing and distributing activities taking place (by a PE or a subsidiary) in
a market jurisdiction.

Amount C:   Profit in excess of fixed return
contemplated under Amount B, which is attributable to marketing and
distribution activities taking place in marketing jurisdiction or any other
activities. Example: Expenses on brand building or advertising, marketing and
promotions (beyond routine in nature).

           

It is suggested to divide the total profit
of an MNE group into the above mentioned three amounts A, B, and C.

 

2.1    Amount
A:

New taxing right – Under this method, a share of deemed residual profit will be
allocated to market jurisdictions using a formula-based approach. The ‘Deemed
Residual Profit’ for an MNE group would be the profit that remains after
allocating what would be regarded as ‘Deemed Routine Profit’ for activities, to
the countries where activities are performed. Deemed residual profit thus
calculated will be allocated to the market jurisdiction under the new nexus
rules based on sales.

 

The document on Unified Approach provides
that ‘the simplest way of operating the new rule would be to define a
revenue threshold in the market (the amount of which could be adapted to the
size of the market) as the primary indicator of a sustained and significant
involvement in that jurisdiction. The revenue threshold would also take into
account certain activities, such as online advertising services, which are
directed at non-paying users in locations that are different from those in
which the relevant revenues are booked. This new nexus would be introduced
through a standalone rule – on top of the permanent establishment rule – to
limit any unintended spill-over effect on other existing rules. The intention
is that a revenue threshold would not only create nexus for business models
involving remote selling to consumers, but would also apply to groups that sell
in a market through a distributor (whether a related or non-related local
entity). This would be important to ensure neutrality between different
business models and capture all forms of remote involvement in the economy of a
market jurisdiction’.

 

The steps involved in computing profits
allocation to market jurisdictions under the New Nexus Approach are as follows:

Step 1: Determine
the MNE group’s profits from the consolidated financials from CbCR prepared as
per Generally Accepted Accounting Principles (GAAP) or International Financial
Reporting Standards (IFRS).

Step 2: Approximate
the profits attributable to routine activities based on an agreed level of
profitability. The level of profitability deemed to represent such ‘routine’
profits could be determined by way of a predetermined fixed percentage(s) which
may vary by industry. Thus, as the name suggests, routine profits are computed
based on some deeming percentage.

Step 3:
Arrive at the deemed non-routine profits (reducing deemed routine profits from
total profits of the MNE group).

Split these deemed non-routine profits into
two parts: (a) Profits attributable to the market jurisdiction, and (b) Profits
attributable to other factors such as trade intangibles, capital and risk, etc.

The rationale of attributing deemed
non-routine profits to other factors is that many activities that may be
conducted in non-market jurisdiction may give rise to non-routine profits. For
example, a social media business may generate excess profits (non-routine) not
only from the database of its customers, but also from powerful algorithms and
software.

Step 4: Allocate
the deemed non-routine profits to the eligible market jurisdictions based on
the internationally-agreed allocation key using variables such as sales (a
fixed percentage of allocation key may vary as per industry or a business
line).

 

Let us consider an example:

 

Net Profit to Revenue    –           10%

Deemed Routine Profit  –             8%

                                            ————   

Non-Routine Profit         –            2%

                                            =======

 

 

 

2.2    Amount
B:

This type of profit would seek to allocate
profits for certain baseline or routine marketing and distribution functions in
a market jurisdiction, usually undertaken by a PE or a subsidiary of the MNE
group / parent. Traditional methods of transfer pricing rules may not be
sufficient or may result in disputes, therefore in order to simplify the
allocation, a fixed return varying by industry or region is proposed.

 

2.3    Amount
C:

Under this part profit is attributed to
activities in the market jurisdiction which are beyond baseline function. There
could also be some activities which are unrelated to market and distribution.
However, the Unified Approach does not prescribe any formulae or fixed
percentage-based allocation here but leaves the allocation based on the
traditional arm’s length principle. It only suggests a robust dispute
prevention and resolution mechanism to ensure avoidance of litigation and
double taxation.

 

Summary
of Amount C

  •     Allocation of additional
    profits to market jurisdiction for activities beyond baseline level marketing
    and distribution activities (e.g., brand-building).
  •     Other business activities
    unrelated to marketing and distribution.
  •     Amount to be determined by
    applying existing arm’s length principles.

 

Let us understand
this with the help of an illustration given in the document on Unified
Approach.

 

Illustration

The facts are as follows:

  •     Group X is an MNE group
    that provides streaming services. It has no other business lines. The group is
    highly profitable, earning non-routine profits, significantly above both the
    market average and those of its competitors.
  •     P Co (resident in Country
    1) is the parent company of Group X. P Co owns all the intangible assets
    exploited in the group’s streaming services business. Hence, P Co is entitled
    to all the non-routine profit earned by Group X.
  •     Q Co, a subsidiary of P Co,
    resident in Country 2, is responsible for marketing and distributing Group X’s
    streaming services.
  •     Q Co sells streaming
    services directly to customers in Country 2. Q Co has also recently started
    selling streaming services remotely to customers in Country 3, where it does
    not have any form of taxable presence under current rules.

 

 

Proposed Taxability

Taxability
in Country 2

  •    Group X already has taxable
    presence in Country 2 in the form of Q Co. This subsidiary is already
    contracting with and making sales to local customers.
  •    Assuming that Q Co makes
    sufficient sale in Country 2 to trigger the application of new nexus, this
    would give Country 2 the right to tax on a portion of deemed non-routine
    profits of Group X (Amount A).

 

  •    The deemed non-routine profits
    of Group X in Country 2 will be attributable to P Co as it is owning the
    intangibles. P Co would be taxed on a portion of deemed non-routine profits,
    along with Q Co (as its PE to facilitate administration – similar to
    representative assessee under the Income-tax Act, 1961). P Co can claim relief
    under a tax treaty by claiming exemption or foreign tax credit of taxes
    withheld / paid in Country 2.

 

  •    Q Co would be taxed on the
    fixed return for baseline marketing and distribution (Amount B) which may be
    arrived at by applying transfer pricing adjustments to the transactions between
    P Co and Q Co to eliminate double taxation.

 

  •    Q Co may also be taxed on Amount C if Country
    2 considers that its activities go beyond the baseline activities. However, for
    this Country 2 must place a robust measure to resolve disputes and prevent double
    taxation.

 

Taxability in Country 3

  •    In Country 3, Group X does
    not have any direct presence under the existing rules. However, Q Co is making
    remote sales in Country 3.

 

  •    Assuming that Group X makes
    sufficient sales in Country 3 to meet the revenue threshold to trigger new
    nexus, Country 3 will get the right to tax a portion of the deemed non-routine
    profits of Group X of Amount A. Country 3 may tax that income directly from the
    entity that is treated as owning the non-routine profit (i.e. P Co), with P Co
    being held to have a taxable presence in Country 3 under the new nexus rules.

 

  •    Since Group X does not have
    an in-country presence in Country 3 by way of a branch or subsidiary, under
    current rules, Amount B will not be allocated.

 

3.0    Open
issues

There are several open issues in the
proposed document, some of which are listed below:

3.1
Determination of routine profit

The first step in
Amount A is to determine routine profit based on a fixed percentage. As
different industries have different profitability, business cycles, regional
disparities and so on, it is going to be a huge challenge in arriving at a
globally-accepted fixed percentage.

3.2  Determination of residual (non-routine) profit

What percentages
will be attributed to which market jurisdiction and what allocation keys are to
be used for this purpose? These will be difficult to arrive at and make the
entire exercise very complex.

3.3 Other pending issues

The document on
Unified Approach has identified several areas in which further work would be
required, such as regional segmentation, issues and options in connection with
the treatment of losses and challenges associated with the determination of the
location of sales, compliance and administrative burden, enforcement and
collection of taxes where the tax liability is fastened on the non-resident of
a jurisdiction and so on.

 

CONCLUSION

While OECD had
asked for public comments on its document on Unified Approach for New Nexus,
there are several grey areas; reaching a consensus within the stipulated time
of December, 2020 appears to be quite optimistic. However, it is also a fact
that more and more countries are resorting to unilateral measures to tax MNEs
operating in their jurisdictions through digitised means. In fact, introduction
of SEP in Indian tax laws is also perceived as a measure to convey to the world
the urgency of consensus on new nexus favouring marketing jurisdiction or a
source state taxation.

 

Bifurcation of MNEs’ profits in three parts and within three parts,
routine and non-routine profits would create huge complications. Again, both
routine and non-routine parts are determined on an approximation basis.
Consensus on a fixed percentage or allocation keys could be a huge challenge.
India has already expressed its dissent on bifurcation of routine and
non-routine profits. Such a bifurcation has the potential of shifting more
revenue in favour of developed countries. It remains to be seen how the world
reacts to the proposed new nexus rules. 


 

Article 7, 12 of India-Singapore DTAA – Provision of standard bandwidth services could not be classified as FTS or royalty under India-Singapore DTAA

18. TS-305-ITAT-2019 (Mum.)

DCIT vs. Reliance Jio Infocomm Ltd.

ITA No.: 936/Mum/2017

A.Y.: 2016-17

Date of order: 10th May, 2019

 

Article 7, 12 of India-Singapore DTAA – Provision of
standard bandwidth services could not be classified as FTS or royalty under
India-Singapore DTAA

 

FACTS

Taxpayer, an Indian company, was engaged in the business of
providing telecom services in India. During the year under consideration,
Taxpayer entered into an agreement with a Singapore Company (FCo) for availing
bandwidth services. As per the terms of the agreement, Taxpayer withheld taxes
on payments made to FCo for rendition of services.

 

However, Taxpayer subsequently appealed before the CIT(A) u/s
248 of the Act on the ground that the amount paid for bandwidth services was
not taxable in India and hence was not subject to withholding u/s 195 of the
Act on the basis of the following:

 

Bandwidth charges were in the nature of business income for
FCo and in the absence of permanent establishment (PE) or business connection
in India, it was not taxable under Article 7 of the India-Singapore DTAA.

 

Provision of the bandwidth services was fully automated and
did not involve any human intervention. Hence, such services did not qualify as
FTS under the Act or the DTAA.

 

Payments made to FCo were merely for receiving standard
bandwidth services and not for making any use of a ‘process’, whether secret or
not; therefore, it does not qualify as ‘royalty’ under the Act as well as the
DTAA.

 

CIT(A) observed that
Taxpayer had only received an access to service and all the infrastructure and
processes required for provision of bandwidth services were always used and
remained under the control of FCo and were never given either to Taxpayer or to
any person availing such services. It was thus concluded that the payments made
by Taxpayer to FCo for provision of bandwidth services could not be classified
as FTS or royalty either under the Act or the DTAA. The payment made was in the
nature of business profits, not taxable in India in the absence of PE or any
business connection of FCo in India.

 

Aggrieved, the AO appealed before the Tribunal1 .

___________________________________________________

1.  The
AO did not assail the observation of the CIT(A) that payment made for bandwidth
services did not qualify as FTS and hence this aspect was not discussed before
the Tribunal.

 

HELD

The consideration paid by Taxpayer to FCo for provision of
bandwidth services was in the nature of business income and cannot be
classified as ‘royalty’ under the Act or the DTAA for the following reasons:

 

Pursuant to the terms of the agreement, Taxpayer had only
received standard facilities, i.e., bandwidth services from FCo.

 

All infrastructure and processes required for provision of
bandwidth services were always used and under the control of FCo and the same
were never given either to Taxpayer or to any person availing the said service.

 

Taxpayer did not have access to any process used in providing
the bandwidth services. Besides, since the process involved in providing the
bandwidth services was a standard commercial process that was followed by the
industry players, and the IPR in the process was not owned / registered in the
name of FCo, it did not qualify as a ‘secret process’. Besides, as the payment
was neither towards the use of any equipment nor secret formula or process, it
did not qualify as royalty under the DTAA.

 

Further, the amendment to
explanation 6 of section 9(1)(vi)2 
will not override the treaty and hence will have no bearing on the
definition of ‘royalty’ as contained in the DTAA.  

___________________________________________________________

2. 
Explanation 6 to section 9(1)(vi) defines a process to include transmission by
satellite, cable, optic fibre or any other similar technology whether or not
such process is secret



      

Article 12(5) India-Finland DTAA – Payment made for obtaining test results in India is taxable in India under Article 12(5) of India-Finland DTAA irrespective of whether the testing process is done outside India

17.  TS-311-ITAT-2019
(Kol.)

Outotec (Finland) Oy, Kolkata vs. DCIT (International
Taxation)

ITA No.: 2601/Kol/2018

A.Y.: 2015-16

Date of order: 31st May, 2019

 

Article 12(5) India-Finland DTAA – Payment made for
obtaining test results in India is taxable in India under Article 12(5) of
India-Finland DTAA irrespective of whether the testing process is done outside
India

 

FACTS

Taxpayer, a Finnish
company, earned income from rendering of testing and other services to Indian
customers. Taxpayer contended that the services were carried on from its office
/ laboratories located outside India and none of its employees visited India
for providing these services to Indian customers. Thus, as the services were
performed outside India, income from these services was not taxable in India as
per Article 12(5) of the India-Finland DTAA.

 

But the AO contended that
the services can be said to be performed only when they were used by the
beneficiary. Since the intended use of the services tested in the laboratories
in Finland was ultimately in India, service can be said to be performed in
India and income from such services were taxable in India under Article 12(5)
of the DTAA.

 

Taxpayer appealed before
the DRP who upheld the AO’s order. Still Aggrieved, Taxpayer appealed before
the Tribunal.

 

HELD

Article 12(5) of the DTAA provides that the FTS shall be
deemed to arise in a contracting state where the payer is located. However, as
an exception to this in cases where the services for which the FTS is paid is
performed within a contracting state, then it shall be deemed to arise in the
state in which the services are performed.

 

For applying the exception
to Article 12(5) it is necessary that the payment should be made for services
and such services should be performed in the other state (i.e., Finland). In
the present case, payment was made not for the testing but for obtaining the
results of the testing which was used in India. Thus, even where testing was
done outside India, the exception of Article 12(5) does not apply.

 

As services were availed in India, the fee for testing
services was taxable in India.

Section 9(1)(vii) of the Act; Article 13 of India-France DTAA – Reimbursement of salary of seconded employees does not qualify as FTS – By virtue of the MFN clause in India-France DTAA, managerial services do not qualify as FTS

16.  [2019] 56 CCH 0235
(Pune – Trib.)

Faurecia Automotive Holding vs. DCIT (IT)

ITA No.: 784/Pun/2015

A.Y.: 2011-12

Date of order: 8th July, 2019

 

Section 9(1)(vii) of the Act; Article 13 of India-France
DTAA – Reimbursement of salary of seconded employees does not qualify as FTS –
By virtue of the MFN clause in India-France DTAA, managerial services do not
qualify as FTS

 

FACTS – 1

Taxpayer, a company resident in France, was engaged in
designing and building moulded plastic parts for passenger car interiors.
During the year under consideration, it seconded an employee (Mr. X) to an
Indian group entity (ICo). During the relevant year, Taxpayer paid the salary
to Mr X on behalf of ICo, which was then reimbursed by ICo without any mark-up.
Taxpayer contended that the reimbursement received from ICo was not subject to
tax.

 

However, the AO contended that the amount received from ICo
was FTS under the Act and hence subject to tax in India.

 

Aggrieved, Taxpayer appealed before the DRP who upheld the
AO’s order on the contention that Mr. X made available his technical knowledge,
experience and skills, etc. to ICo and hence qualifies as FTS under the DTAA.

 

However, Taxpayer went in appeal before the Tribunal.

 

HELD – 1

FTS under the Act is defined to mean any consideration for
the rendition of managerial, technical or consultancy services, unless such an
amount is chargeable to tax under the head ‘salaries’ in the hands of the
recipient.

 

What is of relevance is the real recipient and not the
literal recipient. If an amount is paid to the expatriate of an NR but the real
recipient is the NR, then the nature of that amount may be FTS. However, if the
real recipient is the employee and the NR is merely a person acting as a post
office on behalf of the employee, then the payment made would be in the nature
of salary. Such amount will then not qualify as FTS.

 

For the following reasons it can be said that the amount paid
by ICo is in the nature of salary payable by ICo to the employee and the
Taxpayer merely receives it on behalf of the employee and hence such payment
does not qualify as FTS:

  •    The remuneration of Mr. X was fixed by ICo;
  •    A perusal of the employment agreement clearly
    indicated that Mr. X was employed by ICo and was rendering services to ICo;
  •    Mr. X was working under the control and
    supervision of ICo;
  •    Taxpayer had no role to play in the rendition
    of services by Mr. X to ICo, except that a part of the salary payable by the
    Indian entity was initially paid by Taxpayer in France, which was later on
    recovered without any profit element from ICo.

 

FACTS – 2

Taxpayer provided Global Information Support services to ICo
which inter alia included assistance in running the operations of ICo,
technical support, etc. Taxpayer contended that such services did not make
available any technical knowledge, experience, skill or knowhow, etc. to ICo
and hence the fee received for such services does not qualify as FTS under the
DTAA.

 

The AO, however, contended that the amount received by
Taxpayer was in the nature of ‘royalty’ as well as ‘FTS’ under the Act and also
the DTAA.

 

Aggrieved, the Taxpayer appealed before the DRP who upheld
the AO’s order. Taxpayer then approached the Tribunal.

 

HELD – 2

Perusal of the agreement indicates that the services rendered
by the Taxpayer catered to various facets of business operations, including
management, marketing, accounting and finance, human resources, IT support
services, etc. These services are in the nature of managerial services as well
as technical services and hence qualify as FTS under the Act as well as the
DTAA.

 

However, having regard to the Most Favoured Nation (MFN)
clause of the India-France DTAA, the limited scope of FTS under the India-UK
DTAA is to be read into the India-France DTAA.

 

Article 13(4) of the
India-UK DTAA defines FTS to mean technical or consultancy services which ‘make
available’ technical knowledge, experience or skill, etc. to the recipient.

 

As the FTS definition in the India-UK DTAA does not include
‘managerial services’, the services rendered by Taxpayer which are in the
nature of managerial services will not qualify as FTS. Further, as the
technical services rendered by Taxpayer did not make available any technical
knowledge or skill, it will not qualify as FTS under the DTAA.

 

Further, as the payment was received for
rendering of services, it does not qualify as ‘royalty’ under the Act as well
as the DTAA.

Section 5(2)(a) and section 15 of the Income-tax Act, 1961 – salary remitted to NRE account in India for services rendered in Nigeria is not taxable in India on receipt basis

11

TS-220-ITAT-2019(Kol)

Deepak Kumar Todi vs. DDIT

ITA No. 1918/Kol/2017

A.Y.: 2011-12

Dated: 16th April, 2019

 

Section 5(2)(a) and section
15 of the Income-tax Act, 1961 – salary remitted to NRE account in India for
services rendered in Nigeria is not taxable in India on receipt basis

 

FACTS

The
assessee, a non-resident individual, was employed in Nigeria. For the relevant
year under consideration, the Assessee received foreign inward remittances in
his NRE account maintained in India on account of salary for the services
rendered in Nigeria. The assessee contended that such salary amount was
transferred by the employer only under due instructions of the assessee. Thus,
the constructive receipt of such salary is out of India and the money received
in the NRE account of the assessee is mere remittance which cannot constitute income
‘received or deemed to be received in India’ within the meaning of section
5(2)(a) of the Act.

 

The AO,
however, was of the view that receipt of salary in India by way of direct
remittance by the foreign employer to the assessee’s bank account in India
would amount to first receipt in India. Further, as the income has not been
taxed in Nigeria, non-taxation of such amount in India would amount to double
non-taxation. Consequently, the AO taxed such amount as salary income under the
Act.

 

Aggrieved,
the assessee appealed before the CIT(A) who upheld the AO’s order. Still
aggrieved, the assessee appealed before the tribunal.

 

HELD

  •      The tribunal
    observed that tax had been duly withheld by the foreign employer on the salary
    income of the assessee. It was, therefore, not a case of double non-taxation of
    income. Thus, the AO’s observation that the income had neither been taxed in
    Nigeria nor in India, was incorrect to this extent.
  •      Reliance was
    placed on the Calcutta HC ruling in Utanka Roy vs. DIT, International Tax
    (390 ITR 109)     to hold that the salary income for services rendered
    outside India had to be considered as income accruing outside India and, hence,
    not taxable in India.

Sections 9(1)(vi), 9(1)(vii) and Article 12 of the India-Germany DTAA – subscription fees received for access to online database does not qualify as FTS or royalty

10

TS-215-ITAT-2019(Mum)

Elsevier Information Systems GmbH vs.
DCIT

ITA No.1683/Mum/2015

A.Y.: 2011-12

Dated: 15th April, 2019

 

Sections 9(1)(vi), 9(1)(vii)
and Article 12 of the India-Germany DTAA – subscription fees received for
access to online database does not qualify as FTS or royalty

 

FACTS

The
assessee is a tax resident of Germany and is engaged in the business of
providing access to online database pertaining to chemical information
consisting of articles on the subject of chemistry, substance data and inputs
on preparation and reaction methods as experimentally validated. The assessee
earned subscription fees by providing access to the online database from
customers worldwide, including India.

 

The
assessee, contended that subscription fee received from the customers is not in
the nature of royalty or fee for technical services (FTS). Further, in the
absence of a PE in India, such income is not taxable in India.

 

But the AO
noted that the database was akin to a well-equipped library which provided
users with the desired result without much effort. Further, the AO concluded
that the data was in relation to a technical subject collated from various
researchers and journals involving technical expertise, which would not have
been possible without technical expertise and human element. Hence, he treated
the subscription fees as FTS under the Act as well as the DTAA. Further, the AO
also held that the online database was in the nature of a literary work which
amounts to right to use copyright and hence it qualifies as royalty under
section 9(1)(vi) of the Act as well as the DTAA.

 

HELD

  •      The database
    maintained by the assessee consisted of chemical information which the users
    could access for their own benefit. The data contained in the online database
    was collated by the assessee from articles printed in various journals on
    similar topics which were otherwise available to the public on subscription
    basis. The collated data was stored on the online database in a structured and
    user-friendly manner and was made accessible through regular web browsers,
    without any use of a designated software or hardware.
  •      Examination
    of the subscription agreement between the assessee and the customer revealed
    the following aspects:

(a)  The assessee granted non-exclusive and
non-transferrable right to the subscriber to access, search the browser and
view the search results and print or make copies of such information for its
exclusive use.

(b)  Upon termination of the subscription
agreement, the subscriber was required to delete all such stored data.

(c)  All rights and interests in the subscribed
products and data remained with the assessee and the users were prohibited from
making any unauthorised use of such data.

  •      Thus, the
    assessee merely provided access to the database without conferring any
    exclusive or transferrable right to the users. The intellectual property in the
    data / product remained with the assessee. There is no material on record to
    show that the assessee had transferred its right to use the copyright of any
    literary, artistic or scientific work to the subscribers while providing them
    with access to the database.
  •      Hence, the subscription fee does not qualify as
    royalty. Reliance in this regard was placed on the AAR ruling in the case of Dun
    & Bradstreet Espana SA (272 ITR 99)    , the Ahmedabad Tribunal ruling
    in the case of ITO vs. Cedilla Healthcare Ltd. (77 Taxmann.com 309)
    and DCIT vs. Welspun Corporation Ltd. (77 Taxmann.com 165).
  •      The assessee
    had neither employed any technical / skilled person to provide any managerial
    or technical service, nor was there any direct interaction between the
    subscriber of the database and the employees of the assessee. Further, there
    was no material on record to show that there was human intervention in
    providing access to the database. Thus, in the absence of human intervention,
    the subscription fee did not qualify as FTS under the Act as well as the DTAA.
    Reliance in this regard was placed on SC decisions in the cases of CIT
    vs. Bharati Cellular Ltd. (193 Taxman 97)     and DIT vs. A.P. Moller
    Maersk A.S. (392 ITR 186).

Article 12 and Article 5 read with Article 7(3) of the India–Russia DTAA – consideration received by a member of a consortium qualifies as business income; as the income is attributable to the assessee’s PE in India, it is taxable in India

9

TS-212-ITAT-2019(Del)

PJSC Stroytransgaz vs. DDIT

ITA No. 2842/Del/2010 [A.Y.: 2004-05]

ITA No. 2843/Del/2010 [A.Y.: 2005-06]

ITA No. 6029/Del/2012 [A.Y.: 2006-07]

ITA No. 3821/Del/2010 [A.Y.: 2004-05]

ITA No. 3822/Del/2010 [A.Y.: 2005-06]

A.Y.s: 2004-05 & 2005-06

Dated: 15th April, 2019

 

Article 12 and Article 5
read with Article 7(3) of the India–Russia DTAA – consideration received by a
member of a consortium qualifies as business income; as the income is
attributable to the assessee’s PE in India, it is taxable in India

 

FACTS

The
assessee is a company incorporated in Russia with expertise in implementation
of oil and gas industry projects. During the year under consideration, the
assessee entered into a consortium with an Indian company to execute certain
oil and gas projects for customers in India.

 

As agreed
between the parties to the consortium and the customer, the assessee was
required to (i) depute specialised manpower in India to undertake project
management and execution to the satisfaction of the customers for a specified
monthly consideration, and (ii) to prepare the technical bid to be provided to
the customer on the basis of its technical expertise and knowhow.

 

The
project management and execution work was performed by the branch office (BO)
of the assessee in India. On the other hand, the preparation of the technical
bids was undertaken by the assessee outside India.

 

There was
no dispute on the fact that the BO constituted the permanent establishment (PE)
of the assessee in India. The income from project management and execution
rendered by the BO was offered to tax as fee for technical services on gross
basis and the income from the supply of technical design and knowhow by the HO
was offered to tax as royalty on gross basis under Article 12 of the
India-Russia DTAA.

 

The
assessing officer (AO) contended that since the assessee had a PE in India,
Article 12 of the India–Russia DTAA was not applicable and the entire payment
received by the assessee had to be taxed on net basis as business profits.

 

HELD

  •      A close
    reading of the agreements indicates that the assessee was one of the members of
    the consortium. The consideration received by the assessee from the project
    execution is nothing but its business profits from the execution of the
    project.

 

  •     Being a
    member of the consortium, the assessee cannot pay royalty to itself and,
    therefore, the share received from the execution of the projects is nothing but
    business profits. Even in a case where services are rendered in India by the HO
    and not by the BO, the consideration received by the assessee cannot be
    bifurcated as royalty and business income.

 

  •      Since the
    assessee had a PE in India and the income from both manpower supply and the
    technical bid carried out outside India was attributable to the PE in India,
    the total income earned from the project is taxable as business income in
    India.

Article 5(2)(k)(i) of India–UK DTAA – multiple counting of employee in a single day is impermissible for computing service PE threshold; period of stay during which employee is on vacation in India is also to be excluded for determination of service PE

8

TS-210-ITAT-2019(Mum)

Linklaters vs. DDIT

ITA No. 3250/Mum/2006

A.Y.: 2002-03

Dated: 16th April, 2014

 

Article 5(2)(k)(i) of
India–UK DTAA – multiple counting of employee in a single day is impermissible
for computing service PE threshold; period of stay during which employee is on
vacation in India is also to be excluded for determination of service PE

FACTS

The
assessee, a UK resident partnership firm, was engaged in the business of
practising law. During the year under consideration, the assessee was appointed
to provide legal consultancy services to Indian clients, in respect of which it
received consultancy fees. The assessee contended that the fee received was in
the nature of business income and, in the absence of PE, such income was not
taxable in India.

 

The AO,
however, was of the view that the employees / other personnel of the assessee
rendered services in India for a period of more than 90 days and, hence, the
assessee had a service PE in India under Article 5(2)(k)(i) of the India–UK
DTAA. He, therefore, held that the income earned from rendering legal
consultancy services was taxable in India.

 

However, the assessee argued that one of its
employees present in India was on a vacation here and during such stay the
employee did not render any services in India. Consequently, such period has to
be excluded for the purpose of computing the threshold of 90 days for
determination of service PE. Further, the assessee argued that the period of
stay of employees in India has to be taken cumulatively and not individually.
On the above basis, the total presence of employees in India was only for 87
days. Hence, service PE in India was not triggered.

 

On appeal,
the CIT (A) held that the assessee had a service PE in India. Aggrieved, the
assessee appealed before the tribunal.

 

HELD

  •      As per
    Article 5(2)(k)(i) of the India-UK DTAA, the assessee shall constitute a
    service PE in India only if the presence of its employees for rendering
    services in India exceeds 90 days in any 12-month period.

 

  •      Various
    documentary evidences furnished by the assessee, such as leave register of the
    employer, the log of work maintained by the employee and invoice raised on the
    client, etc., indicated that one of the employees of the assessee was on a
    vacation to India and had not rendered any services in India during such leave
    period. Further, during such period, no other employee of the assessee was
    rendering services in India. Hence, such leave period had to be excluded for
    computing the period of 90 days.

 

  •      Further, for
    computation of the 90-day threshold, stay of employees in India on a particular
    day has to be taken cumulatively and not independently. Thus, multiple counting
    of an employee in a single day is impermissible under Article 5(2)(k)(i) of the
    India–UK DTAA. Reliance in this regard was placed on the ruling of Mumbai ITAT
    in the case of Clifford Chance (82 ITD 106).

 

  •      Since the
    aggregate period of stay of the assessee’s employees in India accounted to only
    87 days, there was no service PE of the assessee in India.

INTERNATIONAL DECISIONS IN VAT / GST

In this, the second in the series, the compiler shares cases developing
throughout the world on VAT / GST as an aid in grasping the finer propositions
of the GST law in India. After each decision, the compiler has put in a note –
‘Principles applicable to Indian law’. This note is meant to draw the readers’
attention to particular propositions which are relevant. Readers are, however,
advised that provisions in India and abroad may not be similar and the
decisions should not be treated as automatically applicable to Indian law

 

EU
VAT / UK VAT

 

(1)   Composite / mixed supply –
(a) Post-supply activities – Whether changes nature of supply; (b) Inter-linked
contracts – Supply of land subject to condition that the land be further
supplied to an identified third party – Whether both contracts are composite

 

Skatterministeriet vs. KPC Herning [Judgement dated 4th
September, 2019 in Case C-71/18]

 

European Court of Justice

 

KPC Herning
purchased from the port of Odense the land known as ‘Finlandkaj 12’ with a
warehouse built on it. The sale contract was subject to a number of conditions,
including that KPC Herning was to conclude a contract with Boligforeningen
Kristiansda for the purpose of carrying out, on the land in question, a
building project composed of social housing for young persons.

 

Neither KPC
Herning under the first contract, nor Boligforeningen Kristiansda under the
second contract, was formally tasked with the duty to demolish the existing
warehouse on the land under the second contract, though the overall intention
and purpose of both contracts necessarily required demolition of the warehouse
at some stage. In fact, Boligforeningen Kristiansda engaged a third party to
undertake the demolition after the second sale was completed. A question arose
during the VAT classification proceedings as to whether the covenant to
demolish in the second contract formed part of the first and / or the second
contract?

 

HELD

It was held
that both the contracts did not require the demolition of the warehouse which
was existing at the time the two contracts were performed. Demolition was
carried out after the second sale was completed and was an independent contract
between Boligforeningen Kristiansda and a third party. This fact of demolition
could not colour the nature of supply under either the first or the second
supply.

 

Furthermore,
the first and the second contracts were held to be independent of each other.
The mere fact that one contract required the conclusion of another contract
with a third party was held not to make the two contracts a single, indivisible
transaction.

 

Principles applicable to Indian law:

This
decision is relevant for similar controversies which may arise u/s 8 of the
CGST Act wherein a determination is required as to whether two transactions are
composite transactions and must be classified as a single transaction or
independent of each other.

 

(2)   Whether making and reselling
hay is a ‘business’

 

Babylon Farm Limited vs. HMRC [2019] UKFTT 562 (TC)

 

UK First Tier Tribunal

 

The taxpayer
in this case was doing no activity except making hay for resale, sale of
outbuildings on the farm and undertaking preparatory steps for new ventures
which he wanted to launch. As such, the only income during the year under
question was from resale of hay. The question was whether making and reselling
hay can be said to be a ‘business’ under the UK VAT Act, since the Revenue had
denied input tax credit to the taxpayer on the basis that he was not engaged in
‘business’.

 

HELD

The
definition of ‘business’ is contained in section 94 of the UK VAT Act:

‘(1) In this
Act “business” includes any trade, profession or vocation.

(2) Without
prejudice to the generality of anything else in this Act, the following are
deemed to be the carrying on of a business:

(a) the provision by a club, association or organisation
(for a subscription or other consideration) of the facilities or advantages
available to its members; and

(b) the admission, for a consideration, of persons to any
premises.…

……

(4) Where a
person in the course or furtherance of a trade, profession or vocation, accepts
any office, (the) services supplied by him as the holder of that office are
treated as supplied in the course or furtherance of the trade, profession or
vocation;

(5) Anything
done in connection with the termination or intended termination of a business
is treated as being done in the course or furtherance of that business;

(6) The
disposition of a business, or part of a business, as a going concern, or of the
assets or liabilities of the business or part of the business (whether or not
in connection with its reorganisation or winding up), is a supply made in the
course or furtherance of the business.’

 

The Tribunal
recognised that there is no comprehensive definition of ‘business’ exhaustively
explaining its meaning under the UK VAT law. It therefore relied on the seminal
judgement in the case of Commissioners of Customs and Excise vs. Lord
Fisher [1981] STC 238 to derive the principles of what constitutes
‘business’ in ordinary parlance:

 

(a) a
serious undertaking earnestly pursued;

(b) has a
certain measure of substance;

(c) is an
occupation or function actively pursued with reasonable or recognisable
continuity;

(d) is
conducted in a regular manner and on sound and recognised business principles;

(e) is
predominantly concerned with the making of taxable supplies for consideration;
and

(f) the
supplies are of a kind that, subject to differences in detail, are commonly made
by those who seek to profit from them.

 

The Tribunal
reviewed all the evidence and the submissions in the appeal against these six
criteria and concluded that:

 

(i) The
hay-making activity was being seriously and earnestly pursued by the taxpayer.
The taxpayer organised this activity using the equipment and machinery that had
been in use for many years when he had a larger active farming business. The
taxpayer explained that he and his wife had wanted a farm and had carried on
farming for many years and remained committed to it. Hay-making was the last
part of that activity. There was a single customer of the business who was the
end-user for the hay and there was a clear purpose in producing
the hay.

(ii)   For the same reasons the hay-making activity
had some substance. The supply of hay was zero-rated but was not VAT-exempt.
However, it was a very modest activity carried out on a casual basis.

(iii)  The hay-making activity had been continuous
even though it was seasonal. The taxpayer undertook this activity regularly and
had done so for many years.

(iv) The
supply of hay for consideration was a common activity that was frequently
carried on for profit in agricultural businesses.

(v)    The activity of hay-making was not being
conducted in a regular manner and on sound and recognised principles. The hay
was grown on land belonging to the taxpayer. There was no evidence of the
commercial basis on which the taxpayer was able to carry out the cutting of hay
or any other activity on the land. The hay was cut and baled by the taxpayer on
the machinery he owned and operated. The bales were then sold to a single
customer for his livery business. He fixed the price that he paid for the hay
and decided what costs were borne by the taxpayer and which he or another of
his businesses bore. The activities of the taxpayer did not appear to give rise
to any staff or other costs. It was only the taxpayer’s ownership of the baling
equipment and machinery that was used in the hay-making activity. The single
customer also had a significant say in the manner in which costs were accrued
and the profitability of the taxpayer’s hay-making activities was entirely
dependent on the single customer’s subjective judgement as to where costs and
revenue should be allocated between his various activities.

(vi) The
hay-making activity was not predominantly concerned with making taxable
supplies for consideration. The activity led to little revenue, under £500 per
year. No invoices had been raised by the taxpayer for payment by its only customer
and no payment had been made for the bales of hay for a number of years. The
taxpayer’s activity was not predominantly concerned with making a profit.

 

On this
basis, the activity of making and reselling hay was held not to be a
‘business’.

 

Principles applicable to Indian law:

The UK VAT
Tribunal has come to the conclusion that the stand-alone hay-making activity on
its own cannot be said to be ‘business’. This decision repays study inasmuch as
it carefully dissects the various elements of the ordinary meaning of
‘business’. Lord Fisher’s (Supra) judgement is a decision
rendered under the UK VAT Act and hence is relevant in the Indian context –
except that the UK Tribunal seems to give some weightage to the profit motive
element. In India, the definition of ‘business’ in the Indian GST law makes the
profit motive irrelevant.

 

However, the
Hon’ble Supreme Court has explained in the case of a similar definition in
sales tax statutes in CST vs. Sai Publication Fund (2002) 126 STC 288 (SC) that even if
the profit motive is irrelevant under the statute, the activity must still have an underlying commercial nature. The UK
VAT Tribunal’s observations as to lack of commercial nature are therefore
relevant in the Indian context.

 

NEW ZEALAND GST

 

(3)   Collection of GST and
non-payment – Penalties – New GST regime – Principles

 

Hannigan vs. Inland Revenue Department [(1988) 10 NZTC 5162]

 

High Court, New Zealand

 

The taxpayer
had collected tax but not paid the same. Regarding the penalty levied on him,
the High Court of New Zealand held that the principle of proportionality will
apply and certain mitigating factors must be taken into account. In particular,
the observations on the GST law being a new law (at that time in New Zealand)
are relevant to our Indian circumstances today:

‘…I am
reluctant at this stage and on this particular appeal to lay down general
guidelines as to the quantum of fines.

 

In the first place,
I imagine that the circumstances will vary enormously. There will be single
traders who, simply from inability to cope with the requirements of present-day
society, have not complied with the law. There may not be substantial sums of
money involved. There may be larger organisations who appear wilfully to have
ignored their legal obligations. There may even, indeed, be offenders who
prefer to face the fine rather than make the payment which is a necessary
consequence of making the return on the due date. Obviously, the fine must be
tempered to the circumstance and in particular must be tempered to the fact
that there are advantages to traders in delaying paying over the GST which they
have recovered. On the other hand, this is new legislation. The stage may not
yet have been reached where it is appropriate to lay down an indication that
offences of this kind will always be treated seriously and by way of the
imposition of a substantial fine. I do not doubt that that day will be
appropriate (sic), but it may be that the Act should be given two or
three years of operation before such a step is taken.’  

Articles 12 and 14 of India-Uganda DTAA – Where services provided by non-resident individuals outside India were covered under Article 14 (which is specific in nature), Article 12 (which is general in nature) could not apply; hence, the payments were not chargeable to tax in India

7. TS-177-ITAT-2019 (Bang) Wifi Networks P. Ltd. vs. DCIT ITA No.: 943/Bang/2017 A.Y.: 2011-12 Dated: 5th April, 2019

 

Articles 12 and 14 of India-Uganda DTAA –
Where services provided by non-resident individuals outside India were covered
under Article 14 (which is specific in nature), Article 12 (which is general in
nature) could not apply; hence, the payments were not chargeable to tax in
India

 

FACTS


The assessee, an Indian company, had engaged
certain non-resident individuals for providing certain technical services
outside India. The assessee had made payments to them without withholding tax
from such payments.



The AO held that the payments were in the
nature of Fee for Technical Services (FTS) under the Act. Since the assessee
had not withheld tax u/s. 195, the AO disallowed the payments u/s. 40(a)(i) of
the Act.

 

Aggrieved, the assessee appealed before the
CIT(A) who upheld the order of the AO on the ground that the payments qualified
as FTS under the Act as well as DTAA, and hence, tax should have been withheld
from the payments. Thus, CIT(A) upheld the order of the AO.

 

Aggrieved, the assessee appealed before the
Tribunal.

 

HELD


  •     Perusal of the order of
    CIT(A) shows that his conclusion is based only on Article 12 of the
    India-Uganda DTAA and section 9(1)(vii) of the Act. He had not considered
    Article 14 of the India-Uganda DTAA.
  •     Article 14 applies in case
    of professional services performed by independent individuals. Article 12(3)(b)
    of the India-Uganda DTAA specifically excludes from its ambit payments made for
    services mentioned in Articles 14 and 15. Reliance was placed on the decision
    of Poddar Pigments Ltd. vs. ACIT (ITA Nos. 5083 to 5086/Del (2014) dated
    23.08.2018)     wherein it was held that specific or special provisions in DTAA
    should prevail over the general ones. Hence, Article 12 which is broader in
    scope and general in nature, will be overridden by Article 14 which
    specifically applies to professional services provided by individuals.
  •     As per the terms of the
    agreement between the assessee and the payees, and considering the scope of
    their services, the services rendered by the payees were professional services
    covered under Article 14. Professional services covered under Article 14 could
    be technical in nature but merely because they were technical in nature it
    cannot be said that Article 14 was not applicable.
  •    
    Further, having regard to specific exclusion in Article 12(3)(b) in respect of
    services covered in Article 14, the payments made by the assessee would be
    covered by Article 14 and on non-satisfaction of conditions specified therein,
    such income was taxable only in Uganda. Hence, tax was not required to be
    withheld from such payments. 

 

 

 

Sub-sections 9(1)(vii), 40(a)(i) of the Act – payments made to foreign agent for services rendered outside India, which assessee was contractually required to perform, were not covered within section 9(1)(vii); hence, payments were not subject to tax withholding; payment for market survey, being for managerial, technical or consultancy services, was subject to tax withholding

6. TS-183-ITAT-2019 (Ahd) Jogendra L. Bhati vs. DCIT ITA No.: 2136/Ahd/2017 A.Y.s.: 2013-14 Dated: 5th April, 2019

 

Sub-sections 9(1)(vii), 40(a)(i) of the Act
– payments made to foreign agent for services rendered outside India, which
assessee was contractually required to perform, were not covered within section
9(1)(vii); hence, payments were not subject to tax withholding; payment for
market survey, being for managerial, technical or consultancy services, was
subject to tax withholding

 

FACTS


The assessee had a sole proprietary business
of trading and export of medicines. The assessee had procured an order from the
Government of Ecuador for supply of medicines to 300 hospitals in Ecuador.

 

The assessee had hired a local agency of
Ecuador (FCo) to undertake various activities to fulfil the conditions of the
order. Such activities included liaising with the local authorities,
registration of products at Ecuador, export of goods to Ecuador, clearing of
goods from customs authorities, storage in warehouse, and physical delivery of
goods to various hospitals across the country; the assessee did not withhold
taxes on such payments.

 

Further, the assessee also made certain
payments towards market survey for new products or territory to other non-resident
entities (FCo1). However, it did not withhold tax while making payments for
such services.

 

According to the AO, since the services
rendered by FCo were specialised services in the field of pharmaceuticals, they
were covered within the expression “management technical or consultancy
services” used in Explanation 2 to section 9(1)(vii) of the Act. Since
the assessee had not withheld tax from such payments, the AO disallowed the
expenditure u/s. 40(a)(i) of the Act.

 

However, the assessee contended that payments
made to FCo and FCo1 did not accrue or arise in India and hence were not taxable in India. Aggrieved, the assessee appealed before
the CIT(A) who upheld the order of the AO.

 

Aggrieved, the assessee appealed before the
Tribunal.

 

HELD

  •     Section 9 of the Act
    defines FTS as any consideration for rendering of any ‘managerial, technical or
    consultancy services’, but does not include the consideration for any
    construction, assembly, etc.
  •     ‘Managerial’ service means
    managing the affairs by laying down certain policies, standards and procedures
    and then evaluating the actual performance in the light of the procedure so
    laid down. The ‘managerial’ services contemplate not only execution but also
    planning of the activity. If one merely follows directions of the other for
    executing a job in a particular manner without planning, it could not be said
    that the former is ‘managing’. Similarly, for ‘consultancy’ some consideration
    should be given to rendering of advice, opinion, etc.
  •     The activities of FCo included
    liaison with local authorities, registration of products in Ecuador, clearing
    of goods from customs, storage in warehouse and physical delivery of the goods
    to various hospitals across the country. The assessee necessarily had to carry
    out these activities to fulfil its obligation under the agreement with the
    Government of Ecuador. The assessee had appointed FCo to render these services
    and incur the expenses. The assessee had also not debited any other expenditure
    separately for these activities.
  •     Thus, the payments made to
    FCo were simplicitor reimbursement of actual expenditure as well as
    commission to FCo for performing the activities that the assessee was obligated
    to perform. All the services were rendered in Ecuador.
  •     Section 195 would apply if payment
    has an element of income. If there is no element of income, tax is not required
    to be withheld.
  •     In several decisions, High
    Courts as well as ITAT have held that the nature of services of foreign agents
    should be determined on the basis of the agreement. If they are services simplicitor
    for procurement of a contract and fulfilment of certain obligations like
    logistics, warehousing, etc., then such services could not be classified as
    technical, managerial or consultancy services.

 

However, as the expenses incurred by the
assessee towards market survey for new products or territory would provide the
assessee with information which would be used by the assessee for exploring new
business opportunity, provision of such information would thus qualify as
managerial, technical or consultancy services. Hence, the assessee was required
to withhold tax from payment made to FCo1.

 

Articles 4, 16 of India-USA DTAA; section 6 of the Act – in case of dual residency, residential status shall be determined by applying tie-breaker test under the DTAA

5. (2019) 104 taxmann.com 183 (Bangalore –
Trib) DCIT vs. Shri Kumar Sanjeev Ranjan ITA No.: 1665 (Bang.) of 2017 A.Y.: 2013-14 Dated: 15th March, 2019

 

Articles 4, 16 of India-USA DTAA; section 6
of the Act – in case of dual residency, residential status shall be determined
by applying tie-breaker test under the DTAA

 

FACTS

The assessee, a US citizen,  was working in the USA since 1986. His spouse
and two children were all US citizens. The assessee was deputed to India by his
employer from June, 2006 to August, 2012. Upon completion of his assignment in
India, the assessee left India on 10.08.2012 and resumed his employment in the
USA. Since then he was residing with his family in the USA.

 

Prior to 1986, the assessee had lived in
India for 21 years. He relocated to the USA in 1986 and became a permanent
resident in 1992. After marriage, his spouse was also residing in the USA.
Their two children were born there. When he was on assignment to India, the
assessee was taking his vacations in the USA.

 

The assessee had a house in India as well as
in the USA. He had let out his house in the USA while he was on assignment to
India.

 

On the basis of his physical presence in
India, the assessee was a tax resident of India for FY 2012-13. The assessee
also qualified as a tax resident of the USA for FY 2012-13. During the period
11.08.2012 to 31.03.2013 the assessee earned a salary in the USA. According to
the AO, since the assessee was a tax resident in India during the relevant AY,
his entire global income, including salary earned in the USA, was liable to tax
in India. Hence, the AO sought to tax his salary in the USA for the period
11.08.2012 to 31.03 2013.

 

The assessee
contended before the AO that he should be considered a tax resident of the USA
under the tie-breaker rule of the India-USA DTAA on the basis that the assessee
furnished detailed particulars on different aspects[1]  to establish that his ‘centre of vital
interests’ was closer to the USA than to India. And to establish that his
habitual abode was in the USA, the assessee highlighted two aspects, namely,
time spent and intent of settling down in the USA on completion of the
assignment.

 

The AO, however, noted that:

 

  •     personal and economic
    relations refer to a long and continuous relation that an individual nurtures
    with a State;
  •     it could not be broken so
    casually into bits and pieces by claiming that on one day the assessee has an
    economic and personal relationship with State A and after a few days with State
    B;
  •     the concept of economic and
    personal relationship is a qualitative one which has to be analysed in a
    holistic manner rather than being compartmentalised;
  •     merely by moving to the USA
    for an assignment from 11.08.2012 to 31.03 2013, the assessee could not claim
    that his economic and personal relationships were suddenly closer to the USA
    than to India, particularly when during the preceding entire AY the assessee
    was present in India.

 

The AO, accordingly, did not accept the
contention of the assessee that his ‘centre of vital interests’ was in the USA.
He further rejected the concept of dual (or split) residency on the ground that
the Act or the India-USA DTAA did not recognise it. The assessee had claimed
exemption under Article 16 of the India-USA DTAA. The AO also rejected this
claim since the assessee had not furnished tax residency certificate.

 

On appeal before CIT(A), the assessee
furnished the tax residency certificate. The CIT(A) noted that the tax
residency certificate furnished by the assessee showed that he was also a tax
resident of the USA. Further, since the assessee had a permanent home in India
as well as in the USA, the CIT(A) applied the test of closer personal and
economic relations (‘centre of vital interests’) and concluded that the ‘centre
of vital interests’ of the assessee was closer to the USA than to India.
Accordingly, the CIT(A) held that the Assessee qualified for exemption under
Article 16 of the India-USA DTAA. Therefore, the AO could not tax the salary
income of the assessee earned in the USA in India.

 

HELD

  •     Article 4 of the India-USA
    DTAA determines the tax residential status of a person. Where a person is a tax
    resident of both the States, Article 4 provides certain tie-breaker tests:
  •     The first test pertains to
    the availability of a permanent home: The assessee had a house in India as well
    as in the USA. However, since he had let out his house in the USA, it was
    deemed to be ‘unavailable for use’. Hence, he did not satisfy the first test.
  •     The second test is about
    ‘centre of vital interests’. After examining various aspects, the CIT(A) had
    found that the ‘centre of vital interests’ of the assessee was closer to the
    USA than to India. The conclusion of the CIT(A) arrived at based on facts
    cannot be faulted.

[1] These were: (i)
where dependent members resided; (ii) where assessee had his personal
belongings such as house, car, personal effects, etc.; (iii) where assessee
exercised his voting rights; (iv) driving licence and vehicle tax payments; (v)
which country was ordinarily his country of residence; (vi) in which State the
assessee had better social ties; (vii) in which State the assessee

had
substantial investments, savings, etc.; (viii) in which State the assessee ultimately
intended to settle down; and (ix) in which State the assessee was contributing
to social security.

Article 12 and Article 14 of DTAA – Consultants providing technical consultancy services in the capacity of an advisor and who also bears the risk in relation to such services, would be treated as an independent person – services rendered by them would qualify as Independent Personal Services.

1.      
TS-43-ITAT-2019 (AHD) DCIT vs.
Hydrosult Inc. A.Y.: 2011-12 Date of Order: 31st
January, 2019

 

Article 12 and Article 14 of DTAA –
Consultants providing technical consultancy services in the capacity of an
advisor and who also bears the risk in relation to such services, would be
treated as an independent person – services rendered by them would qualify as
Independent Personal Services.

 

FACTS

Taxpayer, a foreign Company incorporated in
Canada, was engaged in the business of providing technical consultancy services
for development of irrigation and water resources in India. During the year
under consideration, Taxpayer was awarded a contract for providing consultancy
services in relation to irrigation development project. In relation to the said
project, Taxpayer made payments to certain non-resident individuals as fees for
consultancy services. Taxpayer did not withhold tax from the payments on the
ground that such payments were not chargeable to tax in India for the following
reasons:

 

a. Payments made to professionals were in the
nature of independent personal services (IPS).

b. Aggregate period of presence of such
professionals in India did not exceed the threshold provided in the treaty.

c. Professionals did not have a fixed base in
India.

 

The Assessing Officer (AO), however
contended that the professionals were not independent per se as their
scope of work and activities were regulated by contractual obligations or other
forms of employment. Hence, payments made to them would not qualify as IPS
under the treaty. AO held that the services were rendered by the professionals
specialising in their respective domains. Accordingly, such services were in
the nature of technical/consultancy services covered under the Fees for
Technical Services (FTS) article of the treaty and therefore, subject to
withholding of tax in India.

 

Aggrieved, the Taxpayer appealed before
Commissioner of Income Tax (Appeal) [CIT(A)]. CIT(A) examined the terms of
agreement between Taxpayer and the non resident consultants and held that such
services qualified as IPS and, in absence of a fixed base as also stay in India
being within the prescribed threshold of 90 / 183 days of the respective DTAA,
such income was not taxable in India.

 

Aggrieved, the AO appealed before the
Tribunal.

 

HELD

  • Perusal of the specimen
    agreement entered into between the Taxpayer and one of the non-resident
    consultants indicated the following:

•    The non-resident consultant was engaged in
the capacity of an ‘advisor’.

•    The responsibility or the risk for the
results to a greater degree belonged to the professional.

•    The obligations arising from the contract
could not have been assigned to some other persons unlike in the case of an
employer.  Thus, the contract did not
lack independence of work/services to be rendered.

 

  •   Above factors indicate that
    the services rendered by the consultants was of independent in nature, which
    qualified it as IPS under the treaty. Payment for such services was not taxable
    in India in absence of fixed base in India and the physical presence of
    professionals in India not exceeding the threshold of 90 / 183 days that was
    specified in the respective DTAA. 

 

(PS: However, it is not clear from the
ruling if the recipient would have been taxable in India, if he had rendered
services in the capacity of an employee.)

 

Article 12(5) of India-Netherlands DTAA – Rendering of a bouquet of services where the predominant nature is managerial in nature will qualify for exemption from FTS, even if some of the services have the trappings of technical and consultancy services

15.  [2019] 106
taxmann.com 24 (Mum – Trib.)

DCIT vs. Hyva Holdings B.V.

ITA Appeal No.: 3816 (Mum.) of 2017

A.Y.: 2012-13

Date of order: 30th April, 2019

 

Article 12(5) of India-Netherlands DTAA – Rendering of a
bouquet of services where the predominant nature is managerial in nature will
qualify for exemption from FTS, even if some of the services have the trappings
of technical and consultancy services

 

FACTS

Taxpayer, a company incorporated in the Netherlands, had
entered into a service agreement with its Indian subsidiary (ICo) for rendition
of a bouquet of services (provision of IT, R&D, strategic purchasing
services, etc.) which involved providing certain expertise to support ICo to
grow, expand and achieve business independence. Taxpayer contended that the
services rendered to ICo are ‘managerial’ in nature and in the absence of
coverage of ‘managerial services’ in the Fee for Included Services (FIS)
Article of the India-Netherlands DTAA, it would not trigger source taxation
under the DTAA.

 

On a perusal of the service agreement, the AO noted that the
nature of services provided by the Taxpayer were not confined to managerial
service alone but were all-inclusive, comprising managerial, technical and
consultancy services. As the services rendered by Taxpayer made available
technical knowledge, experience, knowhow and skill, it qualified as FTS under
Article 12 of the DTAA.

 

Aggrieved, the Taxpayer
filed an appeal before the CIT(A) who reversed the AO’s order and concluded
that services rendered by Taxpayer were in the nature of managerial services
and hence did not fall within the ambit of FTS under the DTAA. Further, even if
such services qualify as technical services, in the absence of satisfaction of
make-available condition, it did not qualify as FTS under the DTAA.

 

But the aggrieved AO appealed before the Tribunal.

 

HELD

A perusal of the service agreement indicated that while the
services to be rendered under the agreement were termed as management services,
some of the services such as information technology, R&D, etc. rendered by
Taxpayer were in the nature of technical or consultancy services. Nevertheless,
the core activity of Taxpayer under the agreement was rendering managerial
services.

 

Further, as the AO did not demonstrate that the amount can be
attributed towards technical or consultancy services, the payment received by
Taxpayer does not qualify as FTS under the DTAA.

 

Without prejudice, even if the services are held
to be in the nature of technical or consultancy services, as Taxpayer has not
made available any technical knowledge, experience, knowhow, skill, etc., to
ICo for its independent use, the amount received by Taxpayer did not qualify as
FTS under the DTAA.

Articles 2, 11 and 12 of India-UAE DTAA – Education cess is in the nature of an additional surcharge – As Articles 11 and 12 restrict taxability and have precedence over the Act, royalty and interest could not be taxed at rates higher than that specified in the respective articles by including surcharge and education cess separately

14  [2019] 104 taxmann.com 380 (Hyderabad – Trib.) R.A.K. Ceramics, UAE vs.
DCIT ITA No: 2043 (HYD) of 2018 A.Y.: 2012-13 Date of order: 29th
March, 2019

 

Articles 2, 11 and 12
of India-UAE DTAA – Education cess is in the nature of an additional surcharge
– As Articles 11 and 12 restrict taxability and have precedence over the Act,
royalty and interest could not be taxed at rates higher than that specified in
the respective articles by including surcharge and education cess separately

 

FACTS

The
assessee was a company fiscally domiciled in, and tax resident of, the UAE.
During the relevant previous year, the assessee received royalty and interest
from its group company in India. Under Article 12(2) of the India-UAE DTAA such
receipt is taxable @ 10% and under Article 11(2)(b) interest is taxable @
12.5%.

 

While
the AO applied the aforementioned rates, he further levied 2% surcharge and 3%
education cess on the tax so computed. The CIT(A) upheld this order of the AO.

 

HELD

  •     Article
    2(2) of the India-UAE DTAA defines the expression ‘taxes covered’ in India as “(i)
    the income-tax including any surcharge thereon; (ii) the surtax; and (iii) the
    wealth-tax”.     Article 2(3) clarifies that “this Agreement shall also
    apply to any identical or substantially similar taxes on income or capital
    which are imposed at Federal or State level by either contracting state in
    addition to, or in place of, the taxes referred to in paragraph 2 of this
    Article”.
  •     In the context of India-Singapore DTAA, in
    DIC Asia Pacific (Pte.) Ltd. vs. Asstt. DIT [2012] 22 taxmann.com 310/52 SOT
    447 (Kol.)    , the Tribunal has observed that: “The education
    cess, as introduced in India initially in 2004, was nothing but in the nature
    of an additional surcharge … Accordingly, the provisions of Articles 11 and 12
    must find precedence over the provisions of the Income-tax Act and restrict the
    taxability, whether in respect of income tax or surcharge or additional surcharge
    – whatever name called, at the rates specified in the respective Article”.
  •     This view has also been adopted in a large
    number of cases (See NOTE below), including in the context of the
    India-UAE DTAA. Further, no contrary decision was cited nor any specific
    justification for levy of surcharge and education cess was provided.
  •     The
    provisions of the India-UAE DTAA are in pari materia with those of the
    India-Singapore DTAA, which was the subject matter of consideration in DIC
    Asia Pacific’s     case.
  •     Accordingly, the Tribunal directed the AO to
    delete the levy of surcharge and education cess.

 

{NOTE: Capgemini SA vs. Dy. CIT
(International Taxation) [2016] 72 taxmann.com 58/160 ITD 13 (Mum. – Trib.);
Dy. DIT vs. J.P. Morgan Securities Asia (P.) Ltd. [2014] 42 taxmann.com
33/[2015] 152 ITD 553 (Mum. – Trib.); Dy. DIT vs. BOC Group Ltd. [2015] 64
taxmann.com 386/[2016] 156 ITD 402 (Kol. – Trib.); Everest Industries Ltd. vs.
Jt. CIT [2018] 90 taxmann.com 330 (Mum. – Trib.); Soregam SA vs. Dy. DIT (Int.
Taxation) [2019] 101 taxmann.com 94 (Delhi – Trib.); and Sunil V. Motiani vs.
ITO (International Taxation) [2013] 33 taxmann.com 252/59 SOT 37 (Mum. –
Trib.).}

Article 5 of India-UAE DTAA – Section 9 of the Act – Grouting activity carried out by the assessee for companies in oil and gas industry did not constitute ‘construction PE’ under Article 5(2)(h) – Since assessee had placed equipment and stationed personnel on the vessel of the main contractor for carrying out grouting, the vessel was a fixed place of business through which the assessee carried on business – Hence, income of assessee was taxable in India

13 [2019] 105 taxmann.com 259 (Delhi – Trib.) ULO Systems LLC vs. DCIT ITA
Nos.: 5279 (Delhi) of 2011, 4849 (Delhi) of 2012 A.Y.s.: 2008-09 to 2012-13 Date of order: 29th
March, 2019

 

Article 5 of
India-UAE DTAA – Section 9 of the Act – Grouting activity carried out by the
assessee for companies in oil and gas industry did not constitute ‘construction
PE’ under Article 5(2)(h) – Since assessee had placed equipment and stationed
personnel on the vessel of the main contractor for carrying out grouting, the
vessel was a fixed place of business through which the assessee carried on
business – Hence, income of assessee was taxable in India

 

FACTS

The
assessee was a company incorporated in UAE. It was engaged in the business of
undertaking grouting work for customers in the oil and gas industry. Though the
assessee had executed contracts with Indian companies, it had not offered any
income from these contracts on the ground that it did not have any PE in India.

 

But
the AO held that grouting activity was carried out from a fixed place PE in
terms of Article 5(1) of the India-UAE DTAA. Hence, the income arising
therefrom was taxable in India.

 

Based
on its observations for assessment year 2007-08, DRP held that income from grouting
activity was taxable because of existence of PE in India under Article 5(1).

 

Before
the Tribunal, the assessee submitted that in terms of Article 5(2)(h) of the
India-UAE DTAA, its activities constituted a ‘construction PE’. Therefore, in
order to constitute a construction PE, each construction or assembly project
should have continued for a period of more than nine months in India. Since the
activities carried on by the assessee under contracts involved installation /
construction activities, and since none of the projects had continued for more
than nine months, the assessee could not be said to have a construction PE in
India in terms of Article 5(2)(h).

 

HELD

  •     For the purpose of Article 5(2)(h) of the
    India-UAE DTAA, sub-sea activities that can be treated as ‘construction’ are
    “laying of pipe-lines and excavating and dredging”. Thus, grouting activities
    carried on by the assessee being pipelines and cable crossing, pipeline and
    cable stabilisation, pipeline cable protection, stabilisation and protection of
    various sub-sea structures, anti-scour protection, etc., cannot be held to be
    ‘construction’ under Article 5(2)(h) of the India-UAE DTAA.
  •     Article 7 provides that business profits
    earned by a resident of UAE shall be taxable in India only if such resident
    carries on business in India through a PE. As the activity of the assessee was
    not a construction project, the activity of grouting carried out by the
    assessee for the main contractors could not be considered ‘construction’ under
    Article 5(2)(h).
  •     To bring an establishment of the kind not
    mentioned in Article 5(2) within the ambit of PE, the criteria in Article 5(1)
    should be satisfied. The two criteria are (a) existence of a fixed place of
    business; and (b) wholly or partly carrying out of business or enterprise
    through that place.
  •     The
    Tribunal held that the assessee had a fixed place PE in India in the form of
    the vessel on which equipment was placed and personnel were stationed for the
    following reasons:

 1.     For carrying out
the grouting activity, equipment was the main place of business for the
assessee and equipment was placed and personnel were stationed on the vessel of
the main contractor. Further, in terms of the contracts, the assessee was
required to ensure that whenever required by the main contractor, personnel and
equipment will come to India, and, after completion of work, were sent out of
India until required by the main contractor again. Thus, the equipment and
personnel were demobilised after the work was completed.

2.    Further,
the agreement entered into between the assessee and the customers in India
provided for free of charge food and accommodation to the personnel on board
the offshore vessel.

3.   Thus,
the assessee had a fair amount of permanence through its personnel and its
equipments, within the territorial limits of India, to perform its business
activity for contractors with whom it has entered into agreements.

4.    Thus,
the vessel on which equipment was placed and personnel were stationed, was the
fixed place of business through which business was carried on by the assessee.

5.    Accordingly,
criteria under Article 5(1) were satisfied.

 

  •     Both the OECD Commentary and Professor Klaus
    Vogel’s commentary mention that as long as the presence is in a physically
    defined geographical area, permanence in such fixed place could be relative
    having regard to the nature of business. Hence, the placing of equipment and
    stationing of the personnel on the vessel of the main contractor constituted a
    fixed place of the business of the assessee in India.
  •     The Coordinate bench’s decision in the
    assessee’s own case for the A.Y. 2007-08 (see NOTE below) needed
    reconsideration in view of the fact that the existence of a fixed place PE has
    been decided by holding that ‘equipment’ cannot be held as a fixed place of
    business and such view was not in accordance with the Supreme Court’s decision
    in case of Formula One World Championship Ltd. (80 taxmann.com 347).

 

{NOTE:
For the A.Y 2007-08, the Delhi Tribunal had ruled in favour of the tax-payer by
stating that activities carried out by assessee amounts to ‘construction’ and
since the duration test of each contract is not satisfied, there was no
construction PE in India. Further, it held that Article 5(1) could not be
applied where activities are covered under the specific construction PE article
[Article 5(2)(h)] of the DTAA.}

 

Section 91 of the Act – Credit for state taxes paid in USA can be availed u/s. 91 of the Act Section 91 of the Act – A ‘resident but not ordinarily resident’ being a category carved out of ‘resident’ – Such assessee is a resident – Entitled to claim tax credit u/s. 91

12 [2019] 105 taxmann.com 323 (Delhi – Trib.) Aditya Khanna vs. ITO ITA No: 6668 (Delhi) of 2015 A.Y.: 2011-12 Date of order: 17th
May, 2019

 

Section 91 of the Act
– Credit for state taxes paid in USA can be availed u/s. 91 of the Act

 

Section 91 of the Act
– A ‘resident but not ordinarily resident’ being a category carved out of
‘resident’ – Such assessee is a resident – Entitled to claim tax credit u/s. 91

 

FACTS

The
assessee was an individual. During the relevant year, in terms of section 6(6)
of the Act, he was ‘resident but not ordinarily resident in India’ and had
earned salary in the USA as well as in India. In the USA, the assessee had paid
federal income tax, alternate minimum tax, New York State tax and local city
tax. The assessee had stayed in India for 224 days. Accordingly, he offered
salary proportionate to the period of his stay in India and claimed
proportionate tax credit.

 

He
contended before the AO that he had claimed credit for local taxes u/s. 91 of
the Act and relying on the decision in CIT vs. Tata Sons Ltd. 135 TTJ
(Mumbai). Alternately, the assessee contended that if the AO does not
consider claim for credit of state taxes, they may be allowed as deduction from
the salary earned abroad.

 

The
AO noted that Article 2 of the India-USA DTAA mentions only federal income
taxes imposed by internal revenue code and hence the tax credit should be
limited only to those taxes. He further noted that sections 90 and 91 stand on
different premises. Section 90 deals with the situation wherein India has an
agreement with foreign countries / specified territories, whereas section 91
deals with the situation where no agreement exits between India and other
countries. Since an agreement exists between India and the USA, section 90
would apply which refers to DTAA, and as per DTAA, only federal income taxes
paid in USA qualify for tax credit.

 

On
appeal, even the CIT(A) did not accept the contentions of the assessee.

 

HELD I:

  •     In Wipro Ltd. vs. DCIT [382 ITR 179],
    the Karnataka High Court has held that “The Income-tax in relation to any
    country includes Income-tax paid not only to the federal government of that
    country, but also any Income-tax charged by any part of that country meaning a
    State or a local authority, and the assessee would be entitled to the relief of
    double taxation benefit with respect to the latter payment also. Therefore,
    even in the absence of an agreement u/s. 90 of the Act, by virtue of the
    statutory provision, the benefit conferred u/s. 91 of the Act is extended to
    the Income-tax paid in foreign jurisdictions.”
  •     In Dr. Rajiv I. Modi vs. The DCIT
    (OSD) [ITA No. 1285/Ahd/2014],     dealing with a similar issue, the
    Ahmedabad Tribunal has also granted credit for state taxes.
  •     In light of these judicial precedents, u/s.
    91 of the Act, the assessee is entitled to credit of federal as well as state
    taxes paid by him.

 

HELD II:

  •     Section 91(1) and (2) provide tax credit to
    a person who is a ‘resident’ in India. Section 6(6) has carved out a separate
    category of ‘not ordinarily resident’ in India. However, such person is
    primarily a ‘resident’. Hence, the contention of the tax authority that a
    ‘resident but not ordinarily resident’ in India does not qualify for the
    benefit u/s. 91(1) cannot be accepted.

Article 12 of India-UAE DTAA; Article 12 of India-Germany DTAA; Article 12 of India-Singapore DTAA; sections 9 and 195 of the Act – Since hiring of simulator by itself has no purpose, fee paid for simulator is not royalty – Payment to foreign companies for flight simulation training was in the nature of FTS – In absence of FTS article in India-UAE DTAA, it was to be treated as business income which, in absence of PE of foreign company in India, was not taxable – TDS obligation cannot be fastened on the assessee because of retrospective amendment if such obligation was not there at the time of payment

22. 
Kingfisher Airlines Ltd. vs. DDIT ITA No.: 86 & 87/Bang./2011 and 143
& 144/Bang./2011 A.Ys.: 2007-08 & 2008-09 Date of order: 17th July, 2019; Members: N.V. Vasudevan (V.P.) and Jason P.
Boaz (A.M.) Counsel for Assessee / Revenue: None /
Harinder Kumar

 

Article 12 of India-UAE DTAA; Article 12 of
India-Germany DTAA; Article 12 of India-Singapore DTAA; sections 9 and 195 of
the Act – Since hiring of simulator by itself has no purpose, fee paid for
simulator is not royalty – Payment to foreign companies for flight simulation
training was in the nature of FTS – In absence of FTS article in India-UAE
DTAA, it was to be treated as business income which, in absence of PE of foreign
company in India, was not taxable – TDS obligation cannot be fastened on the
assessee because of retrospective amendment if such obligation was not there at
the time of payment

 

FACTS

The assessee was an Indian company in the
business of running an airline. During the relevant years, it had deputed its
pilots and cockpit crew to non-resident companies located in Dubai (UAE Co),
Germany (German Co) and Singapore (Sing Co) for training on flight simulators.
The assessee had made payments to the three foreign companies towards charges
for use of simulators and for training of its personnel. The assessee had not
deducted tax from the payments made to non-residents.

 

According to the AO, the main purpose of the
assessee was to lease the simulator, which also included charges of trainers.
Hence, the payment was in the nature of ‘royalty’ u/s 9(1)(vi) of the Act. In
respect of payments made to the three foreign companies, the AO concluded as
follows:

 

In respect of the UAE Co, since the payment
was for use of equipment and also for imparting information concerning
industrial, commercial or scientific experience, knowledge or skill, it
constituted ‘royalty’ under Article 12 of the India-UAE DTAA.

 

As for the German Co, it was required to
make available the simulator to the assessee for training. Hence, the payment
was ‘royalty’ under Article 12(3) of the India-Germany DTAA. Besides, the
charges were for use of simulator and for imparting information concerning
industrial, commercial or scientific experience, knowledge or skill. Therefore,
the AO further concluded that the payment was also covered under Article 12(4)
as FTS. Accordingly, they were chargeable to taxin India.

 

In respect of the Sing Co, the payment was
for use of simulator and for training. The trainers were mainly involved in
imparting information to the personnel of the assessee. Accordingly, the
payments were in the nature of ‘royalties’ under Article 12(3), and FTS under
Article 12(4), of the India-Singapore DTAA. Therefore, they were chargeable to
tax in India.

 

Thus, the assessee was required to deduct
tax from the all the payments made to non-resident companies.

 

The CIT(A) directed the AO to exclude
payments made for use of simulators and to regard only the payments made for
training as FTS. CIT(A) held that as the India-UAE DTAA did not have any
article defining or dealing with FTS, and since the UAE Co had received payment
in the course of its business, the receipt was its business income; further,
even assuming that any income had arisen to the UAE Co in India, since the UAE
Co did not have a PE in India, in terms of Article 7(1) of the India-UAE DTAA,
such income could be taxed only in the UAE. This view was supported by the ITAT
Bangalore decision in ABB FZ-LLC vs. ITO (IT) Ward-1(1) Bangalore, [2016]
75 taxmann.com 83 (Bangalore – Trib.) in the context of the India-UAE
DTAA.

 

In respect of
the payments made to the German Co and the Sing Co, relying on the AAR decision
in Inter Tek Testing Services India (Pvt.) Ltd. [2008] 307 ITR 418 (AAR),
the CIT(A) concluded that they were in the nature of FTS. Thereafter, referring
to the retrospective amendment to section 9 regarding deeming of income u/s
9(1)(v), (vi) and (vii), the CIT(A) held that the payment was taxable in India.
Further, insertion of Explanation 2 to section 195 of the Act made it
obligatory for the assessee to deduct tax.

 

HELD

Payment for simulator

Flight
simulator is an essential part of training. Merely because charges for simulator
are separately quantified on an hourly basis did not mean that the assessee had
hired the same or made payment for a right to use the same.

 

Without imparting training by the
instructors, hiring of the simulator on its own is of no purpose. Hence, the
charges paid by the assessee for use of simulator were ‘royalty’.

 

Payment to UAE Co.

In the case of the UAE Co, the question of
payment being FTS did not arise since the India-UAE DTAA does not have an
article relating to FTS.

It is settled position of law that in the
absence of an article in a DTAA regarding a particular item of income, the same
should not be regarded as residuary income but income from business. In the
absence of the PE of a non-resident in India, business income cannot be taxed
in India.

 

Retrospective amendment

The CIT(A) had upheld the order of the AO
only on the ground of retrospective amendment to section 9 in 2010 and to
section 195 in 2012.

 

The law is well settled that TDS obligation
cannot be fastened on a person on the basis of a retrospective amendment to the
law, which was not in force at the time when the payments were made. Since at
the time when the assessee made payments to the non-resident there was no TDS
obligation on him, it was not possible for him to foresee that by a
retrospective amendment to the law a TDS obligation would be fastened on him.

 

Section 9, Article 7 of India-Qatar DTAA – Non-compete fees received under an independent agreement executed after sale of shares was business income which, in absence of PE / business connection in India, was not taxable in India – Shareholding in Indian company by itself would not trigger business connection in India

12. TS-683-ITAT-2019 (Mum.) ITO vs. Mr. Prabhakar Raghavendra Rao ITA No.: 3985/Mum/2018 A.Y.: 2014-15 Date of order: 6th November, 2019

 

Section 9, Article 7 of India-Qatar DTAA –
Non-compete fees received under an independent agreement executed after sale of
shares was business income which, in absence of PE / business connection in
India, was not taxable in India – Shareholding in Indian company by itself
would not trigger business connection in India

 

FACTS

The assessee, a
non-resident individual, was a director and shareholder in an Indian company
(ICo). During the relevant accounting year, he sold the shares of ICo and
offered the same to tax as capital gains. Subsequently, he entered into a
non-compete and non-solicitation agreement with the buyer for not carrying on
similar business in India for ten years.

 

The assessee contended that the non-compete fee received by him was in
the nature of business income. Since he did not have any business connection in
India, the fee was not taxable in India under Article 7 of the India-Qatar
DTAA.

But the AO
contended that shareholding in the Indian company had resulted in a business
connection in India. Hence, the non-compete fee received from the sale of
shares was to be deemed to accrue or arise in India. Alternatively, such fee
was part and parcel of the share sale transaction and hence was to be taxed as
capital gains.

 

On appeal, the
CIT(A) ruled in favour of the assessee. Aggrieved, the AO filed an appeal
before the Tribunal.

 

HELD

(i)     The assessee first transferred the shares
held in ICo. Subsequently, independent of the share transfer, he entered into a
non-compete and non-solicitation fee agreement for not carrying on similar
business in India for ten years;

(ii)     The non-compete fee was business income
since it was received for restraint from trade for a period of ten years.
Hence, it could not be considered part and parcel of the share sale
transaction;

(iii)    Business income is taxable in India only if
the assessee has a business connection or PE in India. Shareholding in an
Indian company by itself would not result in a business connection in India;

(iv)    In the absence of a business connection or PE
in India, the non-compete fee was not taxable in India.  

 

 

 

Section 167B(1) of the Act – Where foreign company is a member of an AOP and share of profits of the members is indeterminate or unknown, income of AOP is subject to maximum marginal rate applicable to foreign company

11. TS-659-ITAT-2019 (Chny.) M/s. Herve Pomerleau International CCCL
Joint Venture vs. ACIT ITA Nos.: 1008/Chny/2017, 17, 18 &
19/Chny/2019 A.Ys.: 2010-11, 2011-12, 2012-13 &
2013-14 Date of order: 21st October, 2019

 

Section 167B(1) of the Act – Where foreign
company is a member of an AOP and share of profits of the members is
indeterminate or unknown, income of AOP is subject to maximum marginal rate
applicable to foreign company

 

FACTS

The assessee was a
consortium between an Indian and a foreign company. It was taxable as an
Association of Persons (AOP) under the Act. The consortium was set up to
execute a contract in India. While the consortium agreement and the
profit-sharing agreement were silent about the profit-sharing ratio of members,
they mentioned that profit before tax on the project would be finally
determined after completion of the project and that the foreign company would
be paid a guaranteed profit share equivalent to 2% of the contract price. The
consortium agreement further mentioned that the obligation to pay the guaranteed
amount was not on the AOP but on the Indian company.

 

The assessee
contended that it was a ‘determinate’ AOP, hence it offered income for tax at
the maximum marginal rate (MMR) applicable to an Indian company.

 

But the AO held
that the assessee was an ‘indeterminate’ AOP. Hence, its income was to be taxed
at the MMR applicable to a foreign company. Therefore, he initiated
re-assessment proceedings under the Act.

 

The CIT(A)
dismissed the appeal of the assessee who filed an appeal before the Tribunal.

 

HELD

(a)   Admittedly, the consortium was assessed as an
AOP;

(b)   Section 167B(1) of the Act would apply if the
shares of the members of the AOP are indeterminate or unknown;

(c)   Perusal of the consortium and profit-sharing
agreements showed that the agreement was silent about the profit-sharing ratio
of its members. However, the foreign company was guaranteed 2% of the contract
price as its profit. The obligation to pay the guaranteed amount was not on the
AOP but on the Indian company;

(d)   The term ‘share of net profit’ implies a
‘share in the net profits’ which is an interest in the profits as profits,
which implies a participation in profits and losses;

(e)   In the facts of the case, the foreign company
was entitled to 2% of the project cost regardless of whether the AOP made
profits or losses. Thus, the minimum guarantee was a charge against the profits
of the AOP but not a share in the profits of the AOP. Therefore, the share of
the members in the profit of the AOP could not be said to be determinate or known;

(f)    Accordingly, the AOP was subject to section
167B(1) of the Act. Consequently, its income was subject to tax at the MMR
applicable to foreign companies.

Section 195 – As services of copyediting, indexing and proofreading do not qualify as FTS, tax could not be withheld u/s 195 of the Act

10. TS-640-ITAT-2019 (Chny.) DCIT vs. M/s Integra Software Services Pvt.
Ltd. ITA No.: 2189/Chny/2017 A.Y.: 2011-12 Date of order: 11th October, 2019

 

Section 195 – As services of copyediting,
indexing and proofreading do not qualify as FTS, tax could not be withheld u/s
195 of the Act

 

FACTS

The assessee was
engaged in the business of undertaking editorial services, multilingual
typesetting and data conversion. The assessee outsourced language translation
to various vendors in the USA, the UK, Germany and Spain and made certain
payments to them without withholding tax, on the ground that such services were
not in nature of FTS.

 

However, the AO
concluded that such payments were subject to withholding and, consequently,
disallowed payments made u/s 40(a)(i) of the Act.

 

On appeal, the CIT(A) concluded that payments made to tax residents of
the USA and the UK did not make available technology to the assessee and hence
they were not FIS under the India-USA DTAA and the India-UK DTAA. Thus, tax was
not required to be withheld from such payments. He, however, held that payments
made to the tax residents of Germany and Spain were in the nature of FTS and in
the absence of ‘make available’ condition in the relevant DTAAs, it was subject
to withholding of tax.

 

Aggrieved, the
assessee filed an appeal before the Tribunal.

 

HELD

Copyediting, indexing and proofreading services only require knowledge
of language and not expertise in the subject matter of the text. Hence such
services could not be considered as technical services. Reliance in this regard
was placed on the decision of the Chennai Tribunal in Cosmic Global Ltd.
vs. ACIT (2014) 34 ITR (Trib.) 114.

 

Since the services
rendered were not technical services, payments made to NRs were not taxable in
India and were also not subject to withholding of tax under the Act.

 

Article 7 of India-Germany DTAA – In absence of common link in terms of contracts / projects, expats, nature of activities, location, or contracting parties, income from activities in India, though similar to activities of PE, could not be attributed to PE by invoking Force of Attraction rule

9. TS-630-ITAT-2019 (Del.) M/s Lahmeyer International vs. ACIT ITA No.: 4960/Del/2004 A.Y.: 2001-02 Date of order: 9th October, 2019

 

Article 7 of India-Germany DTAA – In
absence of common link in terms of contracts / projects, expats, nature of
activities, location, or contracting parties, income from activities in India,
though similar to activities of PE, could not be attributed to PE by invoking
Force of Attraction rule

 

FACTS

The assessee was a
company incorporated in, and tax resident of, Germany. It was engaged in the
business of engineering consulting. During the relevant assessment year the
assessee rendered consultancy services in relation to ten power projects in
India and received Fees for Technical Services (FTS).

 

According to the
assessee, only one of the projects constituted a PE in India. Hence, on FTS
received from that project the assessee paid tax u/s 115A of the Act @ 20% on
gross basis; on the other projects it paid tax @ 10% under Article 12 of the
India-Germany DTAA.

 

The AO observed
that the contracts were artificially split by the assessee to avoid tax and,
applying the force of attraction (FOA) rule, concluded that the entire income
was attributable to PE and chargeable to tax @ 20%.

 

After the CIT(A)
upheld the order of the AO, the aggrieved assessee filed an appeal before the
Tribunal.

 

HELD

(1)    FOA rule under India-Germany DTAA provides
that profits derived from business activities which are of the same kind as
those effected through a PE can be attributed to the PE, if the following
conditions are satisfied cumulatively:

(a) The transaction
was resorted to in order to avoid tax in PE state;

(b)    In some way, PE is involved in such
transaction;

 

(2)    Considering the following factors, the
Tribunal held that the FOA rule could not be applied as PE was not involved in
other projects:

(i)     All the projects undertaken by the assessee
were independent contracts with unrelated parties and the scope of work,
liabilities and risk involved in each of the contracts was independent of each
other;

(ii)     Specific sets of activities were performed
under each project as per the terms of the contracts and such activities were
not interlinked with each other;

(iii)    The projects were carried out using different
teams at a given point of time;

(iv)    RBI regulations stipulated a separate project
office for each project. Funds of each project could be used only for the
specific project for which approval was granted and could not be used for any
other project;

(v)    Each project had a different location. The
work was carried out either from the project site of the client or from the
head office outside India. This demonstrates that owing to the different
geographical location where each project was executed in India, there was no
possibility of the PE to play a part or be involved in the other projects in
India.

 

(3)    For applying the FOA rule there should be
some common link to every contract / project, such as common expats, common
nature of contract / project, common location, common contracting parties, etc.
Such commonality was absent in the case of the assessee. Hence, the FOA rule
could not be applied.

 

(4)    Accordingly, the FTS received by the assessee
under other contracts could not be attributed to a PE in India. Hence, such FTS
was taxable @ 10%.

Non-resident shareholder liable to capital gains tax on transfer of Indian company shares pursuant to conversion of the Indian company into an LLP under the LLP Act – The value of partnership interest as represented by capital as well as reserves and surplus is the full value of consideration for computation of capital gains on transfer of shares — Value of partnership interest is not same as cost of investment in shares

4. Domino
Printing Science Plc. AAR No.: 1290
of 2012 A.Y.: 2008-09 Date of order:
23rd August, 2019

 

Non-resident shareholder liable to capital gains tax on transfer of
Indian company shares pursuant to conversion of the Indian company into an LLP
under the LLP Act – The value of partnership interest as represented by capital
as well as reserves and surplus is the full value of consideration for
computation of capital gains on transfer of shares — Value of partnership
interest is not same as cost of investment in shares

 

FACTS

The applicant, a tax resident of the UK, was 100% shareholder of an
Indian company ICo. During the relevant year and in accordance with the LLP
Act, ICo was converted into an LLP. Consequently, the shareholding of the
applicant in ICo was transformed into a partnership interest in the LLP.

 

The Applicant filed an application before the Authority for Advance
Ruling (AAR) with respect to the aforesaid conversion and raised the following
questions:

(i) Whether conversion of equity shares held by the applicant in ICo
into partnership interest in the LLP, consequent to the conversion of the ICo
into an LLP, would be regarded as a ‘transfer’ under the Act?

(ii) Whether the computation provisions of the Act are capable of being
applied to such transfer?

(iii) Whether the transaction can give rise to any taxable capital gains
in the hands of the applicant when the value for the partnership interest in
the LLP was the same as the value of the applicant’s interest in ICo?

 

HELD

On whether conversion would be regarded as a ‘transfer’ of a capital
asset:

 

(a) The definition of transfer u/s 2(47) of the Act is inclusive and,
therefore, extends to events and transactions which may not otherwise be
‘transfer’ according to the ordinary, popular and natural sense of the term. The
Act also clarifies that transfer includes parting of any asset or any interest
therein;

(b) As per the LLP Act, conversion results in dissolution and vesting of
all the assets of the company into the LLP. On such vesting, the share capital
of the company along with the interest of shareholders in the shares of the
company gets extinguished. Alternatively, conversion involves exchange of
shares in the company with partnership interest;

(c) The argument that charge of capital gains triggers only when there
is a transfer between two existing parties at a time is not correct. This is
evident by the fact that even conversion of capital asset into stock-in-trade
is considered as transfer under the Act;

(d) The Supreme Court in the case of Grace Collis2  concluded that the extinguishment of a
right includes extinguishment of a right in a capital asset independent of and
otherwise than on account of transfer. This also supports that extinguishment
of rights in the shares on conversion results in transfer;

____________________________________________________________

2. ITAT seems to be of the view
that since the income qualifies as a business income u/s 28(va), the assessee
creates a business connection in India

 

(e) Existence of a specific provision under the Act which exempts the
transaction of conversion of company into LLP from capital gains tax also
indicates that such transaction results in transfer, such conversion will be
subject to capital gains tax under the Act.

 

On computation mechanism of capital gains arising on transfer as a
result of conversion:

 

(f) On conversion, shareholders
relinquish their shareholding in the company to acquire capital in the LLP in
the same proportion in which shares were held in the company. Thus, the value
of the partnership interest in the LLP is to be considered as the Full Value of
Consideration (FVC) received / accrued to each shareholder for computation of
capital gains;

(g) FVC can be computed on the
basis of the accounts of the LLP considering the reserves and surplus
transferred. If such FVC is not ascertainable, the deeming provision u/s 50D of
the Act can be adopted to deem the fair market value as the FVC.

(h)        The
assessee’s contention that the value of partnership interest was the same as
the cost of acquisition of the shares in the company, is incorrect for the
following reasons:

(I)  Cost of shares is the price at
which shares are acquired. Such cost of acquisition varies from one shareholder
to another shareholder;

(II)       The value of partnership
interest is inclusive of the share capital as well as the reserves and surplus
(i.e., shareholders fund) which is different from the cost of acquisition of
shares;

(III)      Thus,
the value of partnership interest as reduced by cost of acquisition of shares
is subject to capital
gains tax.

 

Article 11 of India-Cyprus DTAA – Interest earned by Cyprian company from investment in CCDs which were funded by parent company qualified for lower rate under Article 11 of India-Cyprus DTAA since, on facts, the Cyprian company had indicia (marks or signs) of beneficial owner of interest income

3. TS-523-ITAT-2019
(Mum.) Golden Bella
Holdings Ltd. vs. DCIT ITA No.:
6958/Mum/2017 A.Y.: 2013-14 Date of order:
28th August, 2019

 

Article 11 of
India-Cyprus DTAA – Interest earned by Cyprian company from investment in CCDs
which were funded by parent company qualified for lower rate under Article 11
of India-Cyprus DTAA since, on facts, the Cyprian company had indicia
(marks or signs) of beneficial owner of interest income

 

FACTS

The assessee, a limited liability company resident in Cyprus, was an
investment holding company. During the year under consideration, the assessee
earned interest income from investment in CCDs of an Indian company (ICo),
which was offered to tax in India @ 10% in terms of Article 11 of the
India-Cyprus DTAA. The source of funds for investment in CCDs was equity
capital and interest-free funds from the Mauritian parent (MauCo) of the
assessee.

 

 

 

The AO held that the investment in CCDs was made by
the assessee out of a back-to-back loan taken from MauCo and hence the Assessee
did not qualify as the beneficial owner of the interest income. Hence, the
Assessee was not eligible to avail the lower tax rate under Article 11 of the
DTAA.

 

Aggrieved, the assessee appealed before the DRP which affirmed the order
of the AO and held that the assessee’s role was limited to merely routing the
funds from MauCo and acting as a conduit for passage of funds of MauCo, as an
agent / nominee of MauCo. Hence, the assessee was not the beneficial owner of
interest income.

 

The Assessee went in appeal before the Tribunal.

HELD

(i) The assessee had invested in CCDs and received interest for its own
exclusive benefit and not for or on behalf of MauCo;

(ii) As per the OECD Commentary on the Model Convention 2017 on Article
11, beneficial owner is an entity having right to use and enjoy the interest
income unconstrained by contractual / legal obligation to pass it on;

(iii) The mere fact that the investment was funded
using certain interest-free loans and share capital infused by MauCo did not
affect the assessee’s status as the beneficial owner of the interest income,
since the entire interest income was the sole property of the assessee who had
absolute control over the funds received from MauCo;

(iv) Further, the assessee also wholly assumed and maintained the
foreign exchange risk and the counter-party risk on interest payments arising
on the CCDs. Thus, there was no back-to-back transaction lacking economic
substance;

(v) Besides, the AO had failed to prove that:

(a) The assessee did not have exclusive possession and control over the
interest income received;

(b) The assessee was required to seek the approval or obtain consent
from any entity to invest in ICo or to utilise the interest income received;

(c) The assessee was not free to utilise the interest income received at
its sole and absolute discretion, unconstrained by any contractual, legal or
economic arrangements with any other third party;

(vi) Thus, interest income from investment in CCDs qualified to be taxed
@ 10% under Article 11 of the DTAA .

 

 

 

Section 9(1)(i) read with section 28(va) of the Act, Article 5(2)(1) of the India-US DTAA – Consideration received for granting the right to render BPO services to group entities qualified as business income u/s 28(va) of the Act – Such income was not taxable in India under the Act as well as the DTAA in absence of any business activity and PE in India

2. TS-458-ITAT-2019
(Pune) Cummins Inc.
vs. DDIT ITA No.:
2506/Pune/2012 A.Y.: 2008-09 Date of order:
7th August, 2019

 

Section 9(1)(i)
read with section 28(va) of the Act, Article 5(2)(1) of the India-US DTAA –
Consideration received for granting the right to render BPO services to group
entities qualified as business income u/s 28(va) of the Act – Such income was
not taxable in India under the Act as well
as the DTAA in absence of any business activity and PE in India

 

FACTS

The assessee, a resident of USA, was part of a multi-national group
called the ‘Cummins’ group  and rendered
certain BPO services to the group entities as well as to its internal
divisions. During the relevant year, the assessee entered into an agreement
(assignment agreement) with an Indian company (ICo) to transfer the right to
render these BPO services for a lump sum consideration.

 

Pursuant to the assignment agreement, ICo was entitled to render BPO
services to all the Cummins group entities including the assessee. The assessee
contended that the lump sum consideration received was in the nature of
business income and such income was not taxable in India in the absence of a PE
in India.

 

The AO contended that by virtue of the assignment agreement, the
assessee mandated ICo to secure orders and render BPO services to the Cummins
group entities on his behalf. Therefore, the AO was of the view that this
resulted in continuing business activity for the assessee and hence it
established a business connection in India. For the same reason, the AO held
that ICo triggered a dependent agency PE for the assessee in India under the India-US
DTAA and, hence, the lump sum consideration was chargeable to tax in India both
under the Act as well as Article 7 of the DTAA.

 

Aggrieved, the assessee approached the Dispute Resolution Panel (DRP).

 

The DRP did not concur with the AO that an agency PE was constituted in
India. However, on the basis of the assignment agreement, the DRP held that the
employees of the assessee were actively involved in rendering BPO services,
which triggered Service PE in India of the assessee under the India-USA DTAA.
Further, the DRP held that the amount received by the assessee would amount to
an income arising from a ‘source of income’ in India and hence chargeable u/s
9(1)(i) of the Act.

 

Aggrieved, the assessee appealed before the Tribunal.

 

HELD

(i) Prior to the assignment agreement
between the assessee and ICo, the BPO services were rendered by one of the
units of the assessee to other Cummins entities as well as to other units of
the assessee. Pursuant to the assignment agreement, ICo was required to render
services to the assessee as well as other Cummins group entities;

(ii) The assessee obtaining BPO services from ICo could not be equated
to granting of a right to ICo to render BPO services. This was evident from the
fact that a portion of the lump sum consideration was returned to ICo in the
form of higher outgo in the form of payment for receipt of services;

 

(iii) The lump sum compensation received in respect of granting right to
render BPO services to other Cummins group entities would be governed by
section 28(va) of the Act, under which any sum received for not carrying out
any activity in relation to any business or profession should be treated as
business income. This indicated that the assessee had a business connection in
India1. However, in the absence of any business operations in India,
such income was not taxable in India;

(iv) DRP misinterpreted the assignment agreement to
conclude that employees of the assessee were involved in rendering BPO services
in India. In fact, no material was brought on record to demonstrate that the
employees of the assessee were involved in rendition of the BPO services;

 

(v) In the present case, there were no services which were rendered by
the assessee in India through its employees or other personnel. Hence, there
was no service PE of the assessee in India.

(vi) In the absence of a PE of the assessee in India under the DTAA, the
lump sum consideration was not taxable in India under the DTAA.

___________________________________

1. ITAT seems to be of the view
that since the income qualifies as a business income u/s 28(va), the assessee
creates a business connection in India

 

 

Section 90(1)(a)(i) read with Article 25(2) of India-US DTAA — Foreign tax credit is available only in respect of taxes paid on the double-taxed income – Foreign tax credit is allowable against the taxes paid under the Act, which would include surcharge and cess

1. TS-499-ITAT-2019
(Pune) DCIT vs. iGate
Global Solutions Ltd. IT(TP)A. No.:
10/Bang/2014 A.Y.: 2009-10 Date of order:
26th August, 2019

 

Section 90(1)(a)(i) read with Article 25(2) of India-US DTAA — Foreign
tax credit is available only in respect of taxes paid on the double-taxed
income – Foreign tax credit is allowable against the taxes paid under the Act,
which would include surcharge and cess

 

FACTS

The assessee, an Indian company, had branches outside India. The
assessee paid foreign taxes on income earned by its branches outside India.
During the year under consideration, the assessee was assessed to minimum
alternate tax (MAT) u/s 115JB of the Income-tax Act, 1961 (the Act). The total
income earned during the year, consisted of certain export income which was
eligible for exemption u/s 10A of the Act under normal computation of tax.
However, as the assessee was assessed to tax under MAT, such export income was
also subjected to MAT in India.

 

However, the assessee claimed credit of the entire
amount of taxes paid outside India against the taxes payable under MAT,
including by way of surcharge and cess. However, the AO allowed credit only to
the extent of the taxes paid on the double-taxed income and such credit was
limited only against the base taxes paid under the base MAT rate of 10%, i.e.,
excluding the surcharge and cess.

 

Aggrieved, the assessee appealed before the CIT(A) who upheld the view
of the AO. The assessee then appealed before the Tribunal.

 

HELD

(i) Section 90(1)(a) of the Income-tax Act, 1961 requires India to grant
credit of taxes in respect of income which is doubly taxed. In other words,
credit is allowed on taxes paid outside India only if such income has been
included in the total income under the Act as well as under the laws of the
foreign country. Similar provisions are also contained in India’s DTAAs.
Accordingly, the assessee is entitled to credit only for the taxes which are
paid on the double-taxed income;

(ii) Though the assessee is eligible
for deduction u/s 10A of the Act in respect of some portion of its total
income, such deduction was only for normal tax purposes and not for MAT. Since
the entire income was subjected to tax under MAT, the assessee was entitled to
claim credit of taxes paid on such income against taxes payable under MAT;

(iii) The language of section 90 of the Act as well as foreign tax credit
article under the DTAA provides for relief in respect of double-taxed income.
This requires that income tax is to be charged only on the balance amount of
income. As a result, whatever is the amount of tax and surcharge on the
double-taxed income should be automatically excluded from the total tax
liability computed under the Act;

(iv) Perusal of section 90 of the Act and foreign tax credit Article 25
of the DTAA suggests that foreign tax credit should be allowed at the rate at
which the double-taxed income is subjected to tax under the Act (i.e.,
inclusive of surcharge and cess).

 

ATTRIBUTION OF PROFITS TO A PERMANENT ESTABLISHMENT IN A SOURCE STATE

The determination of income of a
Multi-National Enterprise (MNE) having operations in various jurisdictions
faces many challenges. It is not easy to attribute profits to various
constituents of an MNE spread over multiple jurisdictions. OECD has so far adopted
a separate entity approach and recommended determination of profits on the
Arm’s Length Principle (ALP) based on a FAR (Functions, Assets and Risks)
analysis. However, of late ALP based on FAR has been challenged by many
developing nations (including India) on the ground that it is more skewed
towards residence-based taxation and does not take into account the place of
value creation, i.e., the market. In a traditional approach, profits are taxed
in a source country only if there is a Permanent Establishment (PE). It is
easier for MNEs to plan their affairs in a manner so as to avoid the presence
of a PE in a source country. Further, in a digitalised economy, it is extremely
difficult to attribute profits to various jurisdictions based on the traditional
approach. Therefore, many countries worldwide have moved away from ALP and
resorted to either the Formulary Apportionment Method (FAM) or a Presumptive
Basis of Taxation. This article compares and contrasts the different methods of
profit attribution and provides a contextual study to understand the proposed
amendments in Rule 10 of the Income-tax Rules, 1962 (the Rules) in respect of
attribution of profits to the operations of an MNE in India.

 

PRESENT
SYSTEM OF PROFIT ATTRIBUTION

Article 5 of a tax treaty lays down norms
for determination of a PE in the state of source. Article 7 of a tax treaty
stipulates principles of determination of profits attributable to a PE. The
existence of a PE in a source state gives a right to that state to tax profits
which are attributable to its operations. As we know, a treaty only provides
for distributive rules for taxing jurisdictions, leaving detailed computation
of profits to the respective domestic tax laws. For example, once it is
established that there is a PE in India, computation of profits attributable to
that PE will be subject to provisions of the Income-tax Act, 1961 (the Act).
However, Article 7 does provide certain restrictions or guidelines thereof for
computation of profits. A moot issue is to determine how much profits are
attributable to a PE in the source state.

 

Provisions under the Income-tax Act, 1961

Section 9 of the Act deals with income
deemed to accrue or arise in India. It does provide certain source rules for
determination of such income. However, as far as business income is concerned,
section 9(1)(i) provides that all income accruing or arising whether directly
or indirectly through or from any business connection in India… shall be deemed
to accrue or arise in India. Clause (a) of Explanation 1 to section 9(1)(i)
further provides that in the case of a business of which all the operations are
not carried on in India, the income of the business under this clause deemed to
accrue or arise in India, shall be only such part of income as is reasonably
attributable to the operations carried on in India.

 

The provision in tax treaties is similar, in
that it provides that if the enterprise carries on business as aforesaid, the
profits of the enterprise may be taxed in the other state; but only to the extent
as are attributable to that PE. There is one exception, i.e., a tax treaty
which follows the UN Model Convention providing for the force of attraction
rule. According to this rule, when an enterprise has a PE in a source state,
then the entire revenue from the source state may get taxed in the hands of
that enterprise, whether or not it is attributable to that PE. Many Indian tax
treaties do have this Rule. However, the force of attraction is restricted to
the revenue derived from the same or similar activities as that of the PE.

 

Thus, determination of profits attributable
to a PE is crucial for its taxability in the source state. Ideally, the PE
should maintain books of accounts and financial statements in India (for that
matter, any source state) for determination of profit or loss from its business
operations, for it is so mandated in India. However, where such books of
accounts are not maintained (may be due to the head office’s view of
non-existence of PE or for any other reason) or where it is not possible to
ascertain the actual profits from such books of accounts, then the assessing
officer (AO) can invoke the provisions of Rule 10 which provide for
determination of profits as a percentage of the turnover, proportionate profits
or in any other manner as he may be deem appropriate. Thus, Rule 10 gives wide
discretionary powers to the AO in determination of profits attributable to a
PE.

 

Clauses (b) to (e) of Explanation 1 to
section 9(1)(i) of the Act provide various instances where income of a non-resident
from certain activities will not be deemed to accrue or arise in India.
However, Explanation 2 explicitly includes dependent agent within the scope of
business connection. Again, a question arises as to the role played by the
dependent agent and profits attributable to his activities in the dual
capacity: one, as an agent, and two, as a representative of the foreign
enterprise (as a PE).

 

Authorised OECD Approach (AOA)

At present, there are three versions of
Article 7 that feature in tax treaties worldwide, namely, (i) article 7 in the
OECD Model Convention (OECD MC) prior to 2010, (ii) article 7 in the revised
OECD Model Convention post-2010, and (iii) article 7 of the UN Model Convention
(UN MC). The distinguishing features of the above versions are given below.

 

Versions (i) and (iii) are similar in that
the pre-2010 OECD MC and the UN MC contain the provision of considering PE as a
separate and distinct enterprise. The PE, in this case, is considered as being
a separate and independent entity from its head office, such that it would
maximise its own profits. The PE, therefore, would be maintaining separate
books of accounts based on principles of accounting as applicable to a separate
and distinct entity. Klaus Vogel has referred to such a method as ‘separate
accounting’ or ‘direct method’. India supports this view and most of its tax
treaties are based on this principle.

 

However, in 2010, OECD changed its stance
and amended article 7 based on its report on the ‘Attribution of Profits to
Permanent Establishments’. In the said report and the new article 7 in its
model tax convention, OECD pronounced AOA as a preferred approach for
attribution of profits to a PE. AOA is also based on the ‘separate entity
approach’, though profits are to be determined based on Functions performed,
Assets employed and Risks assumed (FAR).

 

AOA provides
options for application of the new article 7 introduced in the OECD Model Tax
Convention in 2010 which requires that profits attributable to PE are in
accordance with the principles developed in the OECD Transfer Pricing
Guidelines wherein the PE is first hypothesised as a functionally separate
entity from the rest of the enterprise of which it is a part, and then profits
are determined by applying the comparability analysis and FAR approach.

 

The AOA recommends a two-step approach for
determination of profits attributable to a PE:

 

Step 1: A
functional and factual analysis of the PE, aligned with FAR analysis, as
recommended in transfer pricing guidelines;

Step 2: A
comparability analysis to determine the appropriate arm’s length return (price)
for the PE’s transactions on the basis of FAR analysis.

 

AOA is based on ALP, which in turn is
determined based on FAR analysis under transfer pricing, which essentially considers
the supply side of the transaction and ignores the demand side, i.e., the
market or sales; and, therefore, India has rejected the same.

 

There is one
more issue in the revised article 7 of the OECD MC. Its pre-2010 version
recognised and acknowledged that apportionment of profits based on one of the
criteria, namely, receipts (or sales revenue), expenses and working capital,
was a reasonable way of apportioning profits to the PE. This was based on
paragraph 4 of the pre-2010 version of the OECD MC which gave an option to
attribute profits by way of an apportionment if it was customary to do so in
the state of PE. However, the revised OECD MC dropped this paragraph. The
impact of this change is that even where accounts are not available or
reliable, one needs to attribute profits to a PE based on FAR without
considering the market or sales. India’s position is very clear in that it
would also take the demand side or sales into consideration for attribution of
profits to a PE.

 

Shortcomings of ALP

Section 92F(ii) defines the ‘Arm’s Length
Price’ as a price which is applied or proposed to be applied to a transaction
between persons other than associated enterprises, in uncontrolled conditions.

Thus, a transaction between two or more AEs
needs to be compared with a similar transaction between two unrelated parties,
for the same or similar product or service, in the same or similar
circumstances. These two unrelated parties, whose transactions are compared
with that of AEs, must have similar functions, assets or risks as that of the
AEs. It is practically impossible to find such comparable companies or
transactions.

 

Section 92C prescribes six methods to
determine the ALP. Pricing depends upon many factors other than FAR. ALP fails
to take into account all aspects of a business. One cannot easily find
comparables for many businesses that are engaged in specialised services or
businesses, especially specialised product-lines involving complex intangibles.

 

Moreover, availability of data in the public
domain at the time of entering into the transaction for comparison purposes is
a big challenge. Public data is available only in cases of commodity trading
through exchanges. Maintenance of contemporaneous documentation and valuation
thereof are another big challenge.

 

Profit Split Method

The Profit Split Method (PSM) is applicable
when transactions are so interrelated that it might not be logical or practical
to evaluate the same individually. Independent entities in such scenarios may
agree to pool their total profits and distribute them to each of the
participating entities based on an agreed ratio. Thus, PSM uses a logical basis
and divides profits among participating entities to a transaction similar to
what independent entities would have apportioned for arriving at such an
arrangement.

 

The PSM method first identifies the outcome
of the transaction (i.e., the net profit of the transaction) of the group. The
profit then is to be divided among the entities of the group on an economically
rational basis such that profits would have been distributed in an arm’s length
arrangement. The total profit may be the profit from the transactions or a
residual profit that cannot readily be assigned to any of the entities of the
group, e.g., profits arising from unique intangibles. The contribution of each
entity is based upon a functional analysis of each entity. Reliable external
market data, if available, is always given preference.

 

The PSM method, although a method under the
arm’s length approach, is in reality based on the principles which are used for
the purpose of ‘Formulary Apportionment’.

 

The positive aspect of every PSM approach is
that it examines the controlled transactions under review in a prudent manner
as it is a two-sided method where every MNE concerned is evaluated. Thus, the
PSM method will be beneficial if the underlying contribution involves
intangibles owned by two or more MNEs, as no transfer pricing method other than
PSM would be applicable. PSM offers flexibility because it considers the
specific facts and circumstances of MNEs which cannot be found in comparable
independent enterprises. Moreover, a real actual profit is being split which
generally does not leave any of the MNEs concerned with an unreasonably high
profit since each MNE is appraised. It also removes the possibility of double
taxation as the total profit is split and distributed to the various
constituent entities across jurisdictions.

 

Challenges of PSM – lack of availability
of data and functions

There are two fundamental disadvantages with
the PSM. First, the application of PSM usually includes a weak and sometimes
doubtful connection of external market data with the controlled transactions
under consideration, resulting in a comparison with a certain amount of
subjectivity. Moreover, there is the lack of availability of data; both
taxpayers and tax administrations might find it hard to obtain reliable
information from MNEs in foreign countries. This inconvenience might materially
affect the reliability of the method since the profit should be an economical
assessment based on each and every function undertaken by the MNE, preferably
using external comparables which can support the valuation. (Source: Markham,
Michelle – Transfer Pricing of Intangible Assets in the US, the OECD and Australia:
Are Profit Split Methodologies the Way Forward?)

 

FORMULARY APPORTIONMENT METHOD (FA)

The Meaning of FA

As the name suggests, it is the
apportionment of the profits / losses of a corporation based on some
predetermined formula, over its different units or group of companies operating
under common control, across different jurisdictions based on significant
economic presence.

 

Formulary Apportionment, popularly known as
unitary taxation, allocates profit earned (or loss incurred) by an MNE wherein
its entity has a taxable presence. It is an alternative to the separate entity
approach under which a branch or PE within a jurisdiction is reckoned as a
separate entity, requiring prices for transactions with other parts of a
corporation or a group thereof, according to ALP.

 

As opposed to this, FA assigns the group’s
total global profit (or loss) to each jurisdiction based on certain variables
such as the proportion of assets, sales or payroll in that particular
jurisdiction. It is thus akin to PSM in a sense.

 

Under this method, all entities of the group
are viewed as a single entity (unitary combination) and therefore the method is
also known as unitary taxation worldwide. This method requires combined
reporting of the group’s results.

 

Advantages of FA

A unitary approach would replace the
following major elements which create fundamental problems for taxation of MNEs
under the ALP:

 

(i)   The need for analysing arm’s length price,
that is, an analysis of internal accounts and transactions for determining the
appropriate arm’s length price;

(ii)   The need to deal with complex anti-avoidance
rules, such as thin capitalisation, controlled foreign corporations, limitation
of benefits et al to prevent base erosion and profit shifting;

(iii) Quantification of contribution of intangibles
in income generation;

(iv) Freedom from
litigation arising from source and residence attribution rules;

(v) Lesser compliance burden on MNEs.

 

The above would enable simplification of the
international tax system, which shall benefit both taxpayers and tax
administrations.

 

At present, a majority of the transfer
pricing disputes undergoing several rounds of litigation are generally decided
in favour of the taxpayer. This is so in the U.S., India and other countries.
This is bound to happen in the absence of clear guidance on transfer pricing
issues. Matters pertaining to selection of appropriate comparable(s), usage of
the most appropriate method for benchmarking the transaction, management fees,
cost allocation arrangements, royalty pay-outs, etc., have been and continue to
be under litigation.

 

On the other hand, the unitary taxation
method, if not totally, would at least reduce and significantly contribute in
settling disputes. Further, in many cases in countries where significant
economic activities are carried out, there may not be any significant
difference in corporate tax rates. Hence, in the absence of wide differences in
corporate tax rates, there may be no significant compulsion or reason to
minimise a firm’s global tax liability by relocating production activities.

 

Limitations of FA

There are two primary questions that need to
be addressed for successful implementation of FA.

 

Q1) How and what shall be the basis for
the apportionment formula?

 

Generally, an overwhelming consensus on the
determination of weights for the factors would be decided by negotiations and
trade-offs. Historical data provides that the factors have been generally given
equal weight, that is, one-third each (sales, labour and assets employed).

 

Approach of the United States of America

The water’s edge approach of the States in
the US has tilted the balance towards sales. This approach apportions income to
production and sale equally, i.e., 50% of income is apportioned based on sales
and 50% on production (assets and labour quantify production).

 

[Water’s edge election basically says that
you (as a business or entity) agree to be taxed within the jurisdiction for the
sales that occur within that state, but only within the parameters laid down by
that state.]

 

Approach of the European Union

On the other hand, in 2012 the EU amended
the proposal drafted by the EU Commission, from equal weights to the three
factors, to 10% for sales, 45% for assets and 45% for labour.

 

Differences in preferences

Countries where wage rates are higher would
favour payroll rather than headcount in respect of the labour factor. This
would tend to benefit from the inclusion of the assets factor with an equal
weight. Therefore, such countries can concede that the labour factor be based
on the number of employees.

 

Conversely, although countries which have
attracted large-scale manufacturing activities would benefit in terms of tax
revenues on account of the labour factor, they should also be willing to accept
a significant weightage for other factors. If the same has not been accepted,
there may be MNEs who would relocate their investments because of formula
over-weight tilt towards the labour factor. Therefore, it is essential that a
fine balance between factors of production and sales is achieved. This is
because some part of the income can be said to be attributable to (a) assets
employed for production, (b) number of employees on the payroll, and (c) the
sales function, of course.

 

Therefore, one may propose a ratio of 1
(assets employed): 1 (number of employees): and 2 (sales function). This is
because it gives equal importance to all factors of production as well as the
sales function. Further, equal importance is also given to the internal two (2)
factors of production as well, namely, capital and entrepreneurship.

 

Q2) 
Would it be appropriate to apply a general formula for all industries?

 

Evidently not. This issue has been debated
since the unitary approach was first mooted in the 1930s. The cause for concern
is that some types of industries do have special characteristics in need of a
special formula.

 

Examples

Transportation industries such as shipping,
aviation, etc., pose an issue because the assets which they are dependent upon
are mobile. In order to address the special nuance of this business, these
could be taxed based on the value of traffic between two contact (entry / exit)
points.

 

In the case of other nuanced industries,
such as extractive industries, the modern approach of ‘resource rent taxation’
is a more effective mode of taxation. Therefore, the interaction between
resource rent taxation and general corporate taxation would require a special
consideration.

 

However, for the purpose of achieving
neutrality, a general apportionment formula applied to most types of businesses
would be appropriate for allocating a general tax on income or profits.

 

Presumptive Taxation (PT)

As stated above, determination or
computation of profits in the source state is not an easy task and therefore there
is always an uncertainty about attribution of income and allowability of
expenses. Moreover, compliance burden is also high. In order to address these
issues, many countries give the option of presumptive taxation to
non-residents. Under this, irrespective of actual profit or loss, a certain
percentage of the gross receipts from the state of source is deemed to be
income and taxed therein. Once a taxpayer is covered by the presumptive tax
scheme, he would be relieved from the rigours of compliances.

 

The Income-tax Act, 1961 contains provisions
for taxing income of non-residents on presumptive basis. Some illustrative
provisions are given below:

 

Section

Types of assessees

Particulars of income

Tax rate

44BB

Any non-resident

Profits and gains in connection with or supplying
P&M on hire used, or to be used, in the prospecting for, or extraction or
production of mineral oils and natural gas in case of NR

10% of the gross receipts is deemed to be profits
and gains.

(Surcharge, health & education cess would be
extra)

44DA

Any non-resident

Royalties / FTS arising through a PE or fixed
place of profession in India

Taxable on net basis.

Basic rate 40%.

(Surcharge, health & education cess would be
extra)

44AE

Any assessee

Business of plying, leasing or hiring of goods
carriages owned by the assessee (not owning more than 10 goods carriages at
any time during the previous year)

Deemed profits @ Rs. 7,500 per vehicle, for every
month (or part thereof) or actual profits, whichever is higher.

In case of a heavy goods vehicle, profits are
deemed to be Rs. 1,000 per ton of gross vehicle weight or unladen weight as
the case may be, per vehicle for every month (or part thereof) or actual
earnings, whichever is higher

115A

Any non-residents and foreign company

Taxation in respect of income by way of dividend,
interest, royalty and technical service fee to non-residents and foreign
companies

(i) Interest income received by non- residents
(not being a company) or a foreign company – 20% plus applicable surcharge
and cess

(ii) Infra debt funds as specified u/s 10(47) –
5% plus applicable surcharge and cess

(iii) Dividend received by a non-resident or a
foreign company – 20% plus applicable surcharge and cess

(iv) Royalty or fees for technical services
income received by non-resident or foreign company – 10% plus applicable
surcharge and cess

115VA to V-O

Any company that owns at least one qualifying
ship and the main object of the company is to carry on the business of
operating ships

Computation of profits and gains from the
business of operating qualifying ships

(i) Qualifying ship having net tonnage up to
1,000 – Rs. 70 for each 100 tons

(ii) Qualifying ship having net tonnage up to
1,000 but not more than 10,000 – Rs. 700 plus Rs. 53 for each 100 tons
exceeding 1,000 tons

(iii) Qualifying ship having net tonnage up to
10,000 but not more than 25,000 – Rs. 5,470 plus Rs. 42 for each 100 tons
exceeding 10,000 tons

(iv) Qualifying ship having ship tonnage
exceeding 25,000 – Rs. 11,770 plus Rs. 29 for each 100 tons exceeding 25,000
tons

172

Any non-resident

Shipping business of non-residents

For the purpose of the levy and recovery of tax
in the case of any ship, belonging to or chartered by a non-resident, which
carries passengers, livestock, mail or goods shipped at a port in India –
7.5% of the amount paid or payable on account of such carriage to the owner
or charterer

Equalisation levy

Any non-resident

Charge of equalisation levy

Equalisation levy shall be charged @ 6% of the amount
of consideration payable, for any specified service received or receivable
from a non-resident, by –

i. A person resident in India carrying on any
business or profession; or

ii. A non-resident having permanent establishment
in India

 

 

Distinction between PSM / FA / PT

The stark difference between the Profit
Split Method (PSM), the Formulary Apportionment Method (FA) and the Presumptive
Taxation Method (PT) is the manner of calculation of profits.

 

Profit Spilt Method: In this method, total profits earned by related entities in
different jurisdictions is determined and then the same are attributed to each
one of them on a separate entity approach (following the arm’s length
principle), based on FAR analysis. In this case, usually the market or demand
side is overlooked or given less importance. This method is criticised in that
it is more skewed towards the country of residence of the enterprise.

Formulary Apportionment Method: Here, the actual profits of the MNE at the global level are
distributed to the participating entities. However, the distribution is based
on a predetermined formula with or without weightage. This method does take
care of demand side arising from ‘sales’, which is usually one of the factors
of profit allocation in the FA. This method considers all entities across the
globe under a single MNE as a single unit and consequently it is known as
‘Unitary Method’ as well.

 

Presumptive Taxation: This method rests on an altogether different footing. It does not
take into account the actual profit or loss of the business undertaking.
Instead, it presupposes a certain element of profit in the source state and
levies taxes based on a notional estimation. Normally, presumptive taxation is
given as an option to the taxpayer to have a tax certainty and reduce
litigation. If the actual profits are lower or there are losses, then the
taxpayer may opt for regular computational provisions along with related
compliances. Safe-harbour provisions under the TP Regulations are akin to
presumptive taxation.

 

PROPOSED PROFIT ATTRIBUTION RULE (COMBINATION
OF FA AND PT)

The CBDT Committee has recommended amendment
of Rule 10 of the Income-tax Rules to provide for detailed profit attribution
rules. It rejected the AOA for profit distribution, which is based on ALP
taking into account FAR analysis. It may be noted that AOA does not take into
account the demand side of a transaction.

 

The committee
suggested distribution of profits based on three factors carrying equal
weightage, namely, (a) sales (b) manpower and (c) assets. It is claimed that
the combination of these three factors would take into consideration both the
demand and the supply side of a transaction.

 

The draft report on Profit Attribution
outlines the formula for calculating ‘profits attributable to operations in
India’, giving due weightage to sales revenue, wages paid to employees and
assets deployed.

 

(Please refer to the July, 2019 issue of
the BCAJ for a detailed discussion on the proposed Profit Attribution Rules.)

 

CONCLUSION

Attribution of profits is a complex
exercise, more so when such attribution is related to complex intangibles or a
PE. The Arm’s Length Principle looks good in theory, but impracticable in real
ground situations. Therefore, even after decades of its existence, there are
litigations galore. Further, FAR analysis takes into account only the supply
side, giving less or no weightage to the demand side. On the other hand,
presumptive taxation, which uses estimation, may result in double taxation as
the residence country may deny the credit of taxes paid on presumptive basis.
The plausible solution seems to be a distribution of profits based on a
predetermined formula, i.e., the Formulary Apportionment Method.

 

However, unless there is a universal
consensus this method also is not practicable. Moreover, availability of data
at a global level or the willingness of a Multi-National Enterprise to share
such data could be a challenge. Difference in accounting treatment, difference
in taxable year, fluctuating exchange rates, changes in domestic tax laws, tax
incentives in different jurisdictions, etc., are all issues for which there are
no answers. This only proves that we are living in an imperfect world and that
we need to accept the imperfect tax system as the hard reality of life in an
era of cross-border transactions and the continuing emergence of giant
multinationals that rule the roost, with law-makers lagging far behind.

 

 

TAXATION OF GIFTS MADE TO NON-RESIDENTS

The Finance (No. 2) Act, 2019 has inserted
section 9(1)(viii) in the Income-tax Act, 1961 (the Act) regarding deemed
accrual in India of gift of money by a person resident in India to a
non-resident. In this article we discuss and explain the said provision in
detail.

 

INTRODUCTION

Taxation of gifts in India has a very long
and chequered history. Ideally, taxes are levied on income, either on its
accrual or receipt. However, with the object of expanding the tax base, the
Indian tax laws have evolved the concept of ‘deemed income’. Deemed income is a
taxable income where the law deems certain kinds of incomes to have accrued to
an assessee in India.

 

Similarly, the legislation in India uses the
concept of deemed income to tax gifts. The Gift Tax Act, 1958 was introduced
with effect from 1st April, 1958 and subsequently amended in the
year 1987. It was repealed w.e.f. 1st October, 1998. Till that date
(1st October, 1998), all gifts (including gifts to relatives)
barring a few exceptions were chargeable to gift tax in the hands of the donor.
The gifts were taxed at a flat rate of about 30% then, with a basic exemption limit
of Rs. 30,000.

 

With the
abolition of the Gift Tax Act, 1958 w.e.f. 1st October, 1998, gifts
were not only used for wealth and income distribution amongst family members /
HUFs, but also for conversion of money. With no gift tax and exemption from chargeability
under the Income-tax Act, gifts virtually remained untaxed until a donee-based
tax was introduced by inserting a deeming provision in clause (v) of section
56(2) by the Finance Act, 2004 w.e.f. 1st April, 2005 to provide
that any sum of money received by an assessee, being an individual or HUF,
exceeding Rs. 25,000 would be deemed to be income under the head ‘Income from
other sources’. Certain exceptions, like receipt of a gift from a relative or
on the occasion of marriage, etc., were provided.

 

The Act was amended w.e.f. 1st
April, 2007 and a new clause (vi) was inserted with an enhanced limit of Rs.
50,000. Another new clause (vii) was inserted by the Finance (No. 2) Act, 2009
w.e.f. 1st October, 2009 to further include under the deeming provision
regarding receipt of immovable property without consideration.

 

When the Act was amended vide Finance Act,
2010 w.e.f. 1st June, 2010, a new clause (viia) was inserted to also
tax (under the deeming provision) a receipt by a firm or company (not being a
company in which public are substantially interested) of shares of a company
(not being a company in which public are substantially interested) without
consideration or at less than fair market value.

 

Via the Finance Act, 2013, and w.e.f. 1st
April, 2013, another new clause (viib) was inserted for taxing premium on the
issue of shares in excess of the fair market value of such shares.

 

Yet another important amendment was made
vide the Finance Act, 2017 w.e.f. 1st April, 2017 suppressing all the
deeming provisions except clause (viib) and a new clause (x) was inserted.

 

At present, clause (viib) and clause (x) of
section 56(2) are in force and deem certain issue of shares or receipt of money
or property as income.

 

SECTION 56(2)(X) AND OTHER RELATED PROVISIONS

Section 56(2) provides that the incomes
specified therein shall be chargeable to income tax under the head ‘Income from
other sources’.

 

Section 56(2)(x) provides that w.e.f. 1st
April, 2017, subject to certain exemptions mentioned in the proviso thereto,
the following receipts by any person are taxable:

(a) any sum of money without consideration,
the aggregate value of which exceeds Rs. 50,000;

(b) any immovable property received without
consideration or for inadequate consideration as specified therein; and

(c) any specified property other than
immovable property (i.e., shares and securities, jewellery, archaeological
collections, drawings, paintings, sculptures, any work of art or bullion)
without consideration or for inadequate consideration, as specified therein.

 

It is important to note that the term
‘consideration’ is not defined under the Act and therefore it must have the
meaning assigned to it in section 2(d) of the Indian Contract Act, 1872.

 

The proviso to
section 56(2)(x) provides for exemption in certain genuine circumstances such
as receipt of any sum of money or any property from any relative, or on the
occasion of a marriage, or under a Will or inheritance, or in contemplation of
death, or between a holding company and its wholly-owned Indian subsidiary, or
between a subsidiary and its 100% Indian holding company, etc.

 

Section
2(24)(xviia) provides that any sum of money or value of property referred to in
section 56(2)(x) is regarded as income.

 

Section 5(2) provides that non-residents are
taxable in India in respect of income which accrues or arises in India, or is
deemed to accrue or arise in India, or is received in India, or is deemed to be
received in India.

 

SECTION 9(1)(VIII)

The Finance (No. 2) Act, 2019 inserted
section 9(1)(viii) w.e.f. A.Y. 2020-21 to provide that any sum of money
referred to in section 2(24)(xviia) arising outside India [which in turn refers
to section 56(2)(x)], paid on or after 5th July, 2019 by a person
resident in India to a non-resident, not being a company, or to a foreign
company, shall be deemed to accrue or arise in India.

 

Section 9(1)(viii) creates a deeming fiction
whereby ‘income arising outside India’ is deemed to ‘accrue or arise in India’.

 

Prior to the insertion of section
9(1)(viii), there was no provision in the Act which covered the gift of a sum
of money given to a non-resident outside India by a person resident in India if
it did not accrue or arise in India. Such gifts therefore escaped tax in India.
In order to avoid such non-taxation, section 9(1)(viii) was inserted.

 

Section 9
provides that certain incomes shall be deemed to accrue or arise in India. The
fiction embodied in the section operates only to shift the locale of accrual of
income.

The Hon’ble Supreme Court in GVK
Industries vs. Income Tax Officer (2015) 231 Taxman 18 (SC) while
adjudicating the issue pertaining to section 9(1)(vii) explored the ‘Source
Rule’ principle and laid down in the context of the situs of taxation,
that the Source State Taxation (SST) confers primacy and precedence to tax a
particular income on the foothold that the source of such receipt / income is
located therein and such principle is widely accepted in international tax
laws. The guiding principle emanating therefrom is that the country where the
source of income is situated possesses legitimate right to tax such source, as
inherently wealth is physically or economically generated from the country
possessing such an attribute.

 

Section 9(1)(viii) deems income arising
outside India to accrue or arise in India on fulfilment of certain conditions
embedded therein, i.e. (a) there is a sum of money (not any property) which is
paid on or after 5th July, 2019; (b) by a person resident in India
to a non-resident, not being a company or to a foreign company; and (c) such
payment of sum of money is referred to as income in section 2(24)(xviia) [which
in turn refers to section 56(2)(x)].

 

Section 9(1)(viii) being a deeming
provision, it has to be construed strictly and its scope cannot be expanded by
giving purposive interpretation beyond its language. The section will not
apply to payment by a non-resident to another non-resident.

 

It is to be noted that any sum of money paid
as gift by a person resident in India to a non-resident during the period 1st
April, 2019 to 4th July, 2019 shall not be treated as income deemed
to accrue or arise in India.

 

Exclusion of gift of property situated
in India:

Section 9(1)(viii) as proposed in the
Finance (No. 2) Bill, 2019 had covered income ‘…arising any sum of money
paid, or any property situate in India transferred…’

 

However, section 9(1)(viii) as enacted reads
as ‘income arising outside India, being any sum of money referred to in
sub-clause (xviia) of clause (24) of section 2, paid…’

 

For example, if a non-resident receives a
gift of a work of art situated outside India from a person resident in India,
then such gift is not covered within the ambit of section 9(1)(viii).

 

Thus, as compared to the proposed
section, the finally enacted section refers to only ‘sum of money’ and
therefore gift of property situated in India is not covered by section
9(1)(viii). It appears that the exclusion of the
property situated in India from the finally enacted section 9(1)(viii) could be
for the reason that such gift of property could be subjected to tax in India
under the existing provisions of section 5(2) where any income received or
deemed to be received in India by a non-resident or on his behalf is subject to
tax in India.

 

Non-application to receipts of gifts
by relatives and other items mentioned in proviso to section 56(2)(x):

As mentioned above, section 9(1)(viii) deems
any sum of money referred to in section 2(24)(xviia) to be income accruing or
arising in India, subject to fulfilment of conditions mentioned therein.

 

Section 2(24)(xviia) in turn refers to sum
of money referred in section 56(2)(x) and regards as income only final
computation u/s 56(2)(x) after considering exclusion of certain transactions
like gifts given to relatives or gift given on the occasion of marriage of the
individual, etc., as mentioned in the proviso to section 56(2)(x).

 

Thus, for example, if there is a gift of US$
10,000 from A who is a person resident in India, to his son S who is a resident
of USA, as per the provision of section 56(2)(x) read with Explanation
(e)(i)(E) of section 56(2)(vii), the same will not be treated as income u/s
9(1)(viii).

 

Therefore,
the insertion of section 9(1)(viii) does not change the position of non-taxability
of receipt of gift from relatives or on the occasion of the marriage of the
individual, etc. Similarly, the threshold limit of Rs. 50,000 mentioned in
section 56(2)(x) would continue to apply and such gift of money up to Rs.
50,000 in a financial year cannot be treated as income u/s 9(1)(viii).

 

It is important
to keep in mind that section 5 broadly narrates the scope of total income.
Section 9 provides that certain incomes mentioned therein shall be deemed to
accrue or arise in India. However, total income under the provisions of the Act
has to be computed as per the other provisions of the Act, and while doing so
benefits of the exemptions / deduction would have to be taken into account.

 

In this connection, the relevant portion of
the Explanatory Memorandum provides that ‘However, the existing provisions
for exempting gifts as provided in proviso to clause (x) of sub-section (2) of
section 56 will continue to apply for such gifts deemed to accrue or arise in
India.’

The Explanatory Memorandum, thus, clearly
provides for application of exemptions provided in proviso to section 56(2)(x).

 

Income arising outside India:

Section
9(1)(viii) uses the expression ‘income arising outside India’ and, keeping in
mind the judicial interpretation of the meaning of the term ‘arise’ or
‘arising’ (which generally means to come into existence), the income has to
come into existence outside India, i.e. the gift of money from a person
resident in India to a non-resident has to be received outside India by the
non-resident.

 

PERSON RESIDENT IN INDIA AND NON-RESIDENT

Person resident in India:

The expression ‘person resident in India’
has been used in section 9(1)(viii). The term ‘person’ has been defined in
section 2(31) of the Act and it includes individuals, HUFs, companies, firms,
LLPs, Association of Persons, etc.

 

The term ‘resident in India’ is used in
section 6 which contains the rules regarding determination of residence of
individuals, companies, etc.

 

It would be very important to minutely
examine the residential status as per the provisions of section 6 to determine
whether a person is resident in India as per the various criteria mentioned
therein, particularly in case of NRIs, expats, foreign companies, overseas
branches of Indian entities, for proper application of section 9(1)(viii).

 

Non-resident:

Section 2(30) of the Act defines the term
‘non-resident’ and provides that ‘non-resident’ means a person who is not a
‘resident’ and for the purposes of sections 92, 93 and 268 includes a person
who is not ordinarily resident within the meaning of clause (6) of section 6.

 

Therefore, for the purposes of section
9(1)(viii), a not ordinarily resident is not a ‘non-resident’.

 

It is to be noted that residential status
has to be determined as per provisions of the Income-tax Act, 1961 and not as
per FEMA.

 

Obligation to deduct tax at source:

Section 195 of the Act provides that any
person responsible for paying to a non-resident any sum chargeable to tax under
the provisions of the Act is obliged to deduct tax at source at the rates in
force. Accordingly, provisions of section 195 would be applicable in respect of
gift of any sum of money by a person resident in India to a non-resident, which
is chargeable to tax u/s 9(1)(viii) and the resident Indian gifting money to a
non-resident shall be responsible to withhold tax at source and deposit the
same in the government treasury within seven days from the end of the month in
which the tax is withheld.

 

The person resident in India shall be
required to obtain tax deduction account number (TAN) from the Indian tax
department, file withholding tax e-statements and issue the tax withholding
certificate to the non-resident. In case of a delay in deposit of withholding
tax / file e-statement / issue certificate, the resident would be subject to
interest / penalties / fines as prescribed under the Act.

 

Applicability of the provisions of
Double Taxation Avoidance Agreement (DTAA):

Section 90(2) of the Act provides that where
the Central Government has entered into a DTAA for granting relief of tax or,
as the case may be, avoidance of double taxation, then, in relation to the
assessee to whom such DTAA applies, the provisions of the Act shall apply to
the extent they are more beneficial to that assessee.

 

Therefore, the relief, if any, under a DTAA
would be available with respect to income chargeable to tax u/s 56(2)(viii).

 

The Explanatory Memorandum clarifies that
‘in a treaty situation, the relevant article of applicable DTAA shall continue
to apply for such gifts as well.’

 

A DTAA distributes taxing rights between the
two contracting states in respect of various specific categories of income
dealt therein. ‘Article 21, Other Income’, of both the OECD Model Convention
and the UN Model Convention, deals with those items of income the taxing rights
in respect of which are not distributed by the other Articles of a DTAA.

 

Therefore, if the recipient of the gift
is a resident of a country with which India has entered into a DTAA, then the
beneficial provisions of the relevant DTAA will govern the taxability of the
income referred to in section 9(1)(viii).

 

Article 21 of the OECD Model Convention,
2017 reads as follows:

Article 21, Other Income:

(i)   Items of income of a resident of a contracting
state, wherever arising, not dealt with in the foregoing Articles of this
Convention, shall be taxable only in that state;

(ii)   The provisions of paragraph 1 shall not apply
to income, other than income from immovable property as defined in paragraph 2
of Article 6, if the recipient of such income, being a resident of a
contracting state, carries on business in the other contracting state through a
permanent establishment situated therein and the right or property in
respect of which the income is paid is effectively connected with such permanent
establishment. In such case, the provisions of Article 7 shall apply.

 

Similarly, Article
21 of the UN Model Convention, 2017 reads as follows:

Article 21,
Other Income:

(1) Items of income
of a resident of a contracting state, wherever arising, not dealt with in the
foregoing Articles of this Convention shall be taxable only in that State;

(2) The provisions
of paragraph 1 shall not apply to income, other than income from immovable
property as defined in paragraph 2 of Article 6, if the recipient of such
income, being a resident of a contracting state, carries on business in the
other contracting state through a permanent establishment situated therein, or
performs in that other state independent personal services from a fixed base
situated therein, and the right or property in respect of which the income is
paid is effectively connected with such permanent establishment or fixed base.
In such a case the provisions of Article 7 or Article 14, as the case may be,
shall apply;

(3) Notwithstanding
the provisions of paragraphs 1 and 2, items of income of a resident of a
contracting state not dealt with in the foregoing Articles of this Convention
and arising in the other contracting
state may also be taxed in that other state.

 

On a comparison of the abovementioned Article 21 of the OECD and UN
Model Conventions, it is observed that Article 21(1) of the OECD Model
Convention provides taxing rights of other income to only a country of
residence.

 

However, Article 21
of the UN Model contains an additional para 3 which gives taxing rights of
other income to the source country also, if the relevant income ‘arises’ in a
contracting state.

 

DTAAs do not define
the term ‘arise’ or ‘arising’ and therefore in view of Article 3(2) of the
Model Conventions, the term not defined in a DTAA shall have the meaning that
it has at that time under the law of the state applying the DTAA.

 

India has currently
signed DTAAs with 94 countries. India’s DTAAs are based on both the OECD as
well as the UN Models. The distribution of taxation rights of other income /
income not expressly mentioned under Articles, corresponding to Article 21 of
the Model Conventions, in the Indian DTAAs can be categorised as under:

 

Sr. No.

Category

No. of countries

Remarks

1.

Exclusive right of taxation to residence state

5

Republic of Korea, Kuwait, Philippines,
Saudi Arabia, United Arab Emirates

2.

Exclusive right of taxation to residence state with limited
right to source state to tax income from lotteries, horse races, etc.

36

Albania, Croatia, Cyprus, Czech Republic,
Estonia, Ethiopia, Georgia, Germany, Jordan, Hungary, Iceland, Ireland,
Israel, Kazakhstan, Kyrgyz Republic, Latvia, Macedonia, Malta, Montenegro,
Morocco, Mozambique, Myanmar, Nepal, Portuguese Republic, Romania, Russia,
Serbia, Slovenia, Sudan, Sweden, Switzerland, Syria, Taipei, Tajikistan,
Tanzania, Uganda

3.

Source state permitted to tax other income

45

Armenia, Australia, Austria, Belarus,
Belgium, Bhutan, Botswana, Brazil, Bulgaria, Canada, China, Columbia, Slovak
Republic, Denmark, Fiji, Finland, France, Indonesia, Japan, Kenya, Lithuania,
Luxembourg, Malaysia, Mauritius, Mongolia, New Zealand, Norway, Oman,
Oriental Republic of Uruguay, Poland, Qatar, Spain, Sri Lanka, South Africa,
Thailand, Trinidad and Tobago, Turkey, Turkmenistan, Ukraine, United Kingdom,
United Mexican States, United States of America, Uzbekistan, Vietnam, Zambia

4.

In both the states, as per laws in force in each state

4

Bangladesh, Italy, Singapore, United Arab Republic (Egypt)

5.

Exclusive right to source state

1

Namibia

6.

No other income article

3

Greece, Libyan Arab Jamahiriya, Netherlands

 

Interestingly, in some of the DTAAs that
India has signed with countries where a large Indian diaspora is present, like
the US, Canada, UK, Australia, Singapore, New Zealand, etc., the taxation right
vests with India (as a source country). It is important that provisions of the
article relating to other income is analysed in detail to evaluate if any tax
is to be paid in the context of such gifts under the applicable DTAA.

 

In cases of countries covered in Sr. Nos.
1 and 2, due to exemption under the respective DTAAs, India would still not be
able to tax income u/s 9(1)(viii) arising to the residents of those countries.

 

IMPLICATIONS UNDER FEMA

Besides tax
laws, one should also evaluate the implications, if any, under the FEMA
regulations for gifts from a person resident in India to a non-resident. Thus,
one must act with caution to ensure compliance with law and mitigate
unnecessary disputes and litigation at a later date.

 

CONCLUDING REMARKS

The stated objective of section 9(1)(viii)
has been to plug the loophole for taxation of gifts of money from a person
resident in India to a non-resident. As the taxability is in the hands of the
non-resident donee, there would be a need for the donee / recipient to obtain
PAN and file an income tax return in India where there is a taxable income
(along with the gift amount that exceeds Rs. 2,50,000 in case of an
individual).

 

In conclusion, this is a welcome provision
providing certainty in the taxability of gifts to non-residents by a person
resident in India.  

 

 

Section 5(2), read with section 9, of the Act – Agency commission received by non resident outside India, for services rendered outside India, is not taxable in India.

2.      
TS-84-ITAT-2019 (Mum) Fox International
Channel Asia Pacific Ltd. vs. DCIT  A.Y.: 2010-11 Date of Order: 15th
February, 2019

 

Section 5(2), read with section 9, of the
Act – Agency commission received by non resident outside India, for services
rendered outside India, is not taxable in India.


FACTS

Taxpayer, a company resident in Hong Kong,
was a part of a group of companies, and was engaged in distribution of
satellite television channels and sale of advertisement air time for the
channel companies at global level.

 

During the year under consideration, Taxpayer
received income in the nature of agency commission for distribution of
television channels and sale of advertisement air time as an agent of the
channel companies. Having noted that the Taxpayer has entered into an
international transaction with its associated enterprises (AEs), AO made a
reference to the Transfer Pricing Officer (TPO) for the determination of the
arm’s length price (ALP).

 

The TPO while computing ALP noted that out
of the global commission received by the Taxpayer from the overseas channel
companies, commission fee received towards the services rendered outside India
was not offered to tax in India and only the commission fees for services
rendered within India was offered to tax in India. The TPO held that the entire
income including for services rendered outside India was taxable in India and
hence made transfer pricing adjustment to the total income of the Taxpayer. In
pursuance to the ALP determined by the TPO, the AO passed a draft assessment
order adding the transfer pricing adjustment to the income of the Taxpayer.

 

Aggrieved, Taxpayer appealed before the
Dispute Resolution Panel (DRP) and contended that agency commission received in
respect of services rendered outside India, and received outside India, is not
taxable in India u/s. 5 and 9 of the Act.

 

However, DRP rejected the Taxpayer’s
contention and held that by virtue of Explanation to section 9(2), entire
income is deemed to accrue or arise in India whether or not the non-resident
has a residence or place of business or business connection in India or the
non-resident has carried on business operations in India. Accordingly, DRP
upheld the adjustment made to the ALP by the TPO.

 

Aggrieved, Taxpayer appealed before the
Tribunal.

 

HELD

  •   The conclusion of the DRP
    that section 9 being a deeming provision can bring to tax any income which
    accrues or arises outside India, is incorrect.
  •   As per Explanation 1 to
    section 9(1)(i), a non-resident whose business operations are not exclusively
    carried out in India, only such part of the income as is reasonably
    attributable to the operations carried out in India, is deemed to accrue or
    arise in India. Thus, on a complete reading of the provisions of section 9 of
    the Act, only such income which has a territorial nexus is deemed to accrue or
    arise in India.
  •  Moreover, provisions of Explanation to section 9(2)1  of the Act, is not applicable to the agency
    commission earned by the Taxpayer.
  •   It is a well settled position
    of law that agency commission paid to non-resident agents outside India, for
    services rendered outside India, is not taxable in India. Thus, agency
    commission paid to Taxpayer outside India, for services rendered outside India,
    is not taxable in India.

 

RENEWED FOCUS ON ‘SUBSTANCE OVER FORM’ IN THE WORLD OF INTERNATIONAL TAX

At first instance,
the term ‘Double Irish Dutch Sandwich’ would appear to be an appetising snack.
However, in the world of international tax this has become an unappetising
proposition for multinational corporations (MNCs). This is because ‘Double
Irish Dutch Sandwich’ refers to the use of a combination of Irish and Dutch
companies by MNCs to shift profits to low or no tax jurisdictions.

 

This and other
similar aggressive tax strategies not only help MNCs reduce their effective tax
outgo, but also highlight the shift in mind-set of tax being a cost against
profit, rather than a duty towards society. Many countries have started
frowning upon such investment and operating ‘structures’ and are implementing
various measures both nationally and internationally to address the issue. The
general consensus amongst them is that MNCs should pay their fair share of
taxes in the countries where they actually operate and earn income. In this
context, the two important aspects identified by the world at large are that

(a) certain countries provide aggressive and preferential tax regimes to
MNCs to enable them to adopt aggressive tax strategies (including access to
favourable tax treaties); and (b) the operations of
MNCs in such countries do not have adequate economic or commercial substance to
justify the income allocated to them.

 

At the heart of
this fairly recent initiative is an age-old concept in tax laws, ‘substance
over form’ – whether the substance of the transaction is in fact different from
what its form is legally made out to be. This article aims to touch upon some
of the recent updates in the world of international tax which have a renewed
focus on ‘substance over form’ and the impact of some of the common structures
involving India.

 

(I)     Meaning of the terms ‘substance’ and ‘form’

‘Substance is
enduring, form is ephemeral’. These are the words
of Mr. Dee Hock (founder of VISA) which imply that while ‘substance’ is
long-lasting, ‘form’ is transitory. The term ‘substance over form’ is a
well-known,
age-old concept under accounting and tax laws not only in India but even
globally. In essence, the concept requires looking at the real purpose /
intention of the transaction rather than simply relying on the way the
transaction is presented legally and on paper (e.g. accounting entries, legal
agreements, etc.). Black’s Law Dictionary defines the terms ‘substance’ and
‘form’ as under:

(i)    Substance: ‘The essence of
something; the essential quality of something as opposed to its mere form’;

(ii)    Form: ‘The outer shape or structure
of something, as distinguished from its substance or matter’.

 

(II)   Landmark
judgements on substance over form

One of the earliest
landmark judgements in the world in the context of ‘substance over form’ is the
English Court judgement in the case of IRC vs. Duke of Westminster (1936)
AC 1 (HL). This judgement laid down certain important observations
which have subsequently been applied even by Indian courts. In this case, based
on professional advice, the Duke of Westminster paid his gardener an annuity
instead of wages and the same was claimed as tax-deductible expenditure. The argument
of the tax authorities was that the substance of the annuity payment was to in
fact pay wages, which were household expenses and not tax-deductible. The said
argument was, however, rejected by the House of Lords and Lord Tomlin observed
as under:

 

‘Every man is
entitled if he can to order his affairs so that the tax attaching under the
appropriate Acts is less than it otherwise would be. If he succeeds in ordering
them so as to secure this result, then, however unappreciative the
Commissioners of Inland Revenue or his fellow taxpayers may be of his
ingenuity, he cannot be compelled to pay an increased tax. This so-called
doctrine of “the substance” seems to me to be nothing more than an attempt to
make a man pay notwithstanding that he has so ordered his affairs that the
amount of tax sought from him is not legally claimable.’

 

The concept of ‘substance over form’ has also been discussed in Indian
judicial precedents since many years – for instance, the Supreme Court
judgement in the case of Mugneeram Bangur & Co.1  on facts of the case held that the sale of
the business of land development as a whole concern was a slump sale not liable
to tax, even though the Tribunal had factually held that the goodwill component
in the sale was the excess value / profit from stock in trade transferred with
the other assets. In a way, the Supreme Court had upheld the principle of form
over substance.

_____________________________________________________

1   [1965] 57 ITR 299 (SC)

2        [2012] 341 ITR 1 (SC)

 

However, in the
context of cross-border / international tax issues arising from ‘structures’,
the concept of ‘substance over form’ has recently gained more significance from
the judgement of the Supreme Court in the case of Vodafone International
Holdings B.V.2  The
judgement underlined the difference between adopting a ‘look-through’ approach
(substance) at the transaction, versus adopting a ‘look-at’ approach (form).
The Supreme Court observed that the following principles emerged from the
Westminster judgement:

1. A legislation is
to receive a strict or literal interpretation;

2. An arrangement
is to be looked at not by its economic or commercial substance but by its legal
form; and

3. An arrangement
is effective for tax purposes even if it has no business purpose and has been
entered into to avoid tax.

 

However, the
Supreme Court also noted that during the 1980s, the House of Lords began to
attach a ‘purposive interpretation approach’ and gradually began to place
emphasis on ‘economic substance doctrine’ as a question of statutory
interpretation. For example, in Inland Revenue Commissioner vs.
McCruckian (1997) BTC 346 the House of Lords held that the substance of
a transaction may be considered if it is a tax avoidance scheme. Lord Steyn
observed as follows:

 

‘While Lord
Tomlin’s observations in the Duke of Westminster
case [1936] A.C. 1 still point to a material
consideration, namely, the general liberty of the citizen to arrange his
financial affairs as he thinks fit, they have ceased to be canonical as to the
consequence of a tax avoidance scheme.’

 

In the light of
various judgements, the Supreme Court laid down the following rationale in the
context of substance over form:

(i)    The principle of the Westminster judgement is
that if a document or transaction is genuine, the court cannot go behind it to
some supposed underlying substance. Subsequent judgements of the English Court
have termed this as ‘the cardinal principle’.

(ii)    Courts have evolved doctrines like ‘substance
over form’ to enable taxation of underlying assets in cases of fraud, sham,
etc. However, genuine strategic tax planning is not ruled out.

(iii)   Tax authorities can invoke the ‘substance over
form’ principle (or ‘piercing the corporate veil’ test) only after establishing
on the basis of facts and circumstances that the transaction is a sham or tax
avoidant.

(iv)   For instance, in a case where the tax
authorities find that in an investment holding structure, an entity which has
no commercial / business substance has been interposed only to avoid tax, then
applying the test of fiscal nullity it would be open to the tax authorities to
discard such inter-positioning of that entity.

 

It is well-known
that the Supreme Court judgement in the Vodafone case was
significantly overridden through retrospective amendments made in the Indian
tax law in 2012. However, the retrospective amendments did not alter the
rationale that, unless there is conclusive evidence to suggest otherwise, once
a non-resident furnishes a tax residency certificate (TRC) from its home
country, benefits under the applicable tax treaty with India should not be
denied3 .

__________________________________________

3   This was also in line with an earlier Supreme
Court judgement in the case of Azadi Bachao Andolan and Another [2003] 263 ITR
706 (SC)

 

 

To address the
issue of ‘substance over form’, the General Anti-Avoidance Rule (GAAR) was
introduced in 2012 itself, although it became effective in India only from 1st
April, 2017. Subject to conditions, GAAR now permits tax authorities to deny
tax treaty benefit in India if the main purpose of undertaking the transaction
was to obtain a tax benefit under an impermissible avoidance arrangement in
India. GAAR also permits disregarding or re-characterising any step in the
impressible avoidance arrangement, including deeming connected persons to be
one person, relocating the situs of any asset or place of residence,
disregarding corporate structure or treating equity as debt or revenue item as
capital or vice versa, as deemed fit. Accordingly, the concept of
‘substance over form’ has now been codified under the Indian law with effect
from 1st April, 2017 through GAAR.

 

Further, with India
adopting the Place of Effective Management (PoEM) criteria from 1st
April, 2016 for determination of tax residency of foreign companies in India,
it can be said that Indian tax laws now have greater focus on the concept of
‘substance over form’. This is also the case under the Income Computation and
Disclosure Standard I relating to accounting policies which categorically
states that the treatment and presentation of transactions and events shall be
governed by their substance and not merely by the legal form.

 

(III)  Renewed international focus on substance over
form, i.e., tax planning vs. tax avoidance

In the past few
years, certain large MNCs were found to implement aggressive business /
investment structures (such as the ‘Double Irish Dutch Sandwich’) which shifted
profits to jurisdictions with low / NIL taxes. At times, while the structures
were legally valid, it was found that the economic activities in the
jurisdictions with lower / NIL taxes were not commensurate with the profits
allocated to such jurisdictions. With courts upholding the legal validity of
the structures in light of tax treaties and international tax law principles,
countries realised that tax treaties along with aggressive tax regimes in
certain countries were in fact the thin line that separated fair tax planning
from aggressive tax mitigation / planning.

 

To tackle this
issue, the OECD and G20 countries adopted a 15-point action plan in September,
2013 to address Base Erosion and Profit Shifting (BEPS). The BEPS Action Plan
identified 15 actions on the basis of three key pillars:

 

(a)   introducing coherence in the domestic rules
that affect cross-border activities;

(b)   reinforcing substance requirements in the
existing international standards; and

(c)   improving transparency as well as certainty.

 

While the concept
of ‘substance’ is one of the three key pillars of the overall BEPS project, it
is discussed in detail in BEPS Action 5: Countering Harmful
Tax Practices More Effectively, Taking into Account Transparency and Substance.
Further, the concept of ‘substance over form’ has been specifically discussed
in BEPS Action 6: Preventing the Granting of Treaty Benefits
in Inappropriate Circumstances.

 

The above-mentioned
15 actions have culminated in the formalisation and signing of the Multilateral
Instrument (MLI) which is a landmark development in the context of tax treaties
across the globe. The MLI seeks to modify thousands of existing bilateral tax
treaties through one instrument. It does not replace these bilateral tax
treaties but acts as an extended text to be read along with the covered
bilateral tax treaties for implementing specific BEPS measures.

 

India has deposited
the ratified MLI with the OECD on 25th June, 2019 and notified the
date of entry into force of the same as 1st October, 2019.
Accordingly, covered Indian tax treaties will be impacted from 1st
April, 2020 onwards. Hence, going forward it is imperative that any Indian
inbound or outbound cross-border structuring of investment / business
operations will have to factor BEPS and MLI aspects, if the structuring
involves availing tax treaty benefits.

 

(IV) Concept of ‘substance over from’ embedded in MLI

Part III of the
MLI, which deals with Treaty Abuse, includes two minimum standards / articles
which are sought to be introduced in the covered bilateral tax treaties. These
articles in essence require testing the substance of a transaction /
arrangement before granting tax treaty benefit. A summary of these articles is
as under:

 

1.    Article 6: Purpose of a Covered Tax
Agreement: This article seeks to act as a preamble to the covered bilateral
tax treaty and clarify that while the purpose of such treaty is to eliminate
double taxation of income, the same should not be used for creating
opportunities for non-taxation or reduced taxation through tax evasion or
avoidance. Specifically, it clarifies that cases of treaty-shopping for the
indirect benefit of residents of third jurisdictions would not be eligible for
tax treaty benefits.

 

2.    Article 7: Prevention of Treaty Abuse: This
article seeks to introduce the Principal Purpose Test (PPT) as a minimum
standard in the covered bilateral tax treaty. There is an option to supplement
the PPT with a Simplified Limitation of Benefits (SLOB) clause4.
Further, the PPT can be replaced altogether with a Detailed Limitation of
Benefits (DLOB) clause, if the same incorporates requisite BEPS standards. The
PPT mainly states that tax treaty benefit shall not be granted if it is
reasonable to conclude, having regard to all relevant facts and circumstances,
that obtaining that benefit was one of the principal purposes of any
arrangement or transaction that resulted directly or indirectly in that
benefit. The benefit would, however, be granted if the same is in accordance
with the object and purpose of the relevant provisions of the tax treaty.

From the above
articles it can be observed that wherever applicable, a transaction or
structure will need to have adequate economic substance in order to pass the
test laid down by the preamble or PPT article of the MLI.

_________________________________________________

4   India has adopted PPT along with SLOB with an
option to adopt an LOB in addition or replacement of PPT through bilateral
negotiation. However, various important tax treaty partners have only adopted
PPT which means that SLOB will not apply to those tax treaties

 

 

(V)    OECD’s focus on substance to tackle cases of
tax treaty abuse

BEPS Action 6 recognises that courts of some countries have developed various
interpretative tools such as economic substance, substance over form, etc.,
that effectively address various forms of domestic law and treaty abuses. There
is, however, an agreement that member countries should carefully observe the
specific obligations enshrined in the tax treaties to relieve double taxation
in the absence of clear evidence that the tax treaties are being abused.

 

BEPS Action 5 explains that the Forum on Harmful Tax Practices (FHTP) was
committed to improving transparency and requiring substantial activity for any
preferential tax regime in any country. FHTP was to take a holistic approach to
evaluate preferential tax regimes in the BEPS context and engage with non-OECD
members for modification to the existing framework, if required.

 

It has been
categorically explained that the work on harmful tax practices is not intended
to promote harmonisation of income taxes or tax structures generally within or
outside the OECD, nor to dictate to any country what should be the appropriate
level of tax rates. The intention mainly is to encourage an environment in
which free and fair tax competition can take place, i.e., a ‘level playing
field’ through agreement of common criteria that promote a co-operative
framework. The broad steps recognised by BEPS Action 5 are:

 

(i)    Enhanced requirement of having substantial
activity in jurisdictions with preferential tax regimes;

(ii)    Suitably checking the ‘nexus’ of actual
activity in such jurisdictions with the nature of income earned there;

(iii)   Improved transparency and addressing of BEPS
concerns through an agreed framework to exchange information pertaining to tax
provisions and rulings amongst countries;

(iv)   Need for amendments to preferential tax
regimes of countries in line with BEPS;

(v)   Ongoing engagement between FHTP and OECD and
non-OECD members to address BEPS.

The nature of core
income-generating activities, other than for IP activities, specifically
discussed in the BEPS Action 5 in the context of substantial
activity is as follows:

 

Nature of
activity

Illustrative core income-generating
activities

a. Headquarters regimes

Taking relevant management decisions;
incurring expenditures on behalf of group entities; and coordinating group
activities

b. Distribution and service centre
regimes

Transporting and storing goods; managing
the stocks and taking orders; and providing consulting or other administrative
services

c. Financing or leasing regimes

Agreeing on funding terms; identifying
and acquiring assets to be leased (in the case of leasing); setting the terms
and duration of any financing or leasing; monitoring and revising any
agreements; and managing any risks

d. Fund management regimes

Taking decisions on the holding and
selling of investments; calculating risks and reserves; taking decisions on
currency or interest fluctuations and hedging positions; and preparing
relevant regulatory or other reports for government authorities and investors

e. Banking and insurance regimes

Banking: Raising funds; managing risk, including credit, currency and
interest risk; taking hedging positions; providing loans, credit or other
financial services to customers; managing regulatory capital; and preparing
regulatory reports and returns

Insurance: Predicting and calculating risk; insuring or re-insuring
against risk; and providing client services

f. Shipping regimes

Managing the crew (including hiring,
paying and overseeing crew members); hauling and maintaining ships;
overseeing and tracking deliveries; determining what goods to order and when
to deliver them; and organising and overseeing voyages

g. Holding company regimes

Regimes providing benefits to companies
only holding equity in other companies should at a minimum require such
companies to adhere to all applicable corporate law filings and have the
substance necessary to engage in holding and managing equity participation.
For example, having both the people and premises necessary for these
activities to mitigate possibility of letterbox and brass plate companies
benefiting from such regimes

 

Subsequent to the Action
Report 5, the FHTP published its 2018 report on preferential regimes in
the context of harmful tax practices. An update to the same has been published
on 19th July, 2019. The report explains in detail the activity-wise
review of tax regimes in various jurisdictions and the FHTP’s view on the same.
Some of the key observations arising from the said report for the purpose of
this article are:

(a)   In the context of the first time review of the
substantial activities factor in ‘no or only nominal tax jurisdictions’, the
status of United Arab Emirates (UAE) was ‘in the process of being amended’,
while the status of others, including Bahrain, Bahamas, Bermuda, BVI, Cayman
Islands, Isle of Man, Jersey, etc., was held to be ‘not harmful’. The report
states that while economic substance requirements were introduced in all these
jurisdictions (in case of UAE from 30th April, 2019 onwards) and
domestic legal framework meets all aspects of the standard, there was ‘one
technical point’ in UAE that is outstanding. However, the UAE has committed to
addressing this issue as soon as possible. The technical point has, however,
not been discussed in the report.

(b)   Tax regimes in Mauritius such as ‘innovation
box’, ‘Global headquarters administration regime’, ‘Global treasury
activities’, ‘Captive insurance’, ‘investment banking’, ‘shipping regime’ and
the recently introduced ‘partial exemption system’ are all compliant and not
harmful. The report also recognised the abolition of the tax regime for Global
Business License 1 and 2 holders
in Mauritius.

 

(VI) Steps regarding
economic substance taken by UAE and Mauritius in light of the BEPS Project

It is well known
that UAE and Mauritius have favourable tax regimes (such as non-levy of
income-tax in UAE, non-levy of income-tax on foreign capital gains in
Mauritius, etc.) and tax treaties which allocate right of taxation of certain
income to these countries. This effectively results in double non-taxation.
Accordingly, to address BEPS concerns both UAE and Mauritius have recently
introduced substance norms. A summary of the substance regulations is provided
below:

 

UAE

With effect from 30th April,
2019 all persons licensed by authorities of UAE (including free zones) are
required to meet the economic substance criteria notified. Only commercial
companies with direct or indirect ownership by the government of UAE / its
emirate or a body under its ownership have been excluded from the
applicability of these provisions. The nature of businesses identified is
similar to the businesses explained above in the context of BEPS Action
5

 

It is important to note that all the
covered persons need to file a report on the economic substance requirements
with the regulatory authority (that has issued trade license to it) for each
financial year. Failure to meet the criteria entails administrative penalties
ranging from AED 10,000 to AED 300,000 depending on nature of default

 

It is crucial to understand that the
regulation grants

power to authorised personnel of the
regulatory

authority to enter the covered person’s
business premises and examine and take copies of business documents. The
regulation also permits exchange of

information from Regulatory Authority to
Ministry of Finance in UAE and further with designated foreign

 

authority in cases where either economic
substance test is not met, or in all cases of persons involved in high-risk
IP activities

 

UAE has also published a guidance
document on 12th September, 2019 to further explain the criteria
for meeting substance regulations

Mauritius

Earlier, Mauritius provided deemed
foreign tax credit of up to 80% for taxable foreign income, where creditable
foreign taxes were lower. This reduced the effective corporate tax on such
income from 15% to 3%. Further, a company incorporated in Mauritius was
considered as resident if its central management and control was exercised in
Mauritius, i.e., the test of residency was earlier not based on PoEM criteria

 

However, the Mauritius tax law has moved
from the deemed foreign tax credit regime to granting 80% exemption to
taxable foreign income from 1st January, 2019. No foreign tax credit would be
granted in Mauritius against the balance 20% taxable foreign income

 

Further, a company incorporated in
Mauritius shall be considered to be a non-resident if its PoEM is outside
Mauritius. The guidance provided by the Mauritius authorities states that in
order for a Mauritius company to be held to have its PoEM in Mauritius, its
strategic decisions relating to its core income-generating activities should
be taken in or from Mauritius. Further, majority of meetings of the Board of
Directors should be held in Mauritius or the executive management of the
company should be regularly exercised in Mauritius. The determination of PoEM
would be based on all relevant facts and circumstances considering the
business activities of the company

 

Detailed circulars have been issued by
the Mauritius tax authorities explaining the various criteria to be met by
different types of companies operating in Mauritius under the Global Business
License (GBL) regime (which permits obtaining TRC in Mauritius). Broadly
speaking, a Mauritius company operating under the GBL regime will now be
required to ensure that at all times it carries out core income-generating
activities in or from Mauritius by employing suitably qualified persons and
has minimum expenditure in line with its level of activities / operations

 

From the above table it can be observed that entities / businesses based
out of UAE and Mauritius are now required to meet the enhanced criteria of
economic substance in those jurisdictions to be considered as tax resident in
that jurisdiction and benefit from their tax regimes.

 

(VII)      Impact on
Indian inbound and outbound business / investment structures

In terms of Indian inbound and outbound structures, Mauritius and UAE
have been popular choices for businesses. Some of the common structures are
discussed below along with their impact on account of BEPS.

 

Structure 1: Indian outbound – use of UAE trading company

Facts: XYZ India has incorporated a
trading company, DUB, in one of the Free Trade Zones (FTZs) of UAE. XYZ India
undertakes import from, and export to, third parties through DUB. DUB maintains
a fairly good margin while dealing with XYZ India.

 

Tax advantage: Subject to Indian transfer pricing
regulations, profits earned by DUB are not liable to any tax in India provided
DUB is non-resident in India under the PoEM regulations and does not have a PE
in India. Since UAE does not levy tax on income of companies incorporated in
FTZs, the effective tax rate on profits of such UAE companies is NIL, unless
repatriated to India as dividend.

 

Impact of BEPS: As a distribution /
service centre company, under the UAE substance regulations DUB will be
expected to undertake the following activities in UAE:

1. Transporting and
storing goods;

2. Managing the
stocks;

3. Taking orders;

4. Providing
consulting or other administrative services.

 

Accordingly,
businesses adopting the above structure will now need to factor the substance requirements
in UAE.

 

Structure 2: Indian inbound – use of Mauritius as holding company

Facts: XYZ USA has incorporated a
company in Mauritius, MAU, as a holding company for investment in XYZ India
(made prior to 1st April, 2017). Income of MAU is either dividend
from XYZ India or capital gains from sale of shares of XYZ India.

 

Tax advantage: MAU will not be liable to pay any tax on capital gains earned from
sale of XYZ India since the same are not taxable in Mauritius and are also
grandfathered from taxation in India under the amended India-Mauritius tax
treaty. The dividend income of MAU, which is exempt from tax in India, will be
subject to an effective tax rate of 3%, which is low. Also, Mauritius has
various favourable tax treaties (especially with African countries) making it
an ideal jurisdiction for holding investments.

 

Impact of BEPS: Mauritius has not notified the tax treaty with India under MLI and
hence, the treaty is not currently impacted by MLI. However, the same is
expected to be bilaterally amended on the lines of BEPS and hence the
requirement of substance in the form of the preamble and PPT (or DLOB) is
expected in the future.

 

In the context of
inbound investment structures through Mauritius, past litigation with Indian
tax authorities has been mainly on the ground that the structures lack
commercial / economic substance and are artificially interposed to avail tax
treaty benefits in India. Now, under Mauritius law, MAU will be required to
have PoEM in Mauritius to be eligible for TRC. Further, as an investment
holding company, in compliance with circular letter CL1-121018 dated 12th
October, 2018 issued by the Financial Services Commission (FSC) of Mauritius,
the minimum expenditure to be incurred by MAU is USD 12,000 p.a. (although no
minimum employees are specified). The same will, however, be tested on a
case-to-case basis, as per facts. For instance, BEPS Action 5
states that in addition to undertaking all applicable corporate law filings,
holding companies are expected to have both the people and premises necessary
to ensure that letterbox and brass plate companies do not benefit from
preferable tax regimes. Whether this will impact the substance evaluation in
Mauritius needs to be seen in the future.

 

It may be noted
that the minimum expenditure in Mauritius will be required even though the
India-Mauritius tax treaty does not provide for any such expenditure under its
LOB clause for availing grandfathering benefit for capital gains.

 

Structures 3-6: Indian inbound structures involving UAE or Mauritius
(others)

 

Structure

Nature of income

from India

UAE

(India-UAE tax treaty is

amended by MLI)

Mauritius

(India-Mauritius tax treaty
is not amended by MLI as yet)

Foreign Direct Investment

Capital gains from sale of
partnership interest in an Indian LLP

Not taxable in India under
Article 13(5) of the India-UAE tax treaty. No tax in UAE as well

Not taxable in India under
Article 13(4) of the India-Mauritius tax treaty. No tax in Mauritius as well

Foreign Portfolio Investment

Capital gains from sale of Indian derivatives /
bonds / debentures

Not taxable in India under Article 13(5) of the
India-UAE tax treaty. No tax in UAE as well

Not taxable in India under Article 13(4) of the
India-Mauritius tax treaty. No tax in Mauritius as well

Structure

Nature of income

from India

UAE

(India-UAE tax treaty is

amended by MLI)

Mauritius

(India-Mauritius tax treaty is not amended by MLI
as yet)

Foreign Service companies providing onshore
services in India

Service income not in nature of fees for technical
services

No PE or tax in India unless presence in India of
9 months within any 12-month period. No tax in UAE
as well

No PE or tax in India unless presence in India of
90 days within any 12-month period. Low tax in Mauritius

Foreign Service companies mainly providing
offshore services

Service income in nature of fees for technical
services

FTS is not taxable in India under the India-UAE
tax treaty. No tax in UAE as well

Although FTS is now taxable in India under the
India-Mauritius tax treaty, the same is subject to a low tax rate
in Mauritius

 

Impact of
BEPS: The above structures seek to obtain tax
treaty benefits in India which may otherwise not be available under India’s tax
treaty with the country of headquarters of the business (say, USA or UK). Any
adverse impact on meeting substance requirements in the UAE or Mauritius could
adversely impact grant of tax treaty benefits in India – especially if TRC is
not granted to entities non-compliant with substance regulations.

 

Accordingly, businesses adopting the above
structures or any other structures involving use of an entity in a preferential
tax regime, in addition to PPT, should factor in the impact of substance
regulations in that country to ensure that the structure is compliant under
BEPS.

 

(VIII)     Parting
note

Considering the intention of the BEPS
project to tackle cases of tax avoidance and aggressive tax planning, it is not
surprising that India has been at the forefront of this landmark global
initiative. In addition to GAAR and PoEM, India has actively also incorporated
BEPS Actions into its domestic tax laws such as:

 

(i)    Country by country reporting (CbCR)

(ii)   Equalisation levy

(iii)
Commissionaire arrangements resulting in taxable presence

(iv) Significant
economic presence (SEP) constituting taxable presence for certain digital
businesses

(v) Limitation on
interest deduction for payments to associated enterprises

 

In fact, as a sign of things to come, the
recently-concluded protocol to the India-China tax treaty incorporated various
MLI provisions within the text of the tax treaty, including PPT (as a
result, India-China tax treaty is outside the purview of the MLI).

 

Accordingly, it is expected that BEPS
Actions and MLI will influence the approach of Indian tax authorities in the
future while granting tax treaty benefits in India. One of the key expected
areas of focus is to probe the economic substance of non-resident entities
under BEPS Action 5.

 

In light of the above, reference may be
made to another set of wise words from Mr. Dee Hock, which may be relevant in
the context of the future of international tax – ‘Preserve substance; modify
form; know the difference’.  

Sections 5 and 9 of the Act – As insurance compensation received by foreign parent company from foreign insurer was for protection of its financial interest in Indian subsidiary, it was not taxable in hands of the Indian subsidiary, although compensation was paid pursuant to fire damage to assets and stock of the Indian subsidiary

21. 
TS-439-ITAT-2019 (Del.) M/s. Adidas India Marketing vs. IT Officer
(P) Ltd. ITA No.: 1431/Del/2015 A.Y.: 2011-12 Date of order: 2nd July, 2019;

 

Sections 5 and 9 of the Act – As insurance
compensation received by foreign parent company from foreign insurer was for
protection of its financial interest in Indian subsidiary, it was not taxable
in hands of the Indian subsidiary, although compensation was paid pursuant to
fire damage to assets and stock of the Indian subsidiary

 

FACTS

The assessee was an Indian company engaged
in the business of sourcing, distribution and marketing of products in India
under a brand name owned by its overseas group company. A German company (F Co)
was the ultimate parent / holding company of the assessee. The assessee had
insured its fixed assets and stocks with an Indian insurer. F Co had insured
its financial interest in its worldwide subsidiary companies (including in
India) under a global insurance policy (GIP) with a foreign insurer. The
assessee had a fire incident against which it received compensation from the
Indian insurer during the relevant year. In respect of loss incurred by the
assessee, F Co also received insurance compensation under GIP in Germany from
the foreign insurer towards loss in economic value of its financial interest in
the assessee. The compensation received was reduced by the amount of
compensation received by the assessee from the Indian insurer. Further, F Co
had paid taxes in Germany on the compensation received under GIP.

 

The AO contended that the insurance
compensation received by F Co was in respect of loss of stock of the assessee
and that the email correspondence between the assessee and F Co indicated that
all receipts from insurance, relating to physical loss, business interruption
and mitigation cost, belonged to the assessee. Thus, overseas compensation
received by F Co had a direct business relationship with the business
activities of the assessee and hence the same should be taxed in India in the
hands of the assessee.

 

The DRP also
held that insurance compensation was taxable in the hands of the assessee as
the profit foregone on the lost stock and the loss suffered on other assets
were part and parcel of the business of the assessee in India.

 

The assessee had contended that

The insurance compensation received by the
assessee and F Co were under two separate and distinct contracts of insurance.
The contracts were with unrelated third-party insurers. The respective insured
persons (claimants) had separately paid the premium without any cross-charge.

 

While the insurance policy taken by the
assessee exclusively covered risk arising out of loss of stock and fixed assets
owned by it, the GIP exclusively covered the financial interest of F Co in the
assessee.

 

The privity of the insurance contract of the
Indian insurer was with the assessee and that of the foreign insurer was with F
Co. Further, the assessee was not a contracting party to the GIP.

 

Income ‘accrues’ to the assessee only when
the assessee acquires the right to receive it. Since there was no actual or
constructive receipt by the assessee, compensation could not be taxed in India
in its hands. Moreover, no income accrued to the assessee as the assessee had
not acquired any unconditional and absolute right to receive claim of
compensation under GIP.

 

F Co had undertaken the GIP with the foreign
insurer for all its investments worldwide, including in India.

 

HELD

Insurance policy between the assessee and
the Indian insurer was to secure stock-in-trade, which is a tangible asset.
However, GIP between F Co and foreign insurer was for securing investment made,
or financial interest, in subsidiaries which is an intangible asset. Thus, the
interest insured by the assessee and that by F Co were two different interests.

 

The insurance contracts entered by the
assessee and F Co were separate and independent since: (i) there were two
different claimants; (ii) claimants had separately paid the premium; (iii) no
part of the premium on GIP was allocated to the assessee; and (iv) the privity
of contract was with different parties.

 

As the assessee did not have any right or
obligation in the GIP and it was not a party to it, the assessee did not have
any right to receive the claim of insurance. The same was also not vested in
the assessee to be regarded as having accrued in the hands of the assessee.
Reliance was placed on the Supreme Court’s decision in the case of ED
Sassoon [26 ITR 27 (SC)].

 

The claim under GIP was in respect of
insured financial interest of F Co in its worldwide subsidiaries. The foreign
insurer had paid compensation for diminution in financial interest. Merely
because the computation of the claim was with reference to loss by fire of the
stock, or profit that could have been earned if such stock was sold, cannot be
construed to mean that the claim was in respect of loss of tangible property in
the form of stock of the assessee. The claim was in respect of the intangible
asset in the form of financial interest of F Co. Hence, the claim cannot be
said to have any ‘business connection’ in India.

 

The insured interest of F Co cannot be said
to be through or from any property in India or through or from any asset or
source of income in India. F Co had entered into a contract in Germany for
insuring the intangible assets in the form of financial interest in its
subsidiaries. This was quite distinct from the physical stock-in-trade of the
assessee that was lost in fire. Thus, the claim received by F Co could not be
treated as income deemed to accrue or arise in the hands of the assessee in
India.Further, the email correspondence was merely to explore the modes of
transfer of money from F Co to the assessee for restoring the financial
interest of F Co in the assessee. The same cannot determine the tax liability.
Such correspondence was related to application of money but did not indicate in
whose hands the money was taxable.

 

The GIP was taken to cover the contingent
losses that may or may not arise in future. Further, as F Co had actually paid
premium in respect of GIP from time to time and also paid tax in Germany in
relation to the insurance claim, there was no colourable device adopted by the
assessee for evading taxes in India.

 

Sections 5, 9, 40(a)(i) and 195 of the Act; Article 7 of India-USA DTAA – As services were rendered outside India and payment was also made outside India, receipts of the foreign company were not within the scope of ‘total income’ in section 5(2) – Fee received for merely referring and introducing clients is business income which, in absence of PE in India, would not be chargeable in India – Besides, the services were not in the nature of managerial, technical or consultancy services

20. 
[2019] 107 taxmann.com 363 (Mum – Trib.) Knight Frank (India) (P) Ltd. vs. ACIT ITA No.: 2842 (Mum.) of 2017 A.Y.: 2012-13 Date of order: 12th June, 2019;

 

Sections 5, 9, 40(a)(i) and 195 of the Act;
Article 7 of India-USA DTAA – As services were rendered outside India and
payment was also made outside India, receipts of the foreign company were not
within the scope of ‘total income’ in section 5(2) – Fee received for merely
referring and introducing clients is business income which, in absence of PE in
India, would not be chargeable in India – Besides, the services were not in the
nature of managerial, technical or consultancy services

 

FACTS

The assessee
was engaged in the business of rendering international real estate advisory and
property management services. During the course of the relevant year, the
assessee had paid referral fees to an American company (US Co) for introduction
of clients to the assessee. According to the assessee, the services rendered by
the US Co did not ‘make available’ any technical knowledge, experience, skill,
knowhow or processes to the assessee. Therefore, they were not in the nature of
‘Fees for included services’ in terms of Article 12 of the India-USA DTAA.
Since they were business profits of the US Co, in the absence of a PE in India
they could not be brought to tax in India.

 

However, the predecessor of the AO had, in
an earlier year, held that after retrospective amendment and insertion of
Explanation to section 9(2) of the Act, the income of a non-resident was deemed
to accrue or arise in India u/s 9(1)(v), (vi) or (vii)irrespective of whether
the non-resident had a place of business or business connection in India or
whether he had rendered services in India, and hence, the referral fee was taxable
in India. Following the order of his predecessor, the AO disallowed the fee u/s
40(a)(i) of the Act. The CIT(A) also followed the view held by his predecessor
CIT(A) and dismissed the appeal.

 

HELD

Sections 5 and 9 (post-2010 amendment)

Under section 5(2), income taxable in India
of a non-resident includes income received or deemed to be received in India
and income which has accrued or arisen, or is deemed to accrue or arise in
India.

 

Since the referral fee was paid outside
India, it was not received or deemed to be received in India. As regards
accrual, place of accrual would be relevant. Since the US Co had rendered the
services outside India, referral fee did not accrue or arise in India.

 

Section 9(1) in its clauses (i) to (vii)
deals with ‘income deemed to accrue or arise in India’. Clauses (ii) [salary
earned in India], (iii) [salary payable by government], and (iv) [dividend] are
not relevant in case of the US Co. Of the seven clauses, only the limb in
respect of ‘…directly or indirectly, through or from any business connection in
India…’ of clause (i) is relevant because the US Co had rendered services in
the course of its business. Explanation 1(a) to section 9(i) provides that if
all operations of a business are not carried out in India, only the income
reasonably attributable to the operations carried out in India shall be
taxable.

 

Since the US Co had rendered all its
services outside India, no part of referral fee could be attributed to any
operation in India. Hence, there was no income deemed to accrue or arise in
India. And, since the CIT(A) had based his conclusion on Explanation to section
9(2), which mentions clauses (v), (vi) and (vii), their applicability should be
examined. As clause (v) is in respect of ‘interest’, it is not relevant.
Similarly, clause (vi) deals with ‘royalty’, which is also not the case. Hence,
what needs to be examined is whether, in terms of clause (vii), the services
rendered were in the nature of managerial services, technical services or
consultancy services.

 

Managerial services

The US Co was referring or introducing
clients to the assessee. It did not provide any managerial advice or services.
Therefore, referral fee cannot be said to have been received for managerial
services.

 

Technical services

The US Co had not performed any services
which required special skills or knowledge relating to a technical field.
Therefore, referral fee cannot be said to have been received for technical
services.

 

Consultancy services

The US Co was using its skill and knowledge for
its own benefit and merely referring or introducing clients to the assessee. It
had not provided any consultation or advise to the assessee. Therefore,
referral fee cannot be said to have been received for consultancy services.

 

Make available

The service of referring or introducing a
client did not ‘make available’ any technical knowledge, experience, skill,
knowhow or processes to the assessee. Therefore, the receipt was not ‘Fees for
included services’ in terms of Article 12 of the India-USA DTAA.

 

Disallowance under section 40(a)(i)

As referral fee was business income of the
US Co, it was covered under Article 7 of the India-USA DTAA. And since the US
Co did not have a PE in India, referral fee was not chargeable to tax in India.
Hence, the assessee was not obligated to deduct tax at source u/s 195 from the
referral fee. Consequently, no disallowance u/s 40(a)(i) could be made.

 

Article 7, India-Malaysia DTAA; Article 7, India-UK DTAA – Compensation paid for contractual default, being business profit, was not taxable in India if recipient had no PE in India – Rebate given for quality issues effectively being discount in sale price, was not taxable; even otherwise, rebate being business profit, was not taxable in India if recipient had no PE in India

19. 
[2019] 108 taxmann.com 79 (Vizag. – Trib.) 3F Industries Ltd. vs. ACIT, Circle-1, Eluru ITA No.: 01 (Viz.) of 2015 A.Y.: 2007-08 Date of order: 17th July, 2019;

 

Article 7, India-Malaysia DTAA; Article 7,
India-UK DTAA – Compensation paid for contractual default, being business
profit, was not taxable in India if recipient had no PE in India – Rebate given
for quality issues effectively being discount in sale price, was not taxable;
even otherwise, rebate being business profit, was not taxable in India if
recipient had no PE in India

 

FACTS

The assessee was an Indian company engaged
in trading of certain products. The assessee procured the products from
suppliers in India and exported the same to foreign customers. Among others, it
had entered into export contracts with a Malaysian company (Malay Co) and a UK
company (UK Co). In respect of the contract with the Malay Co, as the price in
the Indian market was substantially higher the assessee could not procure the
products and did not fulfil the contract. Hence, the Malay Co claimed
compensation towards the losses suffered because of default by the assessee. To
maintain its business reputation and relationship with the Malay Co, the
assessee agreed upon the amount of compensation and paid up. In respect of its
contract with the UK Co, there were certain quality issues. Hence, the UK Co
claimed price rebate. Again, to maintain its business reputation and
relationship with the UK Co, the assessee agreed to a rebate.

 

The AO completed the assessment u/s 143(3)
of the Act. Subsequently, CIT undertook revision of the order u/s 263 and held
that as payment was made to a foreign company and no tax was deducted u/s 195
of the Act, the assessment was erroneous and prejudicial to the interest of the
Revenue. He directed the AO to examine disallowance u/s 40(a)(i) of the Act.
The AO proposed disallowance, which the DRP upheld.

 

HELD

Compensation for contractual default

The transaction of export was a business
transaction. Compensation was paid because of failure of the assessee to supply
the products. Thus, the payment was to compensate the Malay Co for the loss
suffered by it because of non-fulfilment of contract by the assessee.

 

Therefore, the receipt was business income
in the hands of the Malay Co. Further, the Malay Co did not have a PE in India.
In terms of Article 7 of the India-Malaysia DTAA, business income of the Malay
Co would be taxable only in Malaysia unless it had a PE in India. But since it
did not have a PE in India, the business income was not chargeable to tax in
India. Therefore, the question of disallowance u/s 40(a)(i) of the Act did not
arise.

 

Quality rebate

Quality rebate was given because of certain
quality issues. The perusal of the documents showed that the quality rebate
was, effectively, a discount in sale price. Hence, there was no question of
TDS.

 

Even otherwise, quality rebate was in the
nature of business profit for the UK Co. In terms of Article 7 of the India-UK
DTAA, the business income of the UK Co would be taxable only in the UK unless
it had a PE in India. But since it did not have a PE in India, the business
income was not chargeable to tax in India. Therefore, the question of
disallowance u/s 40(a)(i) of the Act did not arise.

 

Article 25 of India-USA DTAA, Article 23 of India-Canada DTAA and similar provisions in various other DTAAs – If a DTAA provides for credit of foreign tax paid even in respect of income on which tax was not paid in India, tax credit u/s 90(1)(a)(ii) would be available – However, if a DTAA provides for credit u/s 90(1)(a)(i) it would be available only if tax is also paid in India

15 [2019] 111 taxmann.com 42 (Mum.) Tata Consultancy Services Ltd. vs. ACIT [IT Appeal No. 5713 of 2016 & IT (TP)
Appeal No. 5823 (Mum.) of 2016] A.Y.: 2009-10 Date of order: 30th October, 2019

 

Article 25 of India-USA DTAA, Article 23 of
India-Canada DTAA and similar provisions in various other DTAAs – If a DTAA
provides for credit of foreign tax paid even in respect of income on which tax
was not paid in India, tax credit u/s 90(1)(a)(ii) would be available –
However, if a DTAA provides for credit u/s 90(1)(a)(i) it would be available
only if tax is also paid in India

 

FACTS

The assessee was an
Indian company engaged in the business of export of software and providing
consultancy services. It had branches in various tax jurisdictions in which it
had paid tax on profits of branches. Under sections 90 and 91 of the Act, the assessee
claimed credit for tax paid in these jurisdictions. To support its claim, the
assessee furnished statements of tax paid in each jurisdiction. The assessee
contended that the tax paid in those jurisdictions was eligible for deduction
from tax payable in India in terms of the applicable DTAAs as well as u/s 91 of
the Act.

 

After examining the
claim of the assessee and verifying the details, the AO allowed tax credit in
respect of tax paid on income which was taxed abroad and also in India but
restricted the credit to the rate of tax payable in India. However, where
income was taxed abroad but was exempted in India, he did not grant credit,
either u/s 90 or u/s 91.

 

In appeal, relying
on the decision in Wipro Ltd. vs. DCIT [2015] 62 taxmann.com 26 (Kar.),
CIT(A) trifurcated foreign tax credit into three parts, namely, tax paid in
USA, tax paid in other DTAA countries and tax paid in non-DTAA countries. He
directed the AO to allow tax credit in respect of tax paid in USA even on
income which was exempt from tax in India u/s 10A/10AA. In respect of tax paid
in other DTAA and non-DTAA countries, he held that no tax credit will be
available in respect of income which was exempt from tax in India u/s 10A/10AA.

 

HELD

  •     Relying on
    the decision in Wipro Ltd. vs. DCIT [2015] 62 taxmann.com 26 (Kar.),
    CIT(A) restricted foreign tax credit only in respect of tax paid in USA even
    though income was exempt u/s 10A/10AA on the premise that the decision granted
    benefit only in case of India-USA DTAA.
  •     However, the Karnataka High Court had held
    that section 90(1)(a)(ii) applies where the income is chargeable1  to tax under the Act and also in the other
    country. Though tax is chargeable under the Act, the Parliament may exempt the
    income from payment of tax to incentivise the assessee.
  •     In the context of the India-USA DTAA2
    , the Court held that it did not require that to claim credit the assessee must
    have paid tax in India on such income. The Court also mentioned that the
    India-Canada DTAA3  allows
    credit for tax paid in Canada only if income is subjected to tax in India.
  •     A careful reading of the said decision shows
    that if a DTAA provides credit for foreign tax paid even in respect of income
    on which the assessee has not paid tax in India, it would qualify for tax credit
    u/s 90. DTAAs between India and Denmark, Hungary, Norway, Oman, US, Saudi
    Arabia, Taiwan have provisions similar to Article 25 of the India-USA DTAA
    providing for credit of foreign tax even in respect of income not subjected to
    tax in India.
  •     However, DTAAs with Canada and Finland
    provide for credit of foreign tax only if income is subjected to tax in both
    the countries.
  •  Therefore, the assessee was
    entitled to credit for tax paid in case of all countries other than tax paid in
    Finland and Canada.

 

____________________________________________________________________________________

1   Section 90(1)(a)(i) of the Act requires that
tax should have been paid in both the jurisdictions

2   Article 25(2)(a) of India-USA DTAA

3    Article 23(3)(a) of India-Canada DTAA

 

 

 

Article 13 of India-Netherlands DTAA – Section 160(1)(iv) of the Act – Benefit under DTAA is available to an assessee acting as trustee (i.e., a representative assessee) of a tax transparent entity, if beneficiaries or constituents of tax transparent entity are entitled to benefit under DTAA

14 [2019] 112
taxmann.com 21 (Mum.) ING Bewaar
Maatschappij I BV vs. DCIT [IT Appeal No.
7119 (Mum.) of 2014] A.Y.: 2007-08 Date of order:
27th November, 2019

 

Article 13 of
India-Netherlands DTAA – Section 160(1)(iv) of the Act – Benefit under DTAA is
available to an assessee acting as trustee (i.e., a representative assessee) of
a tax transparent entity, if beneficiaries or constituents of tax transparent
entity are entitled to benefit under DTAA

 

FACTS

The assessee was a tax transparent
entity established in the Netherlands. It was registered with SEBI as a
sub-account of a SEBI-registered FII. As trustee, it was the legal owner of the
assets held by a fund which, under the Dutch law, was structured as a legal
entity known as FGR (i.e. fonds voor gemene rekening, which means funds
for joint account). The fund had three investors.

The assessee contended as follows.

  •     The fund was a tax transparent
    entity, fiscally domiciled in the Netherlands, and the income earned by it was
    taxable in the hands of its beneficiaries.
  •     All beneficiaries under the
    fund were taxable in respect of their shares of income in the Netherlands and,
    hence, were entitled to benefits under the India-Netherlands DTAA.
  •     The assessee was the trustee
    of the fund and also the legal owner of the assets owned by the fund.
  •     Under
    the Act, the status of the assessee was AOP. Hence, it was taxable in the
    capacity of representative assessee. As the beneficiaries were taxable entities
    in the Netherlands, which were entitled to benefits under the India-Netherlands
    DTAA, the assessee was also entitled to the same benefits.

Following is a diagrammatic presentation of the structure:

 

The AO, however, held that since the fund had earned capital gain in
India as an AOP, it should be assessed as an AOP. As the said AOP was not a tax
resident entity of Netherlands, benefits under the India-Netherlands DTAA and
particularly that under Article 13 cannot be extended to it.

 

CIT(A) confirmed the order of the AO.

 

HELD

  •     The role of the assessee was that of
    custodian of investments. The AO has nowhere mentioned that profits had accrued
    to the assessee in its own right. The AO had framed the assessment order in the
    name of the assessee mentioning its capacity as trustee of the fund and
    describing its business as ‘sub-account of foreign institutional investor’.
    Thus, there was no doubt that the assessment was made in the representative
    capacity of the assessee.
  •     The fund was organised as an FGR in the
    Netherlands (i.e., funds for joint account). Under the Dutch law, FGR is in the
    nature of a contractual arrangement between the investors, fund manager and its
    custodian. Since an FGR is not a legal entity, it does not hold any assets on
    its own and the assets are held by a custodian (in this case, the assessee).
    The clarifications issued by the Government of Netherlands also noted that the
    fund was a tax transparent entity.
  •     The
    question that was to be addressed was who was the actual beneficiary of the
    trust, in whose representative capacity the assessee was to be taxed, and
    whether those beneficiaries were fiscally domiciled in the Netherlands (i.e.,
    ‘liable to taxation by reasons of his domicile, residence, place of management
    or any other criterion of similar nature’). There are two reasons for following
    this approach.
  •     First, the fund was not a legal entity.
    Hence, it was to be seen as to which legal entities the income belonged to. The
    income belonged to the three investors in the fund, who were tax residents of
    the Netherlands. Hence, benefits under the India-Netherlands DTAA could not be
    denied.
  •     Second, even if one accepts that it is a tax
    transparent entity simpliciter, following the principles laid down in Linklaters
    LLP vs. Income Tax Officer [(2010) 9 ITR (Trib.) 217 (Mum.)],     what is
    important is the fact that income should be taxable in the Netherlands and not
    the manner in which it is taxable. In such an asymmetrical taxation situation,
    as long as income is liable to tax in the Netherlands, whether in the hands of the
    assessee or in the hands of its beneficiaries (since it is a tax transparent
    entity), benefits under DTAA should be granted in India.
  •     According to the approach adopted by the AO,
    for claiming benefit under DTAA it was essential that income should have
    accrued to the taxable entities in the Netherlands. Since the beneficiaries
    were the three investors all of which were taxable entities in the Netherlands
    and not the fund, the assessee was wrongly denied benefit under DTAA.
  •     On facts, Article 13(1), (2) and (3) of the
    India-Netherlands DTAA are not applicable. Gains on the sale of shares is
    covered under Article 13(4) if the shares are unlisted and their value is
    principally derived from immovable properties. However, the AO has not brought
    out any such facts. Thus, Article 13(5) being the residuary provision would
    apply. As Article 13(5) allocates taxing rights to the Netherlands, capital
    gain would not be chargeable to tax in India.

 

Section 9 of the Act – Indian subsidiary hired facility of Indian parent to develop technology and transferred it to BVI sister subsidiary at nominal cost – BVI subsidiary transferred it to USA sister subsidiary in consideration of shares of USA subsidiary – Price of shares was determined at the time when agreement for transfer of technology was made but was substantially higher when shares were issued, resulting in huge profit to BVI subsidiary – On facts, Indian subsidiary not owning infrastructure was not relevant; BVI subsidiary was not paper company since it owned IPRs and had pharma registrations; the transaction could not be regarded as colourable device merely because there was no tax liability in hands of parent company – Other than section 92, no other provision permits taxing of international transactions and since AO had not invoked transfer pricing provisions, sale consideration received by BVI subsidiary could not be taxed in hands of Indian parent

13 [2019] 111 taxmann.com 218 (Ahm.) Sun Pharmaceuticals Industries Ltd. vs. ACIT [ITA No. 1659, 1689 (Ahm.) of 2015] A.Y.: 2008-09 Date of order: 20th June, 2019

 

Section 9 of the Act – Indian subsidiary
hired facility of Indian parent to develop technology and transferred it to BVI
sister subsidiary at nominal cost – BVI subsidiary transferred it to USA sister
subsidiary in consideration of shares of USA subsidiary – Price of shares was
determined at the time when agreement for transfer of technology was made but
was substantially higher when shares were issued, resulting in huge profit to
BVI subsidiary – On facts, Indian subsidiary not owning infrastructure was not
relevant; BVI subsidiary was not paper company since it owned IPRs and had
pharma registrations; the transaction could not be regarded as colourable
device merely because there was no tax liability in hands of parent company –
Other than section 92, no other provision permits taxing of international
transactions and since AO had not invoked transfer pricing provisions, sale
consideration received by BVI subsidiary could not be taxed in hands of Indian
parent

 

FACTS

The assessee was an
Indian company engaged in the pharmaceuticals business. In the course of
survey, the tax authority found various documents indicating that BVI
subsidiary of the assessee (‘BVI Co’) had transferred certain technology to the
American subsidiary of the assessee (‘USA Co’). BVI Co had acquired the said
technology from another Indian subsidiary of the assessee (‘Tech Co’) which had
allegedly acquired the same from the assessee. The AO noted that the cost of
acquisition of technology for BVI Co was quite nominal as compared to the value
at which BVI Co transferred the same to USA Co and earned substantial gain. As
BVI did not charge tax on income of BVI Co, it did not pay any tax on the gain.

 

The following is a
diagrammatic presentation of the transaction:

The tax authority
recorded the statements of two directors of the assessee admitting that the
assessee had developed the said technology for use of the USA Co. Hence, the AO
issued notice to the assessee to show cause why the profit of BVI on transfer
of technology to the USA Co should not be taxed in its hands.

The assessee explained that:

  •     it had allowed Tech Co to use its R&D
    facility;
  •     factually, the said technology had been
    developed by Tech Co;
  •     Tech Co had paid charges for use of R&D
    facility of the assessee;
  •     the user charges were duly recorded in its
    own books of accounts as well as those of Tech Co;
  •     the AO had ignored various relevant
    documents, such as agreement between BVI Co and Tech Co, agreement between Tech
    Co and assessee, transactions recorded in the books of all parties;
  •     the AO had not found any defect in those
    documents;
  •     accordingly, it was mere presumption on the
    part of the AO that Tech Co had acquired the said technology from the assessee
    and the transaction was routed through Tech Co to evade tax.

 

Concluding that technology was developed by the assessee for transfer to
the USA Co but was routed through Tech Co and BVI Co only to evade tax in
India, the AO taxed the gain from transfer to the USA Co in the hands of the
assessee. The CIT(A) confirmed the addition made by the AO.

 

HELD

The Tribunal considered the following questions:

  •     Whether Tech Co was a
    name-lender in the impugned transactions?
  •     Whether the statements of
    directors recorded u/s 131 were valid?
  •     Whether BVI Co was a paper
    company?
  •     Whether transfer of technology
    was a colourable device?
  •     Whether the sale consideration
    received by BVI Co belonged to the assessee?

 

  1.     Whether Tech Co had merely lent name
    for transfer of technology?
  •     The AO held that Tech Co had
    not developed the technology because it did not own infrastructure for
    development of technology.
  •     The assessee had furnished all
    the necessary documents (including agreements pertaining to use of the R&D
    facility and transfer of the technology) and details of persons who visited the
    infrastructure facility of the assessee for development of the technology. The
    AO had not pointed out any defect in the same.
  •     Based on details about Tech Co
    which were furnished by the assessee to the AO, the AO could have exercised his
    powers to issue notice u/s 133(6) to verify the facts from Tech Co. However, he
    failed to do so.
  •     The observations of the AO
    indicated that Tech Co was     engaged in the development
    of the technology but indirectly as a job worker. Thus, the role of Tech Co in
    the development of the technology could not be ruled out completely as alleged
    by the Revenue.
  •     In the given facts and circumstances,
    whether Tech Co owned infrastructure for development was not relevant. What
    mattered was whether Tech Co or the assessee had developed the technology.
  •     The assessee had also submitted that Tech Co
    was not an associated party in terms of section 40A(2)(b) of the Act.
  •     Tech Co had developed the technology
    pursuant to the agreement with BVI Co. Hence, the assessee had discharged its
    onus.

 

  2.   Whether the
statements of directors recorded u/s 131 were valid?

  •     A statement recorded on oath u/s 131 cannot
    be the basis of any disallowance / addition until and unless it is supported on
    the basis of some tangible material. The CBDT has discouraged its officers from
    making additions on the basis of statements without bringing any tangible
    materials for any addition / disallowance.
  •     Except the statement, the lower authorities
    had not collected any evidence to prove that the transaction was bogus.

 

3.     Whether BVI Co was a paper
company?

  •        Several transactions
    between the assessee and BVI Co were the subject matter of transfer pricing
    adjustments.
  •        Income of BVI Co could be
    taxed in India only if, in terms of section 6(3), it was resident of India
    which was never alleged.
  •     If transaction of sale of
    technology is treated as international transaction between the AEs in terms of
    section 92C, it should be determined on arm’s length basis. However, the AO had
    not invoked the said provision.
  •    BVI Co had various purchase
    and sales transactions with the assessee, which had led to dispute under
    transfer pricing regulations. Further, BVI Co owns IPR and also has
    registrations with USFDA. Merely because BVI Co did not own infrastructure, it
    could not be treated as a paper company.
  •     In the absence of DTAA between
    BVI and India, the transactions between the assessee and BVI Co were subject to
    the provisions of the Act. However, there is no provision under which income of
    BVI Co could be taxed in India.

4.    Whether the impugned
transaction is a colourable device?

  •     If the AO treats sale of technology by Tech
    Co to BVI Co as a colourable device, then it cannot treat one part of the
    transaction as genuine and another part as non-genuine. While the AO treated
    the sale of technology by Tech Co to BVI Co as a colourable device, he accepted
    rent for using facility for development of technology as genuine business
    income.
  •     Merely because there was no tax liability could
    not be the reason for regarding any transaction as a colourable device.

5.  Whether the sale
consideration received by BVI Co belonged to the assessee?

  •     Consideration for supply of technology was
    to be discharged by issue of shares of USA Co to BVI Co.
  •     Share price of USA Co was lower at the time
    when the agreement between BVI Co and USA Co was made, whereas it had increased
    when the technology was delivered to USA Co. As one cannot predict future price
    of shares, increase in price of shares could not be treated as a colourable
    device. Further, since shares of USA Co were listed on the stock exchange, the
    assessee could not have any role in such increase.
  •     Share price at the time of delivery could
    also have been lower. In such case, the AO would not have allowed the loss.
  •     Even if it was assumed that the technology
    was developed by the assessee, income could be taxed in the hands of the
    assessee by treating BVI Co as an AE and determining arm’s length price u/s 92.
    However, the AO did not invoke section 92. Other than section 92, there is no
    provision under the Act to tax international transactions between AEs.
  •     Despite having power to refer the matter to
    the TPO, the AO did not do so. Since it was not referred, normal provisions of
    the Act would apply under which purchase and sale prices between AEs cannot be
    disturbed even if they are not at arm’s length price.
  •     Even if it was assumed that the purpose of
    BVI Co was to divert income of the assessee, then the transaction should be
    treated as between the assessee and USA Co. Such a transaction should be
    subject to section 92C for determining arm’s length price. But the AO failed to
    invoke the provisions of the transfer pricing.

 

By holding the
transaction between the assessee, Tech Co and BVI Co as a colourable device but
charging rent from Tech Co as income of the assessee, the Revenue had taken
contradictory stands. Once a transaction is treated as a colourable device, the
assessee should not have suffered tax on rent. Hence, the AO was directed to delete
the addition made by him.

 

RECENT IMPORTANT DEVELOPMENTS – PART II

In Part I of the article published in July,
we covered some of the important developments in India relating to
International Tax. In this Part II of the article, we cover recent major
developments in the area of International Taxation and the work being done at
OECD and UN in various other related fields. It is in continuation of our
endeavour to update readers on major International Tax developments at regular
intervals. The news items included here come from various sources and the OECD
and UN websites.

 

(A) DEVELOPMENTS IN INDIA RELATING TO
INTERNATIONAL TAX

 

Ratification by India of the Multilateral
Convention to implement tax treaty-related measures to prevent Base Erosion and
Profit Shifting (Press release dated 2nd July, 2019 issued by CBDT,
Ministry of Finance)

 

India has ratified the Multilateral
Convention to implement tax treaty-related measures to prevent Base Erosion and
Profit Shifting (MLI), which was signed by the Hon’ble Finance Minister in
Paris on 7th June, 2017 along with representatives of more than 65
countries. On 25th June, 2019 India deposited the Instrument of
Ratification to OECD, Paris, along with its final position in terms of Covered
Tax Agreements (CTAs), reservations, options and notifications under the MLI,
as a result of which MLI will come into force for India on 1st
October, 2019 and its provisions will have effect on India’s DTAAs from FY
2020-21 onwards.

 

(B) OECD DEVELOPMENTS

 

(I) OECD
announces progress made in addressing harmful tax practices (BEPS Action 5)
(Source: OECD News Report dated 29th January, 2019)

 

The OECD has
released a new publication, Harmful Tax Practices – 2018 Progress Report on
Preferential Regimes, which contains results demonstrating that
jurisdictions have delivered on their commitment to comply with the standard on
harmful tax practices, including ensuring that preferential regimes align
taxation with substance.

 

The assessment of
preferential tax regimes is part of ongoing implementation of Action 5 under
the OECD/G20 BEPS Project. The assessments are conducted by the Forum on
Harmful Tax Practices (FHTP), comprising of the more than 120 member
jurisdictions of the Inclusive Framework. The latest assessment by the FHTP has
yielded new conclusions on 57 regimes, including:

 

  •    44 regimes where
    jurisdictions have delivered on their commitment to make legislative changes to
    abolish or amend the regime (Antigua and Barbuda, Barbados, Belize, Botswana, Costa
    Rica, Curaçao, France, Jordan, Macau (China), Malaysia, Panama, Saint Lucia,
    Saint Vincent and the Grenadines, the Seychelles, Spain, Thailand and Uruguay).
  •    As a result, all IP regimes
    that were identified in the 2015 BEPS Action 5 report are now ‘not harmful’ and
    consistent with the nexus approach, following the recent legislative amendments
    passed by France and Spain.
  •    Three new or replacement
    regimes were found ‘not harmful’ as they have been specifically designed to
    meet Action 5 standard (Barbados, Curaçao and Panama).
  •    Four other regimes have been
    found to be out of scope or not operational (Malaysia, the Seychelles and the
    two regimes of Thailand), and two further commitments were given to make
    legislative changes to abolish or amend a regime (Malaysia and Trinidad &
    Tobago).
  •    One regime has been found
    potentially harmful but not actually harmful (Montserrat).
  •    Three regimes have been
    found potentially harmful (Thailand).

 

The FHTP has
reviewed 255 regimes to date since the start of the BEPS Project, and the
cumulative picture of the Action 5 regime review process is as follows:

 

The report also
delivers on the Action 5 mandate for considering revisions or additions to the
FHTP framework, including updating the criteria and guidance used in assessing
preferential regimes and the resumption of application of the substantial
activities factor to no, or only nominal, tax jurisdictions. The report
concludes in setting out the next key steps for the FHTP in continuing to
address harmful tax practices.

 

(II) New
Beneficial Ownership Toolkit will help tax administrations tackle tax evasion
more effectively (Source: OECD News Report dated 20th March, 2019)

 

The first ever beneficial
ownership toolkit was released today in the context of the OECD’s
Global Integrity and Anti-Corruption Forum. The toolkit, prepared by the
Secretariat of the OECD’s Global Forum on Transparency and Exchange of
Information for Tax Purposes in partnership with the Inter-American
Development Bank, is intended to help governments implement the Global Forum’s
standards on ensuring that law enforcement officials have access to reliable
information on who the ultimate beneficial owners are behind a company or other
legal entity so that criminals can no longer hide their illicit activities
behind opaque legal structures.

 

The toolkit was
developed to support Global Forum members and in particular developing
countries because the current beneficial ownership standard does not provide a
specific method for implementing it. To assist policy makers in assessing
different implementation options, the toolkit contains policy considerations
that Global Forum members can use in implementing the legal and supervisory
frameworks to identify, collect and maintain the necessary beneficial ownership
information.

 

‘Transparency of
beneficial ownership information is essential to deterring, detecting and
disrupting tax evasion and other financial crimes. The Global Forum’s standard
on beneficial ownership offers jurisdictions flexibility in how they implement
the standard to take account of different legal systems and cultures. However,
that flexibility can pose challenges particularly to developing countries,’
said Pascal Saint-Amans, Head of the OECD’s Centre for Tax Policy and
Administration. ‘This new toolkit is an invaluable new resource to help
them find the best approach.’

 

The toolkit covers
a variety of important issues regarding beneficial ownership, including:

  •    the concepts of beneficial
    owners and ownership, the criteria used to identify them, the importance of the
    matter for transparency in the financial and non-financial sectors;
  •    technical aspects of
    beneficial ownership requirements, distinguishing between legal persons and
    legal arrangements (such as trusts) and measures being taken internationally to
    ensure the availability of information on beneficial ownership, (such as)
    a series of checklists that may be useful in pursuing a specific beneficial
    ownership framework;
  •    ways in which the principles
    on beneficial ownership can play out in practice in Global Forum EOIR peer
    reviews;
  •    why beneficial ownership
    information is also a crucial component of the automatic exchange of
    information regimes being adopted by jurisdictions around the world.

 

With 154 members, a
majority of whom are developing countries, the Global Forum has been heavily
engaged in providing technical assistance on the new beneficial ownership
requirements, often with the support of partner organisations including the
IDB. The Toolkit offers another means to further equip members to comply with
the international tax transparency standards.

 

The Toolkit is the
first practical guide freely available for countries implementing the
international tax transparency standards. It will be frequently updated to
incorporate new lessons learned from the second-round EOIR peer reviews
conducted by the Global Forum, as well as best practices seen and developed by
supporting organisations.

 

(III)
International community agrees on a road-map for resolving the tax challenges
arising from digitalisation of the economy (Source: OECD News Report dated 31st
May, 2019)

 

The international
community has agreed on a road-map for resolving the tax challenges arising
from the digitalisation of the economy, and committed to continue working
towards a consensus-based long-term solution by the end of 2020, the OECD
announced on 31st May, 2019

 

The 129 members of
the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS)
adopted a Programme of Work laying out a process for reaching a new global
agreement for taxing multinational enterprises.

 

The document, which
calls for intensifying international discussions around two main pillars, was
approved during the 28-29 May plenary meeting of the Inclusive Framework, which
brought together 289 delegates from 99 member countries and jurisdictions and
ten observer organisations. It was presented by OECD Secretary-General Angel
Gurría to G20 Finance Ministers for endorsement during their 8-9 June
ministerial meeting in Fukuoka, Japan.

 

Drawing on analysis
from a Policy Note published in January, 2019 and informed by a public
consultation held in March, 2019, the Programme of Work will explore the
technical issues to be resolved through the two main pillars. The first pillar
will explore potential solutions for determining where tax should be paid and
on what basis (‘nexus’), as well as what portion of profits could or should be
taxed in the jurisdictions where clients or users are located (‘profit
allocation’).

 

The second pillar
will explore the design of a system to ensure that multinational enterprises –
in the digital economy and beyond – pay a minimum level of tax. This pillar
would provide countries with a new tool to protect their tax base from profit
shifting to low / no-tax jurisdictions and is intended to address remaining
issues identified by the OECD/G20 BEPS initiative.

 

In 2015, the OECD
estimated revenue losses from BEPS of up to USD 240 billion, equivalent to 10% of
global corporate tax revenues, and created the Inclusive Forum to co-ordinate
international measures to fight BEPS and improve the international tax rules.

 

‘Important progress
has been made through the adoption of this new Programme of Work, but there is
still a tremendous amount of work to do as we seek to reach, by the end of
2020, a unified long-term solution to the tax challenges posed by
digitalisation of the economy,’ Mr Gurría said. ‘Today’s broad agreement on the
technical roadmap must be followed by strong political support towards a
solution that maintains, reinforces and improves the international tax system.
The health of all our economies depends on it.’

 

The Inclusive
Framework agreed that the technical work must be complemented by an impact
assessment of how the proposals will affect government revenue, growth and
investment. While countries have organised a series of working groups to
address the technical issues, they also recognise that political agreement on a
comprehensive and unified solution should be reached as soon as possible,
ideally before the year-end, to ensure adequate time for completion of the work
during 2020.

 

(IV)
Implementation of tax transparency initiative delivering concrete and
impressive results (Source: OECD News Report dated 7th June, 2019)

International
efforts to improve transparency via automatic exchange of information on
financial accounts are improving tax compliance and delivering concrete results
for governments worldwide, according to new data released on 7th
June, 2019 by the OECD.

 

More than 90
jurisdictions participating in a global transparency initiative under the
OECD’s Common Reporting Standard (CRS) since 2018 have now exchanged
information on 47 million offshore accounts, with a total value of around EUR
4.9 trillion. The Automatic Exchange of Information (AEOI) initiative –
activated through 4,500 bilateral relationships – marks the largest exchange of
tax information in history, as well as the culmination of more than two decades
of international efforts to counter tax evasion.

 

‘The international
community has brought about an unprecedented level of transparency in tax
matters which will bring concrete results for government revenues and services
in the years to come,’ according to OECD Secretary-General Angel Gurria,
unveiling the new data prior to a meeting of G20 finance ministers in Fukuoka,
Japan. ‘The transparency initiatives we have designed and implemented through
the G20 have uncovered a deep pool of offshore funds that can now be effectively
taxed by authorities worldwide. Continuing analysis of cross-border financial
activity is already demonstrating the extent that international standards on
automatic exchange of information have strengthened tax compliance and we
expect to see even stronger results moving forward,’ Mr Gurria said.

 

Voluntary
disclosure of offshore accounts, financial assets and income in the run-up to
full implementation of the AEOI initiative resulted in more than EUR 95 billion
in additional revenue (tax, interest and penalties) for OECD and G20 countries
over the 2009-2019 period. This cumulative amount is up by EUR 2 billion since
the last reporting by OECD in November, 2018.

 

Preliminary OECD
analysis drawing on a methodology used in previous studies shows the very substantial
impact AEOI is having on bank deposits in international financial centres
(IFCs). Deposits held by companies or individuals in more than 40 key IFCs
increased substantially over the 2000 to 2008 period, reaching a peak of USD
1.6 trillion by mid-2008.

 

These deposits have
fallen by 34% over the past ten years, representing a decline of USD 551
billion, as countries adhered to tighter transparency standards. A large part
of that decline is due to the onset of the AEOI initiative, which accounts for
about two-thirds of the decrease. Specifically, AEOI has led to a decline of 20
to 25% in the bank deposits in IFCs, according to preliminary data. The
complete study is expected to be published later this year.

 

‘These impressive
results are only the first stock-taking of our collective efforts,’ Mr Gurria
said. ‘Even more tax revenue is expected as countries continue to process the
information received through data-matching and other investigation tools. We
really are moving closer to a world where there is nowhere left to hide.’

 

(V) Money
Laundering and Terrorist Financing Awareness Handbook for Tax Examiners and Tax
Auditors

The OECD in June,
2019 released an update of its 2009 Money Laundering Awareness Handbook for
Tax Examiners and Tax Auditors. This update enhances the 2009 publication
with additional chapters such as ‘Indicators on Charities and Foreign Legal
Entities’ and ‘Indicators on Cryptocurrencies’ relating to money laundering. In
a separate chapter, the increasing threat
of terrorism is addressed by including indicators of terrorist financing.

 

The purpose of the Money
Laundering and Terrorist Financing Awareness Handbook for Tax Examiners and Tax
Auditors is to raise the awareness level of tax examiners and tax auditors
regarding money laundering and terrorist financing. As such, the primary
audience for this Handbook are tax examiners and tax auditors who may come
across indicators of unusual or suspicious transactions or activities in the
normal course of tax reviews or audits and report to an appropriate authority.
While this Handbook is not intended to detail criminal investigation methods,
it does describe the nature and context of money laundering and terrorist
financing activities, so that tax examiners and tax auditors, and by extension
tax administrations, are able to better understand how their contributions can
assist in the fight against serious crimes.

 

While the aim of
this Handbook is to raise the awareness of the tax examiners and tax auditors
about the possible implications of transactions or activities related to money
laundering and terrorist financing, the Handbook is not meant to replace
domestic policies or procedures. Tax examiners and tax auditors will need to
carry out their duties in accordance with the policies and procedures in force
in their country.

 

(VI)  G20 Osaka Leaders’ Declaration

The leaders of the
G20 met in Osaka, Japan on 28-29 June, 2019 to make united efforts to address
major global economic challenges. They stated in their declaration that they
will work together to foster global economic growth while harnessing the power
of technological innovation, in particular digitalisation, and its application
for the benefit of all.

 

In the declaration,
para 16, relating to tax, stated as follows:

 

‘16. We will
continue our co-operation for a globally fair, sustainable, and modern
international tax system, and welcome international co-operation to advance
pro-growth tax policies. We reaffirm the importance of the worldwide
implementation of the G20/OECD Base Erosion and Profit Shifting (BEPS) package
and enhanced tax certainty. We welcome the recent progress on addressing the
tax challenges arising from digitalisation and endorse the ambitious work
programme that consists of a two-pillar approach, developed by the Inclusive
Framework on BEPS. We will redouble our efforts for a consensus-based
solution with a final report by 2020. We welcome the recent achievements on tax
transparency, including the progress on automatic exchange of information for
tax purposes. We also welcome an updated list of jurisdictions that have not
satisfactorily implemented the internationally agreed tax transparency
standards. We look forward to a further update by the OECD of the list that
takes into account all of the strengthened criteria. Defensive measures will be
considered against listed jurisdictions. The 2015 OECD report inventories
available measures in this regard. We call on all jurisdictions to sign and
ratify the Multilateral Convention on Mutual Administrative Assistance in Tax
Matters. We reiterate our support for tax capacity building in developing
countries.’

 

(VII)  OECD expands transfer pricing country
profiles to cover 55 countries

 

The OECD has just
released new transfer pricing country profiles for Chile, Finland and Italy,
bringing the total number of countries covered to 55. In addition, the OECD has
updated the information contained in the country profiles for Colombia and
Israel.

 

These country
profiles reflect the current state of legislation and practice in each country
regarding the application of the arm’s-length principle and other key transfer
pricing aspects. They include information on the arm’s-length principle,
transfer pricing methods, comparability analysis, intangible property,
intra-group services, cost contribution agreements, transfer pricing
documentation, administrative approaches to avoiding and resolving disputes,
safe harbours and other implementation measures as well as to what extent the
specific national rules follow the OECD Transfer Pricing Guidelines.

 

The transfer
pricing country profiles are published to increase transparency in this area
and reflect the revisions to the Transfer Pricing Guidelines resulting from the
2015 Reports on Actions 8-10 Aligning Transfer Pricing Outcomes with Value
Creation and Action 13 Transfer Pricing Documentation and Country-by-Country
Reporting of the OECD/G20 Project on Base Erosion and Profit Shifting
(BEPS), in addition to changes incorporating the revised guidance on safe
harbours approved in 2013 and consistency changes made to the rest of the
OECD Transfer Pricing Guidelines.

 

A.    UN
DEVELOPMENTS

 

(VIII)     Manual
for the Negotiation of Bilateral Tax Treaties between Developed and Developing
Countries, 2019

 

The United Nations Manual for the Negotiation of Bilateral Tax Treaties
between Developed and Developing Countries (2019) is a compact training tool
for beginners with limited experience in tax-treaty negotiations. It seeks to
provide practical guidance to tax-treaty negotiators in developing countries,
in particular those who negotiate based on the United Nations Model Double
Taxation Convention between Developed and Developing Countries. It deals with
all the basic aspects of tax-treaty negotiations and it is focused on the
realities and stages of capacity development of developing countries.

 

The core of the Manual is contained in Section III which
introduces the different Articles of the United Nations Model Double Taxation
Convention between Developed and Developing Countries (United Nations Model
Convention). This section is not intended to replace the Commentaries thereon,
which remain the final authority on issues of interpretation, but rather to
provide a simple tool for familiarising less experienced negotiators with the
provisions of each Article.

 

We sincerely hope that the reader would find the above developments to
be interesting and useful.

 

 

THE FUGITIVE ECONOMIC OFFENDERS ACT, 2018 – AN OVERVIEW – PART 1

In the recent
past, there have been quite a few instances of big time offenders including
economic offenders (For example, Vijay Mallya, Lalit Modi, Nirav Modi, Mehul
Choksi, Deepak Talwar, Sanjay Bhandari, Jatin Mehta, Prateek Jindal etc.),
fleeing the country to escape the clutches of law. The Parliament has therefore
enacted a new law, to deal with such offenders by confiscating the assets of
such persons located in India until they submit to the jurisdiction of the
appropriate legal forum.

 

In this Part 1
of the article, we have attempted to give an overview of some of important
aspects of The Fugitive Economic Offenders Act, 2018 [the FEO Act or the Act].

 

1.  INTRODUCTION


The FEO Bill, 2018
was introduced in the Lok Sabha on 12th March, 2018 but the same
could not be passed both the houses of parliament were prorogued on 6th
April, 2018.  Hence, the FEO Ordinance,
2018 was promulgated on 21st April, 2018 which came into force
immediately. The FEO Bill, 2018 was passed by Parliament on 25th
July, 2018 and received the assent of the President on 31st July,
2018. Section 1(3) of the FEO Act provides that it is deemed to have come in to
force w.e.f. 21st April, 2018 and section 26(1) repeals the FEO
Ordinance, 2018.

 

2. 
NEED AND RATIONALE FOR FEO ACT


2.1  After approval of the proposal of the Ministry
of Finance to introduce the Fugitive Economic Offenders Bill, 2018 in
Parliament, the Press Release dated 1st March, 2018, issued by the
Ministry of Finance, Government of India, explained the background of the FEO
Bill, 2018, as follows:

 

“Background

There have been
several instances of economic offenders fleeing the jurisdiction of Indian
courts, anticipating the commencement, or during the pendency, of criminal
proceedings. The absence of such offenders from Indian courts has several
deleterious consequences – first, it hampers investigation in criminal cases;
second, it wastes precious time of courts of law, third, it undermines the rule
of law in India. Further, most such cases of economic offences involve
non-repayment of bank loans thereby worsening the financial health of the
banking sector in India. The existing civil and criminal provisions in law are
not entirely adequate to deal with the severity of the problem. It is,
therefore, felt necessary to provide an effective, expeditious and
constitutionally permissible deterrent to ensure that such actions are curbed.
It may be mentioned that the non-conviction-based asset confiscation for
corruption-related cases is enabled under provisions of United Nations
Convention against Corruption (ratified by India in 2011). The Bill adopts this
principle. In view of the above context, a Budget announcement was made by
the Government in the Budget 2017-18 that the Government was considering to introduce
legislative changes or even a new law to confiscate the assets of such
absconders till they submit to the jurisdiction of the appropriate legal
forum.”

 

2.2  The Statement of Objects and Reasons of the
FEO Bill, provides as follows:

 

“Statement of objects and reasons


There have been several instances of economic
offenders fleeing the jurisdiction of Indian courts anticipating the
commencement of criminal proceedings or sometimes during the pendency of such
proceedings. The absence of such offenders from Indian courts has several
deleterious consequences, such as, it obstructs investigation in criminal
cases, it wastes precious time of courts and it undermines the rule of law in
India. Further, most of such cases of economic offences involve non-repayment
of bank loans thereby worsening the financial health of the banking sector in
India. The existing civil and criminal provisions in law are inadequate to deal
with the severity of the problem.


2.    In order to address the said problem and
lay down measures to deter economic offenders from evading the process of
Indian law by remaining outside the jurisdiction of Indian courts, it is
proposed to enact a legislation, namely, the Fugitive Economic Offenders Bill,
2018 to ensure that fugitive economic offenders return to India to face the
action in accordance with law.


3.    The said Bill, inter alia, provides for:
(i) the definition of the fugitive economic offender as an individual who has
committed a scheduled offence or offences involving an amount of one hundred
crore rupees or more and has absconded from India or refused to come back to
India to avoid or face criminal prosecution in India; (ii) attachment of the
property of a fugitive economic offender and proceeds of crime; (iii) the
powers of Director relating to survey, search and seizure and search of
persons; (iv) confiscation of the property of a fugitive economic offender and
proceeds of crime; (v) disentitlement of the fugitive economic offender from
putting forward or defending any civil claim; (vi) appointment of an
Administrator for the purposes of the proposed legislation; (vii) appeal to the
High Court against the orders issued by the Special Court; and (viii) placing
the burden of proof for establishing that an individual is a fugitive economic
offender on the Director or the person authorised by the Director.

4.    The Bill seeks to achieve the above
objectives.”

 

2.3  Shri Piyush Goyal, then holding charge as
Finance Minister explained the rationale for the FEOA in the Rajya Sabha debate
on 25th July, 2018, as under:

 

“Sir, there have been many instances of economic
offenders in last several decades, fleeing from the jurisdiction of the Indian
Courts, sometimes in anticipation of commencement of proceedings or sometimes
during the pendency of proceedings. Sir, you are not able to impound of those
leaving the country, except through due process of law. The current laws as
they stand today, have its own limitations in stopping people who flee the
country in anticipation or during the pendency of the proceedings. The absence
of such offenders from the Indian courts has very deleterious consequences. The
existing civil and criminal laws do not allow us to adequately deal with the
severity of the problem, since they are not available or present.

 

Criminal law
does not allow us to push in for punishment, impound their properties and deal
with their properties. Therefore, it was felt necessary to provide an
effective, expeditious and constitutionally permissible deterrent to ensure
that such people do not runaway or, if they runaway, confiscate their
properties. In this context, in the Budget for
2017-18, the hon’ble Finance Minister had announced the intention of the
Government to introduce legislative changes or even a new law to confiscate
assets of such absconders till they submit themselves before the jurisdiction
of the appropriate legal forum. We are not only confiscating their assets but
we are also providing how the confiscated property will be managed and disposed
of, so that dues of Government of India, State Governments and banks, etc., can
be recovered from them.”

 

2.4  The Preamble to the FEO Act
provides as follows:

 

“An Act to
provide for measures to deter fugitive economic offenders from evading the
process of law in India by staying outside the jurisdiction of Indian courts,
to preserve the sanctity of the rule of law in India and for matters connected
therewith or incidental thereto.”

 

2.5  On 30th November, 2018 in the
meeting at Buenos Aires, India suggested following Nine Point Agenda to G-20
for action against Fugitive Economic Offences and Asset Recovery:

 

1.    “Strong and active cooperation across
G-20 countries to deal comprehensively and efficiently with the menace fugitive
economic offenders.

2.    Cooperation in the legal processes such
as effective freezing of the proceeds of crime; early return of the offenders
and efficient repatriation of the proceeds of crime should be enhanced and
streamlined.

3.    Joint effort by G-20 countries to form a
mechanism that denies entry and safe havens to all fugitive economic offenders.

4.    Principles of United Nations Convention
Against Corruption (UNCAC), United Nations Convention Against Transnational
Organized Crime (UNOTC), especially related to “International Cooperation”
should be fully and effectively implemented.

5.    FATF should be called upon to assign
priority and focus to establishing international co-operation that leads to
timely and comprehensive exchange of information between the competent
authorities and FIUs.

6.    FATF should be tasked to formulate a
standard definition of fugitive economic offenders.

7.    FATF should also develop a
set of commonly agreed and standardized procedures related to identification,
extradition and judicial proceedings for dealing with fugitive economic
offenders to provide guidance and assistance to G-20 countries, subject to
their domestic law.

8.    Common platform should be set up for
sharing experiences and best practices including successful cases of
extradition, gaps in existing systems of extradition and legal assistance, etc.

9.    G-20 Forum should consider initiating
work on locating properties of economic offenders who have a tax debt in the
country of their residence for its recovery.”

 

2.6  From the above, it is apparent that the
government is making all possible efforts to compel the FEOs to submit
themselves before the jurisdiction of the appropriate legal forum.

 

3.  OVERVIEW OF THE ACT AND THE RULES


3.1  The FEO Act is divided in three Chapters
containing 26 sections and one Schedule listing the sections and description of
various offences.

 

3.2  Various rules have been made by the Central
Government for various matters for carrying out the provisions of the FEO Act.
The present list of rules is as follows:

 

Sr. No.

Particulars of the Rules

Effective Date

1.

Fugitive Economic Offenders (Manner of Attachment of Property) Rules,
2018

(Issued in suppression of the Fugitive
Economic Offenders (Issuance of Attachment Order) Rules, 2018 dated 24th
April, 2018 and Fugitive Economic Offenders (Issuance of Provisional
Attachment Order) Rules, 2018 dated 24th April, 2018.)

24th August, 2018

2.

Declaration of Fugitive Economic Offenders (Forms and Manner of Filing
Application) Rules, 2018

(Issued in suppression of the Fugitive
Economic Offenders (Application for Declaration of Fugitive Economic
Offenders) Rules, 2018 dated 24th April, 2018.)

24th August, 2018

3.

Fugitive Economic Offenders (Procedure for sending Letter of Request
to Contracting State) Rules, 2018.

(Issued in suppression of the Fugitive
Economic Offenders (Procedure for sending Letter of Request to Contracting
State for Service of Notice and Execution of Order of the Special Court)
Rules, 2018 dated 24th April, 2018.)

24th August, 2018

4.

Fugitive Economic Offenders (Procedure for Conducting Search and
Seizure) Rules, 2018

(Issued in suppression of the Fugitive
Economic Offenders (Forms, Search and Seizure and the Manner of Forwarding
the Reasons and Material to the Special Court) Rules, 2018 dated 24th
April, 2018.)

24th August, 2018

5.

Fugitive Economic Offenders (Manner and Conditions for Receipt and
Management of Confiscated Properties) Rules, 2018.

(Issued in suppression of the Fugitive
Economic Offenders (Receipt and Management of Confiscated Properties) Rules,
2018 dated 24th April, 2018.)

24th August, 2018

 

 

3.3  Some
Salient Features of the FEO Act

a.  
The FEO Act is deemed to have come into force on 21st April
2018 i.e. the date of issuance of the FEO Ordinance, 2018.

b.  
The FEO Act extends to whole of India including Jammu and Kashmir.

c.  
The Act provides for measures to deter fugitive economic offenders from
evading the process of law in India by staying outside the jurisdiction of
Indian courts, to preserve the sanctity of the rule of law in India and for
matters connected therewith or incidental thereto.

d.   
Section 3 of the FEO Act provides that the provisions of the Act apply
to any individual who is, or becomes a Fugitive Economic Offender [FEO] on or
after the date of coming into force of the Act i.e. 21st April,
2018.

e.  
Section 4(3) provides that the authorities appointed for the purposes of
the Prevention of Money-laundering Act, 2002 shall be the Authorities for the
purposes of the Act.

f.  
Section 18 provides that no civil court shall have jurisdiction to
entertain any suit or proceeding in respect of any matter which the Special
Court is empowered by or under the Act to determine and no injunction shall be
granted by any court or other authority in respect of any action taken or to be
taken in pursuance of any power conferred by or under the Act.

 

4.    FUGITIVE ECONOMIC OFFENDER [FEO]


4.1  The term ‘Fugitive Economic Offender’ or FEO
is the main stay of the FEO Act, as the Act provides for action against FEOs
and the significance of the definition of FEO cannot be undermined. Section
2(1)(f) of the Act defines the term FEO, as follows:

“(f) “fugitive
economic offender” means any individual against whom a warrant for arrest in
relation to a Scheduled Offence has been issued by any Court in India, who –

(i)    has left India so as to avoid criminal prosecution;
or

(ii)   being abroad, refuses to return to India to
face criminal prosecution;”

 

Thus, a person is
considered to be a FEO, if he satisfies the following conditions:

a)    He is an individual;

b)    a warrant for arrest in relation to a
Scheduled Offence has been issued by any Court in India against him;

c)    he is a fugitive i.e. he (i) has left India
so as to avoid criminal prosecution; or (ii) being abroad, refuses to return to
India to face criminal prosecution.

 

4.2  Only
an Individual to be declared as FEO

From the definition
in section 2(1)(f) and provisions of section 3 (Application of Act), section
4(1) (Application for declaration of FEO and procedure therefore), section
10(1) (Notice), section 11 (Procedure for hearing application) and section 12(1)
(Declaration of FEO), makes it abundantly clear that only an individual can be
declared as a FEO.

 

Thus, prima
facie, the provisions of the FEO Act should not have application to a
company or Limited Liability Partnership [LLP] or partnership firm or other
association of persons.

 

However, as an
exception, section 14 dealing with ‘Power to disallow civil claims’ provides
that on declaration of an individual as a FEO, any Court or Tribunal in India
in any civil proceeding before it may, disallow any company or LLP (as defined
in section 2(1)(n) of the LLP Act, 2008) from putting forward or defending any
civil claim, if such an individual is (a) filing the claim on behalf of the
company or the LLP, or (b) promoter or key managerial personnel (as defined in
section 2(51) of the Companies Act, 2013) or majority shareholder of the
company or (c) having a controlling interest in the LLP.

 

Section 12(2) of
the FEO Act provides that on declaration of an individual as a FEO, the Special
court may order that any of the following properties stand confiscated to the
Central Government (a) the proceeds of crime in India or abroad, whether or not
such property is owned by the fugitive economic offender; and (b) any other
property or benami property in India or abroad, owned by the fugitive economic
offender. The assets owned by LLPs in which the FEO having controlling interest
or Companies in which the FEO is promoter or key managerial personnel or
majority shareholder, can be confiscated only if it is established that such
LLP or Company is benamidar of the FEO or the property held by the company or
LLP represents proceeds of crime. Further, it appears that the courts can lift
the corporate veil in appropriate cases and rule that the property standing in
the name of the company or LLP is actually the property of the Individual FEO
and the same is liable for confiscation.

 

4.3  Warrant
of Arrest

For an individual
to be declared as a FEO, it is necessary that (a) a warrant of arrest has been
issued against him by a Court in India; (b) such warrant is in relation to a
Scheduled Offence, whether committed before or after the date of coming in to
force of the FEO Act i.e. 21-04-18; (c) it is immaterial whether the warrant
was issued before, on or after 21-04-18 as long as the same is pending on the
date of declaration as FEO; and (d) if the warrant of arrest stands withdrawn
or quashed as of the date of declaration as FEO, then the individual cannot be
declared a FEO.

 

4.4 
Fugitive

The term ‘fugitive’
has not been defined in the FEO Act. Concise Oxford Dictionary defines a
‘fugitive’ as
a person who has escaped from the captivity or is in hiding. To be considered a
FEO the individual should
have (a) has left India so as to avoid criminal prosecution; or (b) being
abroad, refuses to return to India to face criminal prosecution.

 

Section 11(1) of
the Act provides that where any individual to whom notice has been issued under
sub-section (1) of section 10 appears in person at the place and time specified
in the notice, the Special Court may terminate the proceedings under the Act.
Thus, if the alleged FEO returns to India at any time during the course of
proceedings relating to the declaration as a FEO (prior to declaration) and
submits to the appropriate jurisdictional court, the proceedings under the FEO
Act cease by law.

 

4.5  Procedure
to declare an individual as FEO

The FEO Act, inter
alia, provides for the procedure to declare an individual as FEO, which is
as follows:

 

(i)    Application of mind by the Director or other
authorised office to the material in his possession as to whether he has reason
to believe that an individual is a FEO.

(ii)   Documentation of reason for belief in
writing.

(iii)   Provisional attachment (without Special
Court’s permission) by a written order of an individual’s property (a) for
which there is reason to believe that the property is proceeds of crime, or is
a property or benami property owned by an individual who is a FEO; and (b)
which is being or is likely to be dealt within a manner which may result in the
property being unavailable for confiscation. In cases of provisional
attachment, the Director or any other officer who provisionally attaches any
property under this section 5(2) is required to file an application u/s. 4
before the Special Court, within a period of thirty days from the date of such
attachment.

(iv)  Making an application before the special court
for declaration that an individual is a FEO (Section 4);

(v)   Attachment of the property of a FEO and
proceeds of crime (Section 5);

(vi)  Issue of a notice by the special court to the
individual alleged to be a FEO (Section 10);

(vii)  Where any individual to whom notice has been
issued appears in person at the place and time specified in the notice, the
special court may terminate the proceedings under the FEO Act. (Section 11(1))

(viii) Hearing of the application for declaration as
FEO by the Special Court (Section 11);

(ix)  Declaration as FEO by Special Court by a
speaking order (Section 12);

(x)   Confiscation of the property of an individual
declared as a FEO or even the proceeds of crime (Section 12);

(xi)  Supplementary application in the Special Court
seeking confiscation of any other property discovered or identified which
constitutes proceeds of crime or is property or benami property owned by
the individual in India or abroad who is a FEO, liable to be confiscated under
the FEO Act (Section 13)

(xii)  Disentitlement of a FEO from defending any
civil claim (Section 14); and

(xiii) Appointment of an Administrator to manage and
dispose of the confiscated property under the Act
(Section 15).

 

4.6  Manner
of Service of notice

Section 10 dealing
with Notice, provides for two alternative prescribed mode of service of notice
on the alleged FEO: (a) through the contracting state (s/s. (4) and (5); and
(b) e-service.

 

Notice through Contract State

Section 2(1)(c) of
the Act defines Contracting State as follows:

“Contracting
State” means any country or place outside India in respect of which
arrangements have been made by the Central Government with the Government of
such country through a treaty or otherwise;”

 

Section 10(4)
provides that a notice under s/s. (1) shall be forwarded to such authority, as
the Central Government may notify, for effecting service in a contracting
State.

 

Section 10(5)
provides that such authority shall make efforts to serve the notice within a
period of two weeks in such manner as may be prescribed.

 

Service of notice
through the contracting state is possible only when alleged FEO is suspected or
known to be in a contracting state with which India has necessary arrangements
through a treaty or otherwise.

 

E-service of Notice

Section 10(6)
provides that a notice under s/s. (1) may also be served to the
individual alleged to be a FEO by electronic means to:

 

(a)   his electronic mail address submitted in
connection with an application for allotment of Permanent Account Number u/s.
139A of the Income-tax Act, 1961;

(b)   his electronic mail address submitted in
connection with an application for enrolment u/s. 3 of the Aadhaar (Targeted
Delivery of Financial and Other Subsidies, Benefits and Services) Act, 2016; or

(c)   any other electronic account as may be
prescribed, belonging to the individual which is accessed by him over the
internet, subject to the satisfaction of the Special Court that such account
has been recently accessed by the individual and constitutes a reasonable
method for communication of the notice to the individual.

 

4.7  India’s
First Declared FEO

As per the news
report appearing in the New Indian Express dated 19th January, 2019,
Mr. Vijay Mallya is the first businessman to be declared an FEO under the FEO
Act. In absence of the copy of the court’s order being available in public
domain as yet, the key points of the special court’s order, as appearing in the
text of the new report, is given for reference.

 

“Businessman
Vijay Mallya’s claim that the Indian government’s efforts to extradite him were
a result of “political vendetta” was “mere fiction of his
imagination”, a special PMLA court observed in its order.

Mallya, accused
of defaulting on loans of over Rs 9,000 crore, was on January 5 declared a
fugitive economic offender (FEO) by special Judge M S Azmi of the Prevention of
Money Laundering Act (PMLA) court.

 

The judge, in
his order that was made available to media Saturday, said, “Mere statement
that the government of India had pursued a political vendetta against him and
initiated criminal investigations and proceeding against him cannot be ground
for his stay in UK.”

 

Besides these
bare statements, there is nothing to support as to how the government of India
initiated investigation and proceedings to pursue political vendetta, the judge
said in his order.

 

“Hence the
arguments in these regards are mere fiction of his imagination to pose himself
as law-abiding citizen,” he added.

 

The court said
the date of Mallya leaving India was March 2, 2016, and on that day admittedly
there was offence registered by the Central Bureau of Investigation (CBI) and
the Enforcement Directorate (ED).

 

Mallya laid much stress on the fact that he went
to attend a motorsports council meeting in Geneva on March 4, 2016.

 

“Had it
been the case that he went to attend a pre-schedule meeting and is a
law-abiding citizen, he would have immediately informed the authorities about
his schedule to return to India after attending his meeting and
commitment,” Azmi observed.

 

Therefore, in
spite of repeated summons and issuance of warrant of arrest, he had not given
any fix date of return, therefore it would be unsafe to accept his argument
that he departed India only to attend a pre-schedule meeting, he said.

 

The judge stated
that the ED application cannot be read in “piece meal” and must be
read as whole.

 

The satisfaction
or the reasons to believe by ED that Mallya was required to be declared as an
FEO appears to be based upon the foundation that despite repeated efforts, he
failed to join investigation and criminal prosecution.

 

Even the efforts
taken by way of declaring him as a proclaimed offender have not served the
desired purpose, he added.

 

Azmi said the
intention of the FEO Act is to preserve the sanctity of the rule of law and the
expression “reason to believe” has to be read in that context.

 

The reasons
supplied by the ED were the amount involved – Rs 9,990 crore, which is more
than Rs 100 crore which is the requirement of the Act.

 

As pointed out,
the summons issued were deliberately avoided, the passport was revoked,
non-bailable warrants were issued and he was also declared a proclaimed
offender, the judge said.

 

These appear to
be sufficient reasons to declare him an FEO, the judge observed.

 

Mallya is the first businessman to be declared an
FEO under the FEO Act which came into existence in August 2018.

 

The ED, which
had moved the special court for this purpose, requested the court that Mallya,
currently in the United Kingdom, be declared a fugitive and his properties be
confiscated and brought under the control of the Union government as provided
under the act.”

 

The various factors
considered by the court, as mentioned in the news report above, are important
for consideration. The special court has rejected the arguments of (a) that the
Indian government’s efforts to extradite him were a result of “political
vendetta”; (b) that he departed India only to attend a pre-schedule
meeting; (c) satisfaction or the reasons to believe by ED that Mallya was
required to be declared as an FEO appears to be based upon the foundation that
despite repeated efforts, he failed to join investigation and criminal
prosecution; and (d) since the proceedings of his extradition had begun in UK
and with those underway, Mallya cannot be declared a Fugitive.

 

In this connection,
it would be pertinent to mention that the Westminster’s Magistrates’ Court,
London, UK in the case of The Govt of India vs. Vijay Mallya, dated 10th
December, 2018 after detailed examination of various issues raised in
respect of Govt of India’s Extradition Request in its 74 page Judgement
available in public domain, found a prima facie case in relation to three
possible charges and has sent Dr. Vijay Mallya’s case to the Home Secretary of
State for a decision to be taken on whether to order his extradition.

 

4.8  Applications
in Other Cases

In a recent new
report in Hindustan Times, it is mentioned 
that the Enforcement Directorate [ED] has also submitted applications to
have Jewellers Nirav Modi and Mehul Choksi declared fugitives under the FEO Act
after they left India, where they are accused in a Rs. 14,000 scam at Punjab
National bank. These applications are likely to be heard by the same special
court.

 

4.9  Appeals

Section 17 of the Act provides that an appeal shall lie from any
judgment or order, not being an interlocutory order, of a Special Court to the
High Court both on facts and on law.

Every appeal u/s.
17 shall be preferred within a period of 30 days from the date of the judgment
or order appealed from. The High Court may entertain an appeal after the expiry
of the said period of 30 days, if it is satisfied that the appellant had sufficient
cause for not preferring the appeal within the period of 30 days. However, no
appeal shall be entertained after the expiry of period of 90 days. The Bombay
High Court in the case Vijay Vittal Mallya vs. State of Maharashtra
(Criminal Appeal No. 1407 of 2018) vide order dated 22nd
November, 2018, while dismissing the Mallya’s appeal for stay of the
proceedings u/s. 4 of the FEO Act, held that for an appeal to lie against an
order of the special court, the said order would have to determine some right
or issue.

 

5.     CONCLUDING REMARKS


The FEO Act is a
huge step towards creating a deterrent effect for economic offenders and would
certainly help the government bring alleged fraudsters such as Vijay Mallya,
Nirav Modi, Mehul Choksi and such other offenders  to justice.

 

In Part 2 of the
Article we will deal with remaining other important aspects of the FEO Act and
the Rules.

Article 7 of India-Singapore DTAA – No further profit attribution to an Indian agency PE where the commission is paid at arm’s length.

4.      
TS-74-ITAT-2019(Mum) Hempel Singapore
Pte Ltd. vs. DCIT A.Y.: 2014-15 Date of Order: 8th
February, 2019

 

Article 7 of India-Singapore DTAA – No
further profit attribution to an Indian agency PE where the commission is paid
at arm’s length.

 

FACTS


Taxpayer, a foreign company incorporated in
Singapore, was engaged in the business of selling protective coating/paints for
marine industry. Taxpayer had appointed its wholly owned subsidiary in India (I
Co) as a sales agent for rendering sales support services in India. For such
services I Co was remunerated at cost plus mark-up as commission on sales
effected in India. There was no dispute on the ground that I Co constituted
dependent agency PE (DAPE) for the Taxpayer in India under Article 5(4) of
India-Singapore DTAA.

 

Taxpayer contended that the cost plus mark
up to I Co was at arm’s length. Further, since the income attributable to the
DAPE in India was equal to the commission paid to I Co, the resultant income in
India was NIL.

 

AO, however computed an ad hoc amount
of 25 percent of sales in India as the income attributable to the DAPE in
India. Thus, the difference between such income and commission paid to ICo was
held as taxable in India.

 

The DRP affirmed the order of the AO.

 

Aggrieved, Taxpayer appealed before the
Tribunal.

 

HELD

  •    A foreign company is liable
    to be taxed in India on so much of its business profits as is attributable to
    its PE in India.
  •    The commission paid by the
    Taxpayer to I Co was accepted to be at arm’s length in the transfer pricing
    analysis of I Co for the relevant year.
  •    Further, once the commission
    is accepted to be at arm’s length in the hands of the agent, a different view
    cannot be taken in the case of non-resident principal who pays the commission
    to the agent. This principle has been enunciated by Delhi High Court in the
    case of DIT vs. BBC Worldwide Ltd.3
  •    If basis the transfer
    pricing analysis undertaken, the remuneration paid to the Indian agent is held
    to be at an arm’s length, there is no need to attribute further profits to the
    agency PE. The above principle has been confirmed by the Hon’ble Supreme Court
    in the case of Morgan Stanley & Co. Inc4  and the Hon’ble Bombay High Court in the case
    of SET Satellite Singapore Pte Ltd5. For this purpose, it is
    of no relevance if the transfer pricing analysis of the commission paid is done
    in the hands of the agent and not the principal.       

 

 

 

 

3.    ITA Nos. 1341 of
2010 & ors. dated 30.09.2011

4.  292 ITR 416

5.  (2008) 307 ITR 205

 

 

Article 13(4)(c), Article 7 of India-UK DTAA – the development and supply of a technical plan or a technical design does not amount to ‘making available’ technical knowledge, experience, skill, knowhow or process to the service recipient; amount paid for such services does not qualify as FTS.

3.      
TS-76-ITAT-2019 (Mum) Buro Happold
Limited vs. DCIT A.Y.: 2012-13 Date of Order: 15th
February, 2019

 

Article
13(4)(c), Article 7 of India-UK DTAA – the development and supply of a
technical plan or a technical design does not amount to ‘making available’
technical knowledge, experience, skill, knowhow or process to the service
recipient; amount paid for such services does not qualify as FTS.

 

FACTS


Taxpayer, a company incorporated in the UK
was involved in the business of providing engineering design and consultancy
services. Taxpayer also rendered these services to its Indian affiliate, I Co.
During the year under consideration, I Co made payments to the Taxpayer towards
provision of consulting services as well as towards a cost recharge of common
expenses incurred by the Taxpayer on behalf of the group.

 

Taxpayer contended that the consultancy
services did not qualify as “Fee for included services (FIS)” under the treaty
in the absence of satisfaction of the ‘make available’ condition. Further, in
absence of a PE in India, such income is not taxable in India. Taxpayer also
contended that the amount received towards cost recharge is not taxable in India,
since such amount was a part of cost allocation made by the Taxpayer on a
cost-to-cost basis without any profit element. 

 

 

 

1.  Explanation to section 9(2) of the Act
provides that interest, royalty and FTS paid to a non-resident shall be deemed
to accrue or arise in India whether or not non-resident has a place of business
or business connection in India, and whether or not non-resident renders
services in India. The Tribunal appears to have not applied explanation to
section 9(2) on agency commission on the basis that it is business income and
not in the nature of interest, royalty or FTS.

 

 

AO observed that the services rendered by
the Taxpayer included supply of design/drawing. AO held that  as per Article 13(4)of the India–UK DTAA,
payment received for development and transfer of a technical plan or technical
design qualifies as FIS, irrespective of whether it also makes available
technical knowledge, experience, skill, knowhow, etc.  Further, the cost recharge expense which are
related to and are ancillary to the provision of consulting engineering
services held as FIS will bear same character as that of FIS and, hence,
taxable in India.

 

Aggrieved, the Taxpayer appealed before the
CIT(A) who upheld AO’s order. The CIT(A) concluded that provision of a specific
design and drawing requires application of mind by various technicians having
knowledge in the field of architectural, civil, electrical and electronic
engineering, and overseeing its implementation and execution at site in India
by the Taxpayer’s technical personnel, amounts to making available technical
services and hence the amount received would be in the nature of FIS.

 

Aggrieved, Taxpayer appealed before the
Tribunal.

 

HELD

  •    A careful reading of Article
    13 of the India-UK DTAA suggests that the words “development and transfer
    of a technical plan or technical design” is to be read in conjunction with
    “make available technical knowledge, experience, skill, knowhow or
    processes”. As per the rule of ejusdem generis, the words “or
    consists of the development and transfer of a technical plan or technical
    design” will take color from “make available technical knowledge,
    experience, skill, knowhow or processes”.

 

  •    The technical
    designs/drawings/plans supplied by the Taxpayer are project-specific and cannot
    be used by ICo in any other project in the future. Thus, the Taxpayer has not
    made available any technical knowledge, experience, skill, knowhow or processes
    while developing and supplying the technical drawings/designs/plans to I Co.

 

  •    Reliance was placed on the
    Pune Tribunal decision in the case of Gera Developments Pvt. Ltd.2,
    in the context of the FTS Article under the India-US DTAA. In Gera’s case it
    was held that mere passing of project-specific architectural drawings and
    designs with measurements does not amount to making available technical
    knowledge, experience, skill, knowhow or processes. The Tribunal also held that
    unless there is transfer of technical expertise skill or knowledge along with
    drawings and designs and unless the recipient can independently use the
    drawings and designs in any manner whatsoever for commercial purpose, the
    payment received cannot be treated as FTS.

 

2.   
[(2016) 160 ITD 439 (Pune)]

Article 13(4) and (5) of India-UAE DTAA – As Article 13(4) covered only gains from ‘share’, gains from ‘unit’ of mutual fund were subject to Article 13(5) under India-UAE DTAA

8. DCIT vs. K.E. Faizal ITA No.: 423/Coch/2018 A.Y.: 2012-13 Date of order: 8th July, 2019

 

Article 13(4) and (5) of India-UAE DTAA –
As Article 13(4) covered only gains from ‘share’, gains from ‘unit’ of mutual
fund were subject to Article 13(5) under India-UAE DTAA

 

FACTS

The assessee was a
non-resident under the Act. He was located in UAE and qualified for benefit
under the India-UAE DTAA. During the relevant year he sold units of
equity-oriented mutual funds and derived short-term capital gain (STCG). The
assessee claimed that the STCG derived by him was not chargeable to tax in
India in terms of Article 13(5) of the India-UAE DTAA.

 

The AO noted that the underlying instrument of an equity-oriented mutual
fund was nothing but a ‘share’. Accordingly, the AO held that in terms of
Article 13(4) of the India-UAE DTAA, STCG was chargeable to tax in India.

 

The CIT(A) held
that the units were not ‘shares’. Hence, in terms of Article 13(5) of the
India-UAE DTAA, STCG from units was not chargeable to tax in India.

____________________________________________

3.  CIT vs. Tata Autocomp Systems Ltd. [2015] 56
taxmann.com 206/230 taxman 649/374 ITR 516; CIT vs. Great Eastern Shipping Co
Ltd. [2018] 301 CTR 642

 

 

HELD


(a)         Article 13(4) of the
India-UAE DTAA provides that income arising to a resident of the UAE from the
transfer of shares in an Indian company other than those specifically covered
within the ambit of other paragraphs of Article 13, may be taxed in India.
Article 13(5) provides that income arising to such a resident from transfer of
property, other than shares in an Indian company, is liable to tax only in the
UAE.

(b)   Article 13(4) covers within
its purview capital gains arising from transfer of ‘shares’ and not any other
property. Therefore, units of a mutual fund could be covered under Article
13(4) only if they could be considered as shares.

(c)   Since the DTAA does not define
‘share’ in terms of Article 3(2), the definition under the Companies Act, 2013
should be referred. Further, as per SEBI regulations, a mutual fund can be
established only as a ‘trust’. Therefore, the units issued by an Indian mutual
fund could not be considered a ‘share’.

(d)   Under the Securities Contract
(Regulation) Act, 1956 a ‘security’ is defined to include inter alia
shares, scrips, stocks, bonds, debentures, debenture stock or other body
corporate and units or any other such instrument issued to the investors under
any mutual fund scheme.

(e)   From the definition of
‘securities’, it is clear that ‘share’ and ‘unit of a mutual fund’ are two
separate types of securities. Hence, gains arising from transfer of units of a
mutual fund would not be covered within the ambit of Article 13(4).
Consequently, it would be covered under Article 13(5).

(f)    Therefore, the assessee was
not liable to tax in India in respect of STCG arising from the sale of units.  

 

 

ERRATA: In BCAJ September, 2019
issue in the feature TRIBUNAL AND AAR INTERNATIONAL TAX DECISIONS, on page 58
in the 2nd paragraph under ‘HELD – PAYMENT FOR SIMULATOR’, the last
line should read as ‘Hence, the charges paid by the assessee for use of
simulator were not “royalty”. It may be noted that while the catch notes (page
57) correctly mentioned ‘not’, inadvertently the word ‘not’ was omitted in the
gist.

 

 

 

 

Section 92C of the Act, Article 11 of India-Germany DTAA – In respect of loans advanced to AE, arm’s length rate of interest should be determined on the basis of the rate prevalent in the country where loan is given – EURIBOR / LIBOR is not average interest rate at which loans are advanced and hence, they cannot be considered comparable uncontrolled rate of interest

7. [2019] 109 taxmann.com 48 (Trib.) Pune DCIT vs. iGate Global Solutions Ltd. ITA No.: 286 (Bang.) of 2013 A.Y.: 2007-08 Date of order: 5th August, 2019

 

Section 92C of the Act, Article 11 of
India-Germany DTAA – In respect of loans advanced to AE, arm’s length rate of
interest should be determined on the basis of the rate prevalent in the country
where loan is given – EURIBOR / LIBOR is not average interest rate at which
loans are advanced and hence, they cannot be considered comparable uncontrolled
rate of interest

 

FACTS

The assessee, an
Indian company, was a subsidiary of an American company. It acted as a single
source of a broad range of information technology applications, solutions and
services that included client / server position and development. The assessee
advanced loans to its German AE in Euro and to its American AE in USD. The
assessee had charged interest @ 1.50% to its German AE and @ 6% to its American
AE.

 

 

The TPO observed
that the arm’s length interest rate on such loans should be the rate which the
assessee would have earned if it had advanced loan to an unrelated party in
India. Applying the Comparable Uncontrolled Price (CUP) method as the Most
Appropriate Method (MAM), the TPO determined the arm’s length rate interest as
per BBB bonds in India and accordingly recommended transfer pricing adjustment.

 

Aggrieved, the assessee
appealed before the CIT(A). The CIT(A) held that the domestic Prime Lending
Rate would have no application and the interest rate prevalent in the country
in which the loan is received should be considered for determining arm’s length
rate of interest. Since the loan was given
in Germany and in the USA, international rates like LIBOR or EURIBOR should be
considered.

________________________________

2.  Functional and risk analysis was recorded in
the transfer pricing study report. The report was accepted by the Transfer
Pricing Officer both, in case of I Co and in case of the assessee

 

 

HELD

1. There is almost
judicial3  consensus ad
idem at the higher appellate forums that the arm’s length rate of interest
on loans advanced to the AEs should be considered with reference to the country
(in this case, Germany / USA) in which the loan was received and not from where
it was paid. Since India was the lender country, it was not correct to
determine the rate of interest in India as arm’s length rate of interest.

2. EURIBOR was
merely a reference rate calculated on the basis of the average rate at which
Euro Zone banks offer lending in the inter-bank market. Similar was the case
with the LIBOR, Thus EURIBOR / LIBOR could not per se be considered as
comparable uncontrolled rate of interest at which loans were advanced in
Germany.

3. Thus, the
impugned order was set aside and the matter was remanded to the AO for
considering EURIBOR plus 2% as arm’s length rate of interest.

 

Section 9 of the Act, Article 5 of the India-USA DTAA – Though Indian company was controlled by foreign company, since all economic risks were borne by Indian company no fixed place PE was constituted – Since services were rendered outside India and no personnel had visited India, no service PE was constituted – Indian company neither had authority to conclude, nor had it concluded, contracts and since it had also not secured orders for foreign company, no agency PE was constituted

6. [2019] 109 taxmann.com 99 (Trib.) Mum. Gemmological Institute of America, Inc. vs.
ACIT ITA No.: 1138 (Mum.) of 2015 A.Y.: 2010-11 Date of order: 21st June, 2019

 

Section 9 of
the Act, Article 5 of the India-USA DTAA – Though Indian company was controlled
by foreign company, since all economic risks were borne by Indian company no
fixed place PE was constituted – Since services were rendered outside India and
no personnel had visited India, no service PE was constituted – Indian company
neither had authority to conclude, nor had it concluded, contracts and since it
had also not secured orders for foreign company, no agency PE was constituted

 

______________________________________________

1.  (2012) 52 SOT 93 (Mum.)(Trib.) – In Daimler
Chrysler (DC), it was held that: the subsidiary of a company cannot be regarded
as PE; since sales of completely knocked down (CKD) kits were made by DC to the
Indian company on principal-to-principal basis, they became property of the
Indian company and did not constitute the Indian company as sales outlet or
warehouse of DC; as the Indian company had not carried out any operation in
India in respect of sales of CKD kits on behalf of DC, it could not be
considered as PE of DC in India

 

 

FACTS

The assessee was an
American company and a tax resident of USA. It was engaged in the business of
diamond grading and preparation of diamond dossiers. The assessee also owned
100% shares in an Indian company (I Co) which was also engaged in similar
services. Whenever I Co faced capacity and / or technical constraints, it would
send precious stones to the assessee for grading.

 

During the relevant
year, the assessee earned ‘Instructor Fee’ from I Co for rendering diamond
grading services. The AO contended that the assessee and I Co had established a
JV business in which both operated as partners. Consequently, he held that I Co
constituted a PE of the taxpayer in India.

 

The assessee
claimed that the impugned receipts were in the nature of business profits and,
in the absence of any PE in India, the said income was not chargeable to tax in
India in terms of the DTAA.

 

HELD

As regards
fixed place PE

In a joint venture,
each party contributes its share to undertake an economic activity under joint
control. The arrangement between I Co and the taxpayer could not be considered
a joint venture for the following reasons:

(a)   I Co had independent
expertise. It used the services of the assessee only when it faced technical or
capacity constraints. Thus, this was a sub-contracting arrangement;

(b)   I Co entered into agreement with the clients.
All the economic risks in relation to the agreement, viz., credit risk, risk of
loss or damage to articles while in transit, etc., were borne by I Co.

 

Merely because a
company has controlling interest in the other company would not by itself
constitute the other company’s (its) PE in terms of Article 5(6) of the
India-USA DTAA. Accordingly, the assessee did not have a ‘’fixed place’ PE in
India.

 

As regards
service PR

(i)    The assessee rendered services to I Co only
when I Co was facing capacity or technical constraints and requested the
assessee for providing services. The assessee rendered these services outside
India. None of the employees / personnel of the assessee had visited India for rendering
services;

(ii)    Two graders who were earlier employed with
the assessee were employed with I Co and were on the payroll of I Co. They were
working under the control and supervision of I Co.

 

Therefore, no
service PE was constituted in India in terms of the India-USA DTAA.

 

As regards
agency PE

Considering the
functions and the risks assumed2 
by I Co vis-à-vis its business activities in India, I Co was an
independent and separate legal entity incorporated in India. I Co had also
borne all the economic risks. Further, I Co did not have any authority to
conclude contracts and had not concluded any contracts on behalf of the
assessee. It had also not secured any orders for the assessee in India. Thus, I
Co could not be said to have constituted agency PE of the assessee in India.

 

Section 5 of the Act – Article 9 of India-Germany DTAA – Foreign car manufacturing company sold completely built-up cars to Indian company on principal-to-principal basis – Indian company sold such cars to dealers on principal-to-principal basis, each transaction constituted a separate and independent activity, and since Indian company was not acting on behalf of the foreign company, the foreign company could not be said to have PE in India, either u/s 9 of the Act or under article 5 of India-Germany DTAA

5. TS-548-ITAT-2019
(Mum.) Audi AG vs. ADIT ITA No.:
1781/Mum/2014 A.Y.: 2010-11 Date of order: 3rd
September, 2019

Section 5 of the
Act – Article 9 of India-Germany DTAA – Foreign car manufacturing company sold
completely built-up cars to Indian company on principal-to-principal basis –
Indian company sold such cars to dealers on principal-to-principal basis, each
transaction constituted a separate and independent activity, and since Indian
company was not acting on behalf of the foreign company, the foreign company
could not be said to have PE in India, either u/s 9 of the Act or under article
5 of India-Germany DTAA

 

FACTS

The assessee was a
car manufacturer based in Germany (F Co). It was a tax resident of Germany. F
Co was inter alia engaged in the business of selling its cars globally
under its own brand name (F Co Brand).

 

It had appointed an
Indian company (I Co 1), which was its associated enterprise (AE) as its
exclusive distributor for sale of F Co Brand cars in India. During the relevant
year, the assessee had sold completely built-up cars (CBU cars) and accessories
to I Co 1. The assessee also had another AE (I Co 2) in India. The assessee
sold parts and accessories to I Co 2 from which I Co 2 manufactured F Co Brand
cars in India. I Co 2 sold these cars to I Co 1 who, in turn, distributed them
to the dealers / distributors.

 

 

The assessee
offered only fees for technical services for tax under the India-Germany DTAA.
However, on the basis of the following observations, the AO held that the
assessee had a business connection and a PE in India in terms of Article 5(1)
and 5(5) of the India-Germany DTAA.

 

(i)    I Co 1 was an exclusive distributor and its
only business activity and source of income was from the sale of F Co Brand
cars;

(ii)    Activities of the assessee and I Co 1
complemented each other and I Co 1 was functioning as an extended arm of, and
replaced, the assessee in India;

(iii)   The assessee and I Co 1 jointly established
sales targets;

(iv)   Most of the senior officials working with I Co
1 had come from F Co group; and

(v)   The activities of storage, marketing,
soliciting with clients and potential customers, after-sales services and
support services, supply of spare parts and accessories, taking part in Auto
Expo were undertaken in India by I Co 1 on behalf of the assessee.

 

The DRP upheld the
order of the AO. Aggrieved, the assessee appealed before the Tribunal.

 

HELD

(a)   The manufacture of cars was completed by the
assessee outside India. Hence, it constituted a separate and independent
activity;

(b)   The sale of cars was also completed outside
India. Hence, income arising from sales could not be taxed in India;

(c)   The assessee had contended
that the cars were sold to I Co 1 on principal-to-principal basis outside India
and I Co 1 had sold these on principal-to-principal basis to dealers. I Co 1
was not acting on behalf of the assessee and the assessee was not selling cars
through I Co 1. Income from sale of such cars in India was taxed separately in
the hands of I Co 1 in India. The AO did not bring any material to counter
this. Thus, I Co 1 did not constitute a PE of the assessee in India and income
from sale of cars is not taxable in India. The Tribunal relied on the decision
in the case of ACIT vs. Daimler Chrysler AG1 .

 

THE FUGITIVE ECONOMIC OFFENDERS ACT, 2018 – AN OVERVIEW – PART 2

In Part 1 of the
article published in the April, 2019 issue of the Journal, we have covered the
need and rationale for the FEO Act, an overview of the Act and the Rules framed
thereunder, and various aspects relating to a Fugitive Economic Offender.

 

In this
concluding Part 2 of the article, we have attempted to give an overview of some
of the remaining important aspects of The Fugitive Economic Offenders Act, 2018
[the FEO Act or the Act].

 

1.  SCHEDULED OFFENCES


Section
2(1)(m) of the Act defines the Scheduled Offences as follows:

 

(m) “Scheduled Offence” means an offence specified
in the Schedule, if the total value involved in such offence or offences is
one hundred crore rupees or more;”

 

The Schedule
to the Act lists out offences under 15 different enactments and 56 different
sections/sub-sections. The Schedule of the FEO Act is given in the Annexure to
this article for ready reference.

 

The Schedule covers offences under the Indian
Penal Code, 1860; Negotiable Instruments Act, 1881; Reserve Bank of India  Act, 1934; Central Excise Act, 1944; Customs
Act, 1962; Prohibition of Benami Property Transactions Act, 1988; Prevention of
Corruption Act, 1988; Securities and Exchange Board of India Act, 1992;
Prevention of Money-Laundering Act, 2002; Limited Liability Partnership Act,
2008; Foreign Contribution (Regulation) Act, 2010; Companies Act, 2013; Black
Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015;
Insolvency and Bankruptcy Code, 2016; and Central Goods and Services Tax Act,
2017.

 

It is
pertinent to note that the aforesaid list of 15 enactments does not include the
offences under the Income-tax Act, 1961, though it includes offences under the
Black Money Act, PMLA and the Benami Act.

 

In order to
ensure that courts are not overburdened with such cases, only those cases
where the total value involved in such offences is Rs. 100 crore or more
are covered within the purview of the FEO Act.

 

2.  DECLARATION OF AN INDIVIDUAL AS AN FEO


Section 12(1)
of the Act provides that after hearing the application u/s. 4, if the Special
Court is satisfied that an individual is a fugitive economic offender (FEO), it
may, by an order, declare the individual as an FEO for reasons to be recorded
in writing. The order declaring an individual as an FEO has to be a speaking
order.

 

Section 16
deals with rules of evidence. Section 16(3) of the Act provides that the
standard of proof applicable to the determination of facts by the Special Court
under the Act shall be preponderance of probabilities. Preponderance of
probabilities means such proof that satisfies the Special Court that a certain
fact is true rather than the reverse. The proof of beyond reasonable doubt
applicable to criminal law is not applicable in case of the FEO Act.

 

3.  CONSEQUENCES OF AN INDIVIDUAL BEING DECLARED AS AN FEO

3.1  Confiscation
of Property

3.1.1  Section 12(2) of the Act provides that on a
declaration u/s. 12(1) as an FEO, the Special Court may order that any of the
following properties stand confiscated by the Central government:

 

(a)  the proceeds of crime in India or abroad,
whether or not such property is owned by the FEO; and

(b)  any other property or benami property in
India or abroad owned by the FEO.

Article 2(g)
of the UNCAC defines confiscation as follows: “Confiscation”, which includes
forfeiture where applicable, shall mean the permanent deprivation of property
by order of a court or other competent authority. It results in the change of
ownership and property vesting in the government, which is irreversible unless
the individual declared as an FEO succeeds in appeal.

 

Section
2(1)(k) defines proceeds of crime as follows:

 

“proceeds
of crime” means any property derived or obtained, directly or indirectly,
by any person as a result of criminal activity relating to a Scheduled Offence,
or the value of any such property, or where such property is taken or
held outside the country, then the property equivalent in value held within the
country or abroad.

 

The fact that
the benami property of an FEO can be confiscated shows that section 12(2)
emphasises de facto ownership rather than de jure ownership.

 

3.1.2  Section 21 of the FEO Act provides that the
provisions of the Act shall have effect, notwithstanding anything inconsistent
therewith contained in any other law for the time being in force. Section 22
provides that the provisions of the Act shall be in addition to and not in
derogation of any other law for the time being in force.

 

A question
arises for consideration as to whether adjudication under Prohibition of the
Benami Property Transactions Act, 1988 [Benami Act] is necessary for
confiscation of the benami property of the FEO. From the aforesaid provisions,
it appears that if the alleged FEO does not return to India and submit himself
to the Indian legal system, the Special Court can order confiscation of benami
properties of the FEO after adjudicating whether property is benami property
owned by the FEO or not.

 

It is
important to note that adjudication and confiscation of benami property under
the Benami Act will apply when the individual returns to India and submits
himself to the Indian legal process.

 

The
confiscation of benami property under the FEO Act will apply when an individual
evades Indian law and is declared an FEO and consequently confiscation is
ordered by the Special Court.

 

It is
important to note that the adjudication and confiscation under the Benami Act
would cover only benami property in India, whereas under the FEO Act benami
property abroad of the FEO can also be confiscated.

 

3.1.3  Section 12(3) of the Act provides that the
confiscation order of the Special Court shall, to the extent possible, identify
the properties in India or abroad that constitute proceeds of crime which
are to be confiscated and in case such properties cannot be identified,
quantify the value of the proceeds of crime.

 

Section 12(4)
of the Act provides that the confiscation order of the Special Court shall separately
list any other property owned by the FEO in India which is to be
confiscated.

 

3.1.4  As pointed out in para 2.1 of Part 1 of the
article, the non-conviction-based asset confiscation for corruption-related
cases is enabled under provisions of the UNCAC. The FEO Act adopts the said
principle and accordingly it is not necessary that the FEO should be
convicted for any of the scheduled offences for which an arrest warrant was
issued by any court in India.

 

3.1.5  A further question arises as to whether
confiscation can be reversed if the FEO returns to India and submits himself to
the court to face proceedings covered by his arrest warrant. The answer appears
to be “No”, as once an individual is declared an FEO and his assets are
confiscated, his return to India will not reverse the declaration or the
confiscation.

 

3.2  Disentitlement
of the FEO as well as his Companies, LLPs and Firms to defend civil claims

Section 14 of the Act provides that
notwithstanding anything contained in any other law for the time being in
force,

 

(a)  on a declaration of an individual as an FEO,
any court or tribunal in India, in any civil proceeding before it, may disallow
such individual from putting forward or defending any civil claim; and

(b)  any court or tribunal in India in any civil
proceeding before it, may disallow any company or LLP from putting forward or
defending any civil claim, if an individual filing the claim on behalf of the
company or the LLP, or any promoter or key managerial personnel or majority
shareholder of the company or an individual having a controlling interest in
the LLP, has been declared an FEO.

 

3.3 Individual found to be not an FEO

Section 12(9)
of the Act provides that where, on the conclusion of the proceedings, the
Special Court finds that the individual is not an FEO, the Special Court shall
order release of property or records attached or seized under the Act to the
person entitled to receive it.

 

4.  POWERS OF AUTHORITIES

4.1  Power
of Survey

Section 7 of
the FEO Act contains the provisions relating to power of survey. It appears
that power of survey may be exercised at any time before or after filing an
application u/s. 4 for declaration as an FEO.

 

Section 7(1)
provides that —

 

  •     notwithstanding anything
    contained in any other provisions of the FEO Act,
  •     where a director or any
    other officer authorised by the director,
  •     on the basis of material in
    his possession,
  •     has reason to believe (the
    reasons for such belief to be recorded in writing),
  •     that an individual may be
    an FEO,
  •     he may enter any place –

(i)   within the limits of the area assigned to
him; or

(ii)   in respect of which he is authorised for the
purposes of section 7, by such other authority who is assigned the area within
which such place is situated.

 

Section 7(2)
provides that if it is necessary to enter any place as mentioned in s/s. (1),
the director or any other officer authorised by him may request any proprietor,
employee or any other person who may be present at that time, to – (a) afford
him the necessary facility to inspect such records as he may require and which
may be available at such place; (b) afford him the necessary facility to check
or verify the proceeds of crime or any transaction related to proceeds of crime
which may be found therein; and (c) furnish such information as he may require
as to any matter which may be useful for, or relevant to, any proceedings under
the Act.

 

Section 7(3)
provides that the director, or any other officer acting u/s. 7 may (i) place
marks of identification on the records inspected by him and make or cause to be
made extracts or copies therefrom; (ii) make an inventory of any property
checked or verified by him; and (iii) record the statement of any person
present at the property which may be useful for, or relevant to, any proceeding
under the Act.

 

4.2  Power
of Search and Seizure

Section 8 of
the Act and Fugitive Economic Offenders (Procedure for Conducting Search and
Seizure) Rules, 2018 contain the relevant provisions and procedure to be
followed in respect of search and seizure.

 

Section 8(1)
of the Act provides that:

 

Notwithstanding
anything contained in any other law for the time being in force, where the
director or any other officer not below the rank of deputy director authorised
by him for the purposes of this section, on the basis of information in his
possession, has reason to believe (the reason for such belief to be recorded in
writing) that any person –

 

(i)   may be declared as an FEO;

(ii)   is in possession of any proceeds of crime;

(iii)  is in possession of any records which may
relate to proceeds of crime; or

(iv)  is in possession of any property related to
proceeds of crime,

then, subject
to any rules made in this behalf, he may authorise any officer subordinate to
him to —

 

(a)  enter and search any building, place, vessel,
vehicle or aircraft where he has reason to suspect that such records or
proceeds of crime are kept;

(b)  break open the lock of any door, box, locker,
safe, almirah or other receptacle for exercising the powers conferred by
clause (a) where the keys thereof are not available;

(c)  seize any record or property found as a result
of such search;

(d)  place marks of identification on such record
or property, if required, or make or cause to be made extracts or copies
therefrom;

(e)  make a note or an inventory of such record or
property; and

(f)   examine on oath any person who is found to be
in possession or control of any record or property, in respect of all matters
relevant for the purposes of any investigation under the FEO Act.

 

Section 8(2)
of the Act provides that where an authority, upon information obtained during
survey u/s. 7, is satisfied that any evidence shall be or is likely to be
concealed or tampered with, he may, for reasons to be recorded in writing,
enter and search the building or place where such evidence is located and seize
that evidence.

 

4.3  Power
of Search of Persons

Section 9 of
the Act contains provisions relating to power of search of persons and it
provides as follows:

(a)  if an
authority, authorised in this behalf by the Central government by general or
special order, has reason to believe (the reason for such belief to be recorded
in writing) that any person has secreted about his person or anything under his
possession, ownership or control, any record or proceeds of crime which may be
useful for or relevant to any proceedings under the Act, he may search that
person and seize such record or property which may be useful for or relevant to
any proceedings under the Act;

(b)  where an authority is about to search any
person, he shall, if such person so requires, take such person within
twenty-four hours to the nearest Gazetted Officer, superior in rank to him, or
a Magistrate. The period of twenty-four hours shall exclude the time necessary
for the journey undertaken to take such person to the nearest Gazetted Officer,
superior in rank to him, or the Magistrate’s Court;

(c)  if the requisition under clause (b) is
made, the authority shall not detain the person for more than twenty-four hours
prior to taking him before the Gazetted Officer, superior in rank to him, or
the Magistrate referred to in that clause. The period of twenty-four hours
shall exclude the time necessary for the journey from the place of detention to
the office of the Gazetted Officer, superior in rank to him, or the
Magistrate’s Court;

(d)  the Gazetted Officer or the Magistrate before
whom any such person is brought shall, if he sees no reasonable ground for
search, forthwith discharge such person but otherwise shall direct that search
be made;

(e)  before making the search under clause (a)
or clause (d), the authority shall call upon two or more persons to
attend and witness the search and the search shall be made in the presence of such
persons;

(f)   the authority shall prepare a list of records
or property seized in the course of the search and obtain the signatures of the
witnesses on the list;

(g)  no female shall be searched by anyone except a
female; and

(h)  the authority shall record the statement of
the person searched under clause (a) or clause (d) in respect of
the records or proceeds of crime found or seized in the course of the search.

 

5. CONCLUDING REMARKS

In response
to unstarred question No. 3198, the Minister of State in the Ministry of
External Affairs on 14-03-18 answered in the Parliament that as per the list
provided by the Directorate of Enforcement, New Delhi, 12 persons involved in
cases under investigation by the Directorate of Enforcement are reported to
have absconded from India who include Vijay Mallya, Nirav Modi, Mehul Choksi
and others. In addition, as per the list provided by the CBI, New Delhi, 31
businessmen, including the aforementioned Vijay Mallya, Nirav Modi and Mehul
Choksi are absconding abroad in CBI cases.

 

It is hoped
that the stringent provisions of the FEO Act creating a deterrent effect would
certainly help the government in compelling FEOs to come back to India and
submit themselves to the jurisdiction of courts in India.

Annexure

THE SCHEDULE

[See section 2(l) and (m)]

Section

Description of offence

I.

Offences under the Indian Penal Code, 1860 (45 of 1860)

 

120B read with any offence in this Schedule

Punishment of criminal conspiracy.

 

255

Counterfeiting Government stamp.

 

257

Making or selling instrument for counterfeiting Government
stamp.

 

258

Sale of counterfeit Government stamp.

 

259

Having possession of counterfeit Government stamp.

 

260

Using as genuine a Government stamp known to be counterfeit.

 

417

Punishment for cheating.

 

418

Cheating with knowledge that wrongful loss may ensue to
person whose interest offender is bound to protect.

 

420

Cheating and dishonestly inducing delivery of property.

 

421

Dishonest or fraudulent removal or concealment of property to
prevent distribution among creditors.

 

422

Dishonestly or fraudulently preventing debt being available
for creditors.

 

423

Dishonest or fraudulent execution of deed of transfer
containing false statement of consideration.

 

424

Dishonest or fraudulent removal or concealment of property.

 

467

Forgery of valuable security, will, etc.

 

471

Using as genuine a forged [document or electronic record].

 

472

Making or possessing counterfeit seal, etc., with intent to
commit forgery punishable u/s. 467.

 

473

Making or possessing counterfeit seal, etc., with intent to
commit forgery punishable otherwise.

 

475

Counterfeiting device or mark used for authenticating
documents described in section 467, or possessing counterfeit marked
material.

 

476

Counterfeiting device or mark used for authenticating
documents other than those described in section 467, or possessing
counterfeit marked material.

 

481

Using a false property mark.

 

482

Punishment for using a false property mark.

 

483

Counterfeiting a property mark used by another.

 

484

Counterfeiting a mark used by a public servant.

 

485

Making or possession of any instrument for counterfeiting a
property mark.

 

486

Selling goods marked with a counterfeit property mark.

 

487

Making a false mark upon any receptacle containing goods.

 

488

Punishment for making use of any such false mark.

 

489A

Counterfeiting currency notes or bank notes.

 

489B

Using as genuine, forged or counterfeit currency notes or
bank notes.

II.

Offences under the Negotiable Instruments Act, 1881 (26 of
1881)

 

138

Dishonour of cheque for insufficiency, etc., of funds in the
account.

III.

Offences under the Reserve Bank of India Act, 1934 (2 of
1934)

 

58B

Penalties.

IV.

Offences under the Central Excise Act, 1944 (1 of 1944)

 

9

Offences and Penalties.

V.

Offences under the Customs Act, 1962 (52 of 1962)

 

135

Evasion of duty or prohibitions.

VI.

Offences under the Prohibition of Benami Property
Transactions Act, 1988 (45 of 1988)

 

3

Prohibition of benami transactions.

VII.

Offences under the Prevention of Corruption Act, 1988 (49 of
1988)

 

7

Public servant taking gratification other than legal
remuneration in respect of an official act.

 

8

Taking gratification in order, by corrupt or illegal means,
to influence public servant.

 

9

Taking gratification for exercise of personal influence with
public servant.

 

10

Punishment for abetment by public servant of offences defined
in section 8 or section 9 of the Prevention of Corruption Act, 1988.

 

13

Criminal misconduct by a public servant.

VIII.

Offences under the Securities and Exchange Board of India
Act, 1992 (15 of 1992)

 

12A read with section 24

Prohibition of manipulative and deceptive devices, insider
trading and substantial acquisition of securities or control.

 

24

Offences for contravention of the provisions of the Act.

IX.

Offences under the Prevention of Money-Laundering Act, 2002
(15 of 2003)

 

3

Offence of money-laundering.

 

4

Punishment for money-laundering.

X.

Offences under the Limited Liability Partnership Act, 2008 (6
of 2009)

 

Sub-section (2) of section 30

Carrying on business with intent or purpose to defraud
creditors of the Limited Liability Partnership or any other person or for any
other fraudulent purpose.

XI.

Offences under the Foreign Contribution (Regulation) Act,
2010 (42 of 2010)

 

34

Penalty for article or currency or security obtained in
contravention of section 10.

 

35

Punishment for contravention of any provision of the Act.

XII.

Offences under the Companies Act, 2013 (18 of 2013)

 

Sub-section (4) of section 42 of the Companies Act, 2013 read
with section 24 of the Securities and Exchange Board of India Act, 1992 (15
of 1992)

Offer or invitation for subscription of securities on private
placement.

 

74

Repayment of deposits, etc., accepted before commencement of
the Companies Act, 2013.

 

76A

Punishment for contravention of section 73 or section 76 of
the Companies Act, 2013.

 

Second proviso to sub-section (4) of section 206

Carrying on business of a company for a fraudulent or
unlawful purpose.

 

Clause (b) of section 213

Conducting the business of a company with intent to defraud
its creditors, members or any other persons or otherwise for a fraudulent or
unlawful purpose, or in a manner oppressive to any of its members or that the
company was formed for any fraudulent or unlawful purpose.

 

447

Punishment for fraud.

 

452

Punishment for wrongful withholding of property.

XIII.

Offences under the Black Money (Undisclosed Foreign Income
and Assets) and Imposition of Tax Act, 2015 (22 of 2015)

 

51

Punishment for wilful attempt to evade tax.

XIV.

Offences under the Insolvency and Bankruptcy Code, 2016 (31
of 2016)

 

69

Punishment for transactions defrauding creditors.

XV.

Offences under the Central Goods and Services Tax Act, 2017
(12 of 2017)

 

Sub-section (5) of section 132

Punishment for certain offences.  

 

 

RECENT IMPORTANT DEVELOPMENTS – PART I

In this issue we are covering recent major developments in the field of
International Taxation and the work being done at OECD in various other related
fields. It is in continuation of our endeavour to update readers on major
International Tax developments at regular intervals. The items included here
are sourced from press releases of the Ministry of Finance and CBDT
communications.

 

DEVELOPMENTS IN INDIA
RELATING TO INTERNATIONAL TAX

 

(I) CBDT’s proposal for amendment of Rules
for Profit Attribution to Permanent Establishment

 

The CBDT vide its communication dated 18th
April, 2019 released a detailed, 86-page document containing a proposal for
amendment of the Rules for Profit Attribution to Permanent Establishment, for
public comments within 30 days of its publication. The CBDT Committee suggested
a ‘three-factor’ method to attribute profits, with equal weight to (a) sales,
(b) manpower, and (c) assets. The Committee justifies the three-factor approach
as a mix of both demand and supply side that allocates profits between the
jurisdictions where sales takes place and the jurisdictions where supply is
undertaken. The CBDT Committee has recommended far-reaching changes to the
current scheme of attribution of profits to permanent establishments.

 

The report outlines the formula for
calculating “profits attributable to operations in India”, giving weightage to
sales revenue, employees, wages paid and assets deployed.

 

The relevant portion of the ‘Report on
Profit Attribution to Permanent Establishments’ containing the
Committee’s conclusions and recommendations in paragraphs 179 to 200 is given
below for ready reference:

 

“Conclusions and
recommendations of the Committee

179.   After detailed analysis of the issues related to attribution of
profits, existing rules, their legal history, the economic and public policy
principles relevant to it, the international practices, views of academicians
and experts, relevant case laws and the methodology adopted by tax authorities
dealing with these issues, Committee concluded its observations, which are
summarised in following paragraphs.

 

11.1 Summary of Committee’s
observations and conclusions

 

180.   The business profits of a non-resident enterprise is subjected to
the income-tax in India only if it satisfies the threshold condition of having
a business connection in India, in which case, profits that are derived from
India from its various operations including production and sales are taxable in
India, either on the basis of the accounts of its business in India or where
they cannot be accurately derived from its accounts, by application of Rule 10,
which provides a wide discretion to the Assessing Officer. Where a tax treaty
entered by the Central government is applicable, its provisions also need to be
satisfied for such taxation. As per Article 7 of UN model tax convention (which
is usually followed in most Indian tax treaties, sometimes with variations),
only those profits of an enterprise can be subjected to tax in India which are
attributed to its PE in India, and would include profits that the PE would be
expected to make as a separate and independent entity. Under the force of
attraction rules, when applicable, it would include profits from sales of same
goods as those sold by the PE that are derived from India without participation
of PE. Profits attributable to PE can be computed either by a direct accounting
method provided in paragraph 2 or by an indirect apportionment method provided
in paragraph 4 of Article 7.

 

181.   An analysis of Article 7 and its legal history shows that there
are three standard versions. The Article 7 which exists in UN model tax
convention is similar to the Article 7 as it existed in the OECD model
convention prior to 2010, except that the UN model tax convention allows the
application of force of attraction rules and restricts deduction of certain
expenses payable to the head office by the PE. This Article in the OECD model
convention was revised in 2010. Under the revised article the profits
attributable to the PE are required to be determined taking into account the
functions, assets and risk, and the option of determining them by way of
apportionment has been excluded.

 

182.   One of the primary implications of the 2010 revision of Article 7
by OECD was that in cases where business profits could not be readily
determined on the basis of accounts, the same were required to be determined by
taking into account function, assets and risk, completely ignoring the sales
receipts derived from that tax jurisdiction. This amounts to a major deviation,
not only from the rules universally accepted till then, but also from the
generally applicable accounting standards for determining business profits,
where business profits cannot be determined without taking sales into account.

 

183.   Economic analysis of factors that affect and contribute to
business profits makes it apparent that profits are contributed by both demand
and supply of the goods. Accordingly, a jurisdiction that contributes to the
profits of an enterprise either by facilitating the demand for goods or
facilitating their supply would be reasonably justified in taxing such profits.
The dangers of double taxation of such profits can be eliminated by tax
treaties. If taxes collected facilitate economic growth in that jurisdiction,
the demand for goods rises, which in turn also benefits the tax-paying
enterprise, resulting in a virtuous cycle that benefits all stakeholders. On
the contrary, if the jurisdiction is unable to collect tax from the
non-resident suppliers, it would be forced to collect all the taxes required
from the domestic tax-payers, which in turn would reduce the ability of
consumers to pay, reduce their competitiveness, hurt economic growth and the
aggregate demand, resulting in a vicious cycle, which will adversely affect all
stakeholders, including the foreign enterprises doing business therein.

 

184.   Broadly, possible approaches for profit attribution can be summed
in three categories – (i) supply approach allocates profits exclusively to the
jurisdiction where supply chain and activities are located; (ii) demand
approach allocates profits exclusively to the market jurisdiction where sales
take place; (iii) mixed approach allocates profits partly to the jurisdiction
where the consumers are located and partly to the jurisdiction where supply
activities are undertaken.

185.   The mixed approach appears to have been most commonly adopted in
international practices, though in some cases demand approach has also been
favoured. In contrast, supply side does not appear to have been adopted
anywhere, except in the 2010 revision of Article 7 of the OECD model
convention, which requires determination of profits without taking sales into
account. As a consequence, the contribution of demand to profits is completely
ignored.

 

186.   A purview (sic) of academic literature and views suggests a
wide acceptance in theory that demand, as represented by sales, can be a valid
ground for attribution of profits. There also exists a diversity of views among
academicians and experts on the validity of the revised OECD approach for
profit attribution contained in the AOA. A number of international authors
disagree with it and many have been critical of this approach.

 

187.   The AOA approach can have significant adverse consequences for
developing economies like India, which are primarily importers of capital and
technology. It restricts the taxing rights of the jurisdiction that contributes
to business profits by facilitating demand, and thereby has the potential to
break the virtuous cycle of taxation that benefits all stakeholders. Instead,
it can set a vicious cycle in place that can harm all stakeholders.

 

188.   The lack of sufficient justification or rationale and its
potential adverse consequences fully justify India’s strongly-worded position
on revised Article 7 of OECD model convention, wherein India has not only found
it unacceptable for adoption in Indian tax treaties, but also rejected the
approach taken therein. This view of India, that since business profits are
dependent on sale revenues and costs, and since sale revenues depend on both
demand and supply, it is not appropriate to attribute profits exclusively on
the basis of function, assets and risks (FAR) alone, has been communicated and
shared with other countries consistently and on a regular basis.

 

189.   Since, the revised Article 7 of OECD model tax convention has not
been incorporated in any of the Indian tax treaties, the question of AOA being
applicable on Indian treaties or profit attributed therein cannot arise. For
the same reason, additional guidance issued by OECD with reference to AOA in
respect of the changes in Article 5 introduced by the Action 7 of the BEPS
project on Artificial Avoidance of PE Status, also does not have any relevance
to Indian tax treaties. This, however, means that India cannot depend on OECD
guidance and gives rise to a need for India to consider ways and means for
bringing greater clarity and objectivity in profit attribution under its tax
treaties and domestic laws, especially in consequence to the changes introduced
as a result of Action 7.

 

190.   An analysis of case laws indicates that the courts have upheld the
application of Rule 10 for attribution of profits under Indian tax treaties. In
several such cases, the right of India to attribute profits by apportionment,
as permissible under Indian tax treaties, has also been upheld by the courts.
The judicial authorities do not appear to have insisted on a universal and
consistent method. They have also upheld the wide discretion in the hands of
the Assessing Officer under Rule 10 of the Rules, but corrected or modified his
approach for the purpose of ensuring justice in particular cases. Thus, diverse
methods of attributing profits by apportionment under Rule 10 of the Rules are
in existence. In the view of the Committee, the lack of a universal rule can
give rise to tax uncertainty and unpredictability, as well as tax disputes.
Thus, there seems to be a case for providing a uniform rule for apportionment
of profits to bring in greater certainty and predictability among taxpayers and
avoid resultant tax litigation.

 

191.   A detailed analysis of methods adopted by tax authorities for
attributing profits in recent years also highlights similar diversity in the
methods adopted by assessing officers for attribution of profits, which
reaffirms the need to consider possible options that can be consistently
adopted as an objective method of profits attribution under Rule 10 of the
Rules, and bring greater clarity, predictability and objectivity in this
exercise. Any options considered for this purpose must be in accordance with
India’s official position and views and must address its concerns.

 

192.   Accordingly, the Committee considered some
options based on the mixed or balanced approach that allocates profits between
the jurisdiction where sales take place and the jurisdiction where supply is
undertaken. The Committee did not find the option of formulary apportionment
method apportioning consolidated global profits feasible, in view of the
practical constraints in obtaining information related to jurisdictions outside
India. Thus, the Committee considers that it may be preferable to adopt a
method that focuses on Indian operations primarily and derives profits applying
the global profitability, with necessary safeguards to prevent excessive
attribution on the one hand and protect the interests of Indian revenue on the
other.

 

193.   The Committee found the option of Fractional
Apportionment based on apportionment of profits derived from India permissible
under Indian tax treaties as well as Rule 10, and relatively feasible as it is
based largely on information related to Indian operations. Out of various
possible options of apportioning profits by a mixed approach, the Committee
found considerable merit in the three-factor method based on equal weight
accorded to sales (representing demand) and manpower and assets (representing
supply, including marketing activities).

 

194.   After taking into account the principle laid down by the Hon’ble
Supreme Court in the case of DIT vs. Morgan Stanley, and the need to avoid
double taxation of profits from Indian operations in the hands of a PE, which
is primarily brought into existence either by the presence of an Indian
subsidiary carrying on parts of an integrated business, whose profits are
separately taxed in its hands in India, the Committee found it justifiable that
the profits derived from Indian operations that have already been subjected to
tax in India in the hands of a subsidiary should be deducted from the
apportioned profits. The Committee observed that in a case where no sales takes
place in India, and the profits that can be apportioned to the supply
activities are already taxed in the hands of an Indian subsidiary, there may be
no further taxes payable by the enterprise.

 

195.   In this option, in order to ensure objectivity and certainty,
profits derived from India need to be defined objectively. The Committee considers
that the same can be arrived at by multiplying the revenue derived from India
with global operational profit margin [in order to avoid any doubt the global
operational profit margin is the EBITDA margin (earnings before interest,
taxes, depreciation and amortization) of a company]. However, the Committee
also noted the need to protect India’s revenue interests in cases where an
enterprise having global losses or a global profit margin of less than 2%,
continues with the Indian operations, which could be more profitable than its
operations elsewhere. In the view of the Committee, the continuation of Indian
operations justifies the presumption of higher profitability of Indian
operations, and in such cases a deeming provision that deems profits of Indian
operations at 2% of revenue or turnover derived from India should be
introduced.

 

196.   After taking into account the developments in taxation of digital
economy and the new Explanation 2A, inserted by the Finance Act, 2018,
explicitly including significant economic presence within the definition of
business connection, the Committee considered it necessary to take into account
the role and relevance of users in contributing to the business profits of
multi-dimensional business enterprises. Users can be a substitute to either
assets or employees and supplement their role in contributing to profits of the
enterprise.

 

197.   After considering various aspects of users’ contribution, the
Committee came to the conclusion that user data and activities contribute to
the profits of the multi-dimensional enterprises and there is a strong case of
taking them into account, per se, as a factor in apportionment of profits
derived from India by enterprises conducting business through multi-dimensional
business models where users are considered crucial to the business. The
Committee concluded that for such enterprises, users should also be taken into
account for the purpose of attribution of profits, as the fourth factor for
apportionment, in addition to the other three factors of sales, manpower and
assets.

 

198.   Although a recent amendment of the 2016 proposal for CCCTB has
proposed assigning a weight to the users that is equal to the other three
factors of sales, manpower and assets, the Committee found it preferable to assign
a relatively lower weight of 10% to users in low and medium user intensity
models and 20% in high user intensity models at this stage, with the
corresponding reduction in the weightage of employees and assets except for
sales being assigned 30% weight in apportionment in both the fact patterns.
Given the rapid expansion of digital economy and the ongoing developments
related to rules governing its taxation, it may be necessary to monitor the
role of users and their contribution to profits in future and accordingly
assess the need for considering a review of the weight assigned to users in
subsequent years.

 

11.2 Recommendations

 

199.   In view of the above, the Committee makes the following
recommendations:

 

(i)   Rule 10 may be amended to provide that in the case of an assessee
who is not a resident of India, has a business connection in India and derives
sales revenue from India by a business all the operations of which are not
carried out in India, the income from such business that is attributable to the
operations carried out in India and deemed to accrue or arise in India under
clause (i) of sub-section(1) of section 9 of the Act, shall be determined by
apportioning the profits derived from India by three equally weighted factors
of sales, employees (manpower and wages) and assets, as under:

 

Profits attributable to
operations in India =

‘Profits derived from
India’ (“Profits derived from India” = Revenue derived from India x Global
operational profit margin as referred in paragraph 159.) x [SI/3xST + (NI/6xNT)
+(WI/6xWT) + (AI/3xAT)]

 

Where,

SI = sales revenue derived
by Indian operations from sales in India

ST = total sales revenue
derived by Indian operations from sales in India and outside India

NI =number of employees
employed with respect to Indian operations and located in India

NT = total number of
employees employed with respect to Indian operations and located in India and
outside India

WI = wages paid to
employees employed with respect to Indian operations and located in India

WT = total wages paid to
employees employed with respect to Indian operations and located in India and
outside India

AI = assets deployed for
Indian operations and located in India

AT = total assets deployed
for Indian operations and located in India and outside India

 

(ii)  The amended rules should provide that ‘profits derived from Indian
operations’ will be the higher of the following amounts:

a. The amount arrived at by
multiplying the revenue derived from India x Global operational profit margin,
or

b. Two percent of the
revenue derived from India

 

(iii) The amended rules should provide an exception
for enterprises in case of which the business connection is primarily
constituted by the existence of users beyond the prescribed threshold, or in
case of which users in excess of such prescribed threshold exist in India. In
such cases, the income from such business that is attributable to the
operations carried out in India and deemed to accrue or arise in India under
clause (i) of sub-section (1) of section 9 of the Act, shall be determined by
apportioning the profits derived from India on the basis of four factors of
sales, employees (manpower and wages), assets and users. The users should be
assigned a weight of 10% in cases of low and medium user intensity, while each
of the other three factors should be assigned a weight of 30%, as under:

 

Profits attributable to
operations in India in cases of low and medium user intensity business models =

‘Profits derived from
India’ x [0.3 x SI/ST + (0.15 x NI/NT) + (0.15 x WI/WT) + (0.3 x AI/3xAT)] +
0.1]

In case of digital models
with high user intensity, the users should be assigned a weight of 20%, while
the share of assets and employees be reduced to 25% each after keeping the
weight of sales as 30% as under:

 

Profits attributable to
operations in India in cases of high user intensity business models =

‘Profits derived from
India’ x [0.3 x SI/ST + (0.125 x NI/NT) + (0.125 x WI/WT) + (0.25 AI/3xAT)] +
0.2]

 

(iv) The amended rules should also provide that where the business
connection of the enterprise in India is constituted by the activities of an
associate enterprise that is resident in India and the enterprise does not
receive any payments on accounts of sales or services from any person who is
resident in India (or such payments do not exceed an amount of Rs. 10,00,000)
and the activities of that associated enterprise have been fully remunerated by
the enterprise by an arm’s length price, no further profits will be
attributable to the operation of that enterprise in India.

 

(v) However, where the
business connection of the enterprise in India is constituted by the activities
of an associate enterprise that is resident in India and the payments received
by that enterprise on account of sales or services from persons resident in
India exceeds the amount of Rs. 10,00,000 then profits attributable to the
operation of that enterprise in India will be derived by apportionment using
the three factors or four factors as may be applicable in his case and
deducting from the same the profits that have already been subjected to tax in
the hands of the associated enterprise. For this purpose, the employees and
assets of the associated enterprise will be deemed to be employed or deployed
in the Indian operations and located in India.

 

200.   The Committee recommends the amendment of Rule
10 accordingly. The Committee also recommended that an alternative can be
amendment of the IT Act itself to incorporate a provision for profit
attribution to a PE.”


The Bombay Chartered Accountants’ Society has also given its comments and
suggestions in this regard. The final rules based on the public comments
received are awaited.

 

(II)    Finance Minister N. Sitharaman bats for
‘SEP’-based solution to vexed digitalisation issue at G-20 meet (Source:
Press Release of Ministry of Finance dated 9th June, 2019)

The Union Minister for Finance and Corporate
Affairs, Mrs. Nirmala Sitharaman, attended the G-20 Finance Ministers’ and
Central Bank Governors’ meeting and associated events and programmes on 8th
and 9th June, 2019 at Fukuoka, Japan. She was accompanied by Mr. Subhash C. Garg, Finance Secretary and Secretary,
Economic Affairs, Dr. Viral Acharya, Deputy Governor of the RBI, and other
officers.

 

Mrs. Sitharaman flagged serious issues
related to taxation and digital economy companies and to curb tax avoidance and
evasion. She highlighted the issue of economic offenders fleeing legal
jurisdictions and called for cohesive action against them.

 

The Finance Minister noted the urgency to fix
the issue of determining the right nexus and profit allocation solution for
taxing the profits made by digital economy companies. Appreciating the
significant progress made under the taxation agenda, including the Base Erosion
and Profit Shifting (BEPS), tax challenges from digital economy and exchange of
information under the aegis of G-20, she congratulated the Japanese Presidency
for successfully carrying these tasks forward.

 

She noted that the work on tax challenges
arising from the digitalisation of economy is entering a critical phase with an
update to the G-20 due next year. In this respect, Mrs. Sitharaman strongly
supported the potential solution based on the concept of ‘significant economic
presence’ of businesses taking into account the evidence of their purposeful
and sustained interaction with the economy of a country. This concept has
been piloted by India and supported by a large number of countries, including
the G-24. She expressed confidence that a consensus-based global solution,
which should also be equitable and simple, would be reached by 2020.

 

Welcoming the commencement of automatic
exchange of financial account information (AEOI) on a global basis with almost
90 jurisdictions successfully exchanging information in 2018, the Finance
Minister said this would ensure that tax evaders could no longer hide their
offshore financial accounts from the tax administration. She urged the G-20 /
Global Forum to further expand the network of automatic exchanges by
identifying jurisdictions, including developing countries and financial centres
that are relevant but have not yet committed to any timeline. Appropriate
action needs to be taken against non-compliant jurisdictions. In this respect,
she called upon the international community to agree on a toolkit of defensive
measures which can be taken against such non-compliant jurisdictions.

 

Earlier, she participated in the Ministerial
Symposium on International Taxation and spoke in the session on the ongoing
global efforts to counter tax avoidance and evasion. During the session, she
also dwelt on the tax challenges for addressing digitalisation of the economy
and emphasised that nexus was important. Mrs. Sitharaman also raised the need
for international co-operation on dealing with fugitive economic offenders who
flee their countries to escape from the consequences of law. She also
highlighted the fugitive economic offenders’ law passed by India which provides
for denial of access to courts until the fugitive returns to the country. This
law also provides for confiscation of their properties and selling them off.

 

She drew attention to the practice permitted
by many jurisdictions which allow economic offenders to use investment-based
schemes to obtain residence or citizenship to escape from legal consequences
and underlined the need to deal with such practices. She urged that closer
collaboration and coordinated action were required to bring such economic
offenders to face the law.

 

India’s Finance Minister highlighted the need
for the G-20 to keep a close watch on global current account imbalances to
ensure that they do not result in excessive global volatility and tensions. The
global imbalances had a detrimental effect on the growth of emerging markets.
Unilateral actions taken by some advanced economies adversely affect the
exports and the inward flow of investments in these economies. She wondered if
the accumulation of cash reserves by large companies indicated the reluctance
of these companies to increase investments. This reluctance could have adverse
implications on growth and investments and possibly leading to concentration of
market power. She also urged the G-20 to remain cognizant of fluctuations in
the international oil market and study measures that can bring benefits to both
the oil-exporting and importing countries.

In a session on infrastructure investment,
Mrs. Sitharaman emphasised on the importance of making investments in
cost-effective and disaster resilient infrastructure for growth and
development. She suggested the G-20 focus on identifying constraints to flow of
resources into the infrastructure sector in the developing world and solutions
for overcoming them. She also took note of the close collaboration of India,
Japan and other like-minded countries, aligned with the Sendai Framework, in
developing a roadmap to create a global Coalition on Disaster Resilient
Infrastructure.

 

The Japanese Presidency’s priority issue of
ageing was also discussed. Mrs. Sitharaman highlighted that closer
collaboration between countries with a high old-age dependency ratio and those
with a low old-age dependency ratio was necessary for dealing with the policy
challenges posed by ageing. She suggested that if ageing countries with
shrinking labour force allow calibrated mobility of labour with portable social
security benefits, the recipient countries can not only take care of the aged
but also have a positive effect on global growth. She said that India’s
demography presented a dual policy challenge since India’s old-age dependency
ratio is less than that of Japan, while at the same time India’s aged
population in absolute numbers exceeds that of Japan. She detailed the policy
measures that the Government of India is taking to address these challenges.

 

While speaking on the priority of Japanese
Presidency on financing of universal health coverage (UHC), she emphasised the
importance of a holistic approach which encompasses the plurality of pathways
to achieve UHC, including through traditional and complementary systems of
medicine.

 

(III) Ratification of the
Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent
Base Erosion and Profit Sharing (Source: Press Release of the Ministry of
Finance dated 12th June, 2019)

 

Text of the Press Release
of the Ministry of Finance dated 12th June, 2019:

 

“Ratification of the
Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent
Base Erosion and Profit Shifting.

 

The Union Cabinet, chaired
by the Prime Minister, Mr. Narendra Modi, has approved the ratification of
the Multilateral Convention to Implement Tax Treaty-Related Measures to
Prevent Base Erosion and Profit Shifting (MLI).

 

IMPACT

The Convention will modify India’s treaties
in order to curb revenue loss through treaty abuse and base erosion and profit
shifting strategies by ensuring that profits are taxed where substantive
economic activities generating the profits are carried out and where value is
created.

 

DETAILS

i. India has ratified the
Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent
Base Erosion and Profit Shifting, which was signed by the Hon’ble Finance
Minister, Mr. Arun Jaitley, at Paris on 7th June, 2017 on behalf of
India;

ii.   The Multilateral Convention is an outcome of the OECD / G-20
Project to tackle Base Erosion and Profit Shifting (the “BEPS
Project”) i.e., tax planning strategies that exploit gaps and mismatches
in tax rules to artificially shift profits to low or no-tax locations where
there is little or no economic activity, resulting in little or no tax being
paid. The BEPS Project identified 15 actions to address base erosion and profit
shifting (BEPS) in a comprehensive manner;

iii.  India was part of the ad hoc group of more than 100 countries
and jurisdictions from G-20, OECD, BEPS associates and other interested
countries which worked on an equal footing on the finalisation of the text of
the Multilateral Convention, starting May, 2015. The text of the Convention and
the accompanying Explanatory Statement was adopted by the ad hoc Group on 24th
November, 2016;

iv.  The Convention enables all
signatories, inter alia, to meet treaty-related minimum
standards that were agreed as part of the final BEPS package, including the
minimum standard for the prevention of treaty abuse under Action 6;

v. The Convention will
operate to modify tax treaties between two or more parties to the Convention. It
will not function in the same way as an amending protocol to a single existing
treaty, which would directly amend the text of the Covered Tax Agreement. Instead,
it will be applied alongside existing tax treaties, modifying their application
in order to implement the BEPS measures;

vi.  The Convention will modify India’s treaties in order to curb
revenue loss through treaty abuse and base erosion and profit shifting
strategies by ensuring that profits are taxed where substantive economic
activities generating the profits are carried out and where value is created.

BACKGROUND

The Convention is one of
the outcomes of the OECD / G-20 project, of which India is a member, to tackle
base erosion and profit shifting. The Convention enables countries to implement
the tax treaty-related changes to achieve anti-abuse BEPS outcomes through the
multilateral route without the need to bilaterally re-negotiate each such
agreement which is burdensome and time-consuming. It ensures consistency and
certainty in the implementation of the BEPS Project in a multilateral context.
Ratification of the multilateral Convention will enable application of BEPS
outcomes through modification of existing tax treaties of India in a swift
manner.

 

The Cabinet Note seeking
ratification of the MLI was sent to the Cabinet on 16th April, 2019
for consideration. Since the said Note for Cabinet could not be taken up in the
Cabinet due to urgency, the Hon’ble Prime Minister, vide Cabinet Secretariat
I.D. No. 216/1/2/2019-Cab dated 27.05.2019 has approved ratification of MLI and
India’s final position under Rule 12 of the Government of India (Transaction of
Business) Rules, 1961 with a direction that ex-post facto approval
of the Cabinet be obtained within a month. Consequent to approval under Rule
12, a separate request has already been sent to the L&T Division, MEA, for
obtaining the instrument of ratification from the Hon’ble President of India
vide this office OM F.No. 500/71/2015-FTD-I/150 dated 31/05/2019.”

 

In Part II of the Article, we will cover
various developments at the OECD relating to International Taxation. We sincerely
hope that the reader would find the above developments to be interesting and
useful. 

 


 

Article 7(3) of India-Mauritius DTAA – in absence of DTAA providing any restrictions on deduction of expenses, domestic law restrictions on deductibility cannot be imported into DTAA

9. DDIT vs. Unocol Bharat Ltd

ITA Nos.: 1388/Del/2012

Date of Order: 5th October, 2018

A.Y.: 1998-99

 

Article 7(3) of India-Mauritius DTAA – in absence of DTAA
providing any restrictions on deduction of expenses,  domestic law restrictions on deductibility
cannot be imported into DTAA

 

Facts

The Taxpayer was a company
incorporated in Mauritius. It was engaged in business of development and
promotion in the energy sector in India for its parent company. The Taxpayer
was pursuing certain projects in India. It had constituted a PE in India.
Accordingly, it was offering its income on net basis. During the relevant year,
the Taxpayer had incurred certain expenses relating to operating contract,
employee salaries and travel and entertainment but did not earn any income.
Thus, Taxpayer incurred losses in the relevant year. 

 

According to the AO, the Taxpayer
had not produced appropriate documentary evidences in respect of the said
expenses. Further, it had also not withheld any tax from such payments.
Accordingly, the AO, relying on Supreme Court decision in Transmission Corporation
vs. CIT, 239 ITR 587 (SC), concluded that the expenditure was not allowable
and further invoked the provisions of section 40 (a)(i) to disallow the
expenditure.

 

Before CIT(A), the Taxpayer
contended that having regard to the short stay exemption under Article 15 of
India-USA DTAA, employee salaries were not taxable in India. The Taxpayer also
furnished information relating to expenses incurred. Further, compared to DTAAs
with other countries, Article 7(3) of India-Mauritius DTAA is worded differently.
In other DTAAs not only there is restriction on deduction of expenses but
deduction is also subject to the limitation of domestic tax law. In support of
its contention, the Taxpayer relied on the decision in JCIT vs. State Bank
of Mauritius Limited 2009 TIOL 712. The Taxpayer also contended that it had
furnished sufficient details to the AO to support its claim. Thereafter, to
disallow the expenses, the onus was on the AO to point out errors/omission. The
CIT(A) held in favour of the Taxpayer.


Held

The contention of the AO that the
Taxpayer has not furnished details of expenditure is untenable. Further, the
amount paid to employees was eligible for short stay exemption under the DTAA.
Further, relying on Mumbai Tribunal decision in JCIT vs. State Bank of
Mauritius Limited 2009 TIOL 712, the Tribunal held that:

 

  •    Article 7(3) of
    India-Mauritius DTAA provides for determining profits of a PE after deduction
    of expenses (including executive and general administrative expenses) incurred
    for the business of the PE. Accordingly, all expenses, which were incurred for
    the purpose of the business of the PE were to be allowed.
  •    The language in Article
    7(3) of India-Mauritius DTAA is different from that in other treaties.
    Illustratively, Article 7(3) of India-US DTAA provides deduction subject to the
    limitation of domestic tax laws. After the Protocol, India-UAE DTAA also
    incorporates similar restriction.
  •    In absence of such
    restriction in DTAA, any limitation under the Act cannot be imported into DTAA.
    Accordingly, if the expenditure was incurred for the purpose of the business of
    PE, it had to be allowed fully without any restriction that may have been
    provided under the Act.      

Sections 9, 195 of the Act – Fees paid to surveyors for assessing damage was not taxable in India since the surveyors had undertaken work outside India and had merely provided their report without imparting any knowledge to the Taxpayer

8. [2018] 97 taxmann.com 644 (Chennai – Trib.)

Royal Sundaram Alliance Insurance Co. Ltd. vs. DCIT

ITA Nos.: 1622 to 1630 (Chny) of 2011

Date of Order: 6th August, 2018

A.Ys.: 2002-03 TO 2010-11

 

Sections 9, 195 of the Act – Fees paid to surveyors for assessing
damage was not taxable in India since the surveyors had undertaken work outside
India and had merely provided their report without imparting any knowledge to
the Taxpayer 

 

Facts

The Taxpayer was engaged in the
business of general insurance in India. The Taxpayer had engaged surveyors to
assess loss or damage to goods insured by it in transit to foreign country.
During the relevant year, the Taxpayer paid fees to the surveyors for such
assessment. The surveyors had assessed the damages outside India using their
experience and knowledge and furnished their report to the Taxpayer. The
Taxpayer contended that such income is not taxable in India and hence, it did
not withhold tax from the fees paid to surveyors.

 

In the course of assessment, the AO
disallowed the payment.

 

Held

  •    The surveyors were
    non-residents. They had undertaken the assessment of damage outside India using
    their experience and knowledge.
  •    The surveyors had not
    imparted their knowledge to the Taxpayer and had merely provided a report of
    the extent of damage to the Taxpayer so as to enable it to compensate its
    customers.
  •    Accordingly, the payment
    made by the Taxpayer to the surveyors was not chargeable to tax in India.
    Consequently, the Taxpayer was not required to withhold tax from such payment.

Article 7(3), India-Japan DTAA – Having regard to Article 7(3), read with Protocol thereto, of India-Japan DTAA, interest paid by Indian branch of a foreign bank to HO was allowable as a deductible expenditure

7.  DCIT vs. Mizuho
Corporate Bank Ltd.

ITA No.: 4711/Mum/2016 & 4710/Mum/2016

Date of Order: 13th August, 2018

A.Ys. 2007-08 & 2008-09

 

Article 7(3), India-Japan DTAA – Having regard to Article 7(3),
read with Protocol thereto, of India-Japan DTAA, interest paid by Indian branch
of a foreign bank to HO was allowable as a deductible expenditure

 

Facts       

The Taxpayer
was a bank incorporated in Japan. It was carrying on banking operations in
India through its branches at Mumbai and Delhi. It had furnished its return of
income for the relevant year. Subsequently, it furnished a revised return and
reduced the income. During the relevant year, the branch had paid interest to
Head Office (HO) on the funds that the HO had advanced to the branches in the
normal course of banking business. The branch had also withheld tax from the
interest payment. The Taxpayer had claimed the interest paid as a deduction by
relying on the protocol to Article 7(3) of India-Japan DTAA. In terms of the
said Protocol, interest on moneys lent by a banking institution to its PE is
allowable as a deduction.

 

In the course of assessment proceedings,
the AO observed that the branch in India constituted PE of the Taxpayer in
India and concluded as follows.

 

  •    The AO noted the interest
    paid by branch to HO. According to the AO, the branch and HO were not separate
    entities for the tax purpose. Hence, payment made by branch to HO was payment
    to self. Therefore, AO disallowed the deduction of interest paid to the HO. In
    this respect, the AO relied on the decision in ABN Amro Bank NV vs. ADIT
    [2005] 97 ITD 89 (SB).
  •    The AO further concluded
    that the source of the interest earned by HO was the branch in India. Hence, in
    terms of section 9(1)(v)(c) of the Act, the interest was deemed to have accrued
    or arisen in India. Therefore, it was taxable in India as per the Act.
  •    Further, as the payer of the
    income to a non-resident, the AO treated the branch as a representative
    assessee/agent of the Taxpayer in terms of section 163(1)(c) of the Act.
  •    Finally, the AO concluded
    that the interest received by HO was taxable in India @10% in terms of Article
    11(2)(a) of India-Japan DTAA on gross basis.

 

In appeal, CIT(A) ruled in favour
of the Taxpayer. Hence, the tax authority preferred an appeal before the
Tribunal.

 

Held2

  •    The Special bench decision in ABN Amro Bank
    case was reversed by Kolkata High Court in ABN Amro Bank NV vs. CIT [2012]
    343 ITR 81 (Cal)    . Further, in Sumitomo Mitsui Banking Corporation vs.
    DDIT [2012] 136 ITD 66 (SB) (Mum)    , Special Bench of Mumbai Tribunal had
    deviated from the view of Kolkata Tribunal. The tax authority has not brought
    on record any decision to the contrary.
  •    In case of the Taxpayer in
    earlier year, relying on the decision in Sumitomo Mitsui banking corporation
    case    , the Tribunal had held that the interest paid by Indian branch of the
    Taxpayer to HO was not chargeable to tax in India.
  •    While reversing the
    Tribunal decision in ABN Amro bank case, the High Court had observed that
    though a branch and HO are same person under general law, Articles 5 and 7 of
    India-Netherlands DTAA provided for assessment of PE as a separate entity.
    Hence, the High Court allowed interest paid by the branch to HO as a deduction
    from income of PE.
  •    Since Article 7(3) of
    India-Japan DTAA, read with Protocol thereto, provides for deduction of interest
    on moneys lent by HO of a banking institution to its branch in India, interest
    paid by branch to HO was allowable as a deduction.

 

_______________________________________________

2   The
Tribunal had issued notice of hearing to the Taxpayer. The Taxpayer neither
sought adjournment nor did it represent before the Tribunal. Accordingly,
Tribunal delivered its decision ex parte.

Decoding The Consequences of POEM in India

The Finance Act, 2016 substituted section
6(3) of the Income-tax Act, 1961 (the Act), w.e.f. 1st April 2017.
The “Place of Effective Management” (POEM) was introduced as one of the tests
for determination of the residential status of a company. Various stakeholders
raised concerns that a foreign company which is treated as a “POEM resident” in
India may not be able to comply with the provisions of the Act applicable to a
resident as the determination of POEM transpires during the assessment
proceedings that are usually years after the relevant tax year for which the
foreign company is treated as “POEM resident” in India. To mitigate such
concerns, the Finance Act, 2016 introduced section 115JH which gave the Central
Government power to notify exceptions, modifications and adaptations.
Therefore, laws and regulations applicable to an Indian company for computing the
tax liability would apply to a foreign company, which is a “POEM resident” in
India subject to such exceptions, modifications and adaptations notified by the
Central Government. On 15th June 2017, the CBDT issued a draft
notification for implementing the provisions of the section 115JH of the Act.
The Central Government has now published the final notification u/s. 115JH of
the Act on 22nd June 2018, specifying the consequences in respect of
a foreign company treated as “POEM resident” in India for the first time. This
write-up dissects and decodes the transitory consequences for a foreign
company.

 

1. 
Backdrop:

Prior to the
introduction of Place of Effective Management (POEM), a company was considered
as a resident of India only if its control and management were “wholly
situated in India”. An absolute threshold meant that companies could avoid
being classified as a resident by merely holding one key board meeting outside
India.

 

Therefore, to
protect India’s tax base and to align provisions of the Income-tax Act, 1961
(‘the Act’) with the Double Taxation Avoidance Agreements (DTAAs) entered into
by India with other countries1, India introduced the concept of POEM2
vide amendment3 to section 6(3)(ii) of the Act:

 

“Section
6(3): For the purpose of the Act, a company is said to be a resident
in India in any previous year, if—

 

(i)  it is an Indian company; or

 

(ii)  its place of effective management, in that
year, is in India.

 

Explanation.—For
the purposes of this clause “place of effective management” means a
place where key management and commercial decisions that are necessary for the
conduct of business of an entity as a whole are, in substance made.”

 

However, the use of
POEM as a test for residency was made applicable from assessment year 2017-18 onwards4.

 

As noted in the
Explanation to section 6(3), POEM is defined as the place where the “key
management and commercial decisions that are necessary for the conduct of
business of an entity as a whole are, in substance made.”

Therefore, the
definition of POEM has four limbs:-

___________________________________________________________

1   However, as per the 2017 update to the
OECD Model Tax Convention, the OECD has moved away from “POEM” to a
case-by-case resolution using Mutual Agreement Procedure (MAP) for determining
conflicts of dual residency.

2   According to the Explanatory Notes to the
provisions of the Finance Act, 2015. Circular No.- 19 /2015 dated 27th
November 2015. F. No. 142/14/2015-TPL.

3.  Refer section 4 of Finance Act 2015.

4.    Refer section 4 of
Finance Act 2016.

 

i.    Key Managerial and Commercial decisions

ii.    Necessary for the Conduct of Business

iii.   Of an entity as a whole

iv.   In substance made.

 

Since the
introduction of POEM in India, the CBDT has issued three circulars providing guidelines
with respect to POEM. The three circulars can be broadly classified as follows:

 

Circular No.

Date of Circular

Description

6

24th January 2017

Guidelines on determination of POEM.

8

23rd February 2017

Clarification on the turnover threshold for
applicability of POEM.

25

23rd October 2017

Clarification on applicability of POEM
for regional headquarters and applicability of General Anti-Avoidance Rule
(GAAR) for abuse of this Circular.

 

 

The first circular
(i.e. Circular No. 6) issued by the CBDT introduced following:

 

i.   An objective test –To determine whether a
foreign company has active operations outside India (formally known as “active
business outside India” test)5

 

ii.  Subjective Guidelines – To provide important
factors that may be considered while determining POEM.

 

A company is
considered to have an “active business outside India” when (a) its passive
income (An aggregate of sale and purchase transactions between related parties,
dividend, interest, royalty and capital gains) is less than 50 per cent of its
total income, and (b) the number of employees in India, value of assets in
India and payroll expenses relating to Indian employees is less than 50 per
cent of the company’s total employees, assets and payroll expenses,
respectively. The determination of these factors is based on an average of the
data pertaining to the relevant financial year and two previous years.

______________________________________________________

5   The “active business outside India” test and
‘passive income’ clause are akin to provisions or objectives of a Controlled
Foreign Corporation (CFC) Rule. It is pertinent to note that no country in the
world has such conditions for determination of POEM that tries to achieve dual
purposes.

 

A company having an
active business outside India is presumed to be non-resident as long as
majority of its board meetings are held outside India.

 

For companies that
fail the active business outside India test, the determination of residence
would involve identification of (a) persons who are responsible for management
decisions, and (b) place where decisions are actually made.

 

If a foreign
company gets hit by the POEM provisions, it becomes a resident and all
provisions of a resident company would apply to it. However, various
stakeholders raised concerns that a foreign company which is treated as a “POEM
resident” in India may not be able to comply with the provisions of the Act
applicable to a resident as the determination of POEM transpires during the
assessment proceedings that are usually years after the relevant tax year for
which the foreign company is treated as “POEM resident” in India. To mitigate
such concerns, the Finance Act, 2016, amongst other things, introduced special
provisions in respect of a foreign company said to be “POEM resident”6  in India by way of insertion of a new Chapter
XII-BC consisting of section 115JH in the Act with effect from 1st
April 2017. Section 115JH of the Act, inter alia, provides that the
Central Government may notify exception, modification and adaptation subject to
which, provisions of the Act relating to computation of total income, treatment
of unabsorbed depreciation, set off or carry forward and set off of losses,
etc., shall apply.

 

On 15th
June 2017, the CBDT issued a draft Notification for implementing provisions of
the section 115JH of the Act. The draft Notification invited comments from
stakeholders and the public. The Central Government, vide Notification dated 22nd
June 2018, released the final Notification7 under section 115JH(1)
of the Act. The final guidelines take forward the concept laid down in the
draft guidelines. It further provides clarification on other areas which were
not mentioned in the draft guidelines such as deemed computation of Written
Down Value (WDV) when WDV is not available in tax records, allowing carry
forward of unabsorbed depreciation on a proportionate basis when the accounting
year followed by the foreign company is different, explicitly defining “foreign
jurisdiction” etc. The consequences of a foreign company attracting POEM
provisions for the first time have been summarised below.

___________________________________________________–

6   “POEM resident” is a term coined by the
authors for companies that become “resident” as per the Income Tax Act, 1961
due to the attraction of the “POEM” provisions.

7     Notification No. S.O. 3039(E) dated 22nd
June 2018. The Notification is applicable from 1st April 2017.

 

2.  Key
takeaways from the Final Notification

The key takeaways
of the Notification are summarised below and a hypothetical case study of Ace
Ltd., is used to elucidate the takeaways in a more comprehensive manner.

 

2.1 Determination of WDV, brought forward
losses and unabsorbed depreciation for the relevant year

 

When the
foreign company is assessed to tax in the foreign jurisdiction

a)  The WDV of the depreciable asset shall be
determined as per the company’s tax records in the foreign jurisdiction.

 

b)  When WDV of the depreciable asset is not
available in tax records, the WDV is to be calculated as per the provisions of
the laws of that foreign jurisdiction.

 

c)  The brought forward loss and unabsorbed
depreciation shall be determined (year wise) on the basis of the foreign tax
records of the company.

 

When the
foreign company is NOT assessed to tax in the foreign jurisdiction

a)  The WDV of the depreciable asset, the brought
forward loss and unabsorbed depreciation (year wise) is to be determined on the
basis of the books of account maintained in accordance with the laws of the
foreign jurisdiction.

 

Other
miscellaneous provisions

a)  The brought forward losses and unabsorbed
depreciation determined above shall be allowed to be set-off and carry forward
in accordance with the provision of the Act for the remaining period,
calculated from the year in which brought forward loss and unabsorbed
depreciation occurred for the first time.

 

b)  The brought forward losses and unabsorbed
depreciation will be allowed to set off only against such income that has
become chargeable to tax in India on account of the foreign company becoming a
“POEM resident” in India.

 

c)  If there is a revision or modification in the
amount of brought forward loss and unabsorbed depreciation in the foreign
jurisdiction, then such revisions will also be made in India for set-off and
carry forward.

 

Case Study:

Ace Ltd., a foreign
company, was incorporated on 1st April 2016. It follows the same
financial year as India i.e. 1st April-31st March. It
acquired a fixed asset worth Rs 10 crores on 1st April 2016 itself.
The company attracts POEM provisions in India for financial year 2017-18. The
facts of the company are summarised below:

 

Depreciation as per
tax law – 10%.

WDV as per tax law
– 9 crores

 

Depreciation as per
company law – 20%.

WDV as per company
law – 8 crores

 

Business Loss as
per tax law – Rs 1,00,000/-

Business Loss as
per company law – Rs 1,50,000/-

 

Q1) What would be
the WDV of Ace Ltd.’s fixed assets as on 1st April 2017?

 

Scenario 1: Ace
Ltd. is incorporated in Singapore and the Singapore tax laws provide 10 rate of
depreciation.

 

Scenario 2: Ace
Ltd. is a Singapore company; however, the Singapore’s tax laws don’t provide
any specific rates for depreciation.

 

Scenario 3: Ace
Ltd. is incorporated in UAE.

 

Q2) What loss Ace
Ltd. can set off in the previous year 2017-18 in India?

 

Scenario 1: Ace
Ltd. is incorporated in Singapore.

 

Scenario 2: Ace
Ltd. is incorporated in UAE.

 

Solutions:

Answer 1:

Scenario 1: Since
Ace Ltd. is assessed to tax in Singapore and the Singapore tax laws specify the
rate of depreciation for the fixed asset, the WDV of such asset as on 1st
April 2017 will be Rs 9 crores (computed as per Singapore’s tax law).

Scenario 2: Since
Ace Ltd. is assessed to tax in Singapore and the Singapore tax laws do not
specify the rate of depreciation for the fixed asset, the WDV of such asset as
on 1st April 2017 will be Rs 8 crores (computed as per
Singapore’s company law).

 

Scenario 3: Since
Ace Ltd. is not assessed to tax in UAE, the WDV of such asset as on 1st
April 2017 will be Rs. 8 crores (determined on the basis of the books of
account maintained in accordance with UAE’s company law).

 

Answer 2:

Scenario 1: Since
Ace Ltd. is assessed to tax in Singapore, the loss in accordance with
Singapore’s tax law will be considered. Therefore, the brought forward loss
of Rs. 1,00,000/- will be allowed to be set off for eight consecutive years.

 

Scenario 2: Since
Ace Ltd. is not assessed to tax in UAE, the loss as determined in the books
of account maintained in accordance with the company law will be considered. Therefore,
the brought forward loss of Rs. 1,50,000/- will be allowed to be set off for
eight consecutive years.

 

Note: The loss calculated in both scenarios was from the year in which
brought forward loss occurred for the first time (i.e. previous year 2016-17).
It is important to always calculate the remaining period of set off from the
year the loss first occurred and not from the year in which the foreign company
becomes “POEM resident” in India.

    

2.2   Preparation of Profit and Loss and Balance
Sheet

a)  The foreign company will have to prepare
financial statements8
for the period immediately following its accounting year to the period in which
the foreign company becomes “POEM resident” in India.

 

b)  The foreign company shall also be required to
prepare financial statements for succeeding periods of twelve months till the
year the foreign company remains resident in India on account of POEM.

 

In other words, the
foreign company needs to prepare its financial statements for India on a
financial year basis consistently till it remains a “POEM resident” in India.

c)  For carry forward of loss and unabsorbed
depreciation, the following provision will apply:

 

–   If the “split period” is
less than six months, then such loss and unabsorbed depreciation will be
included in the year in which the foreign company becomes “POEM resident” in
India. Additionally, the financial statements will be extended to include the
split period.

____________________________

8   Profit and Loss Account & Balance Sheet.

 

For example:
Assuming Ace Ltd. is following a calendar year, then with a “split period” of
three months it does not have to prepare a “split” financial statement of three
months and financial year 2017-18 financial statement of twelve months
INDIVIDUALLY. It can combine both the financial statements and prepare a
fifteen month statement from 1st January 2017 to 31st
March 2018.

 

Furthermore, the
loss of previous year 2016-17 (Rs 1,00,000/- or Rs 1,50,000/- as the case may
be) will be now considered as current year business loss for the previous year
2017-18 in India.

 

–    If the “split period” is
equal to or greater than six months, then the split period would be classified
as a separate accounting year and consequently, the financial statements for
such split period need to be prepared.

 

For example: If Ace
Ltd. was incorporated in Australia where the previous year is from 1st
July – 30th June, then the split period for Ace Ltd would be nine
months  (1st July 2016 to 31st
March 2017).

 

Therefore, in such
a case, Ace Ltd. would have to file two separate financial statements i.e. (a)
split financial statement of nine months, and (b) previous year 2017-18
financial statement of twelve months.

 

It is pertinent to
note that the loss of previous year 2016-17 (Rs 1,00,000/- or Rs 1,50,000/- as
the case may be) will be allowed as a carry forward of business loss for eight
years in the previous year 2017-18 in India.

 

d)  Further, the Notification provides that in
case when separate split period accounts are prepared, the loss and unabsorbed
depreciation as per tax records or books of account, as the case may be, shall
be allocated on a proportionate basis.

 

2.3 Applicability of TDS Provisions (Chapter
XVII-B)

a)  Prior to becoming “POEM resident” in India, if
the foreign company has complied with the relevant provisions of Chapter XVII-B
of the Act, then it is considered to be compliant with the provisions of the
said Chapter.

 

b)  If more than one provision of Chapter XVII-B
of the Act applies to such foreign company as a:

–   resident, and

–    foreign company

 

then the provisions
applicable to a foreign company shall apply.

 

c)  Any payment to a foreign company who is “POEM
resident” in India – section 195(2) will still be applicable.

 

For example: If Ace
Ltd., a foreign company who is “POEM resident” in India, entered into a
management consultancy contract with an Indian entity, Soham Pvt. Ltd., then,
Soham Pvt. Ltd. (the payer) can make an application to the AO to determine an
appropriate sum chargeable to tax and to determine the liability for
withholding tax.

 

Since section
195(2) explicitly mentions that the payee i.e. Ace Ltd must be a
“non-resident”, (in the instant case Ace Ltd., being a “resident” due to the
POEM in India), the Notification specifically clarifies that the beneficial
provisions of section 195(2) will be applicable to the foreign company which is
resident in India due to its POEM in India.

 

Interestingly, it
is pertinent to note that the provisions of section 195 specifically mention
applicability to a foreign company. Therefore, any person making payment to Ace
Ltd. would be covered by the provisions of section 195 notwithstanding the fact
that Ace Ltd. has become resident of India by virtue of its POEM in India.

 

 

2.4  
Rate of Tax

a)  The rate of tax in case of the foreign company
shall remain the same even though the residential status of the foreign company
changes from non-resident to resident on the basis of POEM.9  

 

Therefore, Ace Ltd.
would be taxed at 40 per cent plus surcharge and cess. POEM, being in the
nature of
anti-avoidance to prevent base erosion, the high tax rates acts as a deterrent.

 

_____________________________________________

9   This is a derivation of key takeaways
explained in paragraphs 2.7 and 2.8.

 

 

2.5  
Foreign Tax Credit

a)  A foreign company will be eligible to avail
the benefits of India’s DTAA after it becomes “POEM resident” in India.

 

b)  In a case where income on which foreign tax
has been paid or deducted, is offered to tax in more than one year, credit of
foreign tax shall be allowed across those years in the same proportion in which
the income is offered to tax or assessed to tax in India in respect of the
income to which it relates and shall be in accordance with the provisions of
Rule 128 of the Rules.

 

2.6  
Limitation on setting off against India sourced Income

a)  The exceptions, modifications and adaptions
referred to in Para A of the Notification shall not apply to India sourced
income of a foreign company. Therefore, brought forward loss, unabsorbed
depreciation and foreign tax credit will not will available for India sourced
Income of a foreign company.

 

For example: Ace
Ltd, a Singapore entity, follows calendar year (1st January – 31st
December), and the income earned and tax paid by Ace Ltd. in Singapore and in
India is summarised below:

 

Singapore

Source

Financial Year 2017-18

(January-December)

Financial Year 2018-19

(January-December)

Amount
(Rs  in crores)

Tax (Rs 
in crores)

Amount
(Rs  in crores)

Tax (Rs 
in crores)

Business

1,200

240

2400

480

 

 

India

Source

Financial Year 2017-18 (April-March)

Amount (Rs in crores)

Tax (Rs in crores)

Business

10,000

3,000

 

 

How much foreign
tax credit can Ace Ltd. claim, assuming that Ace Ltd. gets hit by POEM
provisions in financial year 2017-18?

 

Solution:

Sine Ace Ltd. is
struck by POEM provisions in financial year 2017-18, it will be considered as a
resident in India and consequently, its global income will be taxed in India.

Furthermore, it
will be taxed at the rate applicable for foreign companies.

 

Computation of Income and tax paid for

financial year 2017-18 in India

Particulars

Amount (Rs in crores)

India sourced Income (A)

10,000

Singapore Income:

 

9 months Income of financial year
2017-18
(1 March 2017 to 31 December 2017) (B)

 

900

3 months income of financial year
2018-19

(1 January 2018 to 31 March 2018) (C)

 

600

Total Global Income (A+B+C) = (D)

11,500

Taxed at the Rate – 43.26 per cent  (E)

4974.9

Less: Proportionate Foreign Tax
Credit: 

 

9 months tax of financial year 2017-18

(1 March 2017 to 31 December 2017) (F)

 

(180)

3 months tax of financial year 2018-19

(1 January 2018 to 31 March 2018) (G)

 

(120)

Net Tax Liability (E-F-G) = (H)

4674.9

 

 

Note for determining Source wise
Foreign Tax Credit

 

 

2.7  
Transacting with a foreign company who is “POEM resident” in India

Any transaction of the foreign company with any other person or entity
under the Act shall not be altered only on the ground that the foreign company
has become Indian resident.

 

For Example: Ace Ltd. has an associated enterprise Beta Private Limited
in India. Will transfer pricing provisions apply to “international
transactions” between Ace Ltd. and Beta Ltd.?

 

As per section 92B,
an “international transaction” means a transaction between two or more
associated enterprises, either or both of whom are non-residents. Therefore, it
is important for one of the associated enterprises to be a non-resident.

 

In the instant
case, since Ace Ltd. has become a “resident” in India due to the applicability
of POEM provisions, ideally, transfer pricing provisions should not be
applicable. However, the language of the Notification creates confusion and
needs clarity.

 

2.8   
Conflict between Provisions

a)  Subject to the paragraph 2.7 above, a foreign
company shall continue to be treated as a foreign company even if it is said to
be “POEM resident” in India and all provisions of the Act shall apply
accordingly.

 

b)  It is pertinent to note that the provisions of
the Act which are specifically applicable to either a foreign company or a
resident assessee will apply to such companies. The provisions relating to
non-resident assessees will not apply to such companies. It has been further
clarified that any conflict between provisions of the Act applicable to it as a
foreign company and provisions of the Act applicable to it as a resident
assessee, the former shall prevail.

 

For example: Act
Ltd., a foreign company, who is “POEM resident” in India, is taxed on:

 

Particulars

Ace Ltd.

Reason

Scope of 
Tax

Global Income

Provisions specifically applicable to
resident shall apply to Ace. Ltd.

Rate of Tax10

40%

Conflict between Foreign company as
Resident (30%) and Foreign Company (40%) – provision applicable to foreign
company will apply.

 

 

3. 
Issues

The final
Notification has provided much-needed clarity regarding the consequences of
POEM for foreign companies who are “POEM resident” in India for the first time.
However, there remains ambiguity in the applicability of POEM for cases where
POEM is applied for the second or more time. Determination of POEM is an annual
exercise which needs to be conducted for every assessment year. Therefore, it
is always possible that the facts of the case may reveal that a foreign company
might attract POEM provisions in Year 1, not attract POEM provisions in Year 2
and again attract POEM provisions in Year 3. In such a case, there are no
guidelines about the consequences of POEM for foreign companies who are “POEM
resident” in India for multiple times.

 

Furthermore, there are some issues which have not been addressed by the
final Notification such as the applicability of advance tax, transfer pricing,
etc. For example, according to Para D of the Final Notification, transactions
of a foreign company with any other person or entity under the Act shall not be
altered only on the ground that such foreign company has become a “POEM
resident” in India. This Para implies that transfer pricing provisions will
continue to apply even if a foreign associated enterprise has become “POEM
resident” in India. Therefore, such a foreign company will have to comply with
transfer pricing provisions while transacting with its Indian associated enterprise.
This concept is irrational because transfer pricing provisions were introduced
in India to prevent shifting of profits from India to another tax jurisdiction.
Transfer pricing should not apply when both the entities are taxed in India, as
there is no opportunity for tax arbitrage.

 

4. 
Conclusion

Section 4 of the Act empowers the Central Government, to specify the
rate of tax. As per the Act, a company is differentiated either as a “domestic
company”11 or a “foreign company”12.  A higher rate of tax is provided for the
foreign company as its scope of tax is limited to Indian sourced income only. A
domestic company, however, is liable to tax on its worldwide (global) income
and therefore subject to a reduced tax rate. Thus, the principle seems to be
that as the scope of tax widens, the rate of tax reduces.13  However, in the case of a foreign company who
is “POEM resident” in India, not only is its scope of tax broader but also its
rate of tax.

Particulars

Domestic Company

Foreign

Company

Foreign Company

being “POEM resident”

Scope of 
Tax

Global Income

India sourced

Income

Global Income

Rate of Tax14

30%15

40%

40%

 

 

The consequences of
POEM of a foreign company in India are harsh and punitive. Since the
Explanatory Memorandum to the Finance Bill 2015 provides that the POEM rule is
targeted towards shell companies which are incorporated outside but controlled
from India, POEM should be used as an anti-avoidance tool and be resorted only
in exceptional cases. It is hoped that this provision will be used in the
spirit of the Explanatory Memorandum.  

________________________________________________________

10  Excluding surcharge and cess

11  Read section 2(22A).

12  Read section 2(23A).

13  This principle might be based on the principle
of equity.

14  Excluding surcharge and cess.

15   A domestic company is taxable at 30 per cent.
However, the tax rate is 25 per cent if turnover or gross receipt of the
company does not exceed Rs. 50 crore.

 

4 Article 12 & Article 14 of India-Germany DTAA – Article 14 applies to payments made for obtaining scientific services from a non-resident individual; Article 14 being more specific provision applicable to professional services rendered by individuals shall prevail over Article 12

TS-492-ITAT-2018

Poddar Pigments Limited vs. ACIT

A.Y: 2008-09; Date of Order: 23rd
August, 2018

 

Article 12 & Article 14 of
India-Germany DTAA – Article 14 applies to payments made for obtaining
scientific services from a non-resident individual; Article 14 being more
specific provision applicable to professional services rendered by individuals
shall prevail over Article 12

 

Facts

The Taxpayer, an
Indian company, was engaged in the business of manufacturing master batches and
engineering plastic compounds. During the year, the Taxpayer entered into a
technical services agreement with a German scientist (Mr. X). As per the
agreement, Mr X was required to invent different processes of polymers by
applying different chemistry to raw materials used by the Taxpayer.

 

The Taxpayer
contended that payments made to Mr X was in the nature of independent
scientific services and hence, it qualified as independent personnel services
(IPS) under Article 14 of India-Germany DTAA. Since Mr X did not have a fixed
base in India and his stay in India did not exceed 120 days, payments made to
Mr X were not taxable in India as per Article 14 of India –Germany DTAA.

 

The AO rejected the
Taxpayer’s contention and held that the payments were in the nature of ‘fees
for technical services’ under Article 12 of DTAA as well as ITA. Hence, they
were subject to withholding of tax. Since the Taxpayer made payments to Mr X
without withholding tax, AO disallowed such expense u/s. 40(a)(i) of the Act.

The CIT (A) upheld
AO’s contention. Aggrieved, the Taxpayer filed an appeal before the Tribunal.

 

Held

–     As per Article 14 of
India- Germany DTAA, income derived by an individual resident of Germany from
the performance of professional services or other independent activities is
chargeable to tax only in Germany, if the individual German resident does not
have any fixed base regularly available to him in India for performing his activities
and further, if he has not stayed in India for a period or period exceeding 120
days in the relevant previous year. Also, professional services for the
purposes of Article 14 includes ‘independent scientific services’.

 

–     ITAT noted the documentary
evidence submitted by the Taxpayer and held that the services rendered by Mr X
were in the nature of scientific services. Hence, they would qualify as
professional services under Article 14 of the DTAA.

 

–     ITAT also noted that such
services would also qualify as technical services under the FTS Article of the
DTAA which would trigger source taxation in India. The issue, therefore was,
which of the two Articles governed taxability of Mr. X.

 

–     In the facts of the case,
Article 14 is applicable and not Article 12 for the following reasons:

 

•     Article 14 deals with income from
professional services of an “individual” taxpayer whereas Article 12 deals with
all the taxpayers (including individuals)

 

•     Article 12 is broader in scope and general
in nature as compared to Article 14 of DTAA. Accordingly, Article 14 would
apply on the facts of the case.

 

•     It is a general rule of interpretation that
specific or special provisions prevail over and take precedence over the
general provisions.

 

–     Thus,
in absence of a fixed base of the Taxpayer in India, and since the Taxpayer was
not present in India for a period exceeding 120 days, income from such services
was not taxable in India by virtue of Article 14 of the DTAA.  

 

 

 

3 Article 11(3) of India-Mauritius DTAA – clarification issued by CBDT; Circular No. 789; Tax Residency Certificate can be the basis for determining beneficial ownership of interest income

TS-460-ITAT-2018

HSBC Bank (Mauritius) Limited vs. DCIT

A.Y: 2011-12; Date of Order: 2nd
July, 2018

 

Article 11(3) of India-Mauritius DTAA –
clarification issued by CBDT; Circular No. 789; Tax Residency Certificate can
be the basis for determining beneficial ownership of interest income

 

Facts

The Taxpayer was a
limited liability company incorporated, registered and tax resident, in
Mauritius and was engaged in banking business. During the year under
consideration, the Taxpayer earned interest from investments in debt securities
in accordance with the SEBI Regulations. The Taxpayer claimed that its income
was exempt in India in terms of Article 11(3)(c) of the India-Mauritius DTAA.

 

The AO, in
conformity with the directions of DRP, denied the exemption on the ground that
the Taxpayer did not fulfil the following three conditions prescribed in
Article 11(3)(c) of the India-Mauritius DTAA.

 

(i)   the interest was not “derived” by the
Taxpayer;

(ii)   interest was not “beneficially owned” by the
Taxpayer; and

(iii)  the Taxpayer did not carry on bonafide
banking business.

 

Aggrieved, the
Taxpayer appealed before the Tribunal. The Tribunal held that the Taxpayer
derived interest income and that it was carrying on bonafide banking
business. As regards the third condition pertaining to ‘beneficial ownership’,
the Tribunal remanded the matter to AO.

 

The Taxpayer
agitated the issue through miscellaneous application before the Tribunal.
Thereafter, the Tribunal recalled its order insofar as it pertained to
‘beneficial ownership’. To support its proposition of being beneficial owner of
interest, the Taxpayer primarily relied on the Tax Residency Certificate (TRC)
issued by the Mauritian Revenue authorities.

 

Held

–     Clarification issued by
CBDT on circular no. 789 dated 13.04.2000 states that wherever a Certificate of
Residency is issued by the Mauritian authority, such Certificate will
constitute sufficient evidence for accepting the status of residence as well as
the beneficial ownership for applying the provisions of the India-Mauritius
DTAA.

 

–    While the aforesaid CBDT
Circular was issued specifically in the context of income by way of dividend
and capital gain on sale of shares, same shall also be applicable in the
context of interest income under Article 11(3)(c) of the India-Mauritius Tax
Treaty. Reliance was placed on Bombay HC in case of Universal International
Music B.V (TS-56-HC-2013) wherein HC had relied upon the aforesaid Circular
in the context of royalty income.

 

–    Basis the Circular, TRC
obtained by the Taxpayer from Mauritian tax authority was sufficient evidence
that the ‘beneficial ownership’ of the impugned interest income was of the
Taxpayer.

 

Article 13 of India-UK DTAA; section 9 of the Act – As subscription income from provision of deal matching system for foreign exchange dealing was providing ‘information concerning industrial, commercial or scientific work’, income was royalty

6.  [2018] 96 taxmann.com
354 (Mumbai – Trib.)

DCIT vs. Reuters Transaction Services Ltd.

ITA Nos.: 1393 & 2219 (Mum.) of 2016

Date of Order: 3rd August, 2018

A.Ys.: 2012-13

 

Article 13 of India-UK DTAA; section 9 of the Act – As
subscription income from provision of deal matching system for foreign exchange
dealing was providing ‘information concerning industrial, commercial or
scientific work’, income was royalty

                       

Facts       

The Taxpayer was a company
incorporated in, and tax resident of the UK. It was providing access to its
electronic deal matching system for foreign exchange dealings. Its server was
located in Switzerland. The Taxpayer had entered into an agreement with its
group company in India for marketing of its system.

 

In the course of assessment
proceedings, the AO observed that: the income of the Taxpayer was not covered
under Article 13(6) of India-UK DTAA; the Taxpayer had a PE in India; and
therefore, the income of the Taxpayer was taxable as royalty. However, since
the Taxpayer had disputed the existence of the PE, Article 13(6) was held to be
inapplicable.

 

Following the Tribunal decision in
case of the Taxpayer in earlier years, the DRP upheld the draft order of the AO
to the effect that the payment received by the Taxpayer from its subscribers
was for use of its equipment and process and hence, it qualified as  royalty, both under the Act and India-UK
DTAA. The DRP further held that the server of the Taxpayer in Switzerland
extended to the equipment provided in India by the Taxpayer to the subscribers
constituted an equipment PE in India of the Taxpayer.

 

Held

u   In the earlier years, the
Tribunal had held that income received by the Taxpayer from subscribers in
India was royalty.

u   The Taxpayer had failed to
bring on record any evidence to counter the finding of facts by the Tribunal.

u   Hence, the subscription
income received by the Taxpayer was in the nature of royalty. Since the
subscription income was in the nature of royalty, there was no need to examine
whether the Taxpayer had PE in India. Article 13(6) can be invoked only if
existence of a PE is not in dispute. Since the Taxpayer has contended before
the lower authorities that it does not have a PE in India, Article 13(6) cannot
be applied.

Article 13 of DTAAs; Section 9(1)(vii) – Payment made to non-resident LLPs towards professional services qualified as IPS.

21. TS-10-ITAT-2019 (Del) ACIT vs. Grant Thornton Date of Order: 10th January, 2019 A.Y.: 2010-11

 

Article 13 of DTAAs; Section 9(1)(vii) –
Payment made to non-resident LLPs towards professional services qualified as
IPS.

 

FACTS


Taxpayer, an Indian company was engaged in
providing international accountancy and advisory services to various clients in
India and abroad. During the year under consideration, Taxpayer availed
services2 of various foreign limited liability partnerships (NR
LLPs) to render services to its clients abroad and paid fees to such NR LLPs
without withholding tax. The taxpayer contended that services obtained from NR
LLPs were in the nature of ‘Independent Personal Services’ (“IPS”) rendered
outside India and in absence of a fixed base of the NR LLPs in India, tax was
not required to be withheld on such payments under the relevant DTAA.

 

The AO, however contended that services
rendered by NR LLPs were technical services which accrued or arose in India
u/s. 9(1)(vii). Further, the IPS article under the treaty applied only to an
individual (both in his own capacity or as a member of a partnership) and not
to an LLP. Thus, in absence of any withholding, AO disallowed the payments made
to NR LLPs.

 

Aggrieved, Taxpayer appealed before the
CIT(A) who reversed AO’s order on the ground that income derived by an
individual or a partnership firm by rendering professional services is exempt
from tax in India by virtue of IPS article. Further, as the services rendered
by the NR LLPs did not make available any technical knowledge or skill, it did
not qualify as FIS under the relevant DTAA.

_______________________________

2.  Professional services pertaining to the
field of lawyering (giving reviews and opinions) and accounting e.g. SAS70
engagement, review and filing of form number1120, due diligence, review of US
GAAP financials etc

 

 

Consequently, AO appealed before the
Tribunal.

 

HELD

  •    There is no dispute that the
    services rendered by NR LLPs were professional services. The IPS article in
    some of the DTAAs applied in respect of payments made to “residents”, while in
    some other DTAAs, it applied to individual (both in his own capacity or as a member
    of a partnership). Thus, there was no infirmity in the order of CIT(A) who had
    upheld the applicability of IPS article on payments made to NR LLPs.
  •    Further, in absence of
    satisfaction of make available condition, the payment made to NR LLPs did not
    qualify as FTS under respective DTAAs.
  •    Thus, in absence of
    chargeable income, there was no obligation on Taxpayer to withhold taxes on
    payments made to NR LLPs.

Article 12(1) of India-Israel DTAA and India -Russia DTAA – since charge of tax on royalty arises only at the time of payment, tax is not required to be withheld when provisions for payment of royalty is made.

20. TS-676-ITAT-2018(Ahd) Sophos Technologies Pvt. Ltd. vs. DCIT Date of Order: 16th November,
2018 A.Y: 2012-13

 

Article 12(1) of India-Israel DTAA and
India -Russia DTAA – since charge of tax on royalty arises only at the time of
payment, tax is not required to be withheld when provisions for payment of
royalty is made.

 

FACTS


Taxpayer was a private Indian Company
engaged in the business of development of network security software product. As
part of its business, Taxpayer procured anti-virus software and anti-spam
software from suppliers in Russia and Israel respectively and bundled them with
its own software product. This bundled software was sold by the Taxpayer to the
end customers.

 

In terms of the
understanding with the suppliers, Taxpayer was liable to pay royalty in respect
of such anti-virus and anti-spam software only on activation of the license key
by the end customer (i.e. the ultimate user of the bundled software).
Withholding obligation on such royalty payment was also discharged at the time
of actual payment to the suppliers. 
Taxpayer recognised the income at the time of sale of the bundled
software and correspondingly made a provision for payment of the royalty in its
books of accounts. Withholding obligation on such royalty payment was
discharged at the time of actual payment to the suppliers and not at the time
of making provision in the books.

 

Taxpayer contended that the liability to
withhold taxes arises only on the activation of the key by the actual customer.

 

The AO, however, was of the view that
Taxpayer was required to withhold taxes at the time of making the provision for
royalty and as Taxpayer had failed to withhold taxes at that time, AO
disallowed the expenses claimed towards such provision.  Aggrieved, the Taxpayer appealed before the
CIT (A) who upheld AO’s order.

 

Aggrieved, the Taxpayer appealed before the
Tribunal.

 

HELD

  •    Article 12(1) of
    India-Russia DTAA and India-Israel DTAA are identically worded and provide that
    “royalty arising in a Contracting State and paid to a resident of the other
    Contracting State may be taxed in that other State”. Thus, in terms of the
    DTAA, royalty is taxable only at the point of time when the royalty is paid to
    the resident of the other Contracting State.
  •    The liability to deduct tax at source arises
    only when the income embedded in the relevant payment is eligible to tax.
  •    In the present case, royalty
    in respect of the bundled product became payable when the product was activated
    and not at the point of sale of bundled software. Thus, the taxes were also
    required to be withheld only upon activation of license keys.