Subscribe to the Bombay Chartered Accountant Journal Subscribe Now!

Category: International Taxation

14 Articles 8, 24 of India-Singapore DTAA – Distinction between ‘liable to tax’ and ‘subject to tax’; expression ‘exempt from tax’ implies, treaty benefit of non-taxation in source state depends on taxability in residence state; remanded to CIT(A) for proper deliberation on whether treaty benefits can be granted in source state, where such benefit results in double non-taxation.

TS-556-ITAT-2017(Rjt)

BP Singapore Pte Ltd. vs. ITO

A.Y.: 2015-16,

Date of Order: 28th November,
2017


Facts

A Singapore Company (“the Taxpayer”) was
engaged in the business of operation of ships in international waters. The
Taxpayer had claimed exemption under Article 8 of the DTAA in respect of the
freight income.

 

The Assessing Officer (“AO”) contended that
Article 24 of the India-Singapore treaty grants benefits of an exemption or
lower rate of taxation under the treaty only where income was taxed in
Singapore and since there was no evidence indicating that the freight income
was taxed in Singapore, AO applied Article 24 and denied the treaty benefits to
the Taxpayer.

 

The Taxpayer contended that as per Article
8, India has no right to tax shipping income. Hence, the income cannot be said
to be “exempt from tax in India”. Therefore, Article 24 was not applicable to
the facts of the case. Further, since the income was taxable in Singapore on
accrual basis1 , even for this reason, Article 24 could not be
applied.

_________________________________________________________

1   Though
the Taxpayer had claimed that the income was taxed in Singapore on accrual
basis, during the proceedings before Tribunal, it mentioned that because of
applicability of an incentive provision, such freight income was not taxed in
Singapore.

 

 

Held

?    The income was liable to tax in Singapore as
the fiscal domicile of the Taxpayer was in Singapore. However, it was not
actually taxed because of the incentive provision. In other words, though it
was “liable to tax”, the income was not “subjected to tax”

?    On the issue of whether income was “exempt
from tax in India”, Tribunal held as follows:

 

•    Article 3(2) requires
contextual interpretation of the undefined terms. Even where there is a
domestic law meaning to the undefined term, the contextual meaning will have
precedence.

 

•    The expression ‘exempt
from tax’ in Article 24, essentially implies that the treaty benefit of
non-taxation of an income, or its being taxed at a lower rate in a contracting
state (in this case, India), depends on the status of taxability in other
contracting state (in this case, Singapore).

 

•    Irrespective of whether
the treaty grants taxing rights exclusively to resident state (like the
language used in Article 8) or exempts the income in the source state the
impact on source state taxation remains the same, especially if seen in the context
of the provisions of the treaty where a benefit being granted is dependent
on the taxation in resident state.

 

?    Thus, technically, Article 24 was applicable
to the facts of the case.

 

?    However, noting that granting of treaty
benefits in the facts of the case, would lead to double non-taxation of income,
the matter was remanded back to CIT(A) for adjudication de novo on the issue of
whether, having regard to the underlying objective of the treaty to avoid
double non-taxation, treaty benefits in the source state (i.e India) can be
granted in respect of an income which is exempt from tax in resident state.

 

?    The Tribunal noted that this issue would
impact a large number of Singapore companies and may be difficult to adjudicate
without proper deliberation, backed by the submissions of the parties. Hence,
the Tribunal remanded the matter to the CIT(A) to consider the issue and
directed both the parties to provide detailed arguments before CIT(A).

Impact Of Multilateral Instrument On India’s Tax Treaties From An Anti-Abuse Rules Perspective

BACKGROUND

On 7th June 2017, representatives
of 68 jurisdictions met at the OECD headquarters in Paris to sign the
multilateral instrument[1]
(MLI). The MLI is an outcome of the Base Erosion and Profit Sharing (BEPS)
Action 15, which specifically addresses the issue of how to modify existing
bilateral tax treaties in order to implement BEPS tax treaty measures. The
MLI is an innovative and swift way of modifying bilateral tax treaties without
getting caught in the time-consuming process of re-negotiating each tax treaty.
The implementation of the MLI is expected to have a far-reaching impact on the
existing bilateral tax treaties. The OECD estimates that potentially 1,100
existing bilateral tax treaties are set to be modified. This is a turning
point in the history of international taxation.

 

SCOPE OF MLI FROM INDIA’S PERSPECTIVE

As of now, the MLI is signed but not yet
effective. The MLI will enter into force on the first date of the month after
three calendar months from the date when at least five countries deposit the
instrument of ratification, acceptance or approval; detailed provisions are
also there for entry into effect of the MLI.

 

Once the MLI is effective, it will modify an
existing bilateral tax treaty only if both the countries have notified the tax
treaty for the purposes of MLI. Under the MLI framework, such a tax treaty is
referred to as the covered tax agreement (CTA). India has notified all its tax
treaties (such as tax treaties with USA, UK, Singapore, Netherlands, Japan,
Luxembourg, etc.) as CTAs for the purposes of MLI. However, there are
some countries such as Mauritius, Germany and China who have chosen not to
notify their tax treaty with India – accordingly, the MLI will not apply to
India’s tax treaties with Mauritius, Germany and China. Further, USA and Brazil
are not signatories to the MLI itself. Accordingly, apart from tax treaties
with a few countries, most of India’s tax treaties will stand modified when the
MLI becomes effective.

 

It may be noted that all tax treaties will
not stand modified at the same time. The effective date of MLI for each
signatory country will vary depending upon when that country signed the MLI.
The MLI provisions will apply only after the MLI has become effective for both
countries.

 

MINIMUM STANDARDS OF BEPS ACTION 6
IMPLEMENTED THROUGH MLI

The MLI implements two minimum BEPS
standards relating to prevention of tax treaty abuse (BEPS Action 6) and
improvement of dispute resolution (BEPS Action 14). In this article, we are
discussing the impact of MLI on India’s tax treaties with respect to BEPS
Action 6.

 

The BEPS Action
6 identified treaty abuse, and in particular treaty shopping, as one of the
most important sources of BEPS concerns.Taxpayers engaged in treaty shopping
and other treaty strategies claim treaty benefits in situations where these
benefits are not intended to be granted, thereby depriving countries of tax
revenues. Therefore, countries have come together to include anti-abuse
provisions in their tax treaties, including a minimum standard to counter
treaty shopping. The BEPS Action 6 includes three alternative rules to address
tax treaty abuse:

 

1.  Principal purpose test
(PPT) rule (a general anti-abuse rule based on the principal purpose of
transactions or arrangements)

 

2.  PPT rule, supplemented with
either simplified or detailed limitation of benefits (LOB) rule (a specific
anti-abuse rule which limits the availability of treaty benefits to persons
that meet certain conditions)

 

3.  Detailed LOB rule,
supplemented by a mechanism that would deal with conduit arrangements not
already dealt with in tax treaties.

PPT rule

The MLI presents the PPT rule as the
default option (as the PPT rule meets the minimum standard recommended under
BEPS Action 6 on a standalone basis). Being a
minimum standard, these are mandatory provisions of the MLI and therefore, the
countries who have signed the MLI cannot typically opt out of these provisions.
As an exception, the countries can opt out if a tax treaty already meets the
minimum standards or if it is intended to adopt a combination of a detailed LOB
provision and either rules to address conduit financing structures or a PPT.
Accordingly, generally speaking, PPT rule of the MLI will replace the existing
anti-abuse provision in the tax treaty, or will be inserted in the absence of
anti-abuse provision in the tax treaty. For example, India’s tax treaties with
Canada, Denmark, France, Ireland, Japan, Netherlands, and Sweden do not have an
anti-abuse provision and therefore, the PPT rule of the MLI will be inserted
into those tax treaties.

 

The PPT rule of the MLI provides that a
benefit under a tax treaty shall not be granted if it is reasonable to
conclude, having regard to all relevant facts and circumstances, that obtaining
the benefit was one of the principal purposes of any arrangement or transaction
that resulted directly or indirectly in that benefit. A classic example is
where the PPT rule addresses treaty shopping by multinational companies who set
up ‘letterbox’ or ‘conduit’ companies which do not have substance in reality
and exist only to take advantage of the tax treaty. With the operation of the
PPT rule, the tax treaty benefits would be denied to such ‘letterbox’ or
‘conduit’ companies which are set up primarily with the intention to take
advantage of a favourable tax treaty. However, such benefit may be granted if
it is established that granting that benefit in these circumstances would be in
accordance with the object and purpose of the relevant provisions of the tax treaty.

 

The explanatory statement to the MLI
clarifies that the PPT rule of the MLI will not only replace the existing PPT
rules that deny all tax benefits under a particular tax treaty (a general
anti-abuse rule) but also those existing rules that deny tax benefits under
specific articles such as dividends, royalties, interest, income from
employment, other income and elimination of double taxation. This will ensure
that narrower provisions are replaced by the broader PPT rule of the MLI. In
case of a tax treaty that does not already contain a PPT rule, the PPT rule of
the MLI will be added. All these changes to the tax treaty are going to make
treaty shopping difficult. The amendments to the tax treaty arising from
operation of MLI will be prospective. Further, there is no grandfathering
clause available under the MLI provisions for the existing structures. The taxpayers
may have to evaluate how to align their structures with the amended tax
treaties.

 

The PPT rule of the MLI refers to “one of
the principal purpose” as opposed to “principal purpose” or “main purpose” or
“primary purpose”. Thus, the PPT rule of the MLI is broader than some of the
existing PPT rules contained in tax treaties which only refer to main or
principal or primary purpose. Therefore, the PPT rule of the MLI, once
incorporated into the tax treaties may broaden the scope of anti-abuse provision.
Existing structures which have been put in place simply to take advantage of
the tax treaties and which do not have any substance would be adversely hit by
the amended tax treaties.

 

Simplified LOB rule

In addition to the PPT rule under the MLI, a
country may also opt to apply a simplified or detailed LOB rule. Under the MLI,
an optional provision will be applicable to a tax treaty only if both the
countries have opted for such provision. If one of the countries has not opted
for it, the optional provision will not be applicable to the CTA. Thus, the
simplified LOB rule (an optional provision) will be applicable to a particular
tax treaty only if both the countries to the tax treaty have exercised the
choice to opt for it. While India has chosen to apply the simplified LOB, very
few other countries[2]
have made a similar choice. Practically, simplified LOB will not get
incorporated into India’s tax treaties, except where the other country has also
opted for such rule (such as, Bulgaria, Colombia, Indonesia, Russia, Slovak
Republic and Uruguay). Though the inclusion of PPT rule and simplified LOB rule
makes the anti-abuse provisions in the tax treaty stronger, from an India tax
treaty perspective, the PPT rule is going to be relevant as very few countries
have opted for simplified LOB rule.

 

Detailed LOB

The detailed LOB is out of the ambit of the
MLI and does not provide for the text of the detailed LOB as it requires
substantial bilateral customisation. Instead, countries that prefer to address
treaty abuse by adopting a detailed LOB provision are permitted to opt out of
the PPT and agree instead to endeavour to reach a bilateral agreement that
satisfies the minimum standard.

 

IMPACT ON SELECT INDIA’S TAX TREATIES

 

India-UK

 

Article 28C of the India-UK tax treaty,
which is a general anti-abuse provision, will stand replaced by the PPT rule of
the MLI as India and UK both have notified Article 28C for the purposes of MLI.
The PPT rule of the MLI provides for a carve-out in case where the tax benefits
are in accordance with the purpose and object of the tax treaty whereas Article
28C of India-UK tax treaty does not have such a carve-out. Therefore, the
replacement of the PPT rule in place of Article 28C of the India-UK tax treaty
may lead to relaxation of the general anti-abuse provision in the tax treaty.

 

The UK has also notified anti-abuse
provisions contained in Articles 11(6), 12(11) and 13(9) of the India-UK tax
treaty for the purposes of application of MLI; however, India has not notified
these provisions leading to notification mismatch. Based on the step-by-step
process outlined by the OECD, the PPT rule of the MLI will supersede these
articles to the extent they are incompatible with the PPT rule. India and UK
are not on the same page in case of Articles 11(6), 12(11) and 13(9) of the
India-UK tax treaty.

 

India-Singapore

 

The India-Singapore tax treaty contains
specific anti-abuse provisions which deny tax treaty benefits in relation to
capital gains. These provisions are in the nature of a specific anti-avoidance
rule (SAAR) and will not be impacted by the PPT rule. The PPT rule will
accordingly co-exist with the capital gains SAAR. At this stage, it is unclear
as to how this will play out. It will suffice to say that MLI will make this
treaty one of the most complicated.

 

India-Mauritius

 

Mauritius has not notified the
India-Mauritius tax treaty as a CTA, and accordingly, the PPT rules will not be
included as part of the tax treaty.

 

India-Luxembourg

 

The general anti-abuse provision contained
under Articles 29(2) and (3) of the India-Luxembourg tax treaty can be regarded
as broader in scope than the PPT under the MLI. As India and Luxembourg have
notified the Articles 29(2) and (3), the PPT under the MLI will replace the
aforementioned articles of the India-Luxembourg tax treaty. Thus, there is a
relaxation of the threshold.

 

India’s tax treaties with Canada, Denmark,
France, Ireland, Japan, Netherlands, Sweden

 

These tax treaties do not have an anti-abuse
provision and therefore, the PPT rule of the MLI will be inserted into the tax
treaty.

 

INTERPLAY BETWEEN PPT RULE OF THE MLI AND
GENERAL ANTI-AVOIDANCE RULE (GAAR) UNDER THE INCOME-TAX ACT, 1961

 

Scope of PPT rule of the MLI and GAAR

 

The scope of operation of the PPT rule of
the MLI and GAAR are different; whereas the PPT rule applies only to tax treaty
abuse, the GAAR applies to all kinds of abuse of the tax provisions (including
tax treaty abuse). The PPT rule of the MLI is different than GAAR when it comes
to the use of the terms “one of the principal purposes” as opposed to “main
purpose” under the GAAR. An arrangement which has more than one principal/main
purpose (of which obtaining tax benefit is one, but is not the main purpose)
may get covered under the PPT rule of the MLI, but may not attract GAAR.
Moreover, for GAAR to apply, the transaction should also not be at arm’s
length/ result in abuse of provisions of law/lack or deem to lack commercial
substance/is not bona fide. In contrast, the PPT rule of the MLI
provides a carve-out in terms of which the tax benefits will not be adversely
impacted by the PPT rule of the MLI, if such tax benefits are in line with the
purpose and objects of the tax treaty. Therefore, it cannot be generalised
whether PPT rule of the MLI or GAAR is broader in scope.

 

Interaction between PPT rule and GAAR

 

Let’s consider a situation where if the PPT
rule were applied, the tax treaty benefits would be denied; however, if the
GAAR were invoked, the tax treaty benefits would not be denied. The Income-tax
Act, 1961 (ITA) broadly provides that a taxpayer can apply the provisions of
the ITA or the tax treaty, whichever is beneficial. Relying on this provision,
can a taxpayer contend that it wants to be governed by the provisions of the
GAAR under the ITA and not the PPT rule under the tax treaty? This seems a
difficult proposition, as once the taxpayer elects to claim the benefits of a
tax treaty (say, reduced withholding tax on technical service fees), the entire
treaty (including the PPT rule) has to be considered, leading to the benefit
not being available.

 

To summarise, once a taxpayer seeks to claim
a tax treaty benefit, the PPT rule is to be examined to see whether the benefit
is to be granted or not. Thereafter, even if the PPT rule is not triggered, it
may be open to the tax authorities to deny the tax treaty benefit by invoking
the GAAR.

 

Implementation and administration of GAAR

 

The Indian tax authorities have the right
to deny tax treaty benefits if the GAAR is invoked in a particular case. It all boils down to how the Indian tax authorities will administer
the GAAR. In the context of the LOB rule, the Indian tax authorities have
clarified that GAAR will be invoked in cases where they believe that anti-abuse
rules under the tax treaty have fallen short of preventing the mischief of tax
treaty abuse. There are checks and balances provided under the GAAR in order to
prevent an overzealous tax officer from involving GAAR in every case. Any
proposal to invoke GAAR will be vetted by senior tax authorities at the first
stage and by another panel at the second stage that will be headed by a High
Court Judge. However, time will be the best judge of how Indian tax authorities
implement and administer the GAAR.

 

It is pertinent to note that these processes
and safeguards for invoking GAAR are strictly not applicable to the PPT rule. We will need to see whether these processes and safeguards are
extended for applying the PPT rule as well – clarifications on this are awaited
from the Indian tax authorities.

 

CONCLUSION

India is at the forefront in the fight
against tax avoidance and black money. The BEPS project and its implementation
through the MLI is an important opportunity available to the Indian and foreign
governments to strengthen their tax treaties to tackle the issue of tax treaty
shopping. _


[1] Multilateral Convention to Implement Tax Related Measures to
Prevent Base Erosion and Profit Shifting

[2] Argentina, Armenia, Bulgaria, Chile, Colombia, Indonesia, Mexico,
Russia, Senegal, the Slovak Republic and Ururguay.

2 Article 12 of India-USA DTAA; Section 9(1)(vi), 40(a)(i), 195 of the Act – payments made to the parent company on a cost to cost basis for availing lease line services from third party service provider does not qualify as royalty; it qualifies as a reimbursement, not subject to tax in India.

TS-70-ITAT-2018
T-3 Energy Services India Pvt. Ltd. v. JCIT
ITA No.826/PUN/2015
A.Y- 2010-11;
Date of Order: 2nd February, 2018
 

Facts

Taxpayer, an Indian company, was an affiliate of FCo. FCo had entered
into an agreement with a third party service provider for providing
bandwidth/lease line services for the global business of the FCo’ group
including the Taxpayer. FCo raised back to back invoices on Taxpayer in respect
of Taxpayer’s share of lease line charges.

 

The Taxpayer contended that payment made to FCo was not in the nature of
royalty but in the nature of reimbursement and hence there was no obligation to
withhold taxes on such payments.

 

AO contended that the amount remitted to the third party was not a
reimbursement of expenses but was in the nature of payment made to the service
provider for lease line services through its associated enterprise (AE).
Further, it contended that such lease line charges constituted royalty under
the Act as well as the DTAA basis the amended definition of royalty under the
Act and hence would be subject to withholding u/s. 195 of the Act.

 

Aggrieved by the order of AO, Taxpayer appealed before CIT(A). CIT(A)
observed that in case payments were directly made to third party service
provider, it would have been taxable in the hands of the service provider and
would attract withholding obligations for the Taxpayer. Merely because the
payment is routed through FCo on back to back basis, it cannot be treated as
reimbursement of expenses. Payment made by Taxpayer is taxable in India and
will be subject to withholding.

 

Aggrieved, the Taxpayer appealed before the Tribunal

 

Held

– The
agreement with the service provider was a commercial transaction, in terms of
which FCo contracted the service provider to provide lease line services for
global business of FCo group and was not limited to the Taxpayer alone.

 

–   The understanding
was between FCo and the service provider. Though the Taxpayer benefited from
the negotiated price under the agreement, it was not a party to the agreement.

 

–  The
privity of the agreement was between FCo and service provider, whereby FCo obtained
the services from the service provider and passed it to its affiliates
including the Taxpayer on cost to cost basis. Thus there was no income element
involved in payments made by Taxpayer to FCo.

 

–   Without
prejudice, the contention of AO that it is not case of reimbursement but a case
of payment to third party through its AE and hence qualifies as royalty, cannot
be accepted. This is because the term ‘royalty’ is defined under the DTAA and
it does not cover payments made towards lease line charges.

 

–  Further,
the amended definition of royalty u/s 9(1)(vi) of the Act cannot be read into
the DTAA. Reliance in this regard was placed on Delhi HC decision in the case
of New Skies Satellite BV.

 


1 Article 5(4), 7 & 8 of India-Mauritius DTAA –When place of effective management is not situated in one of the contracting states but in a third country, Article 8 of DTAA (shipping income) does not apply where an agent has more than one principal, he cannot be treated as an exclusive agent for the purposes of Dependent Agent PE (DAPE)

TS-73-ITAT-2018(Mum)
ADIT (IT) vs. Baylines (Mauritius)
I.T.A. No. 1181/Mum/2002
A.Ys: 1998-99 to 2012-13,
Date of Order: 20th February, 2018

Facts

Taxpayer, a company incorporated in Mauritius carried on the shipping
business in India. Taxpayer held a TRC indicating that it was a resident of
Mauritius for the relevant financial year. Taxpayer had an agent in India (ICo)
who concluded the contracts on behalf of the Taxpayer in India.

 

Taxpayer filed its return of income in India and claimed that the income
from shipping business was exempt from tax by relying on Article 8 of the India
Mauritius DTAA dealing with taxation of shipping income.

 

Article 8 of the India-Mauritius DTAA provides that income from shipping
business is taxable in the contracting State in which the POEM of the Taxpayer
is located. AO noted that the place of effective management (POEM) of the
Taxpayer was situated in UAE, a third country. Consequently AO held that
Article 8 of the DTAA was not applicable to the Taxpayer. Further AO held that
ICo created a dependent agent PE (DAPE) for the Taxpayer in India and
accordingly taxed the income from shipping business as per Article 7 of the
DTAA.

 

Aggrieved by the order of AO, Taxpayer appealed before CIT(A).

 

CIT(A) upheld AO’s contention that Article 8 of the DTAA was not
applicable to the Taxpayer. CIT(A) however, held that ICo did not create a DAPE
of the Taxpayer in India. Accordingly, in the absence of PE, shipping income
was held to be exempt from tax in India under the DTAA.

 

Aggrieved, both the Taxpayer and AO appealed before the Tribunal.

 

Held 1

–  On
the basis of following observations, it was held that merely holding of two board
meetings in Mauritius is not sufficient to support that the POEM was in
Mauritius.

–  Only two Mauritian directors
attended the first board meeting in person, while the remaining two UAE
directors of the Taxpayer attended these meeting via phone. The only business
transacted in that meeting was the appointment of the auditors.

–    The business transacted in the
second board meeting was with regard to approval of accounts. It is surprising
how the annual accounts a company could be approved on telephone. This
indicates that the directors of Mauritius were on the Company’s Board only to
satisfy the conditions of the regulatory requirements of Mauritius Government.

 

–   The
fact that ICo was appointed as an agent on a letter head showing its UAE
address and a letter addressed by Taxpayer to AO also originated from UAE
indicated that the major policy decisions were taken in UAE.

 

–  In
case where the POEM is not in one of the contracting States, Article 8 becomes
inapplicable. Reliance in this regard was placed on the commentary by Professor
Klaus Vogel

 

– Thus
whether or not shipping income is taxable in India will have to be evaluated
basis Article 7 of the DTAA.

 

Held 2

–  For
the following reasons it was held that ICo qualified as an agent of independent
status and hence did not create a DAPE for the Taxpayer in India:

 

•    ICo carried on the activities
of the Taxpayer in the ordinary course of its business.

•    Article 5(5) of DTAA between
India and Mauritius requires that when the activities of the agent are devoted
exclusively or almost exclusively on behalf of the foreign enterprise, the
agent will not be considered to be an agent of an independent status.

•    The dictionary meanings of the
term ‘exclusively’ clearly suggests that the agent should earn 100% or something
near to 100% from the principal to qualify as its dependant agent. Reliance in
this regard was also placed on the decision of Mumbai ITAT in case of Shardul
Securities Ltd. vs. JCIT (115 lTD 345).

•    In the facts of the case, ICo
worked on behalf of other principals as well, apart from the Taxpayer and
earned a substantial part of its income from them. Thus ICo’s activities were
not devoted exclusively or almost exclusively on behalf of the Taxpayer.

•    Reliance was placed on the
decision of Mumbai ITAT in the case of DDIT(IT) vs. B4U International
Holdings Ltd. (137 lTD 346) which was upheld by Mumbai High Court in
support of the proposition that for the determination of independence for the
purpose of DAPE, one should look at the activities of the agent and whether or
not the agent works exclusively for one principal.

 

–   The
fact that the principal has only one agent in India who undertakes all the
activities for the principal is not relevant in determination of independence
or otherwise of the agent.

 

–  Thus,
in absence of a PE in India, the income from shipping business is not taxable
in India.

Royalty–The Digital Taxation Debate

1.  Background

Characterisation
of payments for digital goods and services has been a contentious issue,
especially in Indian context. Taxation of payments in the digital economy
segment has been a subject matter of considerable litigation for quite some
time now in India and even globally. In digital economy, delivery of services
can be easily done from overseas without necessitating any part of the activity
being performed or any employees being hired in the country where customers are
located, thereby avoiding taxable presence.

 

The BEPS
Action 1 Report ‘Addressing the Tax Challenges of the Digital Economy’ states
that because the digital economy is increasingly becoming the economy itself,
it would be difficult, if not impossible, to ring-fence the digital economy
from the rest of the economy for tax purposes. The digital economy and its
business models present however some key features which are potentially
relevant from a tax perspective.

 

In India, with respect to online advertising, we have following ITAT
decisions:

 

a) Yahoo India (P.) Ltd. vs. DCIT
[2011] 11 taxmann.com 431 (Mumbai-Trib)

b) Pinstorm Technologies (P.) Ltd.
vs. ITO [2012] 24 taxmann.com 345 (Mumbai-Trib)

c) ITO vs. Right Florists (P.)
Ltd. [2013] 32 taxmann.com 99 (Kolkata-Trib.)

In
these decisions, the ITAT has held that payments made for online advertising
would not constitute “royalty” and in absence of any Permanent Establishment
[PE] in India of the foreign companies, the same would not be taxable in India.

In
the earlier decision of Yahoo India, the ITAT had held that services rendered
by Yahoo Holdings (Hong Kong) Ltd. for uploading and display of the banner
advertisement of the Department of Tourism of India on its portal would not
amount to ‘royalty’. In that decision, the ITAT had observed that advertisement
hosting services did not involve use or right to use by the Indian company of
industrial, commercial or scientific equipment. Further, the Indian company had
no right to access the portal of Yahoo Hong Kong. Based on these facts, the
ITAT concluded that the payment made to Yahoo Hong Kong would be in the nature of business income and not royalty income.

Similar findings have been arrived at in the case of Pinstorm and Right
Florists.


In para 21 of the decision in Right Florist (supra), it
was held as under:


“21. That takes us to the
question whether second limb of Section 5(2) (b), i.e. income ‘deemed to accrue
or arise in India’, can be invoked in this case. So far as this deeming fiction
is concerned, it is set out, as a complete code of this deeming fiction, in
Section 9 of the Income Tax Act, 1961, and Section 9(1) specifies the incomes
which shall be deemed to accrue or arise in India. In the Pinstorm
Technologies (P.) Ltd.’s case (supra) and in Yahoo India (P.)
Ltd’s case (supra), the coordinate benches have dealt with only one
segment of this provision i.e. Section 9(1) (vi), but there is certainly much
more to this deeming fiction. Clause (i) of section 9(1) of the Act provides
that all income accruing or arising whether directly or indirectly through or
from any ‘business connection’ in India, or through or from any property in
India or through or from any asset or source of income in India, etc. shall be
deemed to accrue or arise in India. However, as far as the impugned receipts
are concerned, neither it is the case of the Assessing Officer nor has it been
pointed out to us as to how these receipts have arisen on account of any
business connection in India. There is nothing on record do demonstrate or
suggest that the online advertising revenues generated in India were supported
by, serviced by or connected with any entity based in India. On these
facts, Section 9(1)(i) cannot have any application in the matter. Section
9(1)(ii), (iii), (iv) and (v) deal with the incomes in the nature of salaries,
dividend and interest etc, and therefore, these deeming fictions are not
applicable on the facts of the case before us. As far as applicability of
Section 9(1)(vi) is concerned, coordinate benches, in the cases of Pinstorm
Technologies (P.) Ltd. (supra) and Yahoo India (P.) Ltd. (supra),
have dealt with the same and, for the detailed reasons set out in these erudite
orders – extracts from which have been reproduced earlier in this order,
concluded that the provisions of Section 9(1)(vi) cannot be invoked. We are in
considered and respectful agreement with the views so expressed by our
distinguished colleagues.”

 

2.  Recent Decision in case of Google India- ITAT
Bangalore


Recently,
ITAT Bangalore in the case of Google India Pvt. Ltd. [Google India] vs.
ADCIT [2017] 86 taxmann.com 237 (Bengaluru-Trib) dealt with the issue as to
whether payment by Google India to Google Ireland Ltd. [Google Ireland] under
‘Adwords Program’ Distribution Agreement is royalty. The ITAT held that the
said payment is taxable as royalty under the provisions of the Income-tax Act,
1961 [the Act] as well as under the India-Ireland tax treaty [DTAA] and treated
the Indian company as an assessee in default for not complying with the
withholding tax provisions.


A. Google AdWords


Google
AdWords is an online advertising service developed by Google, where advertisers
pay to display brief advertising copy, product listings, and video content
within the Google ad network to web users. The program uses the keywords to
place advertisements on pages where Google thinks they might be most relevant.
Advertisers pay when users divert their browsing to click on an advertisement.
AdWords enables an advertiser to change and monitor the performance of an
advertisement and to adjust the content of the advertisement.

The
advertisers get their advertisement uploaded into Adword program and log on the
Adword program website owned by Google. It follows the various steps to create
the Adword account for itself. The advertisers select the key words, content
and presentation related to its ads and place a bid on the online system for
the price it is willing to pay every time its user clicks on its advertisement.
Once the advertiser creates the account and uploads advertisement, the same
automatically gets stored on Adword platform owned by Google on the servers
outside India and the ads are displayed in the manner determined by the
programs running on automated platform. Google India periodically raises the
bill on advertisers for advertising spend incurred by the advertiser on clicks
through the users.


B. Brief Facts


a. Google India is a wholly owned subsidiary
of Google International LLC, USA. Google India was providing following services
to its overseas associate Google Ireland, under 2 separate agreements:

i.    Information technology (IT)
and IT enabled services (ITES) [Service Agreement]

ii.   Marketing and
distributorship services under a non-exclusive distributor agreement for resale
of online advertising space under the Adwords program to advertisers in India [Distribution
Agreement]. In addition to marketing and distribution services provided to
Google Ireland, under the Distribution Agreement, Google was also required to
provide pre-sale and post-sale / customer support services to the advertisers.

b. For the purpose of sales and marketing the
space, work wise flow of activities of the Google India and advertiser were as
under:

 i. Enter into resale agreement with Google Ireland and resale on
advertising space under the Adword program under the Indian advertisers.

 ii.   Perform marketing related
activities in order to promote the sales of advertising space to Indian
Advertisers. After training to its own sale force about the features/tools available
as part of Adword program, to enable them to effectively market the same to
advertisers.

 iii.   Enter into a contract with
Indian advertisers in relation to sale of space under the Adword program.

 iv.  Provide assistance/training
to Indian advertisers if needed in order to familiarize that with the
features/tools available as part of Adword product.

 v.   Resale invoice to the above
advertisers.

 vi.  Collect payments from the
aforesaid advertisers.

 vii.  Remit payment to Google
Ireland for purchase of advertising space from it under the resale agreement.

c. Under the distribution agreement, Google
India made a payment aggregating to Rs. 1,457 crore for the period from F.Y.
2005-06 to F.Y. 2011-12. On the premise that it is merely a reseller of advertisement
space, Google India had categorised this payment as Google Ireland’s business
income and in the absence of a PE of Google Ireland in India, the payment was
made without withholding any tax at source. Neither Google India nor Google
Ireland had obtained any order from the tax department for Nil tax withholding.

d.  As
Google India had not complied with the provisions of section 195, the tax
authorities started the proceedings u/s. 201 of the Act. Before the Assessing Officer [AO], Google India
filed the detailed reply for all the years. However, not convinced with the
reasoning of Google India, the AO, on a conjoint reading of Adword program
distribution agreement and service agreement, treated the payment as ‘royalty’
under Explanation 2 to section 9(1)(vi) of the Act as well as DTAA between
India and Ireland and determined the withholding tax liability.

e. The findings of the AO were as under:

i.    The `distribution rights`
were `Intellectual Property’ [IP] rights covered by `similar property` under
the definition of royalty and the distribution fee payable was in relation to
transfer of distribution rights.

ii.   Google Ireland had granted
Google India the right access to confidential information and intellectual property rights.

iii.   Google India had been
allowed the use or the right to use of a variety of specified IP rights and
other IP rights covered by “similar property”.

iv.  Grant of distribution right
also involved transfer of right in copyright.

v.   By exercising its right as
the owner of copyright in the software, Google Ireland had authorized Google
India to sell or offer for sale, i.e., marketing and distribution of Adwords
Software to various advertisers in India.

vi.  The consideration paid by
Google India was for granting license/authorization to use the copyright in the
AdWords program and not for purchase of such software.

vii.  Google India had been given
right to use Google Trademarks and other Brand Features in order to market and
distribute of Adwords program.

viii. Grant of distribution right
also involved transfer of know-how.

ix.  Google Ireland was obliged to
train the distributor so that Appellant could market and distribute AdWords
program.

x.   Referring to Non-Disclosure
Agreement [NDA] clauses forming part of Distribution Agreement, it was held
that Google Ireland, being the copyright holder of the AdWords program, was in
a position to share confidential information whenever required with Google
India.

xi.  Grant of distribution right
also involved transfer of process.

xii.  Without access to the
back-end, Google India could not perform its marketing and distribution
activities. Google India had access to the processes running on the data
centres, based on the distribution rights granted to it by Google Ireland.

xiii. Google India was granted the
use or the right to use the process in the Adwords platform for the purpose of
marketing and distribution.

xiv. Grant of distribution right
also involved use of Industrial, commercial and scientific equipment.

xv. Adwords program, in one way,
was also commercial cum scientific equipment and without having access to
servers running the AdWords platform, Google India could not perform its
functions as per the Distribution Agreement.

f. 
Aggrieved by the order of the AO, Google India preferred an appeal
before CIT(A). However, even the CIT(A) concurred with the view of the AO and
treated the payment to be in the nature of ‘royalty’. Aggrieved by the CIT(A)’s
order, Google India preferred an appeal before ITAT.


C. Main Issue for
consideration before ITAT


The
main issue before ITAT was whether the amounts credited in Google India’s books
to Google Ireland’s account constituted business income or royalties for use of
software, trademarks and other intellectual property rights.


D. Google’s Arguments


Before
the ITAT, Google India extensively argued that the said payment merely
represented purchase of advertisement space and it does not amount to ‘royalty’
and is in the nature of ‘business income’. Google India’s main arguments were
as under:

a)   It
was merely a reseller of advertising space. It only performed market related
activities to promote the sales of advertising space. No right or intellectual
properties were transferred by Google Ireland to Google India or to the
advertiser.

b)   The
brand features were predominantly commercial rights and were incidental to the
distribution activity and did not involve transfer of any separate right.

c)   Google
India had no control or access to the software, Algorithm and data centre. The
server on which the Adword program runs were located outside India over which
it was not having control. Google India or the advertisers did not have any
right of any use or exploitation or the underlying IP and software. None of
these parties were concerned with the back end functioning of the Adwords
program which was solely carried out by Google Ireland. Their objective was to
benefit from the services of Google and they were not interested in the use of
search service.

d)   Reliance
was also placed on the reports of High Powered Committee of the CBDT as well as
Technical Advisory Group of the OECD which had concluded that the payments in
relation to advertisement fees were not in the nature of royalty. Accordingly,
when the payments made directly by advertisers to Google Ireland could not be
regarded as royalty, the payments made by the distributor for the same ad space
also could not be characterised as royalty.

e)   Clauses
containing protection of confidential information and non-disclosure were
generic and these clauses per se could not establish that there was grant of
right to use any IP.

f)    Also,
what was envisaged in the exhibits of the agreement pertaining to after sales
services were that Google India responded to all routine queries of customers
and Google Ireland was to respond to the advertisers issues or technical
issues. Thus, no right to use any IP was granted to Google India.

g)   The
Google brand features are predominantly commercial rights and are incidental/
consequential to the distribution activity and does not involve transfer of any
separate right. In this regard, reliance was placed by Google India on the
decisions in the case of Sheraton International Inc vs. DDIT [2009) 313 ITR
267 (Delhi HC) and Formula One World Championship Ltd. vs. CIT [2016]
176 taxmann.com 6 (Delhi HC).

h)   Google
India relied upon the decisions of the coordinate bench in Right Florist
(P.) Ltd. (supra), Pinstorm Technologies (P.) Ltd. vs. ITO (supra) and Yahoo
India (P.) Ltd. vs. DCIT (supra) to prove that the issue of online
advertisement had been considered in all the decisions and it was held that the
payment made by the advertiser to the website owner was business profit and in
the absence of any business connection and PE in India and not the Royalty.


E. Tax Authorities’ Arguments


The
tax authorities argued that the payments to Google Ireland constituted
royalties on the following grounds:

a)  Google India’s marketing and
distribution functions involved the sale of certain rights in the AdWords
Program, for which Google India required a license to use the AdWords Program.
The distribution rights granted to Google India under the Distribution Agreement
were therefore in effect a license to use Google Ireland’s IP i.e., inter
alia the copyright in the underlying software code of the AdWords Program.

b)  The tax authorities concluded
that the license of Google Ireland’s IP to Google India under the Services
Agreement was actually for the purpose of providing the post-sale services
under the Distribution Agreement, and therefore the payments made to Google
Ireland constituted royalties.

c)  The Non-Disclosure Agreement
which is Exhibit-B of the distribution agreement clearly demonstrated that by
virtue of the disclosure of the confidential information and access provided to
the confidential information to the Google India by Google Ireland, the sums
payable by Google India to Google Ireland is for information, know-how and
skill imparted to Google India.

d)  Google India has been
permitted to use Google Ireland’s trademarks and brand features in order to
market and distribute the AdWords Program.

e)  The grant of distribution
rights involves transfer of rights in ‘similar property’ (Explanation 2 to
section 9(1)(vi)). The grant of distribution rights also involves the transfer
of right to use Google Ireland’s industrial, commercial and scientific
equipment i.e., the servers on which on which the Ad Words Program runs.

f)   The grant of distribution
rights also involves transfer of right in processes, including Google Ireland’s
databases software tools etc., without which it would not be able to perform
its marketing and distribution functions.


 F. ITAT Decision


The
ITAT, to get an understanding as to how Google AdWord program works, relied on
the information obtained through the written submission of Google India, the
books available in public domain on Google AdWord and Google analytics and also
through the website of the Google and the AdWords links therein. Based on its
understanding, the ITAT observed that:

a)  The entire agreement was not
merely to provide the advertisement space but was an agreement for facilitating
the display and publishing of an advertisement to the targeted customer.

b)  The arrangement was not
confined to use of space but also for the use of patented tools and software of
Google Ireland.

c)  Google India got an access to
various information and data pertaining to the user of the website in the form
of their name, age, gender, location, phone number, IP address, habits,
preferences, online behavior, search history etc. and it used this information
for the purpose of selecting the ad campaign and for maximising the impression
and conversion of the customers to the ads of the advertisers.

d)  By using the patented
algorithm, Google India decided which advertisement was to be shown to which
consumer visiting millions of website/search engine.

e)  The ITAT held that there is no
sale of space, as concluded hereinabove rather it is a continuous targeted
advertisement campaign to the targeted and focused consumer in a particular
language to a particular region with the help of digital data and other
information with respect to the person browsing the search engine or visiting the
website.

 f)   The ITAT did not agree that
advertisement distribution agreement and the service agreement were two
independent arrangements. According to the ITAT, both the agreements were
connected with the naval chord with each other.

 g)  The ITAT further held that the
payments made by the assessee under the agreement was not only for marking and
promoting the Ad Word programmes but was also for the use of Google brand
features. Needless to add that the said Google brand features were used by the
appellant as marketing tool for promoting and advertising the advertisement
space, which is main activity of Assessee and is not incidental activities.

The
use of trademark for advertising marketing and booking in the case of Hotel
Sheraton (Supra) as well as in the case of Formula 1 were
incidental activities of the assessee therein as the main activities in the
cases were providing Hotel Rooms and organizing Car Racing respectively whereas
in the present case the main activity of the assessee is to do marketing of
advertisement space for Google Adwords Programme. Therefore, these two
judgments are not applicable to the facts of the present case. Hence, for this
reason also the payment made by Google India to Google Ireland also falls
within the four corners of royalty as defined under the provisions of Act as
well as under the DTAA.

h)  The ITAT has held that the
findings of the High Powered Committee would not be applicable here as this was
not case of placement of the advertisement simpliciter but there was a module
for targeted advertisement/focus marketing campaigns using the Google software
and algorithm, patented technology, secret process, use of trade mark etc.

i)   The reliance placed by Google
India on the decisions of Pinstorm, Yahoo India, Right Florists have been
brushed aside since the ITAT felt that the facts relating to the working of the
AdWords program stood on a different footing.

j)   The ITAT held that IP of
Google vested in the search engine technology, associated software and other
features, and hence, use of these tools by Google India, clearly fell within
the ambit of ‘Royalty’. The ITAT held that as no tax was withheld by Google
India on payments to Google Ireland, Google India was an assessee in default.

k)  The ITAT was of the view that
the Ad Words Program gives an advertiser a variety of tools to enable it to
maximize attention, engagement, delivery and conversion of its advertisements.
The tools are provided using Google’s IP, software and database with Google
India acting as a gateway.

l)   The ITAT was of the view that
the use of customer data for providing services under the Service Agreement was
also utilized for marketing and distribution functions under the Distribution
Agreement. It concluded that the use of customer data and confidential
information should be regarded as the use of Google Ireland’s intellectual
property by Google India.

m) The ITAT concluded that it is
through use of Google’s intellectual property that the AdWords tools for
performing various activities are made available to Google India and the
advertisers. Therefore, payments made to Google Ireland for use of its intellectual
property would therefore clearly fall within the ambit of “Royalty”.


3.  Observations


a)     The ITAT appears to have
undertaken an intensive fact-finding mission to unearth the technological
workings of the Google AdWords Program on the basis of which it has concluded
that the distribution rights involved a grant of license to IP and
advertisements fees were in the nature of royalties.

b)    The ITAT’s ruling is clear
break with earlier positions taken on the characterization of advertisement
revenue, and payments made under distribution arrangements. Where it ruled the
payments to be in the nature of business income. In these cases, the question
is usually whether the foreign entity has a PE in India for income to be
taxable in India. In fact, the issue in such cases has been on the
determination of a PE on account of a fixed place or dependent agent rather
than whether such an arrangement will result in royalty income.

c)     In fact, it was for this
very reason that the equalization levy was introduced to capture advertising
fees within the Indian tax net, in cases where the non-resident does not have a
PE in India.

d)    The ITAT has taken an
aggressive approach where it has read two independent agreements in relation to
services provided by two different units of Google India together to show that
there was utilization of IP by the Indian entity and re-characterized the
nature of income. The decision does not provide for reasons of tax avoidance
for clubbing the two agreements.

e)     The ITAT’s decision could
have far reaching implications from businesses across the board. Utilization of
IP such as customer data, confidential information for performing services is a
fairly common industry practice and the decision raises concerns on these type
of arrangements.

f)     The above decision is very
crucial and is going to impact many cases which have the similar structure and
in such cases issue would arise as to whether such payment is in the nature of
‘royalty’.

However, one could still examine and contend that ultimately the
objective was to place the advertisement and Google India or the advertisers
were not interested in the back end process of Google Ireland and hence such
payment should constitute business income.

g)    It appears that ITAT in
Google’s case has tried to distinguish the earlier decisions by holding that
Google was not only a simpliciter provider of advertisement space but it also
provided access to software, patented tools, information, etc. which helped
Google India in targeting the customers. The ITAT has also gone into
considerable depth to understand as to how these advertisements are placed on
the website of Google, how it was ensured that large number of customers visit
those advertisements, how the bidding by the advertisers take place etc. and
based on this it came to conclusion that Google India plays a pivotal role in
all these and it was not merely placing the advertisement simpliciter.


4.     Equalisation Levy [EL]


a)     The Finance Act, 2016 has
introduced an ‘Equalisation Levy’ (Chapter VIII) in line with the
recommendation of the OECD’s Base Erosion and Profit Shifting [BEPS] project to
tax e-commerce transactions. It provides that the equalisation levy is to be
charged on specified services (online advertising, any provision for digital
advertising space or facilities/service for the purpose of online
advertisement, etc.) at 6% of the amount of consideration for specified
services received or receivable by a non-resident payee not having a PE in
India. The Equalisation Levy Rules, 2016 have also been issued by CBDT to lay
down the compliance procedure to be followed for such levy. The Rules came into
effect from 1st June 2016.

b)    Further income from such
specified services shall be exempt u/s. 10(50) of the Act. Accordingly, with
effect from 1st June, 2016, such income will not be taxed as royalty
or business income but it would be subject to equalisation levy.

An
interesting issue would arise as to whether payments made after 1st June
2016 would be liable to EL or would it still attract withholding tax treating
it as royalty based on Google India’s decision. It is notable that withholding
tax may be creditable in the country of residence of the payee but no credit is
available for EL.


5. Proposed
amendments in Section 9(1)(i) by the Finance Bill, 2018 – ‘Business Connection’
to include ‘Significant Economic Presence’


Currently,
section 9(1)(i) provides for physical presence based nexus for establishing
business connection of the non-resident in India. A new Explanation 2A to
section 9(1)(i) is proposed to inserted to provide a nexus rule for emerging
business models such as digitised businesses which do not require physical
presence of the non-resident or his agent in India.

This
amendment provides that a non-resident shall establish a business connection on
account of his significant economic presence in India irrespective of whether
the non-resident has a residence or place of business in India or renders
services in India. The following shall be regarded as significant economic
presence of the non-resident in India.

–    Any transaction in respect of
any goods, services or property carried out by non-resident in India including
provision of download of data or software in India, provided the transaction
value exceeds the threshold as may be prescribed; or

–    Systematic and continuous
soliciting of business activities or engaging in interaction with number of
users in India through digital means, provided such number of users exceeds the
threshold as may be prescribed.

In such cases, only so much of income as is attributable to above
transactions or activities shall be deemed to accrue or arise in India.


 6. Conclusion


The
Google India’s decision will have a significant impact on how other digital
economy related payments are characterised for tax purposes in India. It would
also influence other pre 1st June 2016 cases that relate to online
advertising.

In
view of the ITAT’s observation that both the Associated Enterprises are trying
to misuse the provision of tax treaty by structuring the transaction with the
intention to avoid payment of taxes, and in view of General Anti Avoidance
Rules provision under the Income-tax Act and India’s commitment to implement
Multilateral Instrument under the BEPS initiative, the taxpayers should take
appropriate caution before entering into any arrangement/structure especially
if it is to avail any tax benefit.

It
appears that the law on this issue will continue to remain somewhat unsettled
until resolved by the higher judiciary.

The
understanding of modern day developments around digital space, the complexities
surrounding it and tax implications on such transactions need a holistic
review. It is time for India to develop a framework for digital transactions.
This would be one important aspect in India’s attempts in its endeavour of ease
of doing business. 

 

13 Article 6 and 7 of India-Kenya DTAA; Indian bank earned rental income from house property in Kenya. Rental income not taxable in India as per Article 6 of DTAA. Notification or circular can neither override the provisions of tax treaty nor alter the nature of income

TS-515-ITAT-2017(Mum)

Bank of India vs. ITO

A.Y: 2009-10                                                                      

Date of Order: 8th November, 2017

Article 6 and
7 of India-Kenya DTAA; Indian bank earned rental income from house property in
Kenya. Rental income not taxable in India as per Article 6 of DTAA.
Notification or circular can neither override the provisions of tax treaty nor
alter the nature of income

 FACTS

The Taxpayer,
an Indian public sector bank, had a branch in Kenya. During the relevant year
the Taxpayer earned business income from its branch in Kenya. Further, the
Taxpayer also earned rental income from a house property located in Kenya.
Taxpayer claimed that the business income and rental income earned by the Kenya
branch was not taxable in India as per Article 6 and Article 7 of India-Kenya
DTAA.

Relying on the
CBDT Notification No.91 of 2008, AO contended that the business income and
rental income is taxable in India1. Aggrieved by the contention of
the AO, the Taxpayer appealed before CIT(A) who upheld the order of the AO.

Aggrieved, the
Taxpayer appealed before the Tribunal.

HELD

–  Relying on
its own order for earlier years in the case of the same Taxpayer, the Tribunal
held that business income from foreign branches was not taxable in India as per
Article 7 of India-Kenya DTAA. The earlier decision of the Tribunal relied on
SC ruling in the case of Kulandagan Chettiar (267 ITR 654) for arriving at such
conclusion.

–  AO had
treated the business income and rental income as one source of income. However,
the DTAA contains two different Articles i.e., Article 7 which governs business
income and Article 6 which governs income from immovable property.

–   Any
notification or circular cannot alter the nature of income that has been
specifically included in DTAA. Even amendment in a section of the Act would not
affect the provisions of tax treaties, unless same are not ratified by both the
countries.

–   Rental
income received by the Taxpayer is covered by Article 6 of India-Kenya DTAA. As
per Article 6, such rental income is not taxable in India.

P.S: The
meaning of “may be taxed” provided by Notification No. 91 of 2008 was not
applicable to the facts of the case. _

_____________________________________________________

 1   Notification No. 91 of 2008 provides that
where an DTAA is entered into by the Central Government of India with the
Government of any country outside India for granting relief of tax or as the
case may be, which 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
a’nd relief shall be granted in accordance with the method for elimination or
avoidance of double taxation provided in such DTAA.

12 Section 5(2), 6(1) of the Act – Salary income earned by a non-resident for services rendered in foreign country while on deputation is not taxable in India

[2017] 87 taxmann.com 98 (Delhi)

Pramod Kumar
Sapra vs. ITO

A.Y: 2011-12                                                                      
Date of Order: 30th October, 2017

Section 5(2),
6(1) of the Act – Salary income earned by a non-resident for services rendered
in foreign country while on deputation is not taxable in India

FACTS

The Taxpayer,
an individual was employed by ICo. Taxpayer was deputed to Iraq for the purpose
of employment by ICo. During the year under consideration, total number of days
of his stay outside India was 203 days. Further, his stay in India for the four
FYs preceding the relevant FY was less than 365 days.

The Taxpayer
filed his return of income in India in the capacity of a non-resident (NR). In
his return, Taxpayer claimed that the salary earned outside India for the
period during which he was on deputation in Iraq is not taxable in India.

The return of
income filed by the Taxpayer was accepted by the AO. However, Principal
Commissioner of Income tax (PCIT) set aside the assessment order. PCIT
contended that the salary earned by the Taxpayer for the period of deputation
was received in his bank account in India. Taxes were also deducted on such
income in India. Thus, such income was taxable on receipt basis in India u/s. 5
of the Act. As A.O. had proceeded with the assessment without considering this
fact and without making any enquiry, the assessment made by AO was erroneous
and prejudicial to the interest of the revenue. Thus, the order of AO was
needed to be set aside u/s. 263 of the Act.

Aggrieved by
the order of PCIT, Taxpayer appealed before the Tribunal

 HELD

–   Since
Taxpayer was present in India for less than 182 days and his total stay in
India during the preceding four FYs was less than 365 days, he was NR for the
relevant FY.

–  The fact
that salary income has been received in India, i.e., it has been credited in
the bank account of the taxpayer in India and also that TDS has been deducted
by the employer, cannot be determinative of the taxability under the Act. What
is relevant is, whether the income can be said to be received or deemed to be
received in India u/s. 5 of the Act.

–   Section
5(2) merely provides that if the income of NR has been received or has accrued
in India or is deemed to be received or accrued in India, the same shall be
treated as total income of that person. Section 5 does not envisage that income
received by NR for services rendered outside India can be reckoned as part of
total income.

–   Taxpayer
received salary during his employment outside India for carrying on his
activities outside India. Such income cannot be treated as income received or
deemed to be received by the Taxpayer in India. Hence salary received by the
Taxpayer for services rendered in Iraq was not taxable in India.

26 Sections 9, 44BB, 44DA and 115A of the Act – Prospecting for or extraction or production of mineral oil is not technical services – therefore, payments for rendering of services for extraction or production of mineral oil as sub-contractor would not be FTS – since payment was received by non-resident Taxpayer from another non-resident for services in connection with prospecting for extraction or production of mineral oil, such payments would be covered by section 44BB.

[2018] 89 taxmann.com 416 (Mumbai – Trib.)
Production Testing Services Inc vs. DCIT
A.Y.: 2011-12, Date of Order: 27th October, 2017

Facts       

ONGC had awarded a contract for providing
certain services to a company incorporated in Scotland and having a project
office in Mumbai (“F Co”). F Co, in turn, sub-contracted the work to the
Taxpayer, which was a non-resident. The Taxpayer received certain payments from
F Co. The Taxpayer offered the receipts to tax u/s.44BB of the Act.

 

The AO held that since F Co was providing
services to ONGC, the Taxpayer who was sub-contracted the said work by F Co was
indirectly performing the services for ONGC. The AO further held that services were
technical services provided by the Taxpayer for prospecting extraction or
production of mineral Oil. The AO also noted that as per the TDS certificates,
tax was withheld u/s. 194J (which, inter alia, applies in case of FTS).
Accordingly, the AO treated the receipts as ‘fees for technical services’
(“FTS”) u/s. 115A of the Act.

 

DRP upheld the findings of the AO.

 

Held

–  Perusal
of the contract showed that the contractor was solely responsible for the
performance of the contract. The contract further stated that if the contractor
engaged any sub-contractor for performing the contract, then the sub-contractor
shall be under the complete control of the contractor and that there shall not
be any contractual relationship between such sub-contractor and ONGC.

–   Thus,
the Taxpayer, who was engaged as a sub-contractor, had nothing to do with ONGC.
Therefore, the AO and DRP were wrong in holding that the amount received by the
Taxpayer for rendering services were indirectly received from ONGC. Hence, the
payments were received by the Taxpayer from FCo.

–   In Oil & Natural Gas Corpn. Ltd. vs. CIT
[2015] 376 ITR 306/233 Taxman 495/59 taxmann.com 1, the Supreme Court has
held that prospecting for extraction or production of mineral oil is not to be
treated as technical services for the purpose of Explanation 2 of 9(1)(vii),
and such activity would be covered by section 44BB.

–   Section
115A(b) presupposes existence of FTS, therefore, the payments received for
rendering of services for extraction or production of mineral oil by the
Taxpayer would not fall within the ambit of FTS. Since the pre-condition for
invoking of section 115A is missing, the same would not be attracted.

–   The
contention of the Taxpayer that it had received the payments for rendering the
services from F Co, which was a foreign company, had merit. Since the receipts
of the Taxpayer were from F Co, and not from Government or an Indian concern,
the provisions of section 115A and section 44DA were excluded.

–   Section
44BB has special and specific provisions for computing profits and gains of a
non-resident in connection with the business of providing services or
facilities in connection with or supplying plant and machinery on hire used or
to be used in the prospecting for or extraction or production of mineral oils.
Hence, the services provided by the Taxpayer in connection with extraction or
production of mineral oil were covered by section 44BB. _

25 Section 9 of the Act and Article 12 of India-USA DTAA – payments to USA subsidiary towards provision of inputs for new product development including market survey expenses in USA, being FIS under Article 12(4), were taxable in India; remittances to an employee towards expenses of overseas representative offices were not taxable in India.

[2018] 89
taxmann.com 445 (Chennai – Trib.)

Tractors &
Farm Equipment Ltd. vs. ACIT

A.Y. 2006-07,
Date of Order: 27th September, 2017

 

Facts       

The Taxpayer
was engaged in manufacture and sale of tractors and farm equipment. It had
established a subsidiary In USA (“US Co”) for sale of tractors in USA. The
Taxpayer had entered into agreement with US Co to provide assistance for
promoting sale of tractors through advertisement, to provide market inputs to
enable increased sale of its tractors and maintain stock. The Taxpayer was
reimbursing promotional activity expenses to US Co on the basis of supporting
documents. The Taxpayer had also set up overseas representative offices in
London, Vienna and Belgrade for sale of tractors and had remitted funds towards
reimbursement of expenses to overseas representative office. The remittances
were made to the account of an employee of the Taxpayer. The employee had
periodically submitted detailed accounts with supporting documents in respect
of expenses incurred.

 

The Taxpayer contended that none of the
payments made to US Co were fee for technical/consultancy services. Further,
they being reimbursements, there was no element of profit. Hence, the
remittances were not taxable in India.

 

The AO
held that as the Taxpayer did not withhold tax while making payments to US Co
and overseas representative offices, such payments were to be disallowed u/s.
40(a)(i) of the Act.

 

With respect to payment to overseas
representative office, the Taxpayer contended that the payment was merely a
reimbursement towards periodic maintenance expenses incurred by the
representative office and hence, was not taxable in India.

 

The
CIT(A) confirmed the order of the AO in respect of payments made to US Co but
deleted disallowance in respect of payments made to overseas representative
offices.

 

Held

–   The
Taxpayer had paid US Co for expenses for two kinds of services. One, sales
promotion and two, market development.

–   As
per Distribution Agreement between the Taxpayer and US Co, the payments were
made “to provide inputs for new Product Development – Improvements in the
present range of products” to US Co “towards the market survey expenses to be
incurred in USA”. Thus, these payments were towards services rendered by US Co
to provide inputs for new product development including market survey in USA.
Such services were covered within the definition of ‘Fees for included
services’ in Article 12(4) of DTAA.

–   The
debit note issued by US Co showed that reimbursement was for expenses incurred
towards detailed review of specifications of compact tractors, obtaining
feedback of dealers/end users, consulting experts/professional engineers
regarding current use and future requirements and evolving broad specifications
for a new range of compact utility models. The debit note also supports the
fact that the services fell within the definition of ‘Fees for included
services’ in Article 12(4) of DTAA.

–  As
regards remittance towards expenses of overseas representative offices, the AO
had neither doubted the genuineness of the expenditure nor had he brought any
material on record for supporting disallowance. Merely because the employee
acted as an authorized signatory in another entity, does not mean that the
payment was not towards reimbursement of expenses of overseas offices of the
Taxpayer. 

24 Sections 5(2), 9, 15, 90(2), 192(2) of the Act; Article 16 of India-USA DTAA – if employee is non-resident and no part of services under employment are performed in India, salary is not subject to withholding in India; employer can consider foreign tax credit at the stage of withholding tax.

AR No 1299 of 2012
Texas Instruments (India) Pvt. Ltd., In re
A.Ys.: 2011-12 and 2012-13, Date of Order: 29th January, 2018

Facts       

The applicant, was an Indian entity which
had sent an employee on an assignment to the USA for two years. During that
period the employee was on payroll with its group entity in the USA (US Co).
While he was in USA, though the employee had not rendered any service in India,
for fulfilling his personal obligations, he received part of the salary in
India from the applicant.

 

In respect of financial year 2011-12 the
employee would have been a non-resident (“NR”) 
in India and for financial year 2012-13 he would have been a resident in
India.

 

The employee would be resident in the USA
for the calendar years 2010, 2011 and 2012 as per the US domestic laws.
Accordingly, his global income, including salary paid in India, would be taxable
in USA.

 

The applicant sought ruling of AAR on the
following questions.

 

Question 1: Whether the Applicant is obliged
to withhold taxes on the salary paid in India to the employee in financial year
2011-12, when the employee qualified as an NR in India;

 

Question 2: Whether the Indian employer can
consider claim of foreign tax credit (“FTC”) at withholding stage in respect of
the taxes paid in the USA by the employee in financial year 2012-13 when he
would be a resident in India.

 

The applicant contended as follows before
the AAR.

 

As regards question 1

 

–   In
terms of section 5(2) of the Act, the scope of total income of a non-resident
comprises income received in India, including salary received by the employee
in India. However, it is to be computed in terms of   section 2(45) of the Act, after providing
reliefs, such as, treaty reliefs. Hence, first the taxability of salary needs
to be determined and then the availability of treaty benefit for computing the
taxable total income.

 

–   Since
no services were rendered in India, salary for employment exercised in the USA
would not accrue in India. This is supported by the provisions of section 15
read with explanation to section 9(1)(ii) of the Act, decision in DIT vs.
Sri Prahlad Vijendra Rao (ITA No 838/ 2009) and decision in CIT vs.
Avtar Singh Wadhwan [2001] 247 ITR 260 (Bom) and commentary by Professor
Klaus Vogel on Article 15 of the OECD Model Convention

 

–  U/s.
90 of the Act, the employee is entitled to adopt either the provisions of the
Act or India-USA DTAA, whichever is more beneficial. As per Article 16 of DTAA,
the salary received by a USA resident in respect of employment is taxable only
in USA since the employment is not exercised in India. Hence, though the salary
was to be paid in India, , it would not be taxable in India.

 

–   U/s.
192 of the Act, an employer is required to withhold taxes only if salary is
chargeable to tax in India. Also, as per section 192 read with section 2(10) of
the Act, taxes are required to be withheld considering the average rate of tax,
which is determined by dividing income-tax on total income by the total income.
In the instant case, as the total income with respect to salary paid in India
would not be chargeable to tax in India, the average rate of tax will work out
to Nil.

 

As regards question 2

–   The
employee would be a resident in India for financial year 2012-13. Hence, in
terms of Article 25 of India-USA DTAA he will be entitled to claim FTC on taxes
paid in USA.

 

–   Section
192(2) of the Act provides that an employee working under more than one
employer during any financial year can furnish details of salary and TDS to one
of the employers, and such employer is obliged to consider the same while
arriving at the quantum of total taxes to be withheld.

 

–   Since
withholding tax provisions apply only to the extent of actual tax liability,
the treaty relief should be available to the employee at the tax withholding
stage without having to wait to seek this relief only at the time of filing
return of income.

 

–  Hence,
relying on decisions in British Gas India Private Limited (AAR/725/2006)
and Coromandel Fertilizers Ltd [1991] 187 ITR 673 (AP), the Indian
employer would be required to consider FTC while arriving at the taxes to be
withheld at source in India.

 

The tax authority contended as follows before the AAR.

 

As regards question 1

–   U/s.
5(2) of the Act, any income (which includes salary) received in India is liable
to tax in India. Hence, it will be subject to withholding tax. Salary due from
an employer in India is chargeable to tax in India and its payment will trigger
withholding tax obligations in India.

 

–  An
Indian employment contract is an evidence of employer-employee relationship in
India. If the employer is an Indian entity, the employment is considered to be
exercised in India. Place where services are actually rendered or where the
employee is physically present is not relevant.

 

As regards question 2

–   Grant
of claim of FTC involves interpretation of the articles of DTAA and examination
of satisfaction of other conditions, such as, actual payment of taxes in USA,
attribution of tax to income, etc. Only tax authority would have such
expertise. An employer would neither have the opportunity nor such expertise to
carry out such exercise at the time of withholding tax at source. From
financial year 2012-13, there is an additional requirement for obtaining a Tax
Residency Certificate (“TRC”) in order to avail Treaty benefits.

 

–   Further,
section 192 of the Act does not provide for allowing FTC at the withholding
stage. Hence, the Indian employer cannot give benefit of FTC at the time of
withholding tax.

 

Held

As regards question 1

–   U/s.
4 of the Act, income tax is to be charged in accordance with, and subject to,
provisions of the Act, on the total income of a taxpayer. The total income
chargeable to tax for a non-resident is subject to other provisions of the Act.

 

–   The
judicial decisions cited by the Indian employer, and decision in Utanka Roy
vs. DIT (International Taxation) (2017) 390 ITR 109 (Cal), have held that,
the actual place of rendering services is the key test in determining place of
accrual of salary to a non-resident, and that salary received in respect of
services rendered outside India has to be considered as being earned outside India.
Since the employee was rendering services in the USA during FY 2011-12, the
salary accrued to him in USA and not in India.

 

–   Whether
the employer was an Indian entity or not was immaterial and the only material
point for consideration is the place where the services were rendered. This is
also supported by the Commentary by Klaus Vogel on Article 15 and Explanation
to section 9(1)(ii) of the Act.

 

–   Further,
even as per the provisions of Article 16 of DTAA, any income from services
rendered in USA would be chargeable to tax in USA. Thus, applying section 90 of
the Act, the beneficial provisions of the DTAA would prevail.

–   Accordingly,
as the employment was exercised in the USA, the salary did not accrue in India.
Therefore, the Indian employer is not required to withhold taxes on the portion
of salary paid in India to its NR employee.

 

As regards question 2

–   Under
Article 25 of India-USA DTAA, the employee is entitled to benefit of claim of
FTC.

 

–   U/s.
192(2) of the Act, in respect of payments received by an employee from more
than one employer, the employee could furnish details of salary paid and tax
deducted to one of the employers, who would then be required to consider the
same at the time of withholding tax.

 

–   Although,
the machinery provisions of the Act do not provide for claim of FTC at
withholding stage, the judicial decisions cited by the applicant had held that
FTC can be considered by the Indian employer at the withholding stage. Thus,
the Indian employer could consider the same while computing withholding tax.

 

–   However,
while the Indian employer can consider FTC at the time of withholding tax, it
is also obligated to exercise due diligence in satisfying itself about the
details of period of residence, TRC, details of income earned and taxes
deducted, the period of income, etc., before doing so.

 

–   If
the tax authority believes that the Indian employer has failed in carrying out
such due diligence, it may take appropriate action under the Act.

23 Articles 5, 7 of Indo-Swiss DTAA – Referral fee received by Dubai branch of a Swiss company from its India branch for referring an Indian resident client was ‘commission’ – since such fee was not attributable to PE in India of the Taxpayer, it was not taxable in India.

[2018] 90 taxmann.com 181 (Mumbai – Trib.)
DCIT vs. Credit Suisse AG
A.Y.: 2011-12, Date od Order: 9th February, 2018

ACTS
The Taxpayer was an entity incorporated in, and tax-resident of, Switzerland. The Taxpayer was a member of a global banking group providing various financial services globally. With permission of RBI, the Taxpayer had established a branch in India (“India Branch”). The Taxpayer also had a branch in Dubai. (“Dubai Branch”).

Dubai Branch had referred an Indian resident client to India Branch. India Branch handled the assignment and in accordance with global policy of the group, paid half of the fee to Dubai Branch as referral fee. The Taxpayer contended that referral fee received by Dubai Branch was ‘business income’. Since Dubai Branch did not have a PE in India, in terms of Article 5 of Indo-Swiss DTAA fee was not liable to tax in India. According to the AO, since the referral fee was payable in connection with a transaction between India Branch and referred client, it was in the nature of ‘fee for technical services’ and not ‘business income’. Hence, in terms of section 5(2)(b), read with section 9(1)(i) of the Act, referral fee was taxable in India since it was deemed to accrue or arise in India.

According to the DRP, Dubai Branch referred the client and it had no PE in India. Such income could not be attributed to activity of India Branch1.

HELD
–    Mere fact that the fee was payable by India Branch to Dubai Branch, after execution of the work was no ground to determine the nature of the payment.

–    In concluding that the ‘referral fee’ is in the nature of ‘commission’ to be taxed as ‘business income’ and not as ‘fees for technical services’ the DRP has referred and relied upon the decisions in Cushman & Wakefield (S) Pte. Ltd., 305 ITR 208(AAR) and CLSA Ltd., vs. ITO (International Taxation), 56 SOT 254(Mum) by the DRP. The tax authority has not brought any contrary decision.

–    The tax authority has not countered the contention of the Taxpayer that Dubai Branch had no PE in India and also that PE in India of the Taxpayer, i.e., India Branch, had no role to play in the performance of the referral activity in question.
–    Since the referral activity was undertaken outside India, and since PE of the Taxpayer had no role to play in the referral activity, the referral fee earned by Dubai Branch could not be considered to be attributable to PE in India of the Taxpayer. Therefore, the DRP was right in applying Article 7 of Indo-Swiss DTAA and holding the referral fee as non-taxable in India.

1  Though the decision has not made any mention, it may be noted that Article 7(1) of Indo-Swiss DTAA contains only limited force of attraction.

Sections 9, 44BB of the Act; Article 5(5) of India-Singapore DTAA – Where drilling rig was brought into India for fabrication and upgradation to make it ready for drilling activities, the number of days for which such fabrication and upgradation was being carried out was to be included to determine whether aggregate days exceeded the threshold.

23.  [2017] 83
taxmann.com 174 (Mumbai – Trib.)

DCIT vs. Deep Drilling (1) Pte. Ltd.

A.Y.: 2011-12, Date of Order: 19th April, 2017

Facts

The Taxpayer was a non-resident company, incorporated in
Singapore. It was engaged in the business of providing jack-up drilling unit
and platform well operations services.

The Government of India had awarded an exploration contract
to an Indian company (“I Co”) for exploration in offshore areas of India.
During the year under consideration, the Taxpayer entered into an agreement
with an I Co for providing jack-up drilling unit and platform well operations
for exploration and earned income from the said agreement.

Under the agreement with
I Co, the Taxpayer was required to provide rig as per stipulated
specifications. The Taxpayer brought rig into India for necessary fabrication,
upgradation and positioning to meet requirements of I Co. Actual drilling
operations commenced after such modifications and were undertaken for 119 days.
The Taxpayer did not offer any income to tax in India on the ground that number
of days for which drilling operations were carried on in India were less than
the threshold period of 183 days for constitution of exploration PE in India
under India-Singapore DTAA and in absence of a PE in India, income from its
activities was not taxable in India.

However, the AO observed that the drilling rig was brought
into India in April 2010. Since the rig was in India for more than 183 days, it
constituted exploration PE of the Taxpayer under India-Singapore DTAA.
Therefore, income of the Taxpayer was taxable u/s. 44BB of the Act.

Aggrieved by the order of AO, Taxpayer appealed before
CIT(A). The CIT (A) decided the issue in favour of
The Taxpayer.

Held

–   Under article 5(5) of India-Singapore DTAA,
an enterprise shall be deemed to have an exploration PE in a contracting state,
if it provides services or facilities in that state for a period of more than
183 days in connection with exploration, exploitation or extraction of minerals
oils in that state.

–   The Taxpayer brought the drilling rig into
India on 26th April 2010. For rendering the services to I Co, the
rig was required to undergo necessary fabrication, upgradation and positioning
as per the requirements of I Co before commencing the drilling activity.

–   The operation on the rig to upgrade it, to
prepare it, and to enable it to perform the drilling activity cannot be
considered in isolation from the actual drilling activity for determining
whether the Taxpayer was having a PE in connection with exploration,
exploitation or extraction of mineral oil in India.

–  Thus, the Taxpayer had an
exploration PE in India from the day it commenced fabrication, etc. in
India to perform the drilling activity. Since the number of days for which the
rig was deployed (including those for fabrication, etc.) was more than
183 days, the Taxpayer had an exploration PE in India.

Section 92C, the Act – No royalty could be said to have accrued to the Taxpayer since there was no agreement between AEs and the Taxpayer to charge royalty during the year and since the Taxpayer had not provided any technical or other support to the AEs.

21.  [2017] 83
taxmann.com 305 (Delhi – Trib.)

Dabur India Ltd. vs. ACIT

A.Y.: 2006-07, Date of Order: 12th April, 2017

Facts       

The Taxpayer was engaged in manufacturing and trading of
health care, personal care, cosmetics and veterinary products. It entered into
the following arrangement with two of its subsidiaries based in UAE (“UAE Co”)
and Nepal
(“Nepal Co”).

–   UAE Co:     

     UAE Co had entered into an agreement with
the Taxpayer prior to becoming subsidiary of the Taxpayer for the use of the
technical know-how and R&D support of the Taxpayer in manufacturing
Ayurvedic products in UAE. The Taxpayer had permitted UAE Co to use its brand
name. In return, UAE Co had paid royalty @3% of FOB sale. Further, UAE Co also
manufactured other products without the technical know-how and R&D support
of the Taxpayer. In respect of such products UAE Co was allowed to use the
trademark of the Taxpayer for which a royalty of 1% of FOB sales was paid by
UAE Co to the Taxpayer.

     Subsequently, UAE Co found that Ayurvedic
products of the Taxpayer were not selling in UAE. Hence, it began to
manufacture and market FMCG products with its own technology and hence, paid
royalty @1% to the Taxpayer.

–   Nepal Co:   

     The Taxpayer had entered into agreement
with Nepal Co for payment of royalty @ 7.5% of FOB sale price and as per the
terms of the agreement, the Taxpayer was required to bear the cost of marketing
expenses. However, Nepal Co had to incur substantial expenditure to penetrate
the market and hence, the agreement was amended and the royalty was reduced to
3%. However, in the relevant assessment year, Nepal Co did not pay any royalty.
Further, the Taxpayer had contended that 80% of production of Nepal Co was
purchased by the Taxpayer. Hence, even if the Taxpayer charged royalty, it
would have increased the cost and the Taxpayer would have paid higher price.

     The TPO noted low/non-receipt of royalty
from AEs during the current year. Hence, he asked the Taxpayer to furnish the
reasons for the same.

     The Taxpayer submitted that there was no
agreement for payment of royalty during the year under consideration. Hence,
right to receive the royalty was absent. Further, UAE Co had also refused the
payment of royalty on the ground that it had incurred huge expenditure on
promotion of bands of the Taxpayer.

     The TPO observed that in the absence of
evidence of termination of agreement between the Taxpayer and its AE, as well
as in absence of corroborative evidence like non-use of brand name or non-use
of technical know-how by the AE, the Taxpayer had permitted UAE Co and Nepal Co
use of its intellectual property without any royalty payment and hence, he made
an adjustment in the hands of the Taxpayer considering royalty @ 4% of sales in
case of UAE Co and @ 7.5% of sales in case of Nepal Co.

     Aggrieved by the order of AO, Taxpayer made
appeal before CIT(A). CIT (A) held that international transaction of permitting
use of brand name by AEs was same in both cases. Therefore, there was no reason
to assign higher royalty in one case than the other. Accordingly, he held
royalty @ 2% of FOB sales as arm’s length price in both cases.

Held

Royalty from UAE Co

–   When the agreement was in existence, the
Taxpayer provided technical know-how and R&D support for manufacturing of
products to the Taxpayer. Further, UAE Co had paid royalty @ 1% in accordance
with the agreement even when no product was manufactured with the help and
support of the Taxpayer since it was using the trademark of the Taxpayer.

–   The agreement was not renewed on completion.
Therefore, it had ceased to exist with effect from financial year 2005-06.
Thus, for the year under consideration, no royalty was payable. Further, the
products manufactured, as well as raw material used, by UAE Co were totally
different from those in India. The AO had not brought anything on record to
substantiate that the Taxpayer had provided technical know-how and R&D
support for manufacture of such products.

–   UAE Co had incurred huge expenses on
marketing and advertising the brand of the Taxpayer. Moreover, the AO had also
not brought on record that:

•    the Taxpayer had incurred expenses for
marketing the products of UAE Co; or

•    the Taxpayer made any efforts or contributed
any money for establishing its name in UAE; or

•    the products manufactured by UAE Co were not
different from the products manufactured in India by the Taxpayer; or

•    the claim of the Taxpayer that the products
manufactured, and materials used, in UAE were totally different from those in
India had not been rebutted. 

–   Under section 92C of the Act, read with rules
10B and 10C of the Rules, ALP should be determined on the basis of similar
payments received by similarly situated and comparable independent entities. In
the present case, no comparable case was brought on record by the TPO or CIT
(A).

–   Since the Taxpayer is not providing any
support to UAE Co, it will be fair and reasonable to charge royalty @ 0.75%.

Royalty
from Nepal Co

–   For the year under consideration, Nepal Co
had not paid royalty to the Taxpayer since it had to incur market penetration
expenses.

–   The contention of the Taxpayer that 80% of
production of Nepal Co was purchased by the Taxpayer had not been rebutted. It
is undisputed that royalty was payable in earlier year on sales. Therefore, it
is unbelievable that the Taxpayer charged the royalty on the purchases made by
it from Nepal Co to increase the cost of its own purchases. Even if it is
presumed that the Taxpayer should have charged the royalty, the same amount
would have been added in the purchase price paid by the Taxpayer. Thus, it
would have been revenue neutral.

–   There was no agreement in existence between
the Taxpayer and Nepal Co. Also, nothing was brought on record to substantiate
that the Taxpayer incurred any expenditure which benefited Nepal Co in any
manner. Having regard to all the facts, charging of royalty was not justified
and addition made is deleted.

Section 92C, the Act – Location savings and advantages are very much relevant in cross-border transaction but only for limited purpose of examination and investigation of transaction and not as a basis for determination of ALP and consequential adjustment.

20.  [2017] 84
taxmann.com 15 (Bangalore – Trib.)

Parexel International Clinical Research (P.) Ltd. vs. DCIT

A.Ys.: 2011-12 & 2012-13,

Date of Order: 16th June, 2017

Facts

The Taxpayer was a subsidiary of a dutch company (“F Co”) and
was engaged in providing clinical research services in India. Certain AEs of
the Taxpayer had outsourced the work of clinical trial and research services to
The Taxpayer in India. For its services, the Taxpayer was paid cost plus 15%
markup.

To benchmark its international transactions, the Taxpayer
selected 17 comparable companies having average PLI of 18.05%. Since operating
profit margin of the Taxpayer was within the tolerance range of +/- 5%, it
claimed that its international transactions were at arm’s length.

The Transfer Pricing Officer (“TPO”) observed that compared
to developed countries, regulatory, compliance and investigatory costs were
significantly lower in India, Hence, conducting trial in India through the
Taxpayer had resulted in location saving for the AE. Since benchmarking against
local comparables did not take this into account. Accordingly, the TPO applied
the profit split on account of location saving. Consequently, the location
savings in relation to the total cost of conducting clinical trials was
allocated in the ratio of 50:50 between the Taxpayer and the AE.

Aggrieved by the order of TPO, the Taxpayer appealed before
the Dispute Resolution Panel (DRP). However, DRP concurred with the view of the
TPO. Aggrieved, the Taxpayer appealed before the Tribunal. 

Held

–   Location savings is one of the primary
factors of any cross-border trade. However, such location savings are available
to all parties irrespective of whether the transaction is between the related
party or unrelated party.

–   Location savings’ advantage is universally
accepted in cross-border trade so far as the transactions are not entered into
solely for the purpose of avoiding taxes. On the other hand, BEPS is relevant
only if the sole purpose of the transaction is to shift profit to no tax or low
tax jurisdiction and treaty shopping.

–  Transfer pricing provisions for
determination of ALP are inserted to deal with such transactions between
related parties. While location saving can be a relevant factor for conducting
a proper enquiry for determination of ALP, if the comparable uncontrolled price
is available, location saving cannot be the basis for determination of ALP and
consequential adjustment.

Foreign Tax Credit Rules

One of the pillars of the Double Tax Avoidance Agreement
(DTAA) is Article on “Methods for Elimination of Double Taxation”. Various
methods are prescribed for elimination of double taxation. However, elimination
of double taxation through a foreign tax credit route was fraught with several
issues such as at what rate of exchange credit for taxes are to be computed,
what documents are required to prove payment of overseas taxes, what about
mismatch of taxable years in the country of source and country of residence,
what about increase or decrease in taxes due to assessment in the foreign
country and so on. In order to address all these issues and some more, last
year CBDT had issued a Notification No. S.O.2213(E) dated 27th June
2016 providing Foreign Tax Credit Rules (FTCR), which came into effect from 1st
April 2017.
This article besides explaining various methods for elimination of double
taxation, deals with salient features of the FTCR.

1.0    Introduction

          The objective of a DTAA (also known as
“tax treaty”) is to distribute tax revenue between the two Contracting States
(CS). Articles 6 to 22 in a typical tax treaty contain distributive rules to
this effect. The methods for elimination of double taxation have been dealt
with by Article 23 of the UN Model Tax Convention (UNMC) and the OECD MC.
Article 24 provides for provisions of Mutual Agreement Procedure which can be
invoked by the tax payer, if the CS fails to eliminate double taxation or
apply/interpret the treaty provisions not in accordance with its intent and
purpose. 

          Usually, State of Residence (SR) taxes
global income of a tax payer including income from the State of Source (SS).
Therefore, SR will give credit for taxes paid in the SS.

          Double taxation is eliminated in two
ways, namely, Exemption of Income or Credit of taxes paid. Various methods for
elimination of double taxation can be summarised as follows:

 

          Before we dwell into foreign tax
credit rules, let us glance through the above methods for appreciating
applicability of FTCR in an Indian scenario.

2.0    Exemption Method

2.1     Full Exemption

          In this case, the income taxed in the
SS is fully exempt in the SR.

2.2     Exemption with Progression

          Under this method, SR considers the
income taxed in the SS only for the purpose of determining the effective tax
rate.

          Let us understand the above two
methods with the help of an example.

          Tax slabs and tax incidence in the SR
are as follows:

Income

Tax Rate

Tax on

Rs. 1500

Tax on

Rs. 1000

First Rs. 200 Exempt

 0

0

0

From Rs. 201 to Rs. 500

10%

30

30

From Rs. 501 to Rs. 1000

20%

100

100

Above Rs. 1000

30%

150

—-

Total Rs.

 

280

130

 

Sr. No.

Particulars

Amount INR

1

Income in the SR

1000

2

Income in the SS

500

3

Total income taxable in SR (1+2)

1500

4

Tax
liability in the SR without 
considering Exemption (Tax on a slab basis)

280

5

Total
Income considering full exemption in the SR (income of SS is ignored totally)

1000

6

Tax
liability based in the SR considering full exemption (On a slab basis only on
income from SR i.e. Rs.1000)

 

130

7

Effective
Tax Rate in SR considering income from SS (4/3)

18.6%

8

Tax
in SR considering Exemption

with
Progression (Tax on Rs.1000 @ 18.6%)

 

186

 

 

 

              

3.0    Credit Methods

          Under the credit method, SR will tax
income of its resident on a global basis and then grant credit of taxes paid in
the SS.

          In simple words, when any income of
the person is taxed on source basis in one country and on the basis of his
residence in other country, the country of residence shall compute tax on
overall global income of such person and while doing so, it shall grant to such
a person a credit of the taxes already paid by it on the income taxable at
source in such other country.

          There are two types of credit methods,
namely, Unilateral and Bilateral.

3.1
   Unilateral Tax Credit

          Section 91 of the Income tax Act deals
with the unilateral tax credit. Sub-section (1) of the section 91 provides that
“If any person who is resident in India in any previous year proves that, in
respect of his income which accrued or arose during that previous year outside
India (and which is not deemed to accrue or arise in India), he has paid in any
country with which there is no agreement under section 90 for the relief or
avoidance of double taxation, income-tax, by deduction or otherwise,
under the law in force in that country, he shall be entitled to the deduction
from the Indian income-tax payable by him of a sum calculated on such
doubly taxed income at the Indian rate of tax or the rate of tax of the said
country, whichever is the lower, or at the Indian rate of tax if both the rates
are equal”. (Emphasis supplied)

          From the above, it is clear that the
amount of credit in India will be restricted to the lower of the proportionate
tax in India on the foreign sourced income or taxes paid in the source country.

3.1.1 Issues

          A
question arose as to whether a tax payer can avail unilateral credit in respect
of income from a country with which India has signed a limited tax treaty?
India had a limited tax treaty with Kuwait till 2008 which covered only income
from International Air Transport. (With effect from 1st April 2008,
a new and comprehensive tax treaty with Kuwait has become operative in India).
In case of JCIT vs. Petroleum India International (26 SOT 105), the
Mumbai Tribunal granted benefit of the unilateral tax credit u/s. 91(1) when
only limited DTAA was in operation. Thus, one may conclude that unilateral tax
relief may be available to a tax payer in respect of income which is not
covered by the limited tax treaty.

3.1.2 Some other issues u/s. 91 addressed by the
Judiciary  are tabulated herein below:

Sr. No.

Issue

Decision

Case Law

1

What
if part of foreign income is taxable in India?

Proportionate
credit is available only in respect of income doubly taxed.

CIT
v. O.VR.SV.VR. Arunachalam Chettiar (49 ITR 574) and Manpreet Singh Gambhir
v. DCIT

(26
SOT 208)

 

2

Whether
relief u/s 91 is available against MAT liability u/s 115JB or 115JC of the
Act in India?

If
the foreign sourced income is included in computation of book profits in
India, then relief u/s. 91 is available against MAT liability.

Hindustan
Construction Co. Ltd. v. DCIT

(25
SOT 359)

Proviso
to section 115JAA and 115JD read with Rule 128(7)

 

3

Whether
the relief u/s. 91 is available qua each country of source or one needs to
aggregate income from all foreign sources, which may have an impact of
setting off loss from one country against income from the other.

Expl.
(iii) to Section 91 defines “rate of tax of the said country” to mean
income-tax paid in the other country as per its tax laws. Therefore, relief
u/s. 91 has to be granted in respect of each source country separately.

Bombay
Burmah Trading Corporation Ltd. (126 Taxman 403)

3.2    Bilateral Tax Credit Methods

          There are four bilateral tax credit
methods, namely, (i) Full Credit Method, (ii) Ordinary Credit Method, (iii)
Underlying Tax Credit Method and (iv) Tax Sparing. Let us understand each of
them with illustrations.

3.2.1 Full Credit Method

          Under this method, total tax paid by
the person on his income in the country of source is allowed as a credit
against his total tax liability in the country of residence. The credit is
irrespective of his tax liability in the country of residence. Thus, a person
may be able to get proportionately more credit than the incidence of tax on his
foreign sourced income in the country of residence. This is known as full
credit method. India does not allow full credit of foreign tax to its residents
except under India-Namibia DTAA, which grants full credit in India of taxes paid
in Namibia.

3.2.2 Ordinary Credit Method

          The credit available under this method
shall be lower of the proportionate tax payable on the foreign sourced income
in the country of residence or the actual tax paid in country of source. As a
result, in this case, if the tax on the foreign sourced income is higher in the
country of residence than in the country of source, the taxpayer shall be
liable to pay the balance amount. However, if it is the other way round, i.e.
if tax paid in the source country is higher than the residence country, then
excess shall not be refunded. As stated earlier, tax treaties are distribution
of taxing rights and sharing of revenue between two contracting states and
therefore, any excess tax paid in one country is usually not refunded by the
other country. However, some countries do provide for carry forward of such
excess credit. As far as India is concerned, such excess amount is ignored.

          Majority of Indian tax treaties follow
Ordinary Tax Credit Method, which is not detrimental to the interest of the
country of residence of the tax payer and at the same time, it eliminates
double taxation of income.

          Let
us understand both these methods with the help of a Case Study. Facts of the
case are same as described in paragraph 2.2 herein above with the only change
of assumption of 20% rate of tax in the SS. SR is assumed to be India and SS as
Canada.

Sr.

No.

Particulars

Without DTAA Relief
Rs.

Full Credit Method
Rs.

Ordinary Credit Method Rs.

A.

Taxable
Income in India (1000+500)

1500

1500

1500

B.

Taxable
Income in Canada

500

500

500

C.

Tax
payable in India (on a slab basis)

280

280

280

D.

Tax
Payable in Canada (B*20%)

100

100

100

E.

Effective
Tax Rate in India (C/A)

18.67%

18.67%

18.67%

F

Foreign Tax Credit

NIL

100

(Full Credit)

93

(18.67% of 500)

G

Tax Paid in India net of FTC (C-F)

280

180

187

H

Total
Tax Liability (G+D)

380

280

287

3.2.3 Underlying Tax Credit Method (UTC)

          Under this method, SR gives credit for
taxes paid on profits out of which dividend is declared by the company located
in the SS. This method attempts to eliminate/reduce economic double taxation as
dividend income is taxed twice, once by way of profits in the hands of the
company and secondly by way of dividends in the hands of the shareholders.

          A few Indian tax treaties which
contain UTC provisions are treaties with Australia, China, Ireland, Japan,
Malaysia, Mauritius, Mexico, Singapore, Spain, the UK, and the USA.

          However, it is interesting to note
that most of UTC provisions in Indian tax treaties are with respect to the
residents of treaty partner country and not Indian residents. Only treaties
with Mauritius and Singapore give benefit of UTC to Indian residents.
India-Singapore DTAA provides for minimum shareholding of 25 per cent in order
to avail UTC benefit. India-Mauritius DTAA provides for minimum shareholding of
10 per cent in order to avail UTC benefit.

          An UTC clause of India-Mauritius DTAA
reads as follows:

          “In the case of a dividend paid by
a company which is a resident of Mauritius to a company which is a resident of
India and which owns at least 10 per cent of the shares of the company paying
the dividend, the credit shall take into account [in addition to any Mauritius
tax for which credit may be allowed under the provisions of sub-paragraph (a)
of this paragraph] the Mauritius tax payable by the company in respect of the
profits out of which such dividend is paid.”

          Illustration of the Underlying Tax
Credit

–   Indian company holds 100% shareholding of a
Singapore Company

–   Profits before tax of the Singapore Company
is Rs. 1,00,000/-

–   Tax rates in Singapore:

     Business Income @ 20%

     Withholding Tax on Dividends 5%

–   Tax rate on foreign dividends in India 30%

–   Assume that 100 per cent of profits are
distributed as dividends

Sr.No.

Particulars

Amount in Rs.

A

PBT
in Singapore

1,00,000

B

Tax
on Business Profits @ 20%

20,000

C

Balance
Profits declared as Dividends

80,000

D

Withholding
tax on Dividends @5%

4,000

In the hands of the Indian Company

E

Dividend
Income

80,000

F

Tax
on Dividends @ 30%

24,000

G

Underlying
Tax Credit (@ 100% of B)

20,000

H

Foreign
Tax Credit for Dividends

(Full
credit available as tax rate

in
India is higher than Singapore)

4,000

I

Total
Tax incidence in India

NIL

3.2.4 Tax Sparing

          Under this method, credit is given by
the state of residence in respect of deemed tax paid in the state of source.
Many a times, developing countries give many tax based incentives to attract
capital and technology from the developed nations. (For e.g. section 10
exemptions in India). However, income which may be exempt in India if taxed in
the other country, then the tax spared by the Indian government would go to the
other government rather than the company/entity concerned. Therefore, the
concept of tax sparing has come into being. Usually, provisions concerning tax
sparing cover specific sections of the domestic tax laws.

          However, sometimes, a general
reference is made to apply tax sparing provisions in respect of incentives
offered by a country for the promotion of economic development. [E.g.
India-Japan DTAA]  

          To illustrate, section 10(15)(iv)(fa)
of the Act provides that interest payable by a scheduled bank to a non-resident
depositor on a deposit placed in foreign currency is exempt from tax in India.
If an NRI depositor from Japan earns interest income from India, which is
exempt under this section but taxable in Japan, then the Japanese Government
will give a credit of tax which he would have otherwise paid in India, but for
this exemption.

Illustration

Sr. No.

Particulars

Amount in Rs.

A

Interest
Income received by an

NRI
in Japan on deposit placed

with
SBI in Yen.

1,00,000

B

Tax
paid in Japan @ 30%

30,000

C

Tax
Payable as per India-Japan Tax Treaty @ 10% {Actual tax

paid
is NIL either under DTAA

 or under the Act –

[exempt
u/s. 10(15)(iv)(fa)]}

10,000

D

Tax
Sparing Credit in Japan

10,000

E

Actual
Tax payable in Japan (B-D)

20,000

4.0    Foreign Tax Credit
Rules

          India by and large, follows ordinary
credit method and therefore, a lot of issues were arising for claiming credit.
There was no guidance as to at what rate taxes paid in the foreign country has
to be converted for claiming credit in India, what documents to be submitted,
what about timing mismatch and so on. In order to address these and other
issues, CBDT notified FTCR on 27th June 2016 and were made
applicable w.e.f. 1st April 2017. Let us study these provisions in
detail.

          Income Tax Rule 128 deals with the
provisions of FTC which are summarised as follows:

Sub Rule No.

Particulars

1

Credit of foreign tax to be allowed in
India in the year in

which the corresponding income is
offered to tax or

assessed in India. If income is offered
in more than one

year, then the credit for foreign tax
shall be allowed

in the same proportion in which such
income is offered

to tax or assessed in India.

(This provision takes care of timing
mismatch. If an

Indian resident receives income from
USA, where it was

taxed on a calendar year basis, then he
can offer the

proportionate income in India on
financial year basis. The

rule now clearly provides proportionate
credit of taxes if the income is offered for tax in two financial years)

 2

Meaning of foreign tax

Tax
referred to in a DTAA or as referred to in clause (iv)

of
the Explanation to section 91.

(It
means credit for state taxes or any other tax other

than
specifically covered by a bilateral tax treaty will

not
be available)

3

It
is clarified that FTC will be available against the tax,

surcharge
and cess payable under the Act but not

against
interest, fee or penalty.

4

FTC
will not be available in respect of disputed amount

of
foreign tax. (See Note 1)

5

This sub rule provides certain important
provisions:

(i)
FTC shall be computed vis-a-vis each source of

income
arising in a particular country;

(ii)
The credit shall be lower of the tax payable under

the
Act on such income and the foreign tax paid on

such
income; (See Note 2)

(iii)
As the tax in foreign country would be paid or deducted in the currency of the
respective country, the same needs to be converted into equivalent Indian
rupees. The rule provides that foreign tax should be converted at the
Telegraphic Transfer (TT) Buying Rate of the State Bank of India (SBI) on the
last day of the month

immediately
preceding the month in which such tax has

been
paid or deducted. (See Note 3)

6

Provision
allowing credit of FTC against MAT liability

u/s
115JB or 115JC

7

Excess
of FTC compared to MAT liability u/s 115JB or 115JC to be ignored

8

Documents to be submitted for claiming
FTC

(i)  Form
No. 67 containing details of foreign income and

     Tax
paid/deducted thereon.

(ii) Certificate or statement specifying
the nature of income and the amount of
tax deducted there from or paid by the assessee,—

(a)  from
the tax authority of the country or the specified territory outside India; or

(b)  from
the person responsible for deduction of such tax; or

(c)   signed
by the assessee along with an acknowledgement of online payment or bank
counter foil or challan for payment of tax or proof of tax deducted at
source, as the case may be.

9

The
above form and documents referred to in rule 8

have
to be filed on or before the due date of furnishing

income
tax return u/s. 139 of the Act.

10

Requirement
for submission of Form No. 67 in a case where The carry backward of loss of
the current year results in refund of foreign tax for which credit has been
claimed in any earlier year or years.

 

(Many
countries allow losses to be carried backward and

set
off against profits of the earlier year/s. In such a

situation,
the taxes paid earlier may be refunded to the

tax
payer. In order to avoid unjust enrichment, the

rules
provide for reversal of the FTC in India in respect

of
taxes which are subsequently refunded in the

foreign
jurisdiction)

Note1:Proviso
to sub rule 4 provides that foreign tax credit shall be allowed for the year in
which such income is offered to tax or assessed to tax in India if the assessee
within six months from the end of the month in which the dispute is finally
settled, furnishes evidence of settlement of dispute and an evidence to the
effect that the liability for payment of such foreign tax has been discharged
by him and furnishes an undertaking that no refund in respect of such amount
has directly or indirectly been claimed or shall be claimed.

Note 2:Proviso to sub rule 5 (i) provides that
where the foreign tax paid exceeds the amount of tax payable in accordance with
the provisions of the agreement for relief or avoidance of double taxation,
such excess shall be ignored for the purposes of this clause.

Illustration:

          An Indian company is taxed @ 20% on
royalty income in a foreign country X as per its domestic tax laws. However,
the DTAA between India and country X provides for the tax rate of 10% on such
royalty income, then notwithstanding, actual payment of 20%, the FTC in India
will be restricted to 10% only.

Note 3:Illustration
on conversion of FTC in Indian currency

          Mr. Patel, a resident in India has
received professional fees of USD 10,000/- on 1st February 2017 from
his UK client. His UK client deducted tax @ 20% (i.e. GBP 2000) under the UK
tax laws and paid the same to the UK government on 7th February
2017. India-UK DTAA provides the rate on FTS as 10%.

          He also earned capital gains on sale
of shares on London Stock exchange on 15th March 2017 amounting to
GBP 5000/- on which he paid tax of GBP 500 in UK on 31st March 2017.

          Consider
following rate of exchange of UK Pound vis-a-vis Indian Rupee:

Sr. No.

Date

Rate of Exchange

1 GBP = INR

1

31st
January 2017

84

2

1st
February 2017

85

3

7th
February 2017

83

4

28th
February 2017

82

5

15th
March 2017

80

6

31st
March 2017

81

 

          Rule 115 of the Act provides for the
mechanism to apply the exchange rate for conversion of foreign income to Indian
rupees.

          In the above case, applying provisions
of Rule 115 and sub-rule 5 of Rule 128, foreign income and FTC in India would
be computed as follows:

          FTC for Fees For Technical Services

          Income 10,000 @ Rs. 81/- = Rs.
8,10,000/-

          [Exchange rate as on the last date of
the previous year i.e. as on 31st March 2017 as per Rule 115(2)(c)
of the Act]

          Indian income tax @ 30% = Rs. 2,43,000/-

          FTC on 1000 @ Rs. 84/- = Rs. 84,000/-

          [Exchange rate as on the last date of
the previous month i.e. as on 31st January 2017 as per Rule 128(5)]

[Notes:

(i)       FTC restricted to the tax rate prescribed
in the India-UK DTAA and not the actual payment of GBP 2000;

(ii)      FTC is given at the exchange rate prevalent
on the last date of the preceding month in which the tax has been paid]

          FTC for Capital Gains

          Capital gains of 5000 @ Rs. 82/-    = Rs. 4,10,000/-

          [Exchange rate as on the last date of
the previous month i.e. as on 28th February 2017 as per Rule 115(f)]

          Indian Income tax @ 20%              (assumed)                                =
Rs. 88,000/-

          FTC on 500 @ Rs. 82/-                                                     =
Rs. 41,000/-

          [Exchange rate as on the last date of
the previous month i.e. as on 28th February 2017 as per Rule 128(5)]

5.0    Summation

FTCR has resolved many issues such as the rate
of exchange of FTC, the timing mismatch of two jurisdictions, credit in respect
of disputed foreign tax, loss situation etc. This will help in better
administration, clarity in claiming FTC and reduction in litigation.

11 Section 92B of the Act – Providing corporate guarantee in respect of loans taken by AE does not constitute international transaction; amendment to section 92B relating to international transaction of issuance of corporate guarantee applies prospectively from FY 2012-13. Transfer of funds with intention to make investment cannot be treated as international transaction especially where shares are allotted against such advances.

[2017] 86 taxmann.com 254 (Hyderabad Trib.)

Bartronics
India Ltd. vs. DCIT

A.Y: 2012-13                                                                      

Date of Order:
27th September, 2017

Section 92B of
the Act – Providing corporate guarantee in respect of loans taken by AE does
not constitute international transaction; amendment to section 92B relating to
international transaction of issuance of corporate guarantee applies
prospectively from FY 2012-13. Transfer of funds with intention to make
investment cannot be treated as international transaction especially where
shares are allotted against such advances.


FACTS

The Taxpayer,
an Indian company provided a corporate guarantee in respect of the borrowings
of one of its overseas associated enterprises (AEs) without charging any
guarantee fee. Further, the Taxpayer had provided certain interest free
advances to its AE. Such advances were recorded in the books of the Taxpayer as
loans.

The Taxpayer
contended that the furnishing of corporate guarantee is not an international
transaction for the reason that the amendment by Finance Act 2012 which
included corporate guarantee within the definition of “international
transaction” is prospective in nature and does not apply to the year under
consideration.

Further, the
advances were provided out of business expediency as an investment and/or as a
parental support to the AE from taxpayer’s surplus/owned funds; without
incurring any costs. Hence, they should not be treated as international
transaction. In any case, since AE had allotted shares against advances
provided by the Taxpayer in the subsequent assessment year, they could not be
treated as international transaction.

During the
course of assessment proceedings, Transfer Pricing Officer (TPO), imputed
corporate guarantee fee and interest on advances in the hands of the Taxpayer.
Aggrieved by the order of TPO, Taxpayer appealed before the DRP. DRP confirmed
the action of the TPO.

Aggrieved by
the order of DRP, Taxpayer appealed before the Tribunal.

HELD

–  Although
the definition of “international transaction” was amended by FA 2012, to
include corporate guarantee within its ambit with retrospective effect, such
amendment has to be treated as effective from FY 2012-13.

–   Although
different views have been taken by different Tribunals on the prospective
applicability of the FA 2012 amendment, Taxpayer can adopt a view which is
favourable to him until a contrary view is taken by a higher court. Reliance in
this regard was placed on the decision of Dr. Reddy Laboratories [2017] 81
taxmann.com 398 (Hyd. Trib). Thus, corporate guarantee granted by the Taxpayer
prior to FY 2012-13 did not qualify as an “international transaction”.

–   Though the
advances were classified in the books of the Taxpayer as “advances”, what is
relevant is to evaluate the intention of providing the advances. Mere
classification of transaction as loans and advances in the balance sheet did
not qualify them as loan.

–   Taxpayer
had transferred the funds with the intention of investing in its AE. In fact,
shares were allotted by the AE against such advances. Thus, granting of such
advances could not be treated as international transaction. Reliance was placed
on KAR Therapeutics & Estates (P.) Ltd. [IT Appeal No. 86 (Hyd.) of 2016].
Thus, ALP adjusted in this regard was also not warranted.

Payments To non-residents law and procedure (Withholding Tax provisions under section 195 of the act)

The
subject of “withholding tax provisions (TDS) from payments made to
non-residents” is always mired in controversies.  Being 
part  of  the 
International  Tax Law, the
subject is dynamic. It is a complex subject as it involves computation of
income in the hands of non- residents. Provisions are very harsh and fraught
with severe penalties. Therefore, an attempt has been made in this write-up to
explain the law and procedure of various aspects of withholding taxes from the
payments made to non-residents, in brief, in the simple format of questions and
answers.

1.0  Introduction

Section
195 of the income-tax act, 1961 (the “act”) contains the provisions to deduct
tax at source (worldwide it is popularly known as “Withholding  tax”) from any payment made to a
non-resident.

Section
195(1) provides that, “any person responsible for paying to a non-resident not
being a company, or to a foreign company, any interest (not being interest
referred to in section 194LB  or section
194LC) or section 194LD or any other sum chargeable under the provisions of the
act (not being income chargeable under the head “salaries”) shall, at the time
of credit of such income to the account of the payee or at the time of payment
thereof in cash or by the issue of a cheque or draft or by any other mode,
whichever is earlier, deduct income-tax thereon at the rates in force. ….”

The
dissection of the above provision reveals that—

(i)  The obligation to deduct tax at source is
cast on every person making payment, be it individual, company, partnership
firm, government or a public sector bank etc. The term ’person’ as defined in
section 2(31) of the act is relevant here.

 (ii)  
The payee may be any type of entity (i.e. individual, company etc.).

(iii)  The payee must be a non-resident under the
act.

(iv)  The payment may be for interest other than
following types of interest:

(a)
Section 194LB – interest from infrastructure debt fund; or

(b)
Section  194LC   – 
interest  income  from 
Indian company before 1st July 2017;

(c)
Section 194LD – interest on certain bonds and government securities.

[In
all above types of interest payments the rate of TDS is 5 %.]

(v)   Payment of salaries is not covered by
section 195 of the act.

(vi)  Tax deduction has to be made at the time of
credit or payment of the sum to the non-resident, whichever is earlier.

(vii)
There is no threshold for deduction of tax at source. It therefore means
payment of even one rupee to a non-resident would attract TDS provisions.

In
the backdrop of above basic provisions, let us proceed to understand in detail
the law and procedure to comply with the provisions of withholding tax at
source u/s 195 of the act.

2.0   Questions and
answers

2.1     What kind of
payments to non-residents would attract withholding tax provisions under the
act? Is there any threshold exemption for deduction of tax at source?

Ans:  Section 195 casts an obligation on the person
who is making any payment to a non-resident to deduct tax at source. The
sweeping language of the section brings almost every payment, made to a
non-resident, which is chargeable to tax, within its ambit. The exclusions here
are in respect of payment of certain types of interest on borrowings (refer
para 1 herein above) and salaries. Section 192 of the act deals with TDS
provisions relating to salary paid to a non-resident, which is chargeable to
tax in India.

There
is no threshold exemption from obligation to deduct tax u/s 195. However, tax
is deductible only if income is chargeable to tax in the hands of  a non-resident and not otherwise.

The
crux of the provisions of section 195 is that the income in the hands of the
recipient must be chargeable to tax. Thus, 
if any income is exempt in the hands of the non-resident, the resident
making payment to such a non-resident need not deduct tax at source u/s 195.
(CBDT Circular no.  786 dated 7th
February, 2000 has clarified this issue).

The  hon’ble Supreme Court in the case of
Transmission Corporation of A.P. Ltd and Another vs. CIT (1999) 239 ITR 587
(SC) has held that the scheme of sub-sections (1), (2) and (3) of section 195
and section 197 leaves no doubt that the expression “any other sum chargeable
under the provisions of this act” would mean “sum” on which income-tax is
leviable. In other words, the said sum is chargeable to tax and could be
assessed to tax under the act. The consideration would be whether payment of
the sum to the non-resident is chargeable to tax under the provisions of the
act or not. That sum may be income or income hidden or otherwise embedded
therein. the  scheme of tax deduction at
source applies not only to the amount paid which wholly bears “income”
character such as salaries, dividend, interest on securities, etc., but also to
gross sums, the whole of which may not be income or profits of the recipient.”

in
this regard, it is important to note that in the subsequent decision in the
case of Ge India technology  (P) ltd (327
itr 456)(SC), the SC has dealt with the above aspect and other aspects relating
to section 195 in detail and has made important observations as follows:

 “7. ……. The most important expression in
section 195(1) consists of the words “chargeable under the provisions of the
act”. A person paying interest or any other sum to a non-resident is not liable
to deduct tax if such sum is not chargeable to tax under the income-tax act.
For instance, where there is no obligation on the part of the payer and no
right to receive the sum by the recipient and that the payment does not arise
out of any contract or obligation between the payer and the recipient but is
made voluntarily, such payments cannot be regarded  as 
income  under  the  income-tax
act. It may be noted that section 195 contemplates not  merely 
amounts,  the  whole 
of  which  are pure income payments, it also covers
composite payments which has an element of income embedded or incorporated in
them. Thus,  where an amount is payable
to a non-resident, the payer is under an obligation to deduct TAS  in respect of such composite payments. The
obligation to deduct TAS is, however, limited to the appropriate proportion of
income chargeable under the act forming part of the gross sum of money payable
to the non-resident. This obligation being limited to the appropriate
proportion of income flows from the words used in section 195(1), namely,
“chargeable under the provisions of the act”. It is for this reason that  vide 
Circular  no.   728 
dated  30-10-1995 that the CBDT
has clarified that the tax deductor can take into consideration the effect of
DTAA in respect of payment of royalties and technical fees while deducting
TAS….

….
While deciding the scope of section 195(2) it is important to note that the tax
which is required to be deducted at source is deductible only out of the
chargeable sum. this  is the underlying
principle of section 195. hence, apart from section 9(1), sections 4, 5, 9, 90
and 91 as well as the provisions of DTAA are also relevant, while applying tax
deduction at source provisions. reference to ito(tdS) u/s. 195(2) or 195(3)
either by the non­ resident or by the resident payer is to avoid any future
hassles for both resident as well as non­ resident. in our view, section 195(2)
and 195(3) are safeguards. the  said
provisions are of practical importance. this 
reasoning of ours is based on the decision of this Court in transmission
Corpn. of A.P. ltd.’s  case (supra) in
which this Court has observed that the provision of section 195(2) is a
Safeguard. from  this it follows that
where a person responsible for deduction is fairly certain then he can make his
own determination as to whether the tax was deductible at source and, if so,
what should be the amount thereof.”

8.
If the contention of the department that the moment there is remittance the
obligation to deduct TAS arises is to be accepted then we are obliterating the
words “chargeable under the provisions of the act” in section 195(1). The said expression
in section 195(1) shows that the remittance has got to be of a trading receipt,
the whole or part of which is liable to tax in India. The payer is bound to
deduct TAS only if the tax is assessable in India. If tax is not so assessable,
there is no question of TAS being deducted. [See : Vijay Ship Breaking Corpn.
vs. CIT [2009] 314 ITR 309 (SC)].

Applicability  
of   the   judgment  
in   the   case  
of Transmission Corporation (supra)

10.
In transmission Corpn. of A.P. ltd.’s case (supra) ‘a non-resident had entered
into a composite contract with the resident party making the payments. The said
composite contract not only comprised supply of plant, machinery and equipment
in India, but also comprised the installation and commissioning of the same in
India. It was admitted that the erection and 
commissioning  of  plant 
and  machinery  in India gave rise to income-taxable in
India. it was, therefore, clear even to the payer that payments required to be
made by him to the non-resident included an element of income which was
exigible to tax in India. The only issue raised in that case was whetherTDS was
applicable only to pure income payments and not to composite payments which had
an element of income embedded or incorporated in them. The controversy before
us in this batch of cases is, therefore, quite different. In transmission
Corpn. of A.P. ltd.’s  case (supra) it
was held that TAS was liable to be deducted by the payer on the gross amount if
such payment included in it an amount which was exigible to tax in India. it
was held that if the payer wanted to deduct TAS 
not on the gross amount but on the lesser amount, on the footing that
only a portion of the payment made represented “income chargeable to tax in
India”, then it was necessary for him to make an application u/s. 195(2) of the
act to the ito(tdS) and obtain his permission for deducting TAS at lesser
amount. Thus,  it was held by this Court
that if the payer had a doubt as to the amount to be deducted as TAS he could
approach the ito(tdS) to compute the amount which was liable to be deducted at
source. In our view, section 195(2) is based on the “principle of
proportionality”. The said sub-section gets attracted only in cases where the
payment made is a composite payment in which a certain proportion of payment
has an element of “income” chargeable to tax in India. it is in this context
that the Supreme Court stated, “if no such application is filed, income-tax on
such sum is to be deducted and it is the statutory obligation of the person responsible
for paying such ‘sum’ to deduct tax thereon before making payment. He has to
discharge the obligation to tdS”. if one reads the observation of the Supreme
Court, the words “such sum” clearly indicate that the observation refers to a
case of composite payment where the payer has a doubt regarding the inclusion
of an amount in such payment which is exigible to tax in India. in our view,
the above observations of this Court in transmission  Corpn. of A.P. ltd.’s  case (supra) which is put in italics has been
completely, with  respect,  misunderstood 
by  the  Karnataka high  Court to mean that it is not open for the
payer to contend that if the amount paid by him to the non-resident is not at
all “chargeable to tax in India”, then no TAS is required to be deducted from
such payment. This interpretation of the high Court completely loses sight of
the plain words of section 195(1) which in clear terms lays down that tax at
source is deductible only from “sums chargeable” under the provisions of the income-
tax act, i.e., chargeable under sections 4, 5 and 9 of the income-tax act.”

Thus,  there is no need to deduct tax at source in
respect of all incomes, which are exempt and/or not taxable under the act.

An
illustrative list of income under the act, which is exempt in the hands of
non-residents, is as follows:

(i)   Section 10(4) – interest on NRE account and
notified securities;

(ii)  Section 
10(6BB)  tax  paid 
on  behalf  of  the
non-resident by an Indian Company which is engaged in the business of operation
of aircraft;

(iii)
Section 10(6C) – income by way of royalty or fees arising to a foreign company
in respect of projects connected with security of India;

(iv)
Section  10(8a)  and 
(8B)  —  income 
of  a consultant/individual         out   
of   funds   made available to an international
organization under a technical assistance grant between the agency and the
government of a foreign State/ Government of India;

(v)
Section 10(15)(iv) etc. – income by way of interest and

(vi)
Section 10(15a) – any payment made by an Indian company engaged in the business
of operation of aircraft, to acquire aircraft or an aircraft engine on lease
from the Government of a foreign State or a foreign enterprise.

(vii)
amounts not liable to tax as per the provisions of the respective DTAAs.

Besides
the above income, if any other income of a non-resident is exempt from tax in
India, then there is no necessity to deduct tax at source by the payer.

2.2     Who has to
deduct tax at source u/s. 195 of the act?

Ans:  Section 195 casts an obligation on the person
who is making any payment to a non-resident to deduct tax at source. The only
condition is that the sum payable must be chargeable to tax in the hands of the
non-resident. The only exception is payment of salaries and specified interest
income.

2.3   Can a payer
obtain a “lower” or “nil” deduction certificate from the income tax
authorities? if yes, what is the procedure for the same?

Ans: yes, the
payer can make an application to the Assessing Officer to obtain a certificate
for “lower” or “nil” deduction of tax u/s. 195 (2) of the act. No particular
form has been prescribed for making an application and therefore, the payer can
apply on a plain paper or a letterhead giving all facts and supporting
documents justifying its claim for lower deduction or nil deduction of tax.

Alternatively,  the payer or the payee can make an
application for an advance ruling u/s. 245n of the act. The decision given by
the AAR would be binding on the applicant for the transaction for which the
ruling is sought and on the Commissioner and other income tax authorities
subordinate to him in respect of the applicant and the said transaction.

2.4   Can a payee
obtain a “lower” or “nil” deduction certificate from the income tax
authorities? if yes, what is the procedure for the same?

Ans:  a payee can apply to the AO for lower
deduction or NIL deduction certificates if the income received by him is either
not chargeable to tax or chargeable at the lower rate than what is prescribed
for withholding. Such an application can be made either u/s. 195 (3) or 197 of
the act.

Section
195(3) read with rule 29B provides for application by payee only in a case
where the income in the hands of the non-resident is not chargeable to tax in
Indian and therefore the payment is to be made without deduction of tax at
source i.e. nil tax. Whereas, the application is to be made u/s. 197 r.w. rule
28AA where the deduction is to be made at a lower rate or nil rate. Section197
covers provisions for application of certificate for lower or nil deduction for
host of other sections (e.g. from section 192 to 194 lBC)  along with section 195 of the Act.

Rule
28AA and rule 29B prescribes various conditions that a payee must fulfill in
order to be eligible to get a certificate.

2.5 At what rate tax is required to be deducted u/s. 195 of
the act?

2.5.1
income-tax act vs. double taxation avoidance agreement (DTAA)

Clause
(iii) of the section 2 (37A) of the Act specifies the rates in force for the
purposes of deduction of tax at source u/s. 195. Accordingly,  one has to apply the rate/s prescribed in the
finance  act of the relevant year or the
rates specified in a DTAA entered into by the Central Government, whichever  is 
applicable  by  virtue 
of  provisions of section 90 of
the act. In view of provisions of section 90(2) of the act, in case of a
remittance to a country with which a DTAA is in force, the tax should be
deducted at the rate provided in the finance 
act of the relevant year or at the rate provided in the DTAA, whichever
is more beneficial to the assessee. This position has been clarified by the
CBDT vide Circular no.  728, dated 30th
October, 1995. However, the provisions of section 90(4) provide that the relief
or benefit from any agreements or DTAA shall be available to a non resident  assessee 
only  on  obtaining 
from  him, a certificate of his
being a resident in a country outside India (TRC), issued by the government of
that country or specified territory.

2.5.2
CBDT Circular no. 333 dated 2-4-1982

Even
before insertion of section 90(2) reproduced above by the finance  (no. 2) act, 1991, with retrospective effect
from 1-4-1972, the CBDT had clarified vide Circular No. 333 dated 2- 4-1982
that where a specific provision is made in the DTAA, the provisions of the DTAA
will prevail over the general provisions contained in the income-tax act and
where there is no specific provision in the DTAA, it is the basic law i.e. the
provisions of the income-tax act, that will govern the taxation of such income.

The
said circular has been accepted and explained by various judicial authorities.
Hence, if a particular payment to non-resident is subject to deduction of tax
at source under the act, but under the relevant DTAA the same is not chargeable
to tax or taxable at a lower rate in India, then such lower/nil rate shall be
applicable.

2.5.3
Levy of Surcharge and the education Cess

The
rates prescribed under the act are to be increased by the Surcharge @ 2 or 5
per cent for foreign companies (as the case may be) and @ 15 per cent for non-residents
other than a company [12% in case of a co-operative society or firm]. Also,
there will be a further levy of the education Cess (@ 3 per cent on the tax and
surcharge amount.

However,  wherever theTDS rate is applied as prescribed
under a DTAA, then the same would be final and the Surcharge and the Education
Cess would not be applicable. Since DTAAs are agreements between the two
sovereign States, the rate prescribed therein is the maximum rate (i.e. the
upper ceiling), regardless of subsequent imposition of surcharge or cess, etc.

In
CIT vs. Srinivasan (K.) [1972] 83 ITR 346 the Supreme Court held that
income-tax includes surcharge. Therefore, 
the term “income tax” as included in tax treaties include surcharge as
well.

In
the following decisions it has been held that in cases where DTAA benefit
applies,TDS cannot be made at a higher rate in terms of section 206AA of the
act:

—
[2015] Serum Institute of India Ltd (68 Sot 254) (ITAT  Pune)

—
[2015] Infosys BPO ltd (154 itd 816)(ITAT 
Bang)

—
[2016]  Wipro  ltd 
(ITA  Nos.   1544 to 1547/ Bang/2013)(ITAT  Bang)

—
[2016] Bharti Airtel Ltd (67 taxmann.com 223) (ITAT  del)

A
contrary decision was earlier rendered in the case of  [2012] 
Bosch  ltd.   (141 
ITD 38)(ITAT  Bang).

2.5.4    Specific Rates prescribed in certain
Sections of the act

2.5.4.1
Section 115A of the act

The
CBDT has, in the context of section 115A [which prescribes special rates of tax
on dividends, interest, income from mutual funds, royalty and fees for
technical services payable to a non-resident (not being a company) or a foreign
company] clarified vide Circular no. 740 dated 17th  April, 1996 that if the DTAA provides for a
lower rate of taxation, the same would be applicable.

2.5.4.2
Presumptive rates of taxes

The  ratio of the above Circular would equally
apply to other special provisions applicable to non-resident such as provisions
contained in sections 44B (Special provisions for computing profits and gains
of shipping business in case of non-residents), 44BBA (Special provisions for
computing profits and gains in connection with the business of operation of
aircraft in case of non-residents), 44BBB (Special provisions for computing
profits and gains of foreign companies engaged 
in  the  business 
of  civil  construction, etc., in certain turnkey power
projects), etc.

Section
44BB prescribes a presumptive rate of 10% in respect of profits and gains in
connection with the business of exploration etc., of mineral oils.
However,  such presumptive rate would not
be applicable, if such income is otherwise covered by section 44D (i.e. Payment
of royalty and FTS  prior to 1-04-2003)
or section 115A (Payment of interest, dividends, royalties or FTS ). [ABC, in
re 234 ITR 37 (AAR)].

Following
the ratio of SC decision in the case of GE India Technology Centre (P.)
Ltd.  (supra), the ITAT  in the case of Frontier Offshore Exploration
(India)  Ltd.  vs. 
DCIT  [2011]  10 
taxmann.com 250 (Chennai) relating to payment to a non­ resident engaged
in the business of prospecting / exploration etc. of mineral oil, covered u/s
44BB of the act, held that obligation to deductTDS is limited to the
appropriate portion of income chargeable to tax.

2.5.4.3 Section 206AA of the act

This
section provides for furnishing of Permanent account number (Pan)  by any person who is entitled to receive any
sum/ income/amount on which tax is to be deducted under Chapter XVII-B  of the income tax act (includes section 195)
to the person responsible for deducting such tax, failing which tax shall be
deducted at higher of any of the following rates;

a)  The rate specified in the relevant provision
of the act,

b)  The rate or rates in force,

c)  The rate of twenty Five Percent.

However,
CBDT has notified a new Rule 37BC in the Income Tax Rules, 1962 vide
Notification no. 53/2016 dated 24th June, 
2016 providing a relaxation from deduction of tax at a higher rate u/s.
206AA in respect of certain payments. The provisions of section 206AA shall not
apply in cases where the deductee does not have a Pan and the payment made to him
is in the nature of interest, royalty, fees for technical services or payments
on transfer of any capital asset and the deductee furnishes the following
details and documents to the deductor:

(i)  Name, E-mail id, contact number;

(ii)
Address  in  the  country  or 
specified  territory outside India
of which the deductee is a resident;

(iii)
A certificate of his being resident in any country or specified territory
outside India from the Government of that country or specified territory if the
law of that country or specified territory provides for issuance of such
certificate;

(iv)
Tax Identification Number of the deductee in the country or specified territory
of his residence and in case no such number is available, then a unique number
on the basis of which the deductee is identified by the Government of that
country or the specified territory of which he claims to be a resident.

2.5.5   No TDS from
payments to foreign shipping companies or agents

The  CBDT, vide Circular no. 723 dated 19th September,
1995 had clarified that there would be no overlapping of section 172 which
provides for recovery of tax from foreign shipping companies and section 194C
& section 195, where payments are made to shipping agents of non-resident
ship owners or charterers of carriage of passengers, etc. shipped at a port in
India. The agent acts on behalf of the non­ resident ship owner or charterers
and therefore he steps into shoes of the principal and accordingly, the
provisions of section 172 shall apply and those of section 194C & 195 will
not apply. Therefore,  a resident making
payment of freight to the foreign shipping companies or their agents will not
be required to deduct TDS u/s. 195 or 194C.

2.6 What is the procedure of claiming tax treaty
benefit  while  remitting 
sum  u/s.  195  of
the act?

Ans:   Sections 90(4) and 90(5) were inserted by
the Finance Act  2012  and 
2013  respectively  to provide that any non-resident assessee who
seeks to obtain the benefit of the relevant DTAA applicable, shall avail so
only if he presents a Tax Residency Certificate (TRC) of the country of which
he is a resident for tax purposes as well 
as  any  other 
prescribed  particulars  as may be notified. Further, by Notification
No. 39/ f.no.142 /13/2012, rule 21AB was inserted which prescribes the
necessary particulars to be submitted along with the TRC u/s. 90(5) for  claiming 
treaty  benefits.  This 
includes  a self declaration by
the assessee in form 10F and it shall contain the Status, nationality, tax
Identification Number of the assessee in the country of which he claims to be a
resident, address of the assessee in that country and the period of residential
status of the assessee as mentioned in the TRC. however,  the Non­ resident shall not be required to
submit form 10F   if  the 
TRC already  contains  all 
such information as specified in form 10F.

2.7 What is the procedure to comply with the provisions of
WHT u/s. 195 of the act?

Section
195(6) of the income-tax act, 1961 provides that a person responsible for paying
any sum to a non-resident shall furnish such information as may be prescribed
under rule 37BB. The said rule 37BB provides that form no. 15CA and/or
form  no. 15CB shall be furnished for the
purpose of payment to a non-resident. Form No. 15CA is to be filed and
submitted online by  the  deductor 
i.e.  payer  and 
form 15CB is to be issued by the practicing Chartered accountant (C.A).
However, form 15CA is required to be filed only when the transaction falls
under reportable category irrespective of chargeability of tax. Form 15CA
contains four parts, A, B, C and D. When a transaction does fall into
reportable category and amount chargeable to tax does not exceed Rs. five lakh,
then part A of the form needs to be filed. But if it is taxable, one needs to
check the amount of the transaction.

If
the  transaction  value 
(payment  to  non­ resident) exceeds Rs. 5 lakh,

(a)
Part B of Form No.15CA needs to be filed after obtaining,­

(i)  A 
certificate  from  the 
Assessing  Officer u/s. 197; or

(ii)
An order from the Assessing Officer under sub-section (2) or sub-section (3) of
section 195;

Or

(b)
Part  C 
of  form   no.15CA 
after  obtaining  a certificate in Form No. 15CB from a
Chartered accountant.

Whereas,
if the transaction is below Rs. 5 lakh, only Part A of form 15CA needs to be
filed. The limit of Rs. 5 lakh is, however, not a threshold limit for
chargeability of tax or deduction of tax at source. In other words, even if
there is an exemption from submission of form 
15CB, the payer needs to deduct tax at source and deposit it with the
Government.

2.8 What are the consequences of failure to deduct tax at
source u/s. 195 of the act?

Ans:  There  
are severe consequences  for  failure 
to deduct tax at source while making payment to a non-resident. Besides
attracting levy of interest and penalty, such payments will not be allowed as
deduction in the hands of the payer while computing the profits and gains from
business and profession under the act [refer provisions of section 40(a)(i)].
Moreover, the payer may be regarded as an ‘agent’ of the non-resident u/s.163
of the act and the tax may be recovered from him. Thus,  one needs to be extremely careful in applying
provisions of the act for deduction of tax at source, from payments made to
non-residents.

Looking
at the serious repercussions of non- deduction of tax at source as a payer one
must always take a conservative view and deduct tax at source.

3.0 Some typical payments to non-residents which attracts
TDS provisions

In
following table some typical payments which are of practical importance are
covered. The idea is to give a bird’s eye view only and not a detailed or
reasoned analysis of provisions or taxability.

Some
Typical Payments to Non-Residents

Relevant
sections under the IT act

Relevant
Articles of a DTAA

Taxability
under the Act (TDS)

Withholding
Tax rate under a DTAA

 

Remarks

Interest from government or an
Indian concern on moneys borrowed or debt incurred by them in foreign
currency.

 

Sec. 115A

 

Article 11

 

20%

 

10%/15%

 

WTH rate differs from treaty to treaty.

Interest on bonds of an Indian
company issued in accordance with such scheme as the Central
Government notifies

 

Sec. 115AC

 

Article 11

 

10%

 

10%/15&

Interest on Infrastructure Debt Fund

Sec. 115A & 194LB

Article 11

5%

10%/15%

It is better to take shelter under the
domestic tax laws rather than DTAAs.

Certain income from units of a business
trust to non-resident 

Sec. 194LBA

Article 11

5%

10%/15%

Interest by an Indian Company or a
business trust in respect of money borrowed in foreign currency under a loan
agreement or by way of issue of long-term bonds

 

Sec. 115A & 194LC

 

Article 11

 

5%

 

10%/15%

Interest on rupee denominated bond of
an Indian Company or Government securities to a FII or a QFI

 

Sec. 115A & 194LD

 

Article 11

 

5%

 

10%/15%

Dividend u/s 115-O

Sec. 9(1)(iv) & 115A

Article 10

NIL

10%/15%

 

Dividend (other than u/s 115-O)

 

Sec. 9(1)(iv) & 115A

 

Article 10

 

20%

 

10%/15%

WTH rate differs from treaty-to-treaty

Purchase Consideration for immovable property (LTCG)

 

Sec. 45 & 195

 

Article 13

 

20%

No rates are prescribed as normally
taxed as per the domestic tax laws of both the countries.

Taxed per the domestic tax laws of both
countries.

 

Rent

 

Sec. 22 to

Sec. 27

 

Article 6

 

30%

 

Taxed in the country of source. No rate
is prescribed.

Taxed per the domestic tax laws of
country of source.

Commission on Imports

Sec. 9(1)(i)

Article 12

30%

10%/15%

WTH rate differs from treaty-to-treaty

Commission on exports

Sec. 9(1)(i)

N.A

Not taxable as Indian Income

N.A

Income does not accrue or arise in
India

4.0 Conclusion

The
subject of withholding tax from payments to non­ resident is faced with many challenges.
The Government’s intention is to protect the tax base of India and collect
revenue from the non-residents at source as it is difficult to catch them once
they are gone or money is transferred to them. As a payer one has to take
conservative view and deduct tax at source as far as possible. Failure to do so
may not only make him an assessee in default, but could also make him a
representative assessee u/s. 164 of the act and the tax may be recovered from
him. Other penal provisions may also follow. Therefore,  it is always advisable to obtain a lower
deduction certificate from the Assessing Officer or go for an advance ruling.

5. [2017] 79 taxmann.com 199 (Bangalore – Trib.) Flughafen Zurich AG vs. DDIT A.Ys.: 2007-08 to 2009-10 and 2011-12 Date of Order: 10th March, 2017

Article 12, India-Switzerland DTAA; Section 9(1)(vii), the Act  – Where foreign company seconding highly qualified skilled managerial personnel to Indian company was obligated to pay them remuneration outside India, and the purpose was to avail managerial services, the amount received from Indian company was FTS under DTAA as well as the Act.

FACTS
The Taxpayer was a company incorporated in, and tax resident of, Switzerland. It was engaged in providing operations and management services to airports. It had, inter alia, entered into Expatriate Remuneration Reimbursement Agreement (“the Agreement”) with an Indian airport operator company (“I Co”) for secondment of skill personnel.

The Taxpayer claimed that since I Co had the right to issue directions to the seconded employees, they had worked under the direct control and supervision of I Co. Thus, they satisfied employee-employer relationship test. Consequently, payment of salary to them, even though routed through the Taxpayer, could not be considered as Fees for Technical Services (‘FTS’).

The AO held that the payment received by the Taxpayer from I Co was chargeable to tax as FTS under section 9(1)(vii) as well as India-Switzerland DTAA.

Before the Tribunal, the Taxpayer contended that:
–    the purpose of secondment was to assign the employees to exclusively work full time for I Co;

–    therefore there was employer-employee relationship between I Co and the seconded employees;

–    the parties had understood and agreed that by assignment of assignees the Taxpayer shall not be considered to have rendered any services whatsoever to I Co;

–    the Taxpayer shall not be held responsible for any act or omission of the assignees during the assignment with I Co;

–    the parties had also understood and agreed that in addition to remuneration paid to the assignees directly by the I Co in India, the assignees would be entitled to remuneration payable by the Taxpayer outside India;

–    documents between the Taxpayer and assignee and between I Co and assignees showed that the assignees too had accepted the terms of the Agreement; and

–    hence, the payment by I Co was merely reimbursement of salary paid by the Taxpayer to the assignees in foreign currency outside India.

The Taxpayer further contended that in Centrica India Offshore Pvt. Ltd. vs. DCIT [364 ITR 336 (Del)]11, seconded employees came to India on deputation for a short period whereas in its case the term of assignment varies from one year to several years and hence, its facts were distinguishable from the said decision.

The tax authority contended that the fact that despite the secondment the Taxpayer was under obligated to pay the assignees outside India showed that employee-employer relationship between assignees and the Taxpayer had not ceased and employee-employer relationship between assignees and I Co did not exist.

HELD
–    Secondees were under the employment with the Taxpayer. Therefore, it was not employment or recruitment by I Co.

–    Secondment was as per the requirement of I Co and in respect of the existing employees of the Taxpayer.

–    All the assignees/secondees were holding high managerial position such as CEO and CCO showing that they had expertise. Therefore, the purpose was to avail the services of highly qualified experts.  

–    In Intel Corporation vs. DDIT [IT(TP)A No.1486/Bang/2013], the Tribunal had considered identical issue. There was no material variation in the terms and conditions of the secondment in the case of the Taxpayer and those in the cases considered by the Tribunal in the said decision and in Food World Supermarkets Ltd. vs. DDIT [174 TTJ 859].

–    Further, there is no significant difference between the definition and the language in Explanation 2 to section 9(1)(vii) and that of FTS in Article 12(4) of India-Switzerland DTAA. Once a payment is for managerial service then it is irrelevant to examine the aspect of provision of service by technical or other personnel. Accordingly, there are no distinguishing facts or circumstances which warrant taking a different view.

4. [2017] 77 taxmann.com 267 (Mumbai – Trib) Qad Europe B V vs. DDIT A.Ys.: 1998-99 & 1999-2000, Date of Order: 21st December, 2016

Article 12, India-Netherlands DTAA; Section 9, the Act  – Since software license issued by Dutch company to Indian customer did not permit ‘adaptation’ as defined in Copyright Act, 1957, payment made by Indian customer was not towards ‘use’ of copyright; hence, it was not ‘royalty’ under DTAA.  

FACTS
The Taxpayer was a company incorporated in Netherlands. It was also a tax resident of Netherlands. The Taxpayer entered into software license agreement with an Indian company (“I Co”). The principal terms and conditions of the said agreement were as follows.

–    The Taxpayer had granted non-exclusive, non-transferable, license for perpetual use on one hardware system which may include up to four servers.

–    I Co did not acquire any copyright in the product.

–    The software was for exclusive use of I Co for the purpose of its own business. I Co was not permitted to exploit it commercially or to assign, transfer or sublicense it.

–    While I Co was permitted to modify source code, it was not permitted to modify object code10.
–    Only the Taxpayer had modification rights of software.

In light of the aforementioned terms and conditions, the Taxpayer treated income arising from the said transaction as its business income. Since it did not have any PE in India, it did not offer the income to tax in India.

According to the AO, the payment received by the Taxpayer on account of sale of software to I Co was ‘Royalty’ and, therefore, it was taxable in India in the hands of the Taxpayer u/s. 9(1)(vi) of the Act.

HELD
–    The Taxpayer had enabled I Co to change source code so as to make the product compatible to the local laws and regulations. The said change in the source code could not be operational till the object code was modified by the Taxpayer. Hence, the limited right of modification qua the source code granted to I Co cannot be viewed adversely.

–    The computer program was governed by The Copyright Act, 1957. I Co was not permitted to do any act referred to in section 14 of the Copyright Act, 1957. Thus, the Taxpayer had not granted any copyright to I Co.

–    Analysis and comparison of various provisions of the Copyright Act with the relevant clauses of the said agreement showed that the said agreement did not permit I Co to carry out any alteration or conversion of any nature, so as to fall within the definition of ‘adaptation’ as defined in Copyright Act, 1957. The right given to the customer for reproduction was only for the limited purpose so as to make it usable for all the offices of I Co in India and no right was given to I Co for commercial exploitation of the same.

–    It is also noted that the terms of the agreement did not allow or authorise I Co to do any of the acts covered by the definition of ‘copyright’. Hence, the payment made by I Co could not be construed as payment made towards ‘use’ of copyright as contemplated under the provisions of the Act and DTAA when read together with the provisions of the Copyright Act, 1957.

–    DTAAs of certain countries (such as, Malaysia, Romania, Kazakhstan and Morocco) specifically include software payment within the definition of ‘Royalty’. However India-Netherlands DTAA does not include software payment while defining ‘Royalty’. Hence, payment received by the Taxpayer on account of sale of software, could not be characterised
as ‘Royalty’.

–    I Co had made payment for use of the software and not the ‘process’ involved in it. Since the definition in article 12(4) of India-Netherlands DTAA did not include consideration for the use or right to use ‘computer programme’ or ‘software’, the same could not be imported into it. Perusal of clauses of the Master Agreement showed that the customer had paid consideration for ‘use of computer software’ and not for ‘copyright of the computer software’. India-Netherlands DTAA treats consideration for the use of copyright of a laboratory or artistic work, etc. as ‘Royalty’. Hence, there is no question of including consideration for use of a laboratory or artistic work, etc. within the ambit of ‘Royalty’ as defined in article 12(4) of the DTAA.

–    Consideration for sale of software should be covered in Explanation 4 to section 9(1)(vi) and accordingly taxable as such. However, since no corresponding amendment is made to India-Netherlands DTAA, the Taxpayer can choose more beneficial provision, i.e., DTAA.

–    Since the payment received by the Taxpayer is in the nature of business profits, it is assessable under Article 7 of India-Netherlands DTAA and not under article 12.

3. [2017] 78 taxmann.com 109 (Mumbai – Trib.) Valentine Maritime (Gulf) LLC vs. ADIT A.Y.: 2007-08, Date of Order: 18th January, 2017

Section 44BB, the Act – Since section 44BB of the Act does not envisage only direct use of the plant and machinery in the prospecting for or extraction or production of mineral oils, hire charges for hiring of barge used for offshore accommodation were also subject to taxation u/s. 44BB.

FACTS    
The taxpayer was a foreign company incorporated in UAE. It was engaged in oil and gas construction industry. During the relevant year, the taxpayer earned income from hiring of two tug boats to Indian companies and earned hire charges from them. The tug boats were used by the hirer in Bombay High offshore field for oil platform related work. The barge was used by the hirer for offshore accommodation/construction activities and was not directly involved in connection with prospecting of oil. In its return of income the taxpayer claimed that the hire charges of two tug boats and the barge were exempt in terms of Article 7 read with Article 5 of India-UAE DTAA.
The AO concluded that in terms of Article 1, read with Article 4, of India-UAE DTAA the Taxpayer was not a resident of UAE. Therefore, it did not qualify for benefit under India-UAE DTAA.

As an alternate contention, the Taxpayer claimed that hire charges should be subject to taxation in accordance with section 44BB of the Act. The AO rejected the alternate contention on the ground that the Taxpayer had not proved that the vessels were used for the purpose of prospecting of or extraction or production of mineral oils. Accordingly, the AO held that the earnings were in the nature of royalty in terms of section 9(1)(vi) of the Act and levied taxed accordingly.

In appeal, the CIT(A) held that the tugs were actually used by the hirer in connection with prospecting for or extraction or production of mineral oils. He further held that the barge was used for offshore accommodation/construction activities and was not directly involved in connection with prospecting of mineral oil. Accordingly, he held that the income from hiring of barge was in the nature of royalty.

HELD
–    Insofar as the tug boats are concerned, they have been used in connection with prospecting for or extraction or production of mineral oils.
–    In Lloyd Helicopters International Pty Ltd. vs. CIT [2001] 249 ITR 162 (AAR), AAR has held that even the income derived from providing of helicopter services to facilitate operation of extraction and production of mineral oil was taxable in accordance with section 44BB of the Act.

–    Following the ruling of AAR, and the phraseology of section 44BB, even the earnings from hiring of barge were eligible for taxation u/s. 44BB.

2. [2017] 78 taxmann.com 240 (Mumbai – Trib.) APL Co. Pte Ltd. vs. ADIT A.Y.: 2008-09, Date of Order:16th February, 2017

Article 8, 24, India – Singapore DTAA – As both the conditions for invoking of Article 24 were not fulfilled, benefit of Article 8 of India-Singapore DTAA in respect of shipping income derived from India could not be denied.

FACTS
The Taxpayer was a company incorporated in, and tax resident of, Singapore. It was engaged in operation of ships in international waters, mainly for transportation of cargo and containers globally. Inter alia, the Taxpayer also carried cargo to and from India. The Taxpayer had a wholly owned subsidiary in India which was acting as its shipping agent in India. The Taxpayer claimed that in term of Article 8 of India-Singapore DTAA, its gross freight earning in India were not chargeable to tax in India.

The AO called for certain documents to verify the claim of the Taxpayer. Out of 136 ships, the Taxpayer could not provide documents in respect of 8 ships. Hence, the AO denied treaty benefits in respect of income from 8 ships. In appeal, invoking limitation of benefits (LOB) provision in Article 24 of India-Singapore DTAA, CIT (A) denied treaty benefits on entire income on the ground that there was no nexus between remittance from India of freight collected in India and the amount that was finally remitted into Singapore, and further that the income was not taxable in Singapore.

HELD
–    Two conditions should be fulfilled to invoke Article 24. Firstly, income should be exempt or taxed at lower rate in source state. Secondly, only the income received in residence state should be taxable.

–    Under Singapore tax law, shipping enterprises are required to furnish statement of income derived from operations of foreign ships in Singapore. The income from shipping operations is treated as ‘accruing in or derived from Singapore’ and taxed on accrual basis. This is also confirmed in the certificate issued by Singapore revenue authority.

–    Use of the term “only” in Article 8 of India-Singapore DTAA shows that shipping income of a Singapore tax resident enterprise is taxable only in Singapore and not in India. Therefore, question of any kind of exemption or reduced rate of taxation in source state does not arise.

–    Accordingly, the condition precedent for invoking Article 24, namely, income should be exempt or taxed at lower rate in source state was not fulfilled. Therefore, Article 24 could not be invoked.

1. [2017] 79 taxmann.com 128 (Delhi – Trib.) Cairn U. K. Holdings Ltd vs. DCIT A.Y. 2007-08, Date of Order: 9th March, 2017

Section 9(1)(i), the Act – Transfer of shares of Jersey company holding shares in Indian company by UK company to another group company was indirect transfer of asset; capital gain arising from such transfer was subject to tax in India

FACTS
The Taxpayer was a tax resident of UK. The Holding Company (Hold Co) of the Taxpayer was acquiring oil and gas assets in India through its subsidiaries. Following is the diagrammatic presentation of the original holding structure.

With a view to simplify the group structure, for better and effective local management and to access capital market, the group effectuated internal reorganisation in a series of transactions in which the Taxpayer was a party.
Briefly, the reorganisation comprised the following transactions.

–    Hold Co entered into share exchange agreement with the Taxpayer and transferred its entire shareholding in nine wholly owned Indian subsidiary companies to the Taxpayer in exchange of issue of shares by the Taxpayer to Hold Co. No capital gain tax was paid on this transaction1.

–    The Taxpayer setup a subsidiary in Jersey (Jersey Co). The Taxpayer entered into share exchange agreement with Jersey Co and transferred its entire shareholding in nine wholly owned Indian subsidiary companies to Jersey Co in exchange of issue of shares by Jersey Co. Jersey Co derived substantial value from assets located in India.

–    Subsequently, the Taxpayer formed another subsidiary in India (I Co). The Taxpayer infused purchased certain shares if I Co for cash consideration. Thereafter, the Taxpayer transferred its entire shareholding in Jersey Co to I Co. I Co paid the consideration partly in cash and partly by issue of shares of I Co. I Co recorded the excess amount over the book value of shares of Jersey Co as goodwill.

–    Subsequently, I Co issued shares by way of IPO of its shares. Post-IPO, the shareholding in I Co was: UK Co ~69% (including ~20% subscribed in cash and ~49% received in exchange of shares of Jersey Co) and public ~31%.

Following is the diagrammatic presentation of the post-reorganisation holding structure.

The AO treated transfer of shares of Jersey Co by the Taxpayer to I Co as indirect transfer of assets in India u/s. 9(1)(i) of the Act and accordingly, assessed capital gains tax in the hands of the Taxpayer.
In appeal before the Tribunal2, the Taxpayer contended as follows.

–    The taxability of the transaction under the indirect transfer provisions should be denied, as the said retroactive amendment is bad in law and ultra vires.

–    The Transactions undertaken by the Taxpayer were for internal reorganisation with a view to consolidate Indian business operations. Such internal reorganisation did not result in any change in controlling interest. Hence, such transaction was non-taxable.

–    The Taxpayer relied on Calcutta HC decision in the case of Kusum products Limited3 to suggest that: post-internal reorganisation no real income accrued to the Taxpayer as all Indian assets were available in different form; and mere accounting entry cannot be regarded as income, unless real income was actually earned.

–    For the purpose of computing capital gain, the cost of acquisition should be stepped up to the fair value of the shares of Jersey Co on the date of acquisition. Further, there was no timing difference between the acquisition and disposal of shares by the Taxpayer, and accordingly the full value of consideration and the cost of acquisition were same.

–    The Taxpayer also relied on Delhi HC decision in New Skies Satellite and contended that the provisions of the Act as were in existence on the date of notification of India-UK DTAA were to be considered and retroactive amendment in relation to indirect transfer provisions was to be ignored.

HELD

On transfer of shares of Jersey Co to I Co

–    Validity of retrospective amendment
    On the contention of non-applicability of indirect transfer provisions, due to the same being retrospective in nature and ultra vires, the Tribunal concluded that it  is not the right forum to challenge validity of provisions of the Act.

–    No change in controlling interest due to internal reorganisation
    The steps undertaken were not mere business reorganisation. It was a fact that the series of transactions culminated into the IPO of I Co from which the funds were used to pay part consideration to the Taxpayer for acquisition of shares of Jersey Co.

–    Property being situated in India
    The Indian WOS, which controls the oil and gas sector in India, will be regarded as the property in which the shareholders have the right to manage and control the business in India. Therefore, any income arising through or from‘ any property in India shall be chargeable to tax as income deemed to accrue or arise in India in terms of the indirect transfer provisions of the Act.

–    No real income accruing in the hands of Taxpayer  
    The audited financial statements of the Taxpayer discussed about disposal of part of the company’s investment and resultant exceptional gains earned upon disposal of shares. Hence, the Taxpayer was not justified in arguing that no real income had accrued.

–    While computing capital gains, cost of acquisition should be stepped up to fair value of Jersey Co.
    Perusal of the provisions of the Act show that the property held by the Taxpayer (i.e., shares of Jersey Co) and its mode of acquisition did not fall under any of the clauses of the Act which required substitution of cost of acquisition in the hands of the previous owner4.
 
    The Tribunal also denied the Taxpayer’s contention on transaction being in the nature of swap and leading to resultant step up in cost of acquisition by stating that in the present case, the price of the shares in each of the agreement is identified and the amount of acquisition recorded in the books of account represents cost of acquisition of share which cannot be substituted by
fair value.

–    Whether ITL provisions  at the time when India-UK DTAA was signed is to be considered
 
    The Tribunal disregarded the argument of the taxpayer and held that:

•    As per the India-UK DTAA, capital gains are taxable as per the domestic law of respective countries. Hence, the provisions in DTAA cannot make the domestic law static when both states have left it to domestic law for taxation of any particular income.

•    Where exemption is provided with retroactive effect under domestic law, non-resident cannot be denied exemption by citing that such law was not in existence at the time DTAA was entered into.

•    DTAA is a mechanism of avoiding multiplicity of taxation globally. If taxes are chargeable in residence state (i.e. UK), the taxpayer should not suffer tax in the source state. The facts indicated that capital gains were not taxable in the residence state. Accordingly, there was no multiplicity of tax being levied.

•    Distinguished the Taxpayer’s reliance on Delhi HC ruling in the case of New Skies Satellite5 which held that amendments made under domestic law cannot be applied to relevant DTAAs.

•    Where the provisions of DTAA simply provide that particular income would be chargeable to tax in accordance with the provisions of domestic laws, such article in DTAA cannot limit the boundaries of domestic tax laws.

On levy of interest

The Tribunal relied upon various judicial precedents6  and agreed with the Taxpayer’s claim that it could not have visualised its liability for payment of advance tax in the year of transaction. Consequently, interest on tax liability arising out of retrospective amendment cannot be levied7. The Taxpayer was also subject to withholding tax. However, based on the SC ruling in the case of Ian Peter Morris vs. ACIT8  and Delhi HC ruling the case of DIT vs. GE Packaged Power Incorporation9, which held that a non-resident cannot be burdened with interest for default of withholding compliance and the fact that liability arises out of a retrospective amendment which could not be foreseen, the Tribunal ruled in favour of the Taxpayer.

Section 92B of the Act – Accretion to brand value, resulting from use of brand name of foreign AE under technology use agreement; since that agreement was accepted as an arrangement at an arm’s length price, an aspect covered by that agreement did not result in a separate international transaction requiring benchmarking.

13. [2017] 81 taxmann.com 5 (Chennai – Trib)

Hyundai Motor India Ltd vs. DCIT

A.Ys.: 2009-10 to 2011-12,

Date of Order: 27th April, 2017

Facts

The Taxpayer was a fully owned subsidiary of a South Korean
automobile company (“FCo”). It was engaged in the business of manufacturing
cars in India. The Taxpayer and FCo had entered into agreement for use of
technology (“the agreement”). Under the agreement, the Taxpayer was mandated to
use the trademark owned by FCo (“the trademark”) on every vehicle manufactured
by it.

According to the TPO, by using the trademark, the Taxpayer
had significantly contributed to its development in Indian market and thereby
FCo had ‘benefited due to brand promotion activity carried out by the
Taxpayer’. Hence, The TPO opined that FCo should have compensated the Taxpayer
with arm’s length amount for the benefit acquired at the cost of the Taxpayer
which was deprived of developing its own brand name and logo.

The TPO took a view that the increase in brand value each
year could be attributed to every vehicle manufactured by all the group
companies. Since sales of the Taxpayer was 18.07 % of the global sales of FCo
group, 18.07% of the global appreciation in the brand value should be
attributed to the Taxpayer. This amount was quantified at Rs. 198.66 crore and
added to ALP of the Taxpayer.

The DRP confirmed the addition.

Held

Whether increase in brand value constitutes ‘international
transaction’? 

–   The TPO has emphasised on the benefit
accruing to FCo from increased brand valuation as a result of the Taxpayer selling
cars in India, and not as a result of conscious brand promotion by the Taxpayer
such as, incurring of advertising, marketing and sales promotion expenses.

–  According to the TPO, the trigger for the
impugned ALP adjustment is not the expense incurred by the Taxpayer, or any
efforts made by the Taxpayer, for brand building for FCo, but the mere fact of
the sale of cars made by the Taxpayer. Though the Taxpayer had not rendered any
services, it should be compensated for the increase in brand valuation, proportionate
to sale of cars by the Taxpayer vis-à-vis the global sale of cars of
that brand, as the increase in the brand valuation is, to that extent, due to
sale of cars by the Taxpayer.

–  The difference is that while AMP is a
conscious effort, brand building by sales simplictor is a subliminal exercise
and by-product of the economic activity of selling the cars in India.

     Whether use of brand name was privilege or
obligation of the Taxpayer?

–   FCo owns a valuable brand name which has
respect and credibility globally including in India. Hence, the use of brand
name owned by FCo is a privilege, a marketing compulsion and of direct and
substantial benefit to the Taxpayer.

Whether mere
use of brand name results in AEs?

–   U/s. 92A(2)(g) of the Act, two enterprises
are deemed to be AEs if “the manufacture or processing of goods or
articles or business carried out by one enterprise is wholly dependent on the
use of know-how, patents, copyrights, trade-marks, licences, franchises or any
other business or commercial rights of similar nature, or any data,
documentation, drawing or specification relating to any patent, invention,
model, design, secret formula or process, of which the other enterprise is the
owner or in respect of which the other enterprise has exclusive rights”.

–   Hence, there can never be a comparable
controlled price for the kind of transaction between the Taxpayer and FCo
because, the moment use of an intangible like brand name is involved, the
entities entering into the transactions will become AEs.

     Whether incidental benefit to AE could be
‘international transaction’?

–   It is a fact that the use of brand name,
owned by FCo, in vehicles manufactured by the Taxpayer does amount to
incidental benefit to the AE of the Taxpayer since increased visibility to the
brand name does contribute to increase in its valuation.

–   In terms of section 92B of the Act, an
international transaction includes a mutual agreement or arrangement between
two or more AEs for the allocation or apportionment of, or any contribution to,
any cost or expense incurred or to be incurred in connection with a benefit,
service or facility provided or to be provided to anyone or more of such
enterprises.

–   This is not a case of allocation of,
apportionment of, or contribution to, any costs or expenses in connection with
a benefit, service or facility. There is no dealing in money in the present
case. Therefore, this limb of the definition is not relevant.

–   In respect of intangible property, only
purchase, sale or lease of intangible property is covered within ‘international
transaction’. However, in this case there is no purchase, sale or lease of
intangibles.

–  Even extended definition in Explanation
(i)(b) to section 92B(2), does not cover accretion to the value of intangibles.
Further, the TPO has also not raised the issue that the consideration paid for
the transactions under this agreement is not an arm’s length consideration.

–     Accretion in brand value due to use in
products of the Taxpayer cannot be treated as service either. A service should
be a conscious activity. A passive exercise cannot be a service. What is
benchmarked is not the accrual of ‘benefit’ but rendition of ‘service’. The
expressions ‘benefit’ and ‘service’ have different connotations, and what is
relevant, is ‘service’ and not the ‘benefit’. In this case, there is no
rendition of service.

–   For determination of arm’s length price, mere
rendition of service is not sufficient; it should be intended to result in such
benefit for which an independent enterprise would pay. Thus, two aspects need
to be present – first, rendition of service and second, benefit accruing from
such service. In the present case, since the first condition is not satisfied,
there is no question of benchmarking the benefit.

–   Unless a transaction affects profits, losses,
income or assets of both the enterprises, it cannot be an ‘international
transaction’. If the assets of one of the enterprises increase unilaterally,
without any active contribution by the other enterprise, such increase in
assets cannot amount to an ‘international transaction’.

–  The Taxpayer has not incurred costs, nor has
it made conscious efforts, for accretion in value of brand owned by FCo. Such
accretion also does not have any impact on profit, losses, income or alteration
in assets of the Taxpayer. Therefore, it cannot result in an ‘international
transaction’ qua the Taxpayer.

– It is not the case of the revenue
that there was any sale, purchase or lease of intangibles. Accretion to brand
value was a result of use of the brand name of foreign AE under the technology
use agreement which permitted as well as bound the Taxpayer to use the brand
name of FCo on the products manufactured by the Taxpayer. Since that agreement
had been accepted to be an arrangement at an arm’s length price, an aspect
covered by that agreement could not be subject matter of yet another
benchmarking exercise. Therefore, such accretion did not result in a separate
international transaction requiring benchmarking.

Sections 9, 172 of the Act; Article 9 of India-Denmark DTAA – since; director of shipping company was resident of Denmark; had been operating business wholly from Denmark; all important decisions were taken in Denmark; tax residency certificate issued by Denmark authorities showed shipping company as resident of Denmark, place of effective management and control of shipping company was in Denmark and accordingly, profits arising from operations of ships in international traffic were not taxable in India.

12. [2017] 80 taxmann.com 217 (Rajkot – Trib)

Pearl Logistics & Ex-IM Corporation vs. ITO

A.Ys. 2010-11 TO 2013-14,

Date of Order: 20th March, 2017

Facts

The Taxpayer was an agent of a Denmark based ship broker
(“DenCo”). DenCo was ‘disponent owner’ and another company (“FCo”) was
charterer of ship which carried cement to ports in India. Freight was payable
by FCo to DenCo.

The Taxpayer filed return of income under section 172(8) and
claimed that since DenCo was beneficiary of freight, it was entitled to benefit
of India- Denmark DTAA. Hence, DenCo was not liable to pay tax on fright in
India.

Held

–   According to section 172, income of owner or
charterer which receives freight is chargeable to tax. In this case, freight is
received by DenCo which has also earned the freight. Hence, income of DenCo is
chargeable to tax in India.

–   As per the tax residency certificate issued
by Danish tax authority, DenCo is resident of Denmark. Hence, DenCo can avail
of the benefit of India-Denmark DTAA.

–   As per article 9 of India-Denmark DTAA,
profits derived from operation of ships in international traffic shall be
taxable only in the State where the ‘place of effective management’ of the
enterprise is situated.

–   The Taxpayer has furnished several documents
showing that: the Director of DenCo was resident of Denmark; he was operating
business wholly from Denmark; all the important decisions were taken in the
meeting in Denmark. Therefore, the place of effective management and control of
DenCo was in Denmark.

–     DenCo was resident of Denmark and its ‘POEM’
was in Denmark. Therefore ‘head and brain’ of DenCo was situated in Denmark.
Accordingly, in terms of article 9 of India-Denmark DTAA, the profits derived
from operation of ship were not taxable in India.

Section 9 of the Act; Article 12 of India-USA DTAA – since professional fee paid to a US company for global biopharmaceutical strategic counselling and advisory services was for rendition of services and not for right to use information concerning industrial, commercial or scientific experience, it was not covered within definition of ‘royalty’ under article 12(3)(a) notwithstanding that in process of availing these services Taxpayer benefited from rich experience of service provider.

11.
[2017] 80 taxmann.com 275 (Ahmedabad – Trib)

Marck Biosciences Ltd. vs. ITO

A.Y.: 2009-10, Date of Order: 28th March, 2017

Facts

The Taxpayer was an Indian company. It paid professional fee
to a US company (“USCo”) for global biopharmaceutical strategic counselling and
advisory services, which comprised (a) business promotion; (b) marketing; (c)
publicity; and (d) financial advisory. In the agreement, the services were
termed as ‘Strategic and Financial Counselling Services”. According to the
Taxpayer, income embedded in professional fee paid for the said services was
not taxable in India in terms of India-USA DTAA. Hence, it did not withhold tax
from the said payment.

According to the AO, however, the rendition of services by
USCo constituted parting with the “information concerning industrial,
commercial and scientific experience”. Hence, the services rendered by
USCo were covered within the definition of “royalty” under Explanation 2 to
section 9(1)(vi) as also under article 12(3)(a) of India-USA DTAA.

Held

–   The payments made by the Taxpayer were for
rendition of the services, which comprised (a) business promotion; (b)
marketing; (c) publicity; and (d) financial advisory. The payments were not for
use of any information concerning industrial, commercial or scientific
information’.

–   The nature of payment should be characterized
from the activity in consideration of which the payment was made. The payment
was made for rendition of services and not for right to use any information
concerning industrial, commercial or scientific experience that was in
possession of the service provider.

–   The fact that in the process of availing
these services, the Taxpayer benefits from rich experience of the service
provider is wholly irrelevant. Accordingly, the impugned payment was not
covered within the definition of “royalty” under article 12(3)(a) of India-USA
DTAA.

Sections 9, 115A of the Act; Article 12 of India-Italy DTAA – on facts, since the new agreement executed by Indian company with foreign company had different terms from the earlier agreement, it could not be regarded as extension of old agreement; hence, royalty was taxable in terms of section 115A @10.5 per cent.

10. [2017] 80 taxmann.com 100 (Pune – Trib)

Piaggio & CSpA vs. DCIT

A.Ys.: 2010-11 and 2011-12,

Date of Order: 21st March, 2017

Facts

The Taxpayer was a company based in Italy. It was
manufacturing motorised two, three and four wheelers. It had a subsidiary in
India (“ICo”). The Taxpayer entered into agreement with ICo on 31-10-2003 for
grant of license of technology to manufacture three wheelers for goods
transportation in consideration for payment of royalty (“the old agreement”).
In terms of India-Italy DTAA, royalty was taxed @20 %.

Subsequently, on 1-8-2008, the Taxpayer and ICo entered into
another agreement (“the new agreement”). The Taxpayer offered the royalty
received in terms thereof for taxation @10.55 % as per section 115A of the Act.

According to the AO, the new agreement was merely an
extension of the old agreement. He, therefore, concluded that even in terms of
new agreement, royalty was chargeable to tax @20 %.

Held

–   Comparison of the terms in the old agreement
and the new agreement showed one main material difference. While the old
agreement mentioned two specific models, the new agreement mentioned class of
vehicles. Pursuant to the new agreement, ICo launched different models which
became possible because of the new agreement.

–  Another difference was that the old agreement
granted license only for sale in India, whereas the new agreement granted
license also for sale to any other country as may be agreed between the
Taxpayer and ICo.

– On the expiry of the old agreement, the
Taxpayer and ICo had renegotiated certain terms which culminated into the new
agreement. Accordingly, the new agreement was not an extension of the old
agreement but an independent legally enforceable agreement.

–  Therefore, the applicable tax rate on the
royalty income as per section 115A was 10 %.

Investment Opportunities in Cambodia: India’s Advantages Tax & Legal

1.      Introduction

1.1.    Cambodia’s economy grew with a GDP of 7.1%
in 2016 and expects growth of 7.3% for FY 2017-18. The expected growth in GDP
resulted rapid in development in various sectors, namely retail, technology,
e-commerce, infrastructure projects etc. Cambodia’s strategic location
in the heart of ASEAN between Vietnam, Thailand, Laos along with coastline
having an easy regional accessibility makes it an attractive investments
destination. By treating foreign investors and local investors equally it gives
an access to ASEAN’s 600-million-strong consumer market. The present foreign
policy allows a foreign investor to incorporate or establish with 100 % foreign
ownership an entity any kind. The only restrictions are in respect of land
ownership. Further, there are no restrictions on repatriation of money. 

2.      Structuring of entity

2.1     For establishing a business in Cambodia, a
Private Limited Company (“PLC”) is always advisable and to process the
incorporation, the Ministry of Commerce (“MoC”) is the regulatory authority and
it takes approximately 7 days, after the necessary documents are submitted for
incorporation. After obtaining the approval from MoC within 15 days, the
documents along with the certificate of incorporation must be submitted to
General Department of Taxation (“GDT”) to obtain Value Added Tax Certificate
(“VAT”) and Patent Tax Certificate (PTC) which can be obtained within 30 days
from the date of submission of documents. The Patent Tax Certificate is issued
for a specific business activities only and need to be renewed on an annual
basis.

3.      Taxation in Cambodia

3.1     The Law on Taxation (“LoT”) in Cambodia is
very simple. The only chargeable tax is the withholding tax and value added
tax, while there is no capital gain tax but tax on profits are applicable.

4.      Structure of entities

4.1     The following are the entities recommended
for doing business in Cambodia

a)  Private Limited Company

     The number of shareholders in the private
limited company ranges between 2 to 30 shareholders. The shares or securities
cannot be offered to the public but can only be offered to the shareholders,
family members and managers.

b)  Public Limited Company

     Unlike Private limited companies, it can
have more than 30 shareholders and the shares or securities can be offered to
the public. In Cambodia, only Public Limited Companies can conduct banking
business, insurance business or be a financial institution.

c)  Representative Office:

     An eligible foreign investor may establish
a Representative Office to facilitate the sourcing of local goods and services
and to collect information for its parent company.

d)  Branch Office:

     A Branch Office is an office opened by a
company for conducting a commercial activity. All activities of the Branch
office are like that of Representative office but in addition, it may purchase,
sell or conduct regular professional services or other operations engaged in
production or construction in the country.

e)  Subsidiary Company: 

     A subsidiary is a company that is
incorporated with either 100% or at least 51% percent of its capital being held
by a foreign company.

5.      Tax System in Cambodia:

5.1     Previously, the Cambodian tax system was
divided into three regimes: real regime, simplified regime and estimated
regime. Recently, all the three regimes have been merged into one regime called
the “Real Regime” and divided into three categories (a) Small Taxpayers (b)
Medium Taxpayers and (c) Large Taxpayers.

5.2     The following are the categories that are
sub categories under which an individual or an entity can be taxed.

–   Tax on Salary

          An individual resident in Cambodia is
liable for tax on salary on both foreign as well as Cambodian source, while a
non-resident person is liable to the tax on salary only on Cambodian source.

–   Withholding Tax (“WHT”)

          The general withholding tax shall be
determined as follows:

          Any resident taxpayer carrying on
business makes any payment to a resident taxpayer shall withhold 15% on
management, consulting, and similar services and royalties for intangibles and
interest in minerals, Income from movable and immovable 10%. Interest paid by a
domestic bank or saving institutions for fixed term 6% and non-fixed term 4%.

          Any
resident taxpayer to a non-resident taxpayer shall withhold, 14 % on interest,
royalties, rent, and other income connected with the use of property;
compensation for management or technical services and dividends.

6.      Fringe Benefits Tax(“FBT”)

          The employer is required to withhold
and pay tax at the rate of 20% of the total value of FB given to all the
employees.

7.      Value Added Tax (“VAT”)

7.1     VAT is only a charge on taxable supply i.e.
supplies of good for tangible property and supply of services for something of
value other than goods, land or money.

7.2     The rates of VAT are as follows:

i)   0% for any goods exported from the Kingdom of
Cambodia and services consumed outside Cambodia

ii)  10% is the standard rate which applies to all
supplies other than exports and non-taxable supplies.

8.      DTAA Singapore – Cambodia (yet to be
ratified):

8.1     On May 20, 2016, an agreement was entered
into between Government of Republic of Singapore and the Royal Government of
Cambodia for prevention of evasion of taxes on income and to avoid any resident
being taxed twice on the income earned. This agreement applies to taxation of a
resident of Cambodia, in respect to taxes on profit including Tax on Salary,
Withholding Tax, Additional Profit Tax on Dividend Distribution and Capital
Gains Tax, while in terms of Singapore applies to the Income Tax.

8.2    Resident (Art. 4)

          Under Article 4 of the DTAA,
“resident” means any person or individual or entity liable to pay tax based on
their domicile, place of incorporation, place of management, principal place of
business or any other activities of similar nature but
also includes State and any local authority or statutory body.

          The article further defines the term
“resident”, by prescribing the following conditions:

a)  only of the state where he has a permanent
home available; or

b)  If there is a permanent home in both the contracting
states, then it is to be determined based on personal and economic relations
are closer i.e. centre of vital interest; or

c)  In the absence of centre of vital interest,
then the place where he has a habitat abode; or

d)  If habitat abode of both the states, then to
be determined based on nationality; or

e)  If otherwise, then the competent authorities
of the contracting states shall settle by agreement mutually.

8.3    Permanent Establishment (Art. 5)

          The term Permanent Establishment “PE”
is defined under Article 5 includes place of management; branch; an office;
factory; workshop; warehouse; mine, an oil or gas well, a quarry or any other
place of extraction of natural resources; and (h) farm or plantation.

          The terms have been further elaborated
by including:

(a) Any activities that last for more than 6 months
in terms of a building site, a construction, assembly or installation project,
or supervisory activities in connection;

(b) Any activities that last for more than 183 days
within any period of twelve months about any furnishing of services, including
consultancy services, by an enterprise of a Contracting State through employees
or other personnel engaged by the enterprise for such purpose, but only if
activities for same or connected project within the other Contracting State;

(c) The carrying on of activities (including the
operation of substantial equipment) for more than 90 days in any twelve months’
period in the other Contracting State for the exploration or for exploitation
of natural resources.

          The Law on Taxation in Cambodia
defines PE under Article 3 (4).

8.4    Immovable Property (Art. 6)

          The term “immovable property”,
shall be defined under the law of the Contracting State in which the property i
is situated. But also, includes property accessory to immovable property,
livestock and equipment used in agriculture and forestry, but not include
ships, boats and aircrafts.

          In addition, any income earned by a
resident from immovable property including agriculture or forestry and applies
to income from the direct use, letting, or use in any other form of immovable
property situated in the other Contracting State may be taxed in that other
State.

          There is no specific provision under
the Law on Taxation for immovable property.

8.6    Dividends (Art. 10)

          The terms as defined under this
agreement means income from shares, mining shares, founders’ shares or other
rights, but does not include debt claims, participating in profits, as well as
income from other corporate rights and be taxed to a resident of other
contracting state. .

          If beneficial owner of the dividend is
a resident of other contracting state, then tax on dividend not to exceed 10%
of the gross amount.

          Under Cambodian law, there is Tax on
Profit and Article 3 (8) defines the term dividends. Recently a new regulation
with respect to dividend distribution from a resident taxpayer in Cambodia to
their non-resident shareholders.

8.7    Capital Gains (Art. 14)

          Any gains derived by the resident of
the Contracting State to be taxable:

a)  Alienation of Immovable property in other
contracting state taxable in other state unless it is related to the Permanent
Establishment of the enterprise situated or any independent personal service to
be taxed in other state.

b)  Alienation of ships or aircrafts or movable
property pertaining to such operation of ships or aircraft shall be taxable in
the state where it is alienated.

c)  Alienation of Shares of more than 50 % of
their value directly or indirectly from immovable property situated in other
state, to be taxable in the other state.

d)  Alienation of any other property other than
above, to be taxable in the contracting state of which the alienator is a
resident.

          Under Cambodian Law on Taxation, no
specific provisions but 0.1 % tax is to be paid on transfer of shares.

8.8    Associated Enterprise (Art. 9)

          The term “associated” means an
enterprise that participates directly or indirectly in the management, control
or capital of other enterprise or a person or individual directly or indirectly
in the management, control or capital of an enterprise of a Contracting State
and an enterprise of the other Contracting State,

          The term associated enterprise has not
been defined but the “related person” under Article 3(10) which includes
families or any enterprise which controls or is controlled or is under the
common ‘control’. The term control means ownership of 51% or more in value or
voting rights. Article 18 of the Law on Taxation (“LoT”) provides, subject to
certain conditions, a wide power to the General Department of Taxation (“GDT”)
in Cambodia to adjust the allocation of income and expenses between related
enterprises. According to the applicable law, two or more enterprises are under
common ownership, if a person owns 20% or more of the equity interests of each
enterprise. In the event, a parent company provides either services, a loan or
any other transaction that will result in remuneration from the owned company,
the GDT will usually verify that the so-called transactions are real.

8.9    Royalties (Art.12)

          The term ‘royalties’ means payments of
any kind received as a consideration for the use of, or the right to use, any
copyright of literary, artistic or scientific work including cinematograph
films, or films or tapes used for radio or television broadcasting, any patent,
trade mark, design or model, plan, secret formula or process, or for the use
of, or the right to use, industrial, commercial, or scientific equipment, or
for information concerning industrial, commercial or scientific experience.

          Any income arising in a Contracting
State, paid to a resident of the other Contracting State may be taxed in that
other State and be taxed in the contracting state as per the local laws, if the
beneficial owner is a resident of the other then the tax not to exceed 10% of
the gross amount.

          Otherwise, if the beneficial owner of
the royalties carries a business through a permanent establishment or has a
fixed place of business in the other contracting state in which the royalties
arise, the same is to be treated as an income earned from the connected PE or
fixed place.

          In case the amount of royalties
exceeds the amount that was agreed by the payer or beneficial owner, the amount
of tax shall not exceed 10 % of the gross amount. Any excess amount is to be
taxed as per the local laws in which the income accrued.

          There is no specific provision about
royalties, but as defined in the Intellectual Property Laws.

9.         DTAA
India – Singapore (1994) 209 ITR 1 (St)

9.1     Immovable properties (Art. 6)

          The term “immovable
property” shall mean the term as defined under the law of the contracting
state and shall also include property accessory to immovable property,
livestock and equipment used in agriculture and forestry, rights to which the provisions
of general law respecting landed property apply usufruct of immovable property
and rights to variable or fixed payments as consideration for the working of,
or the right to work, mineral deposits, sources and other natural resources.
Ships and aircraft shall not be regarded as immovable property. Income from the
direct use of or letting or any other form of use of immovable property is
taxed in the country where the property is located, including real-estate
enterprises.

9.2    Dividends (Art. 10)

          The term “dividends” means
income from shares or other rights not being debt-claims, participating in
profits, as well as income from other corporate rights of which the company
making the distribution is a resident. Any dividends paid to a recipient’s
country of residence from the other country to be taxed in the country
received. The dividend taxed in the source country is as follows:

a)       15% of the gross amount of the dividends
only while the tax rate reduced to 10 % of the gross amount the 25% of the
shares are owned by the recipient’s company.

b)       No dividend tax to be paid by Indian
resident shareholders who derive any profit from the Singapore or Malaysian
resident company in Singapore.

          The dividend income article does not
apply if the company paying is a resident or performs independent personal
services from a fixed base situated in the country and will be treated as
income of the permanent establishment.

Case Laws Referred:

1] Roop Rasyan Industries (P.) Ltd. vs. ACIT [2014] 150
ITD 193 (Mum.) (Trib.).

Dividend was not taxable in Singapore of which company paying
dividend was resident and, therefore, para 2 of article 10 of DTAA was not at
all relevant. Moreover, in terms of Article 10 of DTAA, dividend received by an
Indian company from a Singapore based company was subjected to tax at normal
rate of 30 %.

9.3    Capital gains (Art. 13)

          A resident of one contracting state
from the alienation of immovable property situated in other contracting state
to be taxed in that state. A resident with PE or fixed base in other
contracting state to be taxed for any gains derived from alienation of movable
property. Recently India and Singapore signed the third protocol on December
30, 2016 to amend the DTAA and the amendment is along the lines of India and
Mauritius DTAA that was also recently entered. The Protocol amends the
prevailing residence based tax regime under the Singapore Treaty and gives
India a source based right to tax capital gains which arise from the alienation
of shares of an Indian resident company owned by a Singapore tax resident.

(i) Taxation
of capital gains on shares

Under 2005 Protocol any capital gains derived by a Singapore
resident from alienation of share of Indian resident company to be taxable only
in Singapore after complying with limitation of benefit “LOB” clause. However,
the Protocol marks a shift from residence-based taxation to source-based
taxation. Consequently, capital gains arising on or after April 01, 2017 from
alienation of shares of a company resident in India shall be subject to tax in
India. The change is subject to the following qualifications: –

(a) Grandfathering Clause

Any capital gains arising from sale of shares of an Indian
Company acquired before April 01, 2017 shall not be affected by the Protocol
and would enjoy the treatment available under the Treaty.

(b) Transition
period

The Protocol provides for a relaxation of capital gains
arising to Singapore residents from alienation of shares acquired after April
1, 2017 but alienated before March 31, 2019 (“Transition Period”). The tax rate
on any such gains shall not exceed 50% of the domestic tax rate in India (“Reduced
Tax Rate”).

(c) Limitation of benefits

The Protocol provides that grandfathered investments i.e.
shares acquired on or before 1 April 2017 which are not subject to the
provisions of the Protocol will still be subject to Revised LOB to avail of the
capital gains tax benefit under the Singapore Treaty, which provides that:

–   The benefit will not be available if the
affairs of the Singapore resident entity were arranged with the primary purpose
to take advantage of such benefit;

–   The benefit will not be available to a shell
or conduit company, being a legal entity with negligible or nil business
operations or with no real and continuous business activities.

Case Laws: 

1] Praful
Chandaria vs. ADDIT [2016] 161 ITD 153 (Mum.) (Trib.)

Capital gain could not be held to be taxable in India in
terms of para 6 of article 13 of India-Singapore DTAA under which taxing right
has been given to resident State, that is, State of alienator, which in this
case was Singapore.

2]  Credit Suisse (Singapore) Ltd. vs. Asstt
DIT. [2012] 53 SOT 306 (Mum.)(Trib.)

Gain earned on cancellation of foreign exchange forward
contracts is a capital receipt and must be treated as capital gains.

The Indian companies/ enterprise can look forward for
investment in emerging sectors like Information Technology & Ecommerce,
Infrastructure, venture capital, health care for supply of medical equipment’s,
tourism, education, technology transfer etc. 

11.    Conclusion

          To encourage India’s Act East Policy,
India and Cambodia signed a Bilateral Investment Treaties (BIT) to promote and
protect investments. In the absence of any such bilateral agreements or DTAA,
by incorporating company in Singapore. Indian entities could make an entry into
ASEAN Market or Cambodia and would be able to obtain the reliefs available
under the DTAA between Singapore – Cambodia DTAA using either of the countries as
a PE. In addition, the Cambodia grants tax holiday up to nine (9) years and
also 100 % exemption on export.

22. TS-40-ITAT-2017(Del) Net app B.V vs. DDIT A.Ys.: 2008-09 and 2010-11, Date of Order: 16th October, 2016

Article 5 of India-Netherlands DTAA – Indian subsidiary
rendering certain services to its parent, carries on subsidiary’s own business
in India and does not result in PE trigger for parent in India. Mere fact that
subsidiary and parent have common directors does not result in exercise of control
by the parent on the subsidiary

Facts

Taxpayer, a Netherlands Company (FCo), was engaged in the
business of –

–  Sale of storage system equipment and products
including embedded software

–  Sale of subscriptions

–  Installation, warranty and professional
services with respect to data migration, data integration and disaster recovery
services.

FCo sold goods and services in India through third party
distributors who were appointed on non-exclusive basis. Further, FCo had a
subsidiary in India (ICo), which rendered certain services to the FCo pursuant
to a “commission agent agreement (CAA)”. In terms of CAA, services rendered by
ICo included, marketing and sales support services, assistance in organising
trade shows and pre sales marketing, etc.

Assessing Officer (AO) contended that (a) FCo had a business
connection in India and hence its income in India was chargeable to tax under
the Act; (b) marketing activities being the core business activities of FCo
were carried on by ICo in India. Without such activities of ICo supply/services
by FCo was not possible in India; (c) ICo acted as sales office in India and
hence created a Permanent Establishment (PE) for FCo in India under
India-Netherlands DTAA; (d) Alternatively, ICo had the power to conclude
contracts on behalf of FCo in India as both the entities have common directors
and hence created a dependent Agent PE (DAPE) in India.

FCo contended that the sales in India were carried on by it
through independent distributors. Further, ICo did not have an authority to
conclude contracts on behalf of FCo in India nor did it maintain any stock of
goods on behalf of FCo. ICo derived income from other activities in its own
rights such as IT and ITEs services and hence was not economically dependent on
FCo. Merely because FCo and ICo have common directors does not result in DAPE
in India.

FCo also contended that ICo was merely a service provider and
its employees were working under ICo’s own control and instruction. ICo did not
result in a fixed place PE or Agency PE of FCo in India. Without prejudice, the
activities carried on by ICo are preparatory and auxiliary and hence does not
result in tax presence in India.

Held

–  Services rendered by ICo to FCo, results in a
business connection for FCo in India and thus income of FCo is subject to tax
in India under the Act. One will have to thus evaluate taxability under the
DTAA.

–  A subsidiary company by itself does not
constitute a PE. None of the employees of the FCo are present in India nor are
the personnel or employees of FCo visit India. ICo is a separate legal entity
and has its own board of directors, premises, employees, contract, etc. and the
employees work under the control and supervision of ICo in India and not the
FCo. No evidence has been furnished to show that ICo carries on business of FCo
in India.

–  In terms of the CAA, ICo is required to
merely inform FCo if any orders are placed by the customer in India. It would
then be the sole discretion of FCo to accept or reject it. Further,  ICo has no authority to bind FCo in relation
to any orders received by it.

–   ICo is merely a service provider to FCo and
carries on its own business. It cannot be considered as carrying on the
business of FCo in India.

–  Common directors of FCo and ICo are not
engaged in the day to day activities, negotiation of contracts, marketing
function in India on behalf of the FCo. Nothing has been brought on record to
show that ICo was subject to detailed instruction and control of FCo. Merely
the fact that the directors are common does not result in exercise in control
by FCo over ICo.

–   The revenue streams of ICo also clearly
suggests that it does not derive its income wholly or substantially from FCo,
but from other group entities as well. Thus ICo does not qualify as a dependent
agent of FCo.

21. TS-701-ITAT-2016(Chny) Sical Logisticts Ltd. vs. ACIT(IT) A.Ys.: 2002-03 to 2005-06, Date of Order: 14th December, 2016

Article 12 of DTAA, Section 9(1)(vi) and 172 of the Act –
Payment made for hiring of vessel on time charter basis does not involve
control and possession of the vessel and does not amount to “equipment
royalty”. Hire charges are covered by section 172 and not subject to withholding
u/s. 195

Facts

The Taxpayer, an Indian company, was engaged in carrying on
the business of transporting coal. Taxpayer had hired the vessels owned by
Foreign Shipping Companies (FCo) for transporting the cargo on a time charter
basis and paid hire charges to FCo without withholding taxes thereon.

The Captain/Master of the vessel, crew and other staff of the
ship were controlled by the ship owner, i.e FCo. The repairs and maintenance as
well as the insurance of the vessel was taken care of by FCo. Taxpayer merely
intimated FCo about the availability of the cargo and from where to where the
cargo had to be moved.

Taxpayer argued that payments made to FCo was for
transportation of goods and hence covered u/s. 172 of the Act, which is a
complete code in itself and hence there is no requirement to withhold taxes
u/s. 195 of the Act.

AO contended that the charges paid by the Taxpayer were on
account of the use and hire of the ship and hence, it amounts to royalty within
the meaning of section 9(1)(vi) of the Act and Article 12 of DTAA and hence
subject to withholding u/s. 195 of the Act. Accordingly, AO disallowed the hire
charges paid to FCo for failure to withhold taxes by holding that section 172
is not applicable in respect of hire charges paid to FCo.

Aggrieved by the order of AO, the Taxpayer appealed before
CIT(A), who upheld the order of AO, Taxpayer thus appealed before the Tribunal

Held

–   In the case of Asia Satellite
Telecommunication Co. Ltd. vs. DCIT (332 ITR 340), it was held that for
payment to qualify as equipment royalty’, possession and control are over the
equipment is essential. In the present case, the Taxpayer has neither control
nor possession over the vessel. As noted, the captain/master and the crew were
instructed, directed and were under control of FCo and not the Taxpayer.

–  One needs to differentiate between ‘letting
the asset’ and ‘use of asset’ by the owner for providing services. In the
present case, hire charges paid to FCo was for services of moving the goods by
a fully manned ship. It was not for letting the vessel, Taxpayer only had the
right to utilise the space in the vessel and was not authorised to operate or
exercise control over the vessel.

–   In the present case, FCo did not enjoy any dedicated
berthing facility. Further, the vessel was in Indian waters only for a short
duration and hence does not result in a PE in India. Reliance of AO on Madras
HC ruling in the case of Poompuhar Shipping Corporation (360 ITR 257) is
wrongly placed as Madras HC was concerned with a case where the Taxpayer had a
facility of berthing at an Indian port guaranteed for foreign ship chartered
leading to creation of Permanent Establishment (PE) for the Taxpayer.

–  Thus payment of hire charges does
not amount to royalty under the Act as well as DTAA. The hire charges paid to FCo is covered by section 172 of the Act.

20. TS-7-ITAT-2017(Ahd)-TP ACIT vs. Veer Gems A.Y: 2008-09, Date of Order: 3rd January, 2017

Section 92A of the Act – Reference to “management, control
and capital’ in section 92A(1) is to be understood based on the illustrations
provided u/s. 92A(2) alone – A partnership firm is not controlled by an
individual and hence Clause (j) of section 92A(2) dealing with control by
common individuals and those relatives, does not apply to the facts of the
present case

Facts

Taxpayer, an Indian partnership firm and tax resident of
India, was engaged in the business of manufacture and sale, of polished diamonds
both in India and outside India. The partners of the Taxpayer firm were three
brothers (along with their wives and sons).

During the year under consideration, the Taxpayer firm had
entered into certain international transactions with a Belgian entity (FCo).
FCo was owned and controlled by fourth brother (along with his wife and son) of
the partners of Taxpayer firm.

Assessing Officer (AO) contended that since FCo is controlled
by another brother of the partners, it is to be treated as Associated Enterprises
(AE) in terms of section 92A(2) of the Act and, accordingly, made a reference
to the Transfer Pricing Officer (TPO) to determine the arm’s length price (ALP)
of the transactions entered by Taxpayer with FCo . Thereby, the TPO made an ALP
adjustment u/s. 92CA(3) of the Act.

Aggrieved by the order of the TPO, the Taxpayer appealed to
Commissioner of Income-tax (Appeals) i.e. CIT(A).CIT(A) without discussing the
primary issue of the existence of an AE relationship in terms of section 92A of
the Act, proceeded to examine the correctness of the ALP and deleted the
impugned adjustment.

Aggrieved by the order of CIT(A), revenue appealed before the
Tribunal. Additionally, Taxpayer also appealed before the Tribunal.

Held

Section 92A(1) of the Act provides that an enterprise, in
relation to the other enterprise, would be regarded as AE if, the enterprise
participates, directly or indirectly, in the management or control or capital
of the other enterprise or if the persons who participate in management, control
or capital of both the enterprises are common.

Section
92A(2) of the Act only provides illustrations of the cases in
which an enterprise participates in management, capital or
control of another enterprise.

–   The terms ‘participation’, ‘management’, and
‘control’ are not defined under the Act. One has to thus take recourse to
sub-section (2) to section 92A of the Act which gives practical illustrations,
to understand the meaning of ‘participation in management or capital or
control’. These illustrations are exhaustive and not illustrative.

–   Section 92A(2) governs the operation of
section 92A(1) by controlling the definition of participation in management or
capital or control by one of the enterprises in the other enterprise. If a form
of participation in management, capital or control is not recognised by section
92A(2), it does not result in enterprises being treated as AEs.

–   Even if one enterprise ends up having a de
facto or even de jure participation in the management, capital, or control of
the other enterprises, the two enterprises cannot be said to be AEs, unless
such participation in management, capital or control is covered by section
92A(2). Tribunal relied on Orchid Pharma Ltd vs. DCIT [(2016) 76 taxmann.com
63 (Chennai)] and Page Industries Ltd vs. DCIT [(2016) 159 ITD 680
(Bang)]

–   Clause (j) of section 92A(2) which is
relevant in the present fact pattern provides that two enterprises are to be
treated as AE if one enterprise is controlled by an individual and the other
enterprise is also controlled by such individual or his relative or jointly by
such individual and relative of such individual. In the present case, since the
Taxpayer is a partnership concern, it cannot be said to be controlled by an ‘individual’
and consequentially clause (j) cannot be invoked in the present case.

–   Even though a certain degree of control may
actually be exercised by these enterprises over each other due to relationships
of the persons owning the enterprises, that itself is not sufficient to hold
the two enterprises as AEs.

–   Taxpayer and FCo are thus not to be treated
as AEs.

13. TS-921-ITAT-2016(Ahd)-TP Shell Global Solutions International BV vs. DDIT A.Y.s:2007-08 to 2010-11, Date of Order:17th November 2016

Article 9 of India – Netherlands DTAA – No
bar in Article 9 to address juridical double taxation – Not confined to ALP
adjustment only in hands of domestic entities – Non-availability of relief
under article 9(2) does not negate application of article 9(1)

Facts

The Taxpayer is a company incorporated in
and tax resident of the Netherlands. During the year under consideration,
Taxpayer rendered certain technical services to its associated enterprises
(AEs) in India.The consideration received by the Taxpayer for rendering the
aforesaid services was treated as Fees for technical services (FTS) under
Article 12 of India Netherlands Double Taxation Avoidance Agreement (DTAA) and
thereby, taxed @ 10% on gross basis. During the course of assessment
proceedings, arm’s length price (ALP) in respect of FTS was determined at a
higher level and adjustments under the transfer pricing regulations
wereproposed by the Assessing Officer (AO).

Without disputing mechanics and
quantification of the ALP adjustments, Taxpayer argued that the adjustment was
not justified as additional fees would have been taxed in India in the hands of
Taxpayer @ 10%, whereas the AE in India would have obtained tax shied @ 33.99%
and net effect of adjustment was base erosion of Indian tax. Taxpayer,
therefore,contended that such adjustments are contrary to the scheme of section
92(3) of the Act read with CBDT Circular No. 14 of 2001.

The Taxpayer filed objection before Dispute
resolution panel (DRP). The DRP rejected the objections.

Aggrieved, Taxpayer appealed before the
Tribunal, where theTaxpayer put forth additional claim of treaty protection and
contended that considering the language of Article 9 of India-Netherlands DTAA,
ALP adjustment can only be made in case of juridical double taxation and only
in the hands of domestic enterprise. The Taxpayer further contended that ALP
adjustment was not permissible in its hands under Article 9 of
India-Netherlands DTAA.

Held

(i)   In Instrumentarium
Corporation Ltd. Finland vs. ADIT [(2016) 71 taxmann.com 193 (SB)], the
Special Bench (SB) narrowed the scope of application of the “base erosion
theory” in transfer pricing matters. The Taxpayer was an ‘intervener’ in the
said decision and the argument of the Taxpayer on the base erosion was rejected
by SB.

(ii)  As per the wording of
Article 9, there is no bar to address juridical double taxation. As long as the
conditions precedent in Article 9 are attracted, the application of arm’s
length standards come into play.

(iii)  While Article 9(1) is an
enabling provision, TP mechanism under the domestic law is the machinery
provision. Once it is not in dispute that the arm’s length standards are to be
applied as per Article 9, it is only axiomatic that the manner in which arm’s
length standards provided under the domestic law need to be applied.

(iv) The provisions of Article
9(1) are clear and unambiguous and permit ALP adjustment in all situations in
which the arm’s length standards require higher profits in the hands of any
“one of the enterprises, but by reason of those conditions, have not so
accrued” to be “included in the profits of that enterprise and taxed
accordingly”. The AO has no discretion to read this provision as confined to
enabling ALP adjustment in respect of only domestic entities.

(v)  The non-availability of
corresponding adjustment relief under Article 9(2) does not deter application
of Article 9(1). Therefore, the ALP adjustment cannot be negated onthe ground
that no relief against such taxation is granted by the residence state. An
element of double taxation is inherent in respect of taxation of FTS, which is
taxed in both countries under the treaty. However, in such cases also, the
taxation in source country is not dependent on the relief granted by residence
country. Thus, mere increase in quantum of such taxable income in the source
jurisdiction, due to application of arm’s length principle, need not always be
visited with corresponding adjustment under article 9(2) in the residence
jurisdiction.

(vi) It may not be correct to
suggest that there is conflict between Article 9 and domestic transfer pricing
legislation. There is a school of thought that domestic arm’s length principle
goes much beyond tax treaty’s normal rule making scope since this arm’s length
principle governs taxation of an enterprise in general and the tax treaties do
not restrict domestic law in this respect. The profit adjustment mechanism
envisaged in tax treaties do not deal with supra national income determination.
Therefore, the provisions of tax treaties cannot be seen as restricting, or
overriding, domestic law mechanism on transfer pricing aspects.

(vii) The transfer pricing
legislation is an anti-avoidance provision. It cannot be rendered ineffective
on the basis of the limitations in the provisions of Article 9. Section 90(2)
of the Act gives somewhat unqualified superiority to the treaty provisions over
the provisions of the Income Tax Act which contain transfer pricing legislation
as well. It will infringe the neutrality of an anti-abuse law– notwithstanding
whether it is a specific anti-abuse regulation (SAAR) or a general anti-abuse
regulation (GAAR)– if it is considered to apply only to a non-treaty situation
but not to a treaty situation.

New India-Cyprus DTAA, 2016 – An Overview

A)  Background

(i)  India and Cyprus have recently signed a new Double Taxation Avoidance Agreement (New DTAA). The New DTAA replaces the earlier India-Cyprus DTAA signed in 1994 (Old DTAA), which has been a subject matter of renegotiation between the Government of India (GoI) and the Government of the Republic of Cyprus (GoC) for some time now. The New DTAA was signed on 18th November 2016 and both the Governments had previously issued press releases announcing the same. The text of the New DTAA was recently published in the Gazette of the GoC. However, the GoI is yet to make an official publication of the New DTAA. The New DTAA is the outcome of prolonged and extensive negotiations between both the countries.

(ii)  Significant provisions of the New DTAA include source country taxation rights on capital gains from shares, subject to grandfathering of shares acquired before 1st April 2017, insertion of Service Permanent Establishment (PE), expanded scope of Dependent Agent PE, revised Article on Fees for Technical Services (FTS) etc. The New DTAA limits source country taxation of Other Income. It also reduces taxation of royalty/FTS at the rate of 10% (as compared to the earlier rate of 15%). Furthermore, a modified version of the exchange of information (EOI) provision has been incorporated, which is in line with existing international standards. An additional Article on “assistance in collection of taxes” has also been introduced in the New DTAA.

(iii) The New DTAA will enter into force once the requisite procedures are completed in both the countries. The old DTAA shall stand terminated upon the New DTAA coming into force.

(iv) The GoI has rescinded the classification of Cyprus as a “Notified Jurisdictional Area” (NJA), retrospectively as from 1st November 2013.

B)  Highlights / Salient Features of the New DTAA

1.  Expanded scope of PE (Article 5)

The New DTAA expands the scope of ‘permanent establishment’, introducing the concept of a ‘service’ permanent establishment. The New DTAA has also specifically includes (i) sales outlets, (ii) warehouses (in relation to a person providing storage facilities for others) and (iii) farms, plantations or other places where agricultural, forestry, plantation or related activities are carried on, within the inclusive definition of ‘permanent establishment’. Further, the New DTAA provides for the creation of a construction permanent establishment if activities carry on for more than 6 months, instead of the earlier requirement that the activities be carried on for more than 12 months.

Insertion of a Service PE: A new Service PE clause has been introduced whereby furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only where activities of that nature continue (for the same or connected project) within the country for a period or periods aggregating more than 90 days within any 12 month period shall constitute a PE. The above service PE rule is in line with the UN Model Convention 2011 (2011 UN MC), except that the time threshold is lower at 90 days as compared to 183 days in the 2011 UN MC.

The criteria for the constitution of an agency PE has been amended. Accordingly, the person other than an agent of independent status shall constitute an agency PE if:

–   He is acting on behalf of an enterprise and has, and habitually exercises, in a contracting state an authority to conclude contracts in the name of the enterprise;

–   Has no such authority, but habitually maintains in the first-mentioned state a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise;

–   Habitually secures orders in the first mentioned state, wholly or almost wholly for the enterprise itself.

The above provisions are consistent with most of the Indian DTAAs.

There are a number of other changes in the PE definition which include, inter alia:

a) Lowered threshold for triggering construction/installation/supervisory PE to 6 months from the existing limit of 12 months.

b)  Inclusion of sales outlet, warehouse as fixed PE.

c)  Removal of “delivery” function from the scope of exempted activities.

2.   Profit Attribution / Business Profits (Article 7)

The New DTAA has removed the ‘force of attraction’ rule. Accordingly, the business profits of an enterprise may be taxed in the other state but only so much of them as is attributable to that PE.

No deduction shall be allowed in respect of amounts paid by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of banking enterprises, if any, paid (other than reimbursement of actual expenses) by the PE to the head office or any of its other offices, by way of interest on money lent to the PE.

Similarly, no account shall be taken, in the determination of the profits of a PE, of amounts charged by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of banking enterprises (other than reimbursement of actual expenses) by the PE to the head office or any of its other offices, by way of interest on moneys lent to the head office of the enterprise or any of its other offices.

This provision is comparable to Article 7(3) of the 2011 UN MC and has been adopted lately by India in most of its DTAAs.

3.   Shipping and Air Transport (Article 8)

The criteria of ‘registration’ and ‘headquarters’ have been removed. Accordingly, profits derived by an enterprise of a contracting state from the operation of ships or aircraft in international traffic shall be taxable only in that state

The term profits for the purpose of shipping and air transport has been amended. Accordingly, profits from the operation of ships or aircraft in international traffic shall include profits derived from the rental of ships or aircraft on a full time (time or voyage basis) or bareboat basis.

Exception is provided for the taxability of profits from the use, maintenance, or rental of containers for the transport of goods or merchandise solely between places within the other contracting state.

The New DTAA provides that interest on funds connected directly with the operation of ships or aircraft in international traffic, shall be regarded as profits derived from the operation of such ships or aircraft, and the provisions of Article 11 (interest) shall not apply in relation to such interest.

    by the enterprise are covered under ‘capital gains’. It shall be taxable only in the contracting state in which the alienator is a resident.

4.   Associated Enterprises (AEs) (Article 9)

The New DTAA aligns with the OECD Model Convention (OECD MC) in relation to the provisions related to AEs. Article 9(2) of the old DTAA has been removed, which provided powers to the competent authority to apply domestic laws which allow to use discretion/estimates for computing liability under Article 9(1) in cases where it is not possible, from the available information, to determine profits attributable to the concerned enterprise.

5.   Dividends (Article 10)

The rate of dividend in source state shall not exceed 10%. The rate of 15% has been removed.

6.   Interest (Article 11)

Tax rate of interest in source state shall not exceed 10% if the beneficial owner of the interest is a resident of the other contracting state.

Following entities are additionally exempt from tax:

– Export-Import Bank of India

–  National Housing Bank

– Any other institution as may be agreed upon from time to time between the competent authorities of the contracting states through the exchange of letters.

7.   Royalties and FTS (Article 12)

Under the New DTAA, royalties and FTS will attract tax withholding at the rate of 10%, as against the rate of 15% provided in existing DTAA. However, the scope of source taxation has been modified as follows:

–  The term FIS has been replaced by the term FTS.

–   The tax rate of royalties and FTS in the source state is reduced to 10% from 15 %.

–  The term royalty has been amended to include payment only.

–  The definition of the term ‘royalty’ has been amended as follows:

‘The term ‘royalties’ means payment of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films or films or tapes used for television or radio broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience. The term ‘royalties’ will not include income for the use of, or the right to use aircrafts and ships.’

–   The term ‘FTS’ has been amended as follows:
‘FTS’ means payments of any kind as consideration for managerial or technical or consultancy services, including the provision of services of technical or other personnel.

Further, the ‘make available’ clause has been removed from the term FTS.

Additionally, Article 12(5) provides that where royalties or FTS do not arise in one of the contracting states, and the royalties relate to the use of, or the right to use, the right or property, or the FTS relate to services performed in one of the contracting states, the royalties or FTS shall be deemed to arise in that contracting state.

8.   Source based taxation of capital gains from shares (Article 13)

Capital gains arising from the transfer of shares are taxable solely in the Resident State of the alienator under the old DTAA. The New DTAA provides taxation rights to the State of residence of the company whose shares are alienated (i.e., Source State).

Additionally, taxation of indirect transfer whereby capital gains from sale of shares of a company, the assets of which consist, directly or indirectly, principally of immovable property in a Contracting State (Source State), would be taxable in the Source State.

However, shares acquired up to 31st March 2017 have been grandfathered from both the above rules on source taxation. The exemption will apply irrespective of the date of subsequent transfer of such shares.

Therefore, the source based taxation under the New DTAA shall only be applicable to capital gains arising from the transfer of investments made on or after 1st April, 2017, and capital gains arising from the transfer of investments made prior to 1st April, 2017 should continue to be taxed only in the jurisdiction in which the taxpayer is a resident.

The aforesaid provisions on direct transfer of shares are similar to the recent amendment under the India-Mauritius DTAA. The India-Mauritius DTAA additionally provides for a transitional relief of 50%, subject to fulfilment of Limitation of Benefit (LOB). Such a provision does not feature in the New DTAA with Cyprus.

The clause relating to alienation of ship and aircraft amended to provide that gains from the alienation of ships or aircraft operated in international traffic or movable property pertaining to the operation of such ships or aircraft shall be taxable only in the contracting state of which the alienator is a resident.

A new clause has been inserted to provide that gains from the alienation of shares of the capital stock of a company, the property of which consists directly or indirectly principally of immovable property situated in a contracting state, may be taxed in that state.

9.   Independent Personal Services (Article 14)

The New DTAA has introduced the rolling period concept i.e. for a period or periods amounting to or exceeding in the aggregate 183 days in any 12 month period commencing or ending in the fiscal year concerned.

10. Dependent Personal Services (Article 15)

The New DTAA has introduced the rolling period concept i.e. the remuneration derived in respect of an employment exercised in the other contracting state shall be taxable in source state only if the recipient is present in the other state for a period or periods not exceeding in the aggregate 183 days in any twelve month period commencing or ending in the fiscal year concerned.

In case the remuneration derived in respect of an employment exercised aboard a ship or aircraft operated in international traffic by an enterprise, the New DTAA has removed the place of effective management criteria. Therefore, the remuneration derived in respect of an employment exercised aboard a ship or aircraft operated in international traffic by an enterprise of a contracting state, shall be taxed in that state.

11. Limited source taxation of “Other Income” (Article 22)

Under the old DTAA, any income not expressly covered by other Articles of the DTAA and arising in a Source State could be taxed in that Source State also. The said provision has been removed in the New DTAA.

The New DTAA listed certain specified income for taxability in source state. Accordingly, if a resident of a contracting state derives income from sources within the other contracting state in the form of lotteries, crossword puzzles, races including horse races, card games and other games of any sort or gambling or betting of any nature whatsoever, such income may be taxed in the other contracting state.

12. Methods for elimination of double taxation (Article 23)

Benefits relating to tax sparing and deemed foreign tax credit (FTC) in respect of dividend, interest, royalty and FTS under the old DTAA have been removed.

13. Non Discrimination (Article 24)

The New DTAA has amended the non-discrimination clause. It provides that nationals of a contracting state shall not be subjected in the other contracting state to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other state in the same circumstances, in particular with respect to residence, are or may be subjected. This provision shall also apply to persons who are not residents of one or both of the contracting states.

Interest, royalties and other disbursements paid by an enterprise of a contracting state to a resident of the other contracting state shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned state. Similarly, any debts of an enterprise of a contracting state to a resident of the other contracting State shall, for the purpose of determining the taxable capital of such enterprise, be deductible under the same conditions as if they had been contracted to a resident of the first-mentioned State.

14. Tie-breaker rule for determining residency of non-individuals through Mutual Agreement Procedure (MAP) (Article 25)

In cases of persons other than individuals who are residents of both India and Cyprus, place of effective management (POEM) rule is applied to determine residency. The New DTAA additionally provides that if POEM cannot be determined then the competent authorities of the Contracting States shall settle the question by mutual agreement within 2 years from the date of invocation of MAP under Article 25.

15. Exchange of Information (Article 26)

The scope of the EOI Article in the New DTAA has been enhanced to align with international standards on transparency and the provision in the OECD MC. The EOI Article extends to information relating to taxes of every kind and description imposed by a State or its political subdivisions or local authorities, to the extent that the same is not contrary to the taxation as per the New DTAA. Furthermore, the information can be used for purposes other than tax, with the prior approval of the authority providing such information.

EOI would also be possible in respect of persons who are not residents of the Contracting State, as long as the information requested is in possession of the concerned State. Specifically, information held by banks or financial institutions can be exchanged under the EOI Article.

16. Assistance in Collection of Taxes (Article 27)

The New DTAA includes an Article on “assistance in collection of taxes” largely in line with the OECD MC. Broadly, this Article enables the revenue claims of one State to be collected through the assistance of the other Contracting State, subject to fulfilment of certain conditions and requirements. Assistance would also involve undertaking measures of conservancy by freezing assets located in the requested State, subject to the laws therein.

Clause 4 of the Protocol clarifies that for the purpose of this Article, a State is not obliged to take measures inconsistent with its laws and policies in respect of collection of its own taxes.

C)  India rescinds notification treating Cyprus as “Notified Jurisdictional Area”

The Government of India (GoI) vide Notification No. 114 of 2016 dated 14th December 2016 (Recent Notification) has rescinded its earlier Notification No. 86 of 2013 dated 1st November 2013 which had notified Cyprus as a Notified Jurisdictional Area (NJA) u/s. 94A of the Income-tax Act, 1961 (Act).

On 1st November 2013, the Central Board of Direct Taxes (CBDT) invoked the provisions of Section 94A of the Act and notified Cyprus as an NJA owing to inadequate exchange of information by Cyprus tax authorities. On 1st July 2016, GoI issued a press release that negotiation on the revision of India-Cyprus tax treaty (Cyprus Treaty) between both the countries has been completed with –

–   Rights to source based taxation of capital gains and grandfathering of investments made prior to 1st April 2017.

–   India considering the removal of Cyprus from the list of NJAs under the Act retrospectively and initiating necessary procedures.

On 18th November, 2016, GoI issued a press release announcing the signing of the New Cyprus Treaty. Subsequent to this notification, Government of Cyprus released the text of the New Cyrus Treaty. GoI vide its recent notification has rescinded the earlier notification resulting in Cyprus not being a NJA under the Act. The recent notification also states that things done or omitted to be done before such rescission shall be an exception. On 16th December 2016, GoI has issued another press release confirming completion of internal procedures to amend the Cyprus Treaty. In this press release, GoI has also stated that Cyprus’s status as an NJA u/s. 94A of the Act has been rescinded with effect from 1st November 2013.

Impact of the Recent Notification

–   Deeming fiction provided in section 94A to deem Cyprus tax residents or a person located in Cyprus as an associated enterprise and any transactions with them as an international transaction will no longer be applicable.

–   Claim for deduction of any expenditure / allowance arising on account of transactions with Cypriot tax resident or a person located in Cyprus would now be allowable under general provisions of the Act without documentation requirements as per Rule 21AB of the Income-tax Rules, 1962 read with Form 10FC prescribed u/s. 94A of the Act.

–   Consequent to the Recent Notification, any taxable income accruing / arising to a Cypriot tax resident or a person located in Cyprus would now be subject to the withholding tax rates prescribed under the Act or the New DTAA (as and when India notifies the same), whichever is beneficial to the tax payer.

To illustrate, payments made to Cyprus tax residents or persons located in Cyprus would be subject to withholding tax as follows:

–   Royalties / Fees for Technical Services, earlier liable to withholding u/s. 94A at the rate of 30%, would now be liable to withholding at 10% under the Act.

–   Interest income, earlier liable to withholding u/s. 94A at the rate of 30%, would now be liable to withholding at 10% under the Cyprus Treaty or at an applicable lower rate under the Act, whichever is beneficial.

This is a long awaited and significant development between India and Cyprus and resets the tax position for various transactions on par with other jurisdictions.

D)  Impact and Analysis of New India-Cyprus DTAA

1.  Shift towards source based taxation.

By and large, India’s network of 94 tax treaties provide for source and residence based taxation of capital gains arising from the transfer of shares of a company. However some exceptions exist, for example, India’s tax treaties with Singapore, Jordan (provided the transferor is subject to tax in the state of residence), Philippines, Portugal, and Zambia provide for taxation of gains arising from the transfer of shares of a company only in the state of residence of the transferor.

Over the last few years, India has undertaken a concerted effort to revise its tax treaties and has successfully revised its treaties with Indonesia, Thailand, Mauritius and most recently Korea, to provide for source based taxation of capital gains arising from the transfer of shares of a company. The revision of the treaty with Mauritius (one of India’s largest sources of foreign investment) showed the determination of the Indian government to move towards a source based taxation of capital gains regime. The Indian Government is reportedly also in the process of amending its treaty with Singapore along similar lines. The New DTAA with Cyprus marks yet another milestone in this process.

For the time being, residence based taxation of gains arising from the transfer of investments in instruments other than shares e.g., debentures continues. Under India’s tax treaties, with the exception of gains arising from the transfer of (i) immoveable property, (ii) movable property forming part of a permanent establishment and, (iii) ships and aircraft, gains arising from the transfer of any other property are usually taxable only in the state of residence of the transferor. India’s tax treaties with China, USA, UK, Canada and Australia are some notable exceptions, with gains from any transfer of other property being taxable in both the state of source and the state of residence. Conversely, India’s tax treaties with Fiji, Greece and Egypt, provide for taxation of gains from the transfer any other property only in the country of source. The recently amended tax treaties with Mauritius, Korea and Thailand continue to provide for residence based taxation of gains arising from the transfer of “other property”.

Further, in the absence of an enabling treaty provision along the lines of that in the tax treaty with South Africa (Article 13(5) of the India-South Africa tax treaty provides that “Gains derived by a resident of a Contracting State from the sale, exchange or other disposition, directly or indirectly, of shares or similar rights in a company, other than those mentioned in paragraph 4, which is a resident of the other Contracting State, may be taxed in that other State.” ) gains arising from the indirect transfer of Indian shares should continue to be taxable only in the state of residence of the transferor (Article 13(6) of the New DTAA provides that “Gains from the alienation of any property other than that referred to in paragraphs 1, 2, 3, 4 and 5, shall be taxable only in the Contracting State of which the alienator is a resident). Based on the ruling of the Andhra Pradesh HC in Sanofi Pasteur Holding SA vs. Dept. of Revenue [2013] 30 taxmann.com 222 (AP) gains arising from the transfer of shares of a Cypriot company whose value is derived substantially from shares of an Indian company should fall within the scope of Article 13(6) and therefore be taxable only in Cyprus.). However, other view is also possible in this regard.

2.  Cyprus as a tax efficient jurisdiction for investing into India

While Mauritius negotiated a better interest withholding rate (7.5%) than the New DTAA currently contains (10%), and, unlike the India-Mauritius tax treaty, the New DTAA does not provide for a transition period [Under the recently notified Protocol amending the India-Mauritius Tax Treaty (set to come into effect from April 1, 2017), gains from the sale of investments made after April 1, 2017 but before March 31, 2019 are subject to taxation in the source country at only 50% of the applicable domestic tax rate. Gains from the sale of investments made prior to March 31, 2017 remain taxable only in Mauritius, but gains from investments made after March 31, 2019 will be taxable in Mauritius and India.] of taxation at reduced rates, the continuation of residence based taxation for gains arising on transfer of instruments other than shares, and Cyprus’ membership of the European Union should serve to return some of the country’s lustre as an efficient jurisdiction for investment into India. De-notification of Cyprus as an NJA may even encourage fresh investments through Cyprus prior to April 1, 2017.

3.  Limitation of Benefits Clause

Interestingly, the New DTAA does not contain a Limitation of Benefits clause (“LOB”). This is contrary to the trend that has arisen in recent years, with India amending / revising many of its tax treaties to include an LOB clause. India has incorporated variations of a LOB clause in its tax treaties with the USA (1990), Singapore (1994 / 2005), Namibia (1999), Armenia (2004), UAE (2007), Iceland (2008), Kuwait (2008), Syria (2009), Luxembourg (2010), Myanmar (2010), Tajikistan (2010), Finland (2011), Mexico (2011), Mozambique (2011), Georgia (2012), Lithuania (2012), Norway (2012), Tanzania (2012), Taiwan (2012), Uzbekistan (2012), Ethiopia (2013), Jordan (2013), Malaysia (2013), Nepal (2013), Romania (2013), UK (2013), Albania (2014), Bhutan (2014), Columbia (2014), Fiji (2014), Latvia (2014), Sri Lanka (2014), Uruguay (2014), Macedonia (2015), Malta (2015), Thailand (2015), Poland (2015), Indonesia (2016), Korea (2016) and Mauritius (2016). In the times to come, it will be exciting to see the interplay between the General Anti-Avoidance Rules (“GAAR”) which are slated to come into effect from April 1, 2017 and the re-negotiated tax treaties (especially the LOB clauses) and the impact on structures and investments. Notably, the Shome Committee report had recommended that where anti-avoidance rules are provided for in a treaty, the GAAR provisions should not apply to override the provisions of the treaty. Interestingly, the LOB clause in the amended Mauritius tax treaty requires a company desirous of claiming benefits to either (i) be listed on a stock exchange in Mauritius or (ii) incur expenditure on operations in its state of residence to a tune of Rs. 2.7 million in the 12 months immediately preceding the date on which the gains arise. This is similar to the language of the LOB clause in the Singapore tax treaty. However, the Singapore LOB clause will cease to be in effect on April 1, 2017, unless the Singapore treaty is amended prior to that date.

E)  Concluding Remarks

The New Cyprus DTAA is similar to the recently amended India-Mauritius DTAA in terms of inclusion of Service PE and source taxation of capital gains, as well as grandfathering relief. However, as compared to the amended India-Mauritius DTAA, there is no transitory concessional relief available (subject to LOB) in respect of gains made on shares acquired post 1st April 2017 but transferred before 31st March 2019.

Some other provisions on PE, FTS, EOI are also consistent with the recent trends in Indian DTAAs. Interestingly, the New DTAA does not contain an LOB provision, contrary to the trend in Indian DTAAs being signed/amended lately.

After Mauritius and Cyprus, renegotiation of the India-Singapore DTAA and the India-Netherlands DTAA is expected to be completed.

Taxpayers will need to evaluate the impact of the New DTAA based on the facts of their specific cases. One may also need to watch how the New DTAA will get impacted by the Multilateral Instrument released by the OECD recently.
The above article provides only an overview of the salient features of the New India-Cyprus DTAA. The reader is advised to go through the detailed provisions of the Treaty minutely.

TS-489-AAR-2016 MERO Asia Pacific Pte Ltd Date of Order: 17th August, 2016

On Facts, a single contract for offshore supply and onshore
services was to be treated as composite and indivisible contract – if goods
were delivered in India with the seller bearing the risk, insurance and customs
duty till the point of completion of project work in India, supply  was 
to  be  regarded 
as  completed in India.

Facts

The
taxpayer was a resident of Singapore and was engaged  in 
the  business  of 
executing  contracts  in relation to structural glazing and wall
cladding works. The Taxpayer had set up project offices (PO) in India for the
purpose of executing the work subcontracted to it by one of the Indian
contractor.

In
terms of sub-contract, taxpayer was required to design the curtain wall and
façade, supply materials and carry out installation and other works in India.
Taxpayer was also responsible for delivering goods at construction site in India.

The
taxpayer contended that the supply of goods outside India was to be considered
as a separate contract from the installation work contract. Further as title to
the goods passed outside India and the payment for offshore supply was also
received outside India, income from offshore supply of goods did not accrue or
arise in India. Even if the PO created a business connection or Permanent
establishment (PE) in India, income from offshore supply was not directly or
indirectly attributable to the PO in India. Hence, such income was not taxable
in India.

The
issues before the AAR were: (i) whether the amount received by the taxpayer for
offshore supply of goods was taxable in India; and (ii) if yes, what was the
extent of profit that could be attributed to the business connection and/or PE
in India.

AAR Ruling

Held 1: on the issue of whether contract was divisible

a.
A single contract was entered into by the taxpayer for all the activities of
designing, supply and installation work. the 
contract did not provide any bifurcation between  supply 
of  goods  and 
erection/installation in  the  contract 
either  in  the 
context  of  taxpayer’s work and responsibilities or with
respect to the payment schedule.

 b. Further, payment schedule of the contract
was linked to different milestones of the work, viz., designing, drawing,
supply  and  commissioning 
of  the  entire work. Major milestones were not linked
to supply/sale of plant and materials.

c.
Merely picking up one portion of contract, selectively to show that it
represents independent scope of work is incorrect. Hence, in the present
situation, division is imaginary and artificial.

d.
Even though  the  invoices 
showed  that  sale 
of materials was in Singapore, taxpayer was responsible for delivering
and steering materials at site and was responsible for the risk and insurance
until completion of the project in India. The customs duty for clearance of
goods at Indian port was also paid by the taxpayer. All these factors indicate
that the offshore supply was completed in India and not in Singapore.

e.
The Sale of Goods act makes it clear that property in goods passes when the
parties intend it to pass. in the present case, having regard to the conduct of
the parties as narrated above,  the
intention of the parties was that the property in goods was to pass only when
the installation and erection of entire works was completed in India.

Held 2: On role of PO in offshore supply of Goods and profit
attribution

a.
PO had come into existence much before the design of material and offshore
supply. PO had its own designing team and was working on the contract much
before supply of goods and material started.

b.
PO was also actively involved in designing, selecting and procuring supplies. The
PO cleared the goods from  customs  in  India  and 
paid  customs  duty. 
In these circumstances, taxpayer’s contention that the PO had no role in
supply of goods and materials or that no profit was attributable to the PO in India
was incorrect.

Held 3: Attribution of profits

Since the contract was a composite
one, entire amount was taxable in India.

17 Section 5(2)(a) of the Act – Benefit of Circular 13/2017 regarding non-taxability of remuneration received by non-resident in NRE account available also where such income was received for the first time in India; hence, such income was not taxable under the Act.

TS-219-ITAT-2017(Kol)

Shyamal Gopal Chattopadhyay vs. DDIT

A.Y.: 2011-12, Date of Order: 2nd June, 2017

Facts

Taxpayer, a non-resident individual, was a marine engineer
employed by a Hongkong shipping company (HCo). During the year under
consideration, Taxpayer was a non-resident. Taxpayer received remuneration in
foreign currency from HCo which was directly remitted to the NRE account in
India of the Taxpayer.

Taxpayer argued that salary income for services rendered
outside India is not taxable under the Act. Furthe, since salary was received
outside India in foreign currency and remitted to NRE account, it was not
taxable in India u/s.5 of the Act on receipt basis.

Relying on the decision of the Mumbai Tribunal in the case of
Capt. A. L. Fernandes vs. ITO [81 ITD 203], AO observed that if the
place where the recipient gets the money (on first occasion) under his control,
is in India, such income is to be considered as received in India. According to
AO, since the income was remitted by the employer of the Taxpayer to his bank
account in India, the Taxpayer had control over the money for the first time in
India. Therefore, AO held that such income was received in India.

Taxpayer appealed before CIT(A), who upheld the order of AO.
Aggrieved by the order of CIT(A), Taxpayer appealed before the Tribunal.

Held

–   In terms of Circular 13/2017 dated
11.04.2017, salary accrued to a non-resident seafarer for services rendered
outside India on a foreign going ship (with Indian flag or foreign flag) is not
to be included in the total income merely because such salary is credited in
the Non-resident rupee (NRE) account maintained with an Indian bank by the
seafarer.

–   Remittances of salary into NRE Account
maintained with an Indian Bank by a seafarer could be of two types:

–   Situation 1: employer directly crediting
salary to the NRE Account maintained with an Indian Bank by the seafarer;

–   Situation 2: employer directly crediting
salary to the account maintained outside India by the seafarer and the seafarer
transferring such money to NRE account maintained by him in India.

–   Credit to account outside India and
subsequent transfer to NRE account would be outside the purview of provisions
of section 5(2)(a) of the Act, as what is remitted is not “salary
income” but mere transfer of Taxpayer’s own funds from one bank account to
another which does not give rise to “Income”.

–   In the present case, the employer has
directly credited the salary, for services rendered outside India, into NRE
bank account of the seafarer in India.

–   Circular 13/2017 is vague. It is not clear
whether the expression “merely because” used in the Circular refers
to direct credit to NRE account or transfer of funds to the NRE account and
whether or not it covers both types of credits to NRE account.

–   Accordingly, benefit of doubt should be given
to the Taxpayer by interpreting the Circular as covering both the situations.

–   Though such an interpretation of the Circular
would make provisions of section 5(2)(a) of the Act redundant, such
interpretation is binding on the revenue. Reliance in this regard was placed on
SC decision in the case of Indian Oil Corporation, wherein it was held that
when a circular is in operation then the revenue will be bound by it. Revenue
then cannot plead that the circular is not valid or contrary to the provisions
of the statute.

–   Thus salary income received in NRE account
was not taxable in India.

16 Section 92E of the Act – Allotment of shares is an international transaction; Taxpayer is required to furnish Form 3CEB for reporting such transaction.

TS-319-ITAT-2017(Mum)-TP

BNT Global Pvt. Ltd. vs. ITO

A.Y.: 2011-12, Date of Order: 25th April, 2017

Facts

Taxpayer was an Indian
company. During the course of assessment proceedings, AO observed that the
Taxpayer had received foreign inward remittance on account of share capital and
premium from one of its existing shareholder who was also a director of the
Taxpayer Company. Though no adjustments were made, AO held that the allotment
of shares was an international transaction and levied penalty of INR 1 lakh
u/s. 271BA the Act as the Taxpayer did not file Form 3CEB.

The Taxpayer contended that share allotment transaction is
not an international transaction and in absence of any other international
transaction entered into by the Taxpayer, it was not required to file form
3CEB. Taxpayer appealed before CIT(A), who upheld the levy of penalty.
Aggrieved by the order of CIT(A), the Taxpayer appealed before the Tribunal.

Held

–   It is mandatory for a person entering into
international transactions to furnish Form 3CEB setting forth the particulars
of international transactions.

–   Transaction of share investment, clearly
falls within the ambit of section 92E of the Act and hence it has to be
reported in Form 3CEB. 

–   In IL&FS Maritime Infrastructure Co. Ltd.
(ITA No. 4177/Mum/2002 dated 23.07.2013), co-ordinate bench of the Tribunal has
held that share investment transactions fall within the purview of section 92E
of the Act. Hence, Taxpayer is required to file form 3CEB for such transactions
before the due date. In case of default, penalty u/s. 271BA would be attracted.

–   Thus, Taxpayer’s contentions that it was not
required to file Form 3CEB, since the provisions of section 92E of the Act were
not applicable to allotment of shares does not hold good.

–   Taxpayer’s reliance on Vodafone India
Services Pvt. Ltd. vs. ACIT (2014) 368 ITR 1 (Bom) is not applicable to the
present case, since in the aforesaid case Form 3CEB was filed by the Taxpayer
and issue considered therein was validity of arm’s length price adjustment made
by Transfer Pricing Officer (TPO) to issue of equity shares at a premium.

–   Failure on the part of the Taxpayer to
furnish the audit report in Form 3CEB is a violation of the provisions of
section 92E of the Act. Accordingly, penalty under the Act was leviable u/s.
271BA.

15 Sections 9 of the Act; Article 13 of India-Germany DTAA – Payment made for use of standard operating procedures amounts to sharing of information concerning industrial, commercial or scientific experience and taxable as royalty under India-Germany DTAA.

TS-209-ITAT-2017(Ahd)

Oncology Services India Pvt.Ltd. vs. ADIT

A.Y.: 2009-10, Date of Order: 1st June, 2017

Facts

Taxpayer, an Indian company, had
entered into an agreement for use of standard operating procedures (SOPs)
developed by a German group entity (GCo) in order to harmonise all required
software systems, policy and processes. The Taxpayer was also granted access to
the database, email server and hardware and software of GCo for the aforesaid
purpose. During the year under consideration, the Taxpayer had made payments to
GCo as per the agreement, however, no tax was deducted at source on such
payments by the Taxpayer.

During the course of assessment
proceedings, the Assessing Officer (AO) observed that the payments were made
for “using the name, goodwill and market reputation” of GCo and held that
income from such payment is taxable in India as royalties u/s. 9(1)(vi) of the
Act.

Taxpayer argued that payments were in the nature of business
income and in absence of PE of GCo in India, not taxable in India. Further, GCo
had permitted it to use the brand name, logo and website without any cost or
financial obligation. Hence, no part of the payment may be attributed to such
use.

Aggrieved by the order of AO,
Taxpayer appealed before the CIT(A) who upheld the order of AO. Subsequently,
Taxpayer appealed before the Tribunal.

Held

–   The use of name, brand, logo and website was
without any cost or financial liability. Hence, no part of the payment made to
GCo could be attributed to such use.

–   SOPs granted were “matured validated standard
procedures” which were developed by GCo over a period of time and approved by
the regulatory bodies. The access to database, and allied activities like
harmonisation of software systems, policy and process, were only incidental to
this main object of sharing the SOPs and thus cannot be viewed in isolation.

–   Sharing of SOPs was in effect
sharing of the information about the scientific experiences by GCo. Sharing of
such information was covered within the limb of “use of or right to use
information concerning industrial, commercial or scientific” in Article 13(3)
of India-Germany DTAA. Thus, the payment for sharing of the SOPs was taxable as
‘royalties’ under the India-German DTAA.

New Safe Harbour Provisions in Indian Transfer Pricing Regime

“Safe Harbour Rules”
were notified by the CBDT in the year 20131, which were applicable
to certain select International Transactions, prominent among them were
transactions relating to software, KPO, R&D, manufacturing of auto
components and intra-group loans and guarantees. These Rules aimed at reducing
litigation in the arena of Transfer Pricing. However, these Rules failed to
attract taxpayers due to prescription of high thresholds. A Committee was set
up to look into various aspects of safe harbor regime and based on its report
new safe harbor rules are notified by the CBDT on 7th June 2017. This
article analyses various provisions, their impact and potential issues that may
arise there from.

1.0   Introduction

Safe Harbour Rules (SHR) were first introduced in India vide CBDT
Notification No. SO 2810 (E) dated 18th September 2013. These Rules were
applicable only to international transactions for the Assessment Year (AY)
2013-14 and four AYs immediately following that, i.e. for and up to AY 2017-18.
A new set of SHR have been introduced with effect from 1st April 2017 which
shall apply with effect from the AY 2017-18 and two AYs immediately thereafter
i.e. for and up to AY 2019-20. Thus, new SHR will be effective for three years
only as oppose to five years in case of erstwhile SHR. These Rules are
discussed in the subsequent paragraphs.

It is provided that where a tax
payer is eligible for both the Rules (i.e. Old and New) (the same is possible
for the AY 2017-18, being an overlapping year), then he has an option to choose
the one which is most beneficial to him.

Explanation to section 92CB
of the Income-tax Act, 1961 (the Act) defines safe harbour to mean
circumstances in which the Income-tax authorities shall accept the transfer
price declared by the assessee.

The United Nation’s Practical Manual on Transfer Pricing for Developing
Nations released in the year 2013 defines “Safe harbour rules as rules whereby
if a taxpayer’s reported profits are below a threshold amount, be it as a
percentage or in absolute terms, a simpler mechanism to establish tax
obligations can be relied upon by a taxpayer as an alternative to a more
complex and burdensome rule, such as applying the transfer pricing
methodologies”.

OECD Transfer Pricing Guidelines defines a safe harbour as “a provision
that applies to a defined category of the taxpayers or transactions and that
relieves eligible taxpayers from certain obligations otherwise imposed by a
country’s general transfer pricing rules.”

2.0   New SHR effective from 1st April 2017

A new category of
transactions being “Receipts of Low Value-Adding Intra-Group Services” has been
introduced. The peak rates of safe harbour margins have been reduced in many
categories. In respect of knowledge process outsourcing, (KPO) safe harbour margins
are slashed and divided in to three rates of 18%, 21% and 24% instead of single
rate of 25% in the earlier regime. Moreover, the new rates are linked to
employee cost to operating cost ratio. These and other changes are elaborated
in more detail in the table, which also carries comparison of the old and new provisions.

Comparative
Provisions of the Old and New SHR

 

 

Comparative
Provisions of the Old and New SHR

Sr. No

Eligible
International Transactions

Safe Harbour Margin –

New Provisions

Safe Harbour Margin –
Old Provisions

1

Provision of Software Development Services

[Rule 10TA(m)] read with

[Rule 10TC(i)]

 

Operating Profit Margin (OPM) in relation to Operating
Expenses (OE):

 

For Software Development Services

(i) 17% or more, where the value of international
transaction does not exceed Rs. 100 crore;

 

(ii) 18% or more, where the value of international
transaction exceed Rs. 100 crore but does not exceed Rs. 200 crore;

 

For ITES

(i) 17% or more where aggregate value of such
transactions during the previous year does not exceed Rs. 100
crore; or

 

(ii) 18% or more where aggregate
value of such transactions during the previous year exceeds Rs. 100 crore
but less than Rs. 200 crore.

 

[As the limit of Rs. 500 crore stands reduced, the
companies with high value transactions will have to per force opt for
unilateral or bilateral Advance Pricing Agreements (APAs) to have certainty
of arm’s length pricing]

Operating Profit Margin (OPM) in relation to Operating
Expenses (OE):

 

(i)         20% or
more where total value of such transactions during the previous year does not
exceed Rs. 500 crore; or

 

(ii)         22% or
more where total value of such transactions during the previous year exceeds
Rs. 500 crore.

 

 

Provision of Information Technology Enabled Services (ITES)

[Rule 10TA(e)]

read with

[Rule 10TC(ii)]

 

Remarks:

(i)   “OPM” in relation to “OE” means the ratio
of operating profit, being the operating revenue in excess of operating
expense, to the operating expense expressed in terms of percentage.

(ii)  Rule 10TA defines “Software Development
Services” as well as ITES. In both cases it is clarified that any research
& development (R&D) services will not be included in the definition
whether or not such R&D services are in the nature of contract R&D
services.

(iii)   It may be noted that for applying the
threshold of Rs. 100 crore or two crore, as the case may be, to the Software
Development Services, one need to consider the value of international
transaction (could be read as “single transaction”); whereas for ITES, one
need to consider the aggregate value of all transactions during the relevant
previous year. Earlier this distinction was not there and for both types of
services, the thresholds were computed by to the aggregate value of all
transactions during the previous year.

2

Provision of Knowledge Process Outsourcing Services (KPO)

[Rule 10TA(g)]

 

Value of the International Transaction should not exceed
Rs. 200 crore and the OPM to OE shall be as follows:

(i) 24% or more if Employee Cost (EC) to Operating Expense
(OE) is at least 60%;

 

(ii) 21% or more if EC to OE is 40% or more but less than
60%;

 

(iii) 18% or more if EC to OE is less than 40%.

 

OPM to OE shall be 25% or more.

Remarks:

(i)    Employee Cost (EC) has been defined in
Rule 10TA by insertion of clause (ca). OE has already been defined in clause
(j) of Rule 10TA.

       (Refer paragraph 3.1 below for further
details)

(ii)   Looking at the nature of highly skilled
employees in KPO industries, taxpayers are likely to fall in the higher
brackets of 21% or 24% as EC is higher for KPO services.

3

Provision of Contract R&D Services wholly or partly
relating to Software Development.

[Rule 10TA (aa)] read with

[Rule 10TC(vi)]

 

Value of the International Transaction should not exceed
Rs. 200 crore and the OPM to OE shall be 24% or more

OPM to OE shall be 30% or more.

Remark:

Though there is a reduction in SHR margin, the
applicability is restricted to small transactions and therefore tax payers
with large amount of transaction will have to opt for APA.

4

Provision of Contract R&D Services wholly or partly
relating to Generic Pharmaceutical Drugs.

[Rule 10TA(d)] read with

[Rule 10TC(vii)]

Value of the International Transaction should not exceed
Rs. 200 crore and the OPM to OE shall be 24% or more

OPM to OE shall be 29% or more.

Remarks:

(i)   Contract R&D services in relation to
Generic Pharmaceutical Drugs (GPD) is not defined. However, GPD is defined to
mean a drug that is comparable to a drug already approved by the regulatory
authority in dosage form, strength, route of administration, quality and
performance characteristics and intended use.

(ii)   Other comment relating to large
transactions as mentioned above at point no. 3 applies here also.

5

Manufacture and Export of Core Auto Components

[Rule 10TA(b)] read with

[Rule 10TC(viii)]

 

No change.

 

OPM to OE shall be 12% or more.

 

OPM to OE shall be 12% or more.

Remark:

Core Auto Components are
defined in Clause (b) of Rule 10TA.

6

Manufacture and Export of Non- Core Auto Components

[Rule 10TA(h)] read with

[Rule 10TC(ix)]

 

No change.

 

OPM to OE shall be 8.5% or more.

 

OPM to OE shall be 8.5% or more.

Remark:

Rule 10TA (h) defines non-core auto components as the ones
which are other than core auto components.

7

Advancing of intra-group loans in Indian Rupees

 

[Rule 10TA(f)] read with

[Rule 10TC (iv)]

 

Interest rate should not be less than the one-year marginal
cost of funds lending rate of SBI as on the 1st April of the relevant
previous year plus:

 

* 175 BPS where CRISIL rating of Associated Enterprise (AE)
is between AAA to A or its equivalent;

 

* 325 BPS where CRISIL rating of AE is BBB-, BBB or BBB+ or
its equivalent;

 

* 475 BPS where CRISIL rating of AE is between BB to B or
its equivalent;

 

* 625 BPS where CRISIL rating of AE is between C to D or
its equivalent;

 

* 425 BPS where CRISIL rating of AE is not available and
the amount of loan advanced to the AE including loans to all AEs does not
exceed Rs.100 crore as on 31st March of the relevant previous year (PY);

Interest rate should not be less than the base rate of SBI
as on 30th June of the relevant previous year plus 150 basis points (BPS)
where the loan amount is less than or equal to Rs. 50 crore and

 

300 BPS where the loan amount is exceeding Rs. 50 crore

 

Remarks:

(i)    Intra-group loan is defined in clause (f)
of the Rule 10TA. It covers loans advanced to Wholly Owned Subsidiary (WOS)
in Indian rupees. Banking and Financial Institutions are excluded.

(ii)   In Rule 10TA (f) ironically, the definition
of Intra-group loan is not amended which refers to only WOS whereas, the SHR
makes a reference of AE.

(iii)  It is good that the rate of interest is to
be determined based on the credit rating of the borrower. However, provision
of obtaining CRISIL rating for all borrowers may put them in undue hardships.

8

Advancing of intra-group loans in Foreign Currency (FC)

 

[Rule 10TA(f)] read with

[Rule 10TC (iv)]

 

Interest rate is not less than 6 months LIBOR of the relevant foreign
currency as on 30th September of the relevant PY plus:

* 150 BPS where CRISIL rating of AE is
between AAA to A or its equivalent;

* 300 BPS where CRISIL rating of AE is
BBB-, BBB or BBB+ or its equivalent;

* 450 BPS where CRISIL rating of AE is
between BB to B or its equivalent;

* 600 BPS where CRISIL rating of AE is
between C to D or its equivalent;

* 400 BPS
where CRISIL rating of AE is not available and the amount of loan advanced to
the AE including loans to all AEs does not exceed Rs. 100 crore as on 31st
March of the relevant previous year (PY);

No such distinction between intra-group loans in INR or FC.

 

The rates prescribed above were applicable for all types of
intra-group loans.

 

Remarks:

(i)   
The determination of lending rate based on the currency of a loan is a
best international practice. However, the tenure of the loan and other terms
are not considered in determining the rate of interest.

(ii)   Requirement to obtain CRISIL rating for
all borrowers may put them into undue hardships.

9

Providing corporate guarantee

 

[Rule 10TA (c)] read with

[Rule 10TC (v) (a) (b)]

 

Guarantee commission or the fee charged should be minimum
1% per annum on the amount guaranteed.

Guarantee commission or the
fee charged should be minimum

(i) 2% per annum of the amount
guaranteed where the amount guaranteed does not exceed Rs. 100 crore.

(ii) 1.75% per annum where the amount guaranteed exceeds
Rs. 100 crore.

Remarks:

(i)    The reduction of guarantee commission up
to 1% is a welcome change.

(ii)    However, in number of decisions2  Tribunals have upheld 0.5% as the arm’s
length guarantee commission.

(iii)  Corporate Guarantee is defined to mean
explicit corporate guarantee extended by a company to its WOS being a
non-resident in respect of any short-term or long term borrowing.

(iv)  Unlike SHR for intra-group loans, which are
now extended to AEs and not just WOS, corporate guarantee continues to apply
only in respect of WOS.

10

Receipt of Low value-adding intra-group services

[Rule 10TA (ga)] read with

[Rule 10TC (x)]

The entire value of the
International Transaction, including a mark-up not exceeding 5%, should be
less than or equal to Rs. 10 crore.

Not There.

Remarks:

(i)   
A new Clause (ga) is inserted in Rule 10TA to define the meaning of
“Low Value-Adding Intra-group Services”. (Refer paragraph 3.4 below for
further details)

(ii)  
It is also provided that SHR provisions would apply only if the method
of cost pooling, the exclusion of Shareholder costs and duplicate costs from
the cost pool and the reasonableness of the allocation keys used for
allocation of costs to the assessee by the overseas AE, is certified by an
accountant. A new clause (a) has been added to Rule 10TA to define the
meaning of “accountant”.

3.0        Other
Important Changes in the new regime

       3.1 Employee Cost in relation to KPO
Services

       Employee
cost has been defined in the newly inserted clause (ca) of Rule 10TA which
besides normal employee expenses also includes expenses incurred on contractual
employment of person performing tasks similar to those performed by the regular
employees. Outsourcing expenses, to the extent of employee cost, wherever
ascertainable, which are embedded in the total outsourcing expenses should also
be considered as a part of the total employee cost. Wherever, the extent of
employee costs is not so ascertainable, they will be deemed to be 80 per cent
of the total outsourcing expenses.

       3.2 The
definition of Operating Expenses in clause (j) of Rule 10TA is amended to
include costs relating to Employee Stock Option Plan (ESOP) or similar
stock-based compensation provided by the AE of the assessee to the employees of
the assessee.

       3.3 Reimbursement of expenses to the AE
shall be considered at cost.

       3.4 Low Value-Adding Intra-group Services

       A new
service, namely, Low Value-Adding Intra-Group Services (LVA-IGS) has included
in the SHR. It is defined in the clause (ga) of Rule 10TA. The salient features
of this definition are as follows:

       LVA-IGS refers to services which are:

(i)    in the nature of support services;

(ii)    not part of the core business of the
multinational enterprise group;

(iii)   are not in the nature of shareholder services
or duplicate services;

(iv)   do not require use of unique intangibles nor
lead to creation of unique and valuable intangibles;

(v)   do not involve assumption or control of
significant risk by the service provider nor give rise to creation of
significant risk for the service provider; and

(vi)   do not
have reliable external comparable services that can be used for determining
their arm’s length price.

       However, it is specifically provided
LVA-IGS does not include the following services:

(i)    research and development services; (ii)
manufacturing and production services; (iii) information technology (software
development) services; (iv) knowledge process outsourcing services; (v)
business process outsourcing services; (vi) purchasing activities of raw
materials or other materials that are used in the manufacturing or production
process; (vii) sales, marketing and distribution activities; (viii) financial
transactions; (ix) extraction, exploration, or processing of natural resources;
and (x) insurance and reinsurance;”

       The
definition of LVA-IGS as mentioned above is by and large in sync with the
definition at the paragraphs 7.46. 7.47 and 7.48 of the Base Erosion and Profit
Shifting (BEPS) Action Plan 10 promulgated by the OECD. However, BPO/KPO
services and purchase activities of raw materials or other materials that are
used in the manufacturing or production process are excluded from the
definition of the Indian SHR pertaining to LVA-IGS, which is not so in case of
BEPS Action Plan. It may be noted that BEPS Action Plan excludes “Services of
corporate senior management” from the definition of LVA-IGS, which is not so in
case of Indian regulations.

4.0   SHR on Domestic Transactions

       In
2015, SHR 10TH to 10THD were introduced covering to following domestic
transactions:

_______________________________________________________________________________________________

In Bharti
Airtel Ltd (ITA No 5816/Del/201Z) dated 11 March 2014; Reliance Industries Ltd
(I.T.A. No. 4475/Mum/2007) and Four Soft Ltd. vs. DCIT [(Hyd. ITAT) – 62 DTR
308] respective honorable Tribunals upheld non-charging of guarantee
commission/fees.

 

S. No.

Eligible specified domestic Transaction

Circumstances

1.

Supply of electricity, transmission of electricity,
wheeling of electricity referred to in item (i), (ii) or (iii) of rule 10THB,
as the case may be.

The tariff in respect of supply of electricity,
transmission of electricity, wheeling of electricity, as the case may be, is
determined by the Appropriate Commission in accordance with the provisions of
the Electricity Act, 2003 (36 of 2003).

2.

Purchase of milk or milk products referred to in clause
(iv) of rule 10THB. [i.e. Purchase of milk or milk products by a co-operative
society from its members]

The price of milk or milk products is determined at a rate
which is fixed on the basis of the quality of milk, namely, fat content and
Solid Not FAT (SNF) content of milk; and—

(a) the said rate is irrespective of,—

(i)    the quantity of milk procured;

(ii)   the percentage of shares held by the
members in the co-operative society;

(iii)   the voting power held by the members in the
society; and

(b) such prices are routinely
declared by the co-operative society in a transparent manner and are
available in public domain.

 

Rule 10THC further
provides that no comparability adjustment and allowance under the second
proviso to sub-section (2) of section 92C shall be made to the transfer price
declared by the eligible assessee and accepted under sub-rule (1) and the
provisions of sections 92D (relating to Maintenance and keeping of information
and documents) and 92E (submission of Audit Report) in respect of a specified
domestic transaction shall apply irrespective of the fact that the assessee
exercises his option for safe harbour in respect of such transaction.

5.0   Summation/Way
Forward

       The
erstwhile SHR did not attract many taxpayers due to high rates. Lowering of
rates in some cases would definitely induce more taxpayers to opt for the same
and avoid litigation.

     The significant changes in intra-group
loans will attract many taxpayers. Inclusion of LVA-IGS is a welcome step and
in line with global trends. The acceptable threshold for the Corporate
Guarantee could have further been lowered. Manufacturers and exporters of core
and non-core auto components may continue to avoid SHR due to prescription of
high margins.

All
in all, it is a positive move on the part of Government in the direction of
reduction in litigation, though reduction in the value of the eligible
international transactions will push away many taxpayers out of the ambit of
Safe Harbour Regulations.

Section 92CE and Section 94B – Analysis and Some Issues

This article deals with some of the issues which warrant
attention with respect to section 92CE and section 94B of the Income-tax Act
1961, (Act) as introduced by the Finance Act 2017. 

                                                        
                               

Section 92CE – Secondary adjustment in certain cases

1.      As per the memorandum explaining the
provisions of the Finance Bill 2017, the provision has been introduced to align
transfer pricing provisions with the OECD transfer pricing guidelines and the
international best practices. The said memorandum explains that “Secondary
adjustment” means an adjustment in the books of accounts of the assessee
and its associated enterprise to reflect that the actual allocation of profits between
the assessee and its associated enterprise are consistent with the transfer
price determined as a result of primary adjustment, thereby removing the
imbalance between cash account and actual profit of the assessee. The OECD
recognises that secondary adjustment may take the form of constructive
dividends, constructive equity contributions, or constructive loans. India has
opted for form of secondary adjustment i.e. constructive advance.

2.1.   The section provides that the assessee shall
make a secondary adjustment in certain cases only i.e. where the primary
adjustment to transfer price,

a)  has been made suo motu by the assessee
in his return of income; or

b)  has been made by the Assessing Officer (AO)
and accepted by the assessee; or

c)  is determined by an advance pricing agreement
entered into by the assessee u/s. 92CC; or

d)  has been made as per the safe harbour rules
framed u/s. 92CB; or

e)  is arising as a result of resolution of an
assessment by way of the mutual agreement procedure under an agreement entered
into u/s. 90 or 90A.

2.2.    The provisions will apply only if the
primary adjustment exceeds INR one crore and the excess money attributable to
the adjustment is not brought to India within the prescribed time. From the
above, it is clear that the provision will have a limited applicability and
hence there is no need for the panic. In fact, it will be interesting if the
Government publishes the data that in the last decade of transfer pricing
scrutiny, how many cases were covered by aforesaid clauses.

2.3.    As regards clause (b), once the primary
adjustment made by the AO is contested by the assessee in appeal, he will not
be covered by the same even if the appellate authority upheld the adjustment
made by the AO and assessee accepts the said addition.

2.4.    The taxpayer invoking the MAP to resolve the
transfer pricing dispute needs to be mindful of this provision. In fact, there
is a possibility that the taxpayer may be discouraged to resolve the transfer
pricing dispute through MAP because of this provision.

3        The assessee is not required to make any
secondary adjustment in respect of any primary adjustments made in the
assessment year 2016-17 or any of the earlier years. In other words, the
assessee shall make secondary adjustment only in respect of primary adjustment
made in the assessment year 2017-18 and subsequent years. The provision is
applicable in relation to the assessment year 2018-19 and subsequent years.
Thusfore, the assessee is expected to make a secondary adjustment from   AY 18-19 in respect of primary adjustments
made in AY 17-18 or subsequent years.

4        Section 92CE(3) (iv) provides that
“primary adjustment” to a transfer price means the determination of transfer
price in accordance with the arm’s length principle, resulting in an increase
in the total income or reduction in the loss, as the case may be of the
assessee. The wordings of the definition are not clear and do not seem to
reflect legislative intent.

          In my view, primary adjustment is the
increase in the income or reduction in the loss of the assessee as a result of
the computation of income u/s. 92C(4) r.w.s 92. i.e. if the taxpayer has
imported the goods worth INR 100 from its AE and if the AO computes the ALP of
such import at INR 95, he will increase the income of the taxpayer by INR 5 and
the same would be regarded as the primary adjustment. If the case of the
taxpayer falls in any of the cases listed in paragraph 2.1 above, he is
required to make a secondary adjustment.

5.1     What
secondary adjustment is envisaged? and when should the assessee make the
secondary adjustment? In the above case, the assessee has already made payment
of INR 100 towards the import to the AE and the AE is sitting with the fund
representing the primary adjustment i.e INR 5 .The assessee is required to
debit the account of the AE and credit the profit and loss account (P&L
A/C) with the amount of the primary adjustment. If the amount representing the
debit balance in the account of the AE is repatriated to India within the
stipulated time, no further consequence arises. However, if the amount is not
repatriated to India, the said debit balance in the account of the AE would be
deemed to be an advance made by the assessee to the AE and the interest on such
advance is required to be computed in a prescribed manner.

5.2     The timing of the secondary adjustment in
the books would possibly vary from case to case and would depend on the exact
clause of section 92CE(1) under which the primary adjustment is made. If the
primary adjustment is made suo motu by the assessee in his return of
income, the same should be done in the same year. However, if the assessee is a
company and its accounts are closed, it will have to comply with provisions of
the Companies Act and make the adjustment in the books in accordance with the
Companies Act. 

6        Further issues that may arise in this
regard are:

6.1     Whether the credit to P&L A/C would
form part of book profit for the purpose of section 115JB? Considering the
provision of section 115JB and 92CE, it appears that the said credit would form
part of the book profit.

6.2     Whether the section envisages a
identification of the AE which can be correlated to the primary adjustment and
rule out the mandate to carry out secondary adjustment in other cases?

          In practice, an assessee enters into
various transactions with different AEs and the TPO makes an overall adjustment
following TNM method without identifying the exact transaction or the AE. In
such cases, a question will arise as to which AE’s account is to be debited for
secondary adjustment. Should the adjustment be prorated to various AEs? If the
primary adjustment cannot be identified with an AE, a view may be taken that
the obligation to carry out secondary adjustment does not arise.

6.3   Whether the debiting the account of the AE
with the primary adjustment be regarded as constructive payment? If yes, it may
further require examining the applicability of the provisions of section
2(22)(e) especially when the AE holds more than the threshold level of shares in
the Indian company.

          It must be noted that the deeming
fiction are to be strictly construed and should be confined to the purpose for
which they are enacted. Hence, the primary adjustment which is deemed to be an
advance made by the assessee to its AE should be confined to that only and
should not be extended to any other provision.

6.4     The section requires adjustment in the
books of account of the AE also. Whether the same is warranted, whether the
same is in the control of the assessee and what if it is not carried out in the
books of the AE? If the adjustment is not carried out in the books of the AE,
then the assessee has not carried out the secondary adjustment as envisaged
u/s. 92CE(1) and further consequences in accordance with law should follow.

6.5     The section provides that the assessee
shall make the secondary adjustment, i.e. the assessee is under an obligation
to carry out secondary adjustment. What if the assessee does not make such
adjustment? Whether the existing provisions under the Act are enough to empower
the revenue authorities to make such adjustment when the assessee does not make
such adjustment?

        Currently, there is no separate penal
provision for non-compliance with section 92CE. However, one needs to examine
whether there is an under reporting or misreporting of the income within the
meaning of section 270A when the assessee does not carry out the secondary
adjustment when it is under an obligation to carry out the same.

7    Recently, revenue has made primary
adjustment in the case of nonresident associated enterprises (AE) and such
adjustment has been upheld by the Tribunal i.e. the non-resident should have
earned more royalty from the Indian resident assessee. The newly inserted
section 92CE requires the assessee to repatriate the excess money attributable
to primary adjustment to India. Thus, obviously there cannot be any secondary
adjustment when the primary adjustment is made in the case of foreign AE, since
there cannot be any question of repatriation to India in such cases. In fact,
logically it may require the Indian resident to remit the amount to the non
resident AE representing primary adjustment. This becomes an additional
argument to advance the case of the assessee that primary adjustment cannot be
made in the case of foreign AE.

8       The language of the section needs
attention of the draftsmen so as to bring home the intent and also to provide
clarity and certainty. The following may be noted in this respect:

8.1     In addition to the other terms, the section
defines the term “primary adjustment” and “secondary adjustment”. It may be
noted that sub-section (1) provides that the assessee shall make a secondary
adjustment where there is a primary adjustment to transfer price in certain
cases. However, neither the term “transfer price” nor the term “primary
adjustment to transfer price” is defined either in the section or in the
relevant chapter.

8.2     There is no link between sub-section (1)
and sub-section (2) of the section and hence there is an apprehension that the
deeming fiction of treating the amount representing the primary adjustment as
advance and further consequence as provided in sub-section (2) is applicable to
all cases and not confined to those covered by sub-section(1). However, If
sub-section (2) is interpreted in this manner, then consequence of sub-section
(1) would stop at passing the entry in the books of the assessee. The debit
balance in the books need not be repatriated and would be treated in accordance
with the other provisions. The above does not seem to be the intention. The
intention of the legislature is achieved only when both sub sections are read
together. However, this anomaly in the drafting needs to be corrected.

Section 94B – Limitation on Interest deduction in certain
cases

9        The provision has been introduced to
address the issue of thin capitalisation. The memorandum explaining the
provisions of the Finance Bill 2017 states “A company is typically financed or
capitalised through a mixture of debt and equity. The way a company is
capitalised often has a significant impact on the amount of profit it reports
for tax purposes as the tax legislations of countries typically allow a
deduction for interest paid or payable in arriving at the profit for tax
purposes while the dividend paid on equity contribution is not deductible.
Therefore, the higher the level of debt in a company, and thus the amount of
interest it pays, the lower will be its taxable profit. For this reason, debt
is often a more tax-efficient method of finance than equity. Multinational
groups are often able to structure their financing arrangements to maximise
these benefits. For this reason, the country’s tax administrations often
introduce rules that place a limit on the amount of interest that can be
deducted in computing a company’s profit for tax purposes. Such rules are
designed to counter cross-border shifting of profit through excessive interest
payments, and thus aim to protect a country’s tax base……….”

        In view of the above, it is proposed
to insert a new section 94B, in line with the recommendations of OECD BEPS
Action Plan 4, to provide that interest expenses claimed by an entity to its
associated enterprises shall be restricted to 30% of its earnings before
interest, taxes, depreciation and amortisation (EBITDA) or interest paid or
payable to associated enterprise, whichever is less.

10.1   It provides that the deduction towards interest
incurred by an Indian company or permanent establishment of a foreign
company (specified entity or borrower) in respect of any debt issued by its non-resident
AE (specified lender) will be restricted while computing its income under the
head “profits and gains of business and profession”. The deduction will be
restricted to 30% of earnings before interest, taxes, depreciation and
amortisation (EBITDA) or the actual interest whichever is less.

10.2   The restriction will be applicable only if
the borrower incurs expenditure by way of interest or of similar nature
which exceeds INR one crore in respect of debt issued by the specified lender.
In other words, when such payment is less than INR one crore, the claim for
interest will not be restricted to 30% of EBIDTA. i.e If the EBIDTA is one
crore and such payment is 40 lakh, the claim for interest will not be
restricted under this section. The restriction is also not applicable to
borrower which is engaged in the business of banking or insurance.

10.3   At times, the restriction will apply even if
the debt is issued by a third party which is not an AE. This will be the case
when the AE (resident or non-resident) provides an express or implicit
guarantee in respect of the debt or it places deposit matching with loan fund
with the third party. In such a case debt which is issued by a third party shall
be deemed to have been issued by an AE.

11    The amount so disallowed will be carried
forward and will be eligible for deduction for the next eight assessment years.
However, the deduction for the carried forward amount will be allowed in the
same manner subject to the same upper limit.

12.1   The provision is applicable only when the
expenditure towards “interest or of similar nature” exceeds INR one
crore. The term interest is defined u/s. 2(28A) of the Act. However, a question
may arise as to what can be included within the term “of similar nature”? It
may be noted that the term “debt” has been defined and one can draw on this
definition so as to understand what other nature of payments are likely to be
covered by the term “of similar nature.”

12.2   Section 94B(5)(ii) states that “debt” means
any loan, financial instrument, finance lease, financial derivative, or any
arrangement that gives rise to interest, discounts or other finance charges
that are deductible in the computation of income chargeable under the head
“Profits and gains of business or profession.”

12.3   It needs to be noted that the restriction
towards deduction is applicable to only “interest” expenditure, though for the
purpose of applying threshold limit of INR one crore, one needs to take into
account expenditure of similar nature together with interest.

13      The section provides for the cases when
the debt will be deemed to be issued by the AE. One such case is when there is
an implicit guarantee provided by the AE to the third party lender.
This provision has the potential to create litigation and hence there needs to
be a very clear guidance as to what are the circumstances that could be
regarded as provision of implicit guarantee.

14.1   Whether a special provision dealing with
interest in section 94B excludes applicability of section 92 to such interest
payment? It does not seem to be so. Thus, there can be situations when there is
interplay of both the sections. i.e EBIDTA of the Indian company is INR 20
crore and the interest payment to AE is INR 10 crore. Such interest is paid
@10%. Arm’s length interest rate determined u/s. 92 is 6.5%. This would lead to
an adjustment of INR 3.5 crore u/s. 92. Section 94B would restrict the
deduction of interest to 30% EBIDTA i.e 6 crore. Thus, the income of the Indian
company would be increased by INR 7.5crore.(3.5 crore u/s. 92 and 4 crore u/s.
94B). This leads to an absurd result and does not seem to be intention of the
law.

14.2   In my view, the base for disallowance u/s.
94B should be substituted after giving effect to the adjustment u/s. 92 i.e to
6.5 crore from 10 crore. This will have the effect of restricting the
disallowance u/s. 94B to 50 lakh resulting into an aggregate adjustment of only
4 Crore. Thus, any increase or decrease in the adjustment u/s. 92 will have
consequential impact on the limitation u/s. 94B. The interplay needs to be
clarified by CBDT with examples. 

15      In the above example, section 92CE
requires the assessee to make a secondary adjustment of 3.5 crore in respect of
the primary adjustment made u/s. 92. The Indian company is required to charge
interest on the said deemed advance. Thus, there will be a debit to the
interest account and credit to the interest account in respect of the same
lender in subsequent years. Can such debit and credit be net off while applying
provisions in subsequent years? This question will not arise if the assessee
maintains only one account of the AE in its books and passes the debit entry
for the deemed advance in the same account.

16      The deduction towards interest is
restricted only when the lender is non-resident. In other words, if the lender
is a resident AE, the restriction will not apply. Would it meet the provision
of non-discrimination article in a treaty when the non-resident is a resident
of a treaty country?

          Relevant extract of Article 24(4) of
the OECD and UN model convention (both are identical) is reproduced hereunder
for ready reference:

24(4)
Except where the provisions of paragraph 1 of Article 9, paragraph 6 of Article
11 or paragraph 4 of Article 12, apply, interest, royalties and other
disbursements paid by an enterprise of a Contracting State to a resident of the
other Contracting State shall, for the purpose of determining the taxable
profits of such enterprise, be deductible under the same conditions as if they
had been paid to a resident of the first-mentioned State…..

From the above text, it is clear that the model
article 24(4) prohibits such discrimination when the deduction is restricted
only to non-residents. However, the article provides exceptions when such
nondiscrimination is permitted. Section 94B possibly may fall into such
exception if it excludes application of section 92 when 94B is applied.

14. TS-605-ITAT-2016(HYD) Qualcomm India Private Limited vs. ADIT A.Y.s: 2006-07 to 2009-10, Date of Order: 28th October, 2016

Section 9(1)(vi) of the Act – (i) End user
software license package was a copyrighted article, not license to use the
copyright – payment was not royalty – consequently, payment for ‘support
services’ was also not royalty; (ii) Payment was for internet and bandwidth
services provided by service provider – sophisticated equipment installed by
service provider for providing service – service recipient did not have
exclusive right to use such equipment – payment was not royalty

Facts

The Taxpayer was an Indian company providing
software design, development and testing services to its group companies (its
customers) through its various units in India. The Taxpayer charged
consideration at cost plus 15% for such services.

In respect of AYs 2006-07 to 2009-10, the
tax authority had conducted survey u/s.133A of the Act to examine compliance of
TDS provisions by the Taxpayer.

It was noticed that the Taxpayer had made
several foreign remittances for end user software license packages to companies
in USA, UK, Germany, Japan, Singapore, etc. without deducting tax
u/s.195 of the Act. Since the payments were made for purchase of the
copyrighted article, Assessing Officer (AO) characterised the payment as
royalty for use of copyright, both u/s. 9(1)(vi) of the Act as well as under
respective DTAAs.

Taxpayer also made certain remittances
without deduction of tax to an American Company (USCo) for ‘leased circuit
line’. AO held that the payment being for use of scientific or commercial
equipment was taxable under clause (iva) of section 9(1)(vi) of the Act.

On appeal, CIT(A) confirmed AO’s order.
Aggrieved with the order of CIT(A), the Taxpayer filed appeal before Tribunal.

Held

Taxation of copyrighted software

(i)  The Taxpayer had purchased
end user software license packages which provided the Taxpayer with the right
to use the software. The Taxpayer used it for testing working of equipment.
Thus, the Taxpayer used the software as tools of its business.

(ii) Software purchased by the
Taxpayer was a copyrighted article. It could not be construed as license to use
the copyright. This issue was covered by decision of Delhi High Court in PCIT
vs. M. Tech Indian (P) Ltd. (ITA No. 890.2015 dated 19.01.2016). Hence, the
payment could not be termed as royalty.

(iii) Consequently, payment for
‘support services’ also could not be treated as royalty.

Taxation of bandwidth services

(i)  USCo had provided
connectivity facility to the Taxpayer which mainly consists of advanced
connectivity network and access equipment. These were connected through
under-sea cable and further connected by the routers and digital circuits.
Connectivity was for voice and data communication. The equipment was technical,
such as, ‘modem’ and ‘routers’. It was installed only at premises of customers
of the Taxpayer in USA and not in India.

(ii) US Co provided internet or
bandwidth services to its customers globally, including to the Taxpayer, as
standard services. The undersea cables and the routers etc., were part
of the equipment used by USCo for rendering services to its customers globally.
It could not be said that the Taxpayer was given exclusive right to use the equipment.

(iii) This issue was covered by
decisions of Delhi High Court in Asia Satellite Telecommunications Co. Ltd.
(332 ITR 340) and Estel Communications (P) Ltd. (318 ITR 185) and decision of
Tribunal in Infosys Technologies Ltd. (45 SOT 157). Accordingly, payment made
to USCo being for providing internet and bandwidth services, was not in the
nature of royalty. Consequently, the Taxpayer was not required to deduct tax at
source.

TS-545-ITAT-2016(Del) International Management Group (UK) Ltd. vs. ACIT (IT) A.Y.: 2010-11, Date of Order: 4th October, 2016

Article 13 of the india-uK DTAA, S. 9(1)(vii) of the act – (i) profits
to the extent of the activities carried on through Service PE should be taxable
as business profits under the DTAA; (ii) additional income satisfying make
available condition which is not attributable to PE in india should be taxed as
FTS under the DTAA; (iii) Source rule exclusion applicable to FTS under the act
does not apply as services are utilised for business or earning income from a
source in india

Facts

Taxpayer,   a  UK   tax 
resident,  was  engaged 
in  the business of event
management and talent representation activities in sports events. The taxpayer
entered into a memorandum of understanding (mou) with Board of Control for
Cricket in india (indian entity) for assistance in establishment,
commercialisation and operation of indian Premier league  (‘event’). The services under the MoU, inter
alia, included advising and assisting indian entity  in connection with the following aspects.

Structure of the league.

League rules and regulations.

Franchisee agreements.

Legal implementation budget.

Media rights agreements.

Trading and auction of the
players.

Hospitality guidelines in
relation to the league.

Provision of legal handbooks.

On the basis of the mou, a
service agreement was entered into between taxpayer and the indian entity for
holding the cricket event in india. For this purpose, the taxpayer had deputed
its employees and other third party freelancers for undertaking on-ground
implementation, event management and supervision activities in india. However,
due to some reasons, the venue for the event was shifted from india to South
africa and the remaining services were rendered outside india. During the year under
consideration, the length of stay of taxpayer’s employees and freelancers
exceeded 90 days in india. Accordingly, 
Service Permanent establishment (Pe) 
of the taxpayer was established in india.

The taxpayer contended that:

– 
Amount attributable to the services rendered in South africa were not
taxable in india as they were not attributable to PE in india;

– 
Once income was attributable to Service Pe, it cannot be taxed under
fee  for technical Services (FTS) as both
are mutually exclusive;

– 
Even if FTS article is applied, the services do not make available any
technical knowledge or skill, etc.; and

– Income attributable to such
services is not taxable in india under the DTAA.

Taxpayer argued that even u/s.
9(1)(vii) of the act, the amount was protected by source rule exclusion as the
services were utilised by indian entity for the business outside india.

However, the ao Held that even
the amount received by the taxpayer, 
which was not attributable to the service Pe, was also taxable in india
as FTS under the act, as well as under the DTAA.

Upon filing of objections against
order of AO, the Dispute resolution Panel (DRP) directed that the balance
consideration be taxed as FTS on a protective basis and regarded as business
income to be attributed to the PE on substantive basis. Aggrieved, the
taxpayer, as well as the AO, preferred an appeal before ITAT.

Held 1: Attribution to PE

– As per article 7, income which
is attributable to a PE is taxable in the state in which PE is situated. Further,  as per FTS article, income which is
effectively connected with a PE is taxable as business income and FTS article
ceases to apply.

– For income from services which
are in the nature of FTS, to be regarded as “effectively connected” with the
Pe, one of the following conditions should be established:

i.   PE should be engaged in the performance of
such services or it should be involved in actual rendering of such services, or

ii.  PE should arise as a result of its own
activities, or

iii. PE should,
at least, facilitate, assist or aid in the performance of such services,
irrespective of the other activities that the PE performs.

– Also,  the 
term  “effectively  connected” 
should  not be understood to mean
the opposite of “legally connected” but something in the sense of “really
connected”. Therefore,  the activities
mentioned in the contract should be connected to the PE not only in the form
but also in substance.

– In the contract under
consideration, activities carried by the taxpayer outside india were not
concerned with the functioning of the PE but were carried out by the head
office of the Taxpayer itself. Thus the activities carried on outside india
cannot be treated as being effectively connected with the PE in india and hence
will be taxable as FTS under the DTAA.

– 
The  contention of the taxpayer
that the contract with indian 
entity  itself  was 
effectively  connected  with the PE in india and hence, the whole of
the revenue involved in the contract should be considered as effectively
connected is incorrect.

Held 2: Make available condition

– Technology is considered “made
available” only when the service recipient is enabled to absorb and apply the
technology contained therein.  In order
to satisfy the make available test, the technical knowledge, experience, skill
etc. must remain with the service recipient even after the rendering of the
services has come to an end and the service receiver is at liberty to use the
acquired technical knowledge, skill, know-how and processes in his own right.

– 
In the present case, indian entity is enabled to absorb and apply the
information and advice provided by the taxpayer for conducting sporting events.
The documentation and material provided enables indian entity to use the
know-how and documentation independent of the services of the taxpayer in the
future. Furthermore,  it may not be
appropriate to say that in the absence of the taxpayer, the indian entity, on
its own, cannot hold/organise the event.

– 
Thus,  the services provided by
the taxpayer to indian entity satisfy the ‘make available’ condition. Hence,
income from such services was taxable as FTS under the DTAA.

Held 3: source rule exclusion

– In this case, it was an
established fact that indian entity was carrying on business in india and not
outside india.

– 
The source of income of the indian entity was in india, and not outside
india.

– The source of income of indian
entity could not be regarded as being outside india merely because performance
of the event was outside india. Thus, 
the consideration for services outside india is taxable as FTS even
under the act.

Section 9(1)(vi),(vii) of the Act – composite consideration paid for acquiring various rights including use of marks for advertisement and promotion did not qualify as royalty or FTS since it was not for manufacture and sale of products; however, payment made solely for the use of ICC marks in manufacture and sale of licensed products qualified as royalty

9. 
TS-112-ITAT-2017(Del)

DCIT vs. Reebok India Company

A.Y. 2011-12, Date of Order: 20th March, 2017

Facts

The Taxpayer was an Indian company. It had entered into an
agreement with ICC, a tax resident of BVI for a composite consideration. The
agreement comprised a bundle of rights including association as official
partner and the manner in which the Taxpayer was allowed to advertise/market
its products during ICC events. Under the agreement, the Taxpayer acquired two
categories of rights – ‘promotional and advertising rights’ and ‘marketing
rights’. The Taxpayer was required to pay ‘Rights Fee’ and ‘Royalty’ to ICC.

The ‘Rights Fee’ was payable in respect of a bundle of twenty
one rights which, inter alia, included right to:

–  display boards and signage on match grounds;

–  use past videos and footage from matches for
internal and promotional/advertising purposes;

–  use designations such as “official partner of
ICC”, “ICC official cricket equipment supplier”, etc.;

–  promote itself on website of ICC and other
related websites as the official sponsor of ICC events;

– receive complimentary tickets for ICC events
and also to purchase tickets on preferential basis;

–  display and sell licensed products at ICC
events through the existing concessionaires;

–  identify backdrops for ICC events and other
official press conferences concerning major ICC events, commensurate with the
level of sponsorship rights of the Taxpayer;

–  access specified zones at ICC events for brand
promotion;

–  use ICC marks in connection with manufacture,
distribution, advertising, promotion and sale of the Taxpayer’s products.

The ‘Royalty’ was payable in respect of sale of licensed
products manufactured by the Taxpayer using ICC marks.

Thus, both the first and second categories included payments
for the right to use ICC marks in manufacture and sale of the Taxpayer’s
products.

While the Taxpayer contended that the payment in respect of
‘Rights Fee’ was not in the nature of royalty or fees for technical services
(FTS), the AO held it to be royalty and/or FTS. Since the Taxpayer had not
withheld taxes, the AO disallowed the same.

The DRP held that ‘Rights Fee’ was not in the nature of
royalty or FTS and, hence, it was not taxable under the Act.

Held 1

Taxability of rights other than rights in relation to use of
ICC marks in manufacture and sale of products of the Taxpayer

–  Out of the bundle of twenty one rights in
respect of which the ‘Rights Fee’ was paid, twenty rights were exclusively for
advertisement and promotion of the Taxpayer in connection with ICC events. Only
part of one right involved use of ICC marks for advertisement and promotion and
the other part of the right was for manufacture and sale of products.

– In cases where the advertisement/promotion
rights did not involve the use of designation/ ICC marks, there was no question
of treating the payment as royalty and it would qualify as advertisement
expense.

–  In Sheraton International Inc. (2012) 17 ITR
457 (Del), the High Court had held that consolidated payment for the use of
trademark, trade name etc., in rendering of advertisement, publicity and
sales promotion services was neither in the nature of royalty nor FTS. Since
‘Rights Fee’ was exclusively paid for use of ICC marks for advertisement and
promotion and not for manufacture and sale of licensed products, question of
treating as royalty cannot arise.

–  The tax authority had contended that since
India did not have DTAA with BVI, income of ICC should be taxable u/s.9(1)(i)
of the Act. However, such contention could not be accepted as the Taxpayer had
established before the AO that ICC had no ‘business connection’ in India.

Held 2

Taxability of rights in relation to use of ICC marks in
manufacture and sale of products of the Taxpayer 

–  Generally, payment made for use of trademark,
patents etc., on goods manufactured and sold would qualify as royalty
under the Act.

–  In the present case, the two categories of
payments – ‘Rights Fee’ and ‘Royalty’ – were overlapping. The right to use ICC
marks in manufacture and sale of products was covered by both the categories.

–  While ‘Royalty’ was exclusively for the use of
ICC marks in manufacture and sale of products, ‘Rights Fee’ was for granting
rights to a bundle of twenty one rights which, inter alia, included the
right to use ICC marks in advertisement, promotion, marketing and sale of
products.

–    In absence of any separate consideration for
the right to manufacture under the ‘Rights Fee’, and there being no mechanism
for apportioning ‘Rights Fee’ towards the use of ICC marks for manufacture and
sale of licensed products, no part of ‘Rights Fee’ was attributable to the use
of ICC marks for manufacture and sale of licensed products. Consideration for
such use was exclusively covered under the ‘Royalty’ clause of the agreement.

 

–Accordingly, only the payment made
by the Taxpayer under the second category (i.e., ‘Royalty’) which was for use
of ICC marks in manufacture and sale of products, qualified as royalty under
the Act.

18. ITA No. 642/ Kol / 2016 (Unreported) ITO vs. Emami Paper Mills Ltd A.Y. 2012-13, Date of Order: 4th January, 2017

Section 9(1)(vii) of the Act, Article 12 of
India-Poland DTAA – A ‘contract of work’ is different from a ‘contract of
service’. In ‘contract of work’, the activity is predominantly physical whereas
in ‘contract of service’, the activity is predominantly intellectual. Hence,
payment made under ‘contract of work’ did not constitute FTS.

Facts  

The Taxpayer is an Indian company. The
Taxpayer engaged a Polish company for dismantling of machinery, sea worthy
packing of the same, stuffing it in containers and loading the containers on
trucks. The Polish company carried out the said services in Sweden. In
consideration for these services, the Taxpayer made certain payments to the
Polish company without withholding tax from the payments.

The AO concluded that the payments made to
the Polish company for dismantling and sea worthy packing of machinery was
highly technical and skill oriented and hence it was in the nature of “fees for
technical services” (FTS) in terms of section 9(1)(vii) of the Act as well as
Article 13(4) of India-Poland DTAA. The CIT(A) reversed the decision of the AO
on the grounds that though technical personnel were involved in the work done
by Polish Company, the payment was for a works contract and not for a contract
of service.

Held

–  The
agreement for dismantling of the machinery was part and parcel of the
transaction of purchase of plant and machinery. Perusal of various clauses of
the said agreement showed that the payment was not made for technical services
and did not require any technical skill.

–   The
two expressions ‘Contract of work and ‘Contract of service’ convey different
ideas. In ‘Contract of work’, the activity is predominantly physical and
tangible and intellectual only to some extent. Though the work of a gardener,
mason, carpenter or builder who undertakes “contract of work” also involves
intellectual exercise as he has to bestow sufficient care in doing his job, the
physical (tangible) aspect is more dominant than the intellectual aspect. On
the other hand, in ‘Contract of service’, the activity is predominantly
intellectual, or at least, mental.

–   Thus,
‘contract of work’ is clearly different from ‘contract of service’. ‘Contract
of work’ does not require any technical knowledge or specific skill.

–   In
case of the Taxpayer, Polish company was hired to dismantle the machinery,
which did not require any technical expertise and special skill. Thus, the
agreement was for ‘contract of work’. The payment did not acquire character of
FTS merely because the Taxpayer hired a person resident outside India.

–   In
case of the Taxpayer, Polish company was hired to dismantle the machinery which
was in the nature of ‘contract of work’ and not ‘contract of service’. Hence,
payment made by the Taxpayer for the work done by Polish company did not come
within the ambit of FTS.

Guiding Principles for Determination of Place of Effective Management (POEM)

Readers may be aware that the
Finance Act, 2015 had inserted the concept of Place of Effective Management
(POEM) for determining the residential status of a company by amending section
6(3) w.e.f. 1-4-2016. The said section 6(3) was substituted by the Finance Act,
2016  with effect from 1st April
2016 (i.e. the current Financial Year) and accordingly shall apply from the
Assessment Year 2017-18 onwards. Although the term “POEM” was defined in the
Income-tax Act, 1961 (“Act”), the definition was short and crisp. Subsequently,
the Government issued draft guidelines for determination of POEM. After
considering comments and suggestions from various stakeholders and general
public, these guidelines have been finalised in the form of “Guiding
Principles” for determination of POEM. This write-up covers detailed analysis
of these guiding principles and issues arising out of them and/or unresolved
grey areas which may lead to litigation. 

1.0    Introduction

Section 6(3) of the Act, prior to
its amendment vide Finance Act, 2015, provided that a company would be
considered as resident of India under two circumstances, namely, (i) if it is
incorporated in India or (ii) control and management of its affairs is situated
wholly in India. This definition was prone to misuse. A foreign company
owned and controlled by Indian residents could shift its insignificant part of
control or management outside India to claim its status as non-resident. There
have been cases where foreign companies, though controlled and managed by Indian
residents, were held to be non-resident as their one or two board meetings were
held outside India. In order to address these concerns, the requirement of POEM
was introduced in the Act.

The concept of POEM is not new to
the constituents of international taxation. Essentially it refers to a place
where head and brain of an organisation is located or operates from.

Section 6 (3) as amended with
effect from 1st April 2016, reads as follows:

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.

In the backdrop of the above
amendment, CBDT issued the draft guidelines for determination of POEM on 23rd
December 2015 inviting suggestions and feedback from public at large.
After a year of issuance of the draft guidelines the CBDT has now issued
Circular No. 6 of 2017 dated 24th January 2017 containing the
“guiding principles” for determination of POEM. (Hereinafter referred to as
“Circular”)

2.0 Determining
Criteria

The Circular prescribes various
tests to determine the POEM. They can be broadly classified into:

(i)  Active Business Test having sub
sets of

(a) Passive Income/Total Income Test

(b) Assets Test

(c) Employees Test

(d) Payroll Test

(ii) Control and Management Test

(iii) Location of Head Office and Senior Management Test

(iv) Location of Board of Directors’ Meeting Test and

(v) Secondary Factors Test.

Any foreign company has to be
evaluated based on these tests to determine whether it has a place of effective
management in India or not. Though the objective seems to be to apply these
tests to foreign companies owned or controlled by Indian residents, technically
it applies to any foreign company. 

Let us go through them in detail.

2.1    Active Business
Test

The Circular requires determining
an “active business outside India” with the help of various tests. The POEM of
a foreign company having an “active business outside India” shall be presumed
to be outside India if its majority of Board meetings are held outside India.
(It may be held at a place other than the country of incorporation).

It may be noted here that for the
purpose of determining whether the company is engaged in active business
outside India, the average of the data of the previous year and two years prior
to that shall be taken into account. In case the company has been in existence
for a shorter period, then data of such period shall be considered.

Where the accounting year for tax
purposes, in accordance with laws of country of incorporation of the company,
is different from the previous year, then, data of the accounting year that
ends during the relevant previous year and two accounting years preceding it
shall be considered. For example, for a foreign company following calendar year
(CY) for the previous year 2016-17 (April-March) the data of the foreign
company to be examined are CY 2016, CY 2015 and CY 2014. 

The Circular provides that for the
purposes of these guidelines, –

(a) A company shall be said to be
engaged in “active business outside India”

(i)  if the passive income
is not more than 50% of its total income and,

(ii) less than 50% of its total
assets are situated in India; and

(iii) less than 50% of total
number of employees are situated in India or are resident in India; and

(iv) the payroll expenses incurred on such employees is less
than 50% of its total payroll expenditure;

All the above tests are cumulative
in nature, meaning in order for a company to qualify as doing an active
business outside India, all the above tests need to be satisfied. However, as
reiterated by the Circular the determination of the POEM is a fact based
exercise with the underlying principle of substance over form and therefore,
failure to satisfy any single test by the foreign company per se, should
not be held against it. Much would depend upon the actual conduct of the
business and exercise of the control and management of its affairs.

2.1.1  Income Test

The income test to be fulfilled by
a foreign company for being considered as engaged in  active business outside India is:

“the passive income is
not more than 50% of its total income”.

The Circular defines both total
income as well as passive income.

Total Income

The income for this purpose is
explained to be (a) as computed for tax purpose in accordance with the laws of
the country of incorporation; or (b) as per books of account, where the laws of
the country of incorporation does not require such a computation.

It is not clear as to whether such
books of account need to be audited or not. However, looking at the spirit of
the Circular, one would be guided by the laws of the host country. If audit is
not mandatory in the host country then even self-certified accounts should be
good enough.

Passive Income

“Passive income” of a company
shall be aggregate of, – (i) income from the transactions where both the
purchase and sale of goods is from/to its associated enterprises; and (ii)
income by way of royalty, dividend, capital gains, interest or rental income.

However, any income by way of
interest shall not be considered to be passive income in case of a company
which is engaged in the business of banking or is a public financial
institution, and its activities are regulated as such under the applicable laws
of the country of incorporation.

Inclusion of trading transactions
between two associated enterprises may cause genuine hardships to some foreign
companies owned by Indian residents which may be dealing within its global AEs
without any t  ransaction with any AE
situated in India.

2.1.2  Assets Test

The assets test to be fulfilled by
a foreign company for an active business outside India is:

“less than 50% of its total
assets are situated in India”.

The value of assets : 

(a) In case of an individually
depreciable asset, shall be the average of its value for tax purposes in the
country of incorporation of the company at the beginning and at end of the
previous year; and

(b) In case of pool of a fixed
assets being treated as a block for depreciation, shall be the average of its
value for tax purposes in the country of incorporation of the company at the
beginning and at end of the year;

(c) In case of any other asset,
shall be its value as per books of account;

With world accounting converging
to International Financial Reporting Standards (IFRS), valuation of assets
should not be an issue unless the foreign company is situated in a jurisdiction
which does not follow IFRS or no audit requirements are prescribed.

2.1.3   Employees Test  

The employees test to be fulfilled
by a foreign company for an active business outside India is:

“less than 50% of total number
of employees are situated in India or are resident in India”.

The Circular provides that the
number of employees shall be the average of the number of employees as at the
beginning and at the end of the year and shall include persons, who though not
employed directly by the company, perform tasks similar to those performed by
the employees;

A question may arise as to
payments made to a retainer be included in the list of employees. Here, one may
be guided by the terms of the engagement, the nature of job profile and actual
conduct of the person etc.

2.1.4  Payroll Test

The test to be fulfilled by a
foreign company for an active business outside India is:

“the payroll expenses
incurred on such employees is less than 50% of its total payroll expenditure”.

The Circular provides that “the
term “payroll” shall include the cost of salaries, wages, bonus and all other
employee compensation including related pension and social costs borne by the
employer.

2.2  Control and Management Test

This test is useful in determining
where exactly head and brain of the company resides.

The Circular provides that in
cases of companies other than those that are engaged in active business outside
India, the determination of POEM would be a two stage process, namely:

(i)  First stage would be
identification or ascertaining the person or persons who actually make the key
management and commercial decision for conduct of the company’s business as
a whole.

(ii) Second stage would be
determination of place where these decisions are in fact being made.

It is also provided that the place
where the management decisions are taken would be more important than the place
where they are executed. Day to day routine operational decisions taken by the
junior and middle level management shall not be relevant for the purposes of
determination of POEM. It is also provided that where by operation of law certain
key decisions are left to the shareholders such as dissolution, liquidation or
deregistration of the company etc. which may typically affect the
existence of company rather than the conduct of the company from management and
commercial perspective etc. would generally be not relevant in
determination of the POEM. 

2.3  Location
of Head Office and Senior Management Test

The Circular provides that
location of Head Office (HO) will be an important factor in determining the
POEM as often key decisions are taken there.

The term HO is defined to mean the
place where the company’s senior management and their direct support staff are
located or, if they are located at more than one location, the place where they
are primarily or predominantly located. A company’s head office is not
necessarily the same as the place where the majority of its employees work or
where its board typically meets.

Location of senior management and
their support staff may play a key role in determination of the place of HO.

According to the Circular the
“Senior Management” in respect of a company means the person or persons who are
generally responsible for developing and formulating key strategies and
policies for the company and for ensuring or overseeing the execution and
implementation of those strategies on a regular and on-going basis. While
designation may vary, these persons may include: (i) Managing Director or Chief
Executive Officer; (ii) Financial Director or Chief Financial Officer; (iii)
Chief Operating Officer; and (iv) The heads of various divisions or departments
(for example, Chief Information or Technology Officer, Director for Sales or
Marketing).

Generally the locale of senior
management or the highest level of management personnel (such as the Managing Director
or the Finance Director) shall determine the location of HO. However, if the
company’s senior management is so highly decentralized that it is difficult to
determine its HO, then HO will not be of much relevance in determining the
POEM.

In case of decisions by video
conferencing, telecommunication etc. the location of maximum number of persons
taking such decision would be relevant in determination of the POEM. In case of
circular resolution or round robin voting etc. the location of the
person who has the authority and who exercises the authority to take decisions
would be a relevant factor in determination of the POEM.  

2.4 Location of Board of Directors’ Meeting
Test        

The Circular provides that the
location where a company’s Board regularly meets and makes decisions may be the
company’s place of effective management provided, the Board- (i) retains and
exercises its authority to govern the company; and (ii) does, in substance,
make the key management and commercial decisions necessary for the conduct of
the company’s business as a whole.

In deciding the place of board
meetings as the POEM, one must look at the actual conduct of business at the
board meetings, whether key decisions are taken or not. Therefore, merely a
formal board meeting at a particular place by itself would not result in the
POEM.

If the board has delegated its
power or authority to take key decisions to senior management, executive
committee or any other person including a shareholder, promoter, a strategic,
legal or financial advisor etc. then the POEM would at the place of
location of such decision maker/s.

2.5  Secondary Factors for determination of
the POEM

The Circular provides that if the
primary factors (as mentioned above) do not lead to clear identification of POEM
then the following secondary factors can be considered:

(i)  Place where main and
substantial activity of the company is carried out; or

(ii) Place where the accounting
records of the company are kept.

2.6   Summary of the POEM Tests

Based on the various tests
prescribed by the Circular, the POEM of a company can be determined based on
following criteria:

It may be noted that there is no
fixed hierarchy of the above tests.         

3.0  Exceptions and Assurances

After elaborately prescribing
various guidelines to determine the POEM in paragraphs 1 to 8, the Circular in
paragraphs 9 and 10 provides certain exceptions, clarifications and assurances
in determining the POEM. The Circular reiterates that the guiding principles
are only for the purpose of guidance and that no single principle in itself
will be decisive. One needs to take a holistic view of the matter. The
principles need to be applied over a period of time in a given previous year
and not at a particular moment. “Snapshot” approach is not to be adopted.

Following clarifications are
provided in the Circular with regard to determination of the POEM in India:

Following isolated facts in
themselves will not be conclusive evidences that the conditions for establishing
a POEM in India have been satisfied:        

     (i)  Foreign company is a wholly
owned subsidiary of an Indian company;

(ii) Foreign company has a Permanent
Establishment in India;

(iii) One or more directors of a
foreign company reside in India;

(iv) Local management of a foreign
company being situated in India in respect of activities carried out by a
foreign company in India;

(v) The existence in India of
support functions those are preparatory and auxiliary in character.

4.0  Summary
of various tests in determination of POEM as listed above

4.1         Determination of POEM
is a fact based exercise.

4.2          No single factor can be
considered as final. One needs to take a holistic view of the matter.
Determination of the POEM cannot be based on isolated facts.

4.3        In determination of
POEM, one needs to look at substance over form; only substance will prevail in
the end.

4.4        There can be more than
one place of management but there can be only one POEM at a given point of
time.

4.5        If during the previous
year a company is found to be having POEM, both in India and abroad then it
would be deemed to be at a place where it is mainly or predominantly located.

4.6         POEM is to be
considered over a period of time during the previous year and not at a
particular point in time. One should not take a “snapshot view” of the matter.

4.7         POEM should be
determined on a yearly basis. The existence or otherwise of the POEM should be
examined on year to year basis by applying various tests enumerated in the
Circular.

4.8       Just because an
intermediary holding company (say a first level subsidiary abroad of an Indian
Company) has a POEM in India, its downstream subsidiary/Joint venture companies
per se would not be regarded as having their POEMs in India. In other words,
the tests of determination of the POEM shall be applied to every overseas
entity separately and independently.

4.9        Actual conduct of the
Board of Directors or Senior Management Team or an Executive Council is
important rather than formal delegation of powers.

5.0   Threshold Limit

The Press Release issued by the
Ministry of Finance on 24th January 2017 citing issuance of the CBDT
Circular mentioned and discussed above, provides that the POEM guidelines shall
not apply to companies having turnover or gross receipts of Rs. Fifty (50) Crore or less in a financial year.

It appears that the threshold has
been prescribed for the applicability of the guiding principles only and not of
the POEM of a company itself u/s. 6 (3) of the Act. However, this does not seem
to be the intent of the CBDT. A clarification to this effect should be
issued. 

6.0  Invocation of POEM

The Circular contains certain
administrative safe guards by mandating that the Assessing Officer (AO) will
have to obtain a prior approval of the Principal CIT/CIT for initiating an
inquiry of the POEM. The AO also need to obtain an approval from the Collegium
of 3 Principal CITs/CITs before holding that POEM of a non-resident company is
in India.

One hopes that provisions of the
POEM are invoked in rare cases and used as a deterrent than as a revenue raiser
tool. In this context, highest amount of restraint is called for on the part of
the tax administration so as to strike a balance between genuine cases of
overseas ventures and shell companies.

7.0 Summation/Conclusion

The Circular at paragraph 12
contains certain illustrations as to which situations would constitute a POEM
and which would not. Readers are well advised to go through the same.

The sum and substance of these
guiding principles for determination of the POEM is that the facts are supreme.
No one particular criteria can determine the existence or otherwise of a POEM.
One needs to take a holistic view of the matter and that too over a period of
time and not in isolation. In the ultimate, one needs to look at the substance
over form in establishment of the POEM.

The way these guidelines are
drafted, a question arises as to whether the era of Special Purpose Vehicle
(SPV) at an overseas location, for various commercial reasons, is over? All
SPVs by design will have passive income only and may not have substantial or
any business activities except for holding investments in downstream companies.
It appears that only holding cum operating companies which would fulfill the
conditions of active business outside India will be able to establish their
POEMs outside India.

With the release of the final
guidelines for POEM determination, one has to wait and watch the position with
respect to introduction of Controlled Foreign Corporation [CFC] rules as stated
in the BEPS action reports. However, taking a cue from the CFC regulations
worldwide and in the interest of the Indian entrepreneurship it would be better
if the overseas listed companies are kept outside the scrutiny of the POEM.

The Finance Act, 2016 had also
introduced section 115JH in the Act to enable the Government to notify rules in
relation to computation of income, carry forward and set-off of losses,
treatment of unabsorbed depreciation and applicability of transfer pricing in
relation to foreign companies which are treated as being resident in India.
Rules in this regard are still awaited.

The compliance with these final guidelines which
are issued only now especially since POEM is effective from 1-4-2016 (AY
2017-18) and we are already 10 months down the line. This certainly merits
deferment of the provisions of POEM by a year to 1-4-2017 (AY 2018-19).
Otherwise, this retrospective application of Final guidelines for AY 2017-18
could lead to confusion and unwarranted problems for assessees.

17. [2017] 77 taxmann.com 149 (Ahmedabad – Trib.) Elitecore Technologies (P.) Ltd vs. DCIT A.Ys.: 2009-10, Date of Order: 3rd January, 2017

Article 23 of India-Indonesia DTAA, Article
25 of India-Singapore DTAA – Tax credit is to be allowed only to the extent the
corresponding foreign income has suffered tax in India.

Facts

The Taxpayer was a wholly owned subsidiary
of an American company. It was engaged in the business of software development.
Major portion of income arising to the Taxpayer was in the form of passive
income earned by way of release of retention money and income from maintenance
contract entered into with customer. During the relevant previous year, the
Taxpayer did not have any taxable income under the normal provisions of
the Act. However, its book profits were taxed under Minimum Alternate Tax (MAT)
provisions in section 115JB of the Act.

In the course of assessment, the AO noted
that the Taxpayer had claimed foreign tax credit. This credit was in respect of
the taxes withheld in Singapore and Indonesia. Referring to Article 23 of
India-Indonesia DTAA and Article 25 of India-Singapore DTAA, The Taxpayer had
claimed tax credit to the extent of the entire amount of tax withheld.

However, according to the AO the tax credit
was to be allowed only to the extent the corresponding income had suffered tax
in India. The extent to which income had suffered tax in India was to be computed
by taking ratio of gross foreign receipts to the overall turnover of the
Taxpayer and applying that ratio to the actual MAT liability (i.e., doubly
taxed income was considered after allocating all the expenses including the
expenses in relation to India sourced income in the ratio of foreign sourced
turnover to total turnover).

Held

–   The
Tribunal observed that there are two aspects to be considered. First, the
quantum of income which is to be treated as taxed. Second, the manner in which
the eligible tax credit is to be computed.

–   DTAAs
provide that foreign tax credit shall not exceed the income tax  attributable to doubly taxed income.

–   DTAAs
use the expression ‘income’ which essentially implies ‘income’ embedded in the
gross receipt, and not the ‘gross receipt’ itself. Even as per the UN Model
Commentary, the basis of calculation of income tax is total net income.
Therefore, it is the gross income derived from the source state less any
allowable deductions (specific or proportional) connected with such income
which is to be treated as doubly taxed income. Hence, considering the gross
receipts for computing admissible tax credit is not correct.

–  In
the present case, there is a peculiar situation. A major portion of foreign
sourced income was passive income in nature.

–  Hence,
to that extent, allocation of all the expenses incurred by the Taxpayer to such
earnings will not be justified. Moreover, profit element should be computed on
reasonable basis and not by taking into account the ratio of entire income to
entire turnover of the Taxpayer. The same could have been relevant if the
Taxpayer had not furnished a reasonable computation of income embedded in the
related receipts.

–   However,
because of the aforementioned peculiar situation, this decision cannot be the
authority for the general proposition that only marginal or incremental costs
incurred in respect of foreign income should be taken into account and the
overheads cannot be allocated thereto.

–   Thus
foreign tax credit is to be computed by apportioning actual tax paid under MAT
in the ratio of doubly taxed income to total profits.

–   Tax
credit in respect of both Indonesia and Singapore should be computed separately
as is provided in respective DTAAs. The formula for limitation of tax credit under
Article 23(1) of India-Indonesia DTAA and Article 25(2) of India-Singapore DTAA
is broadly the same. The tax paid under MAT provisions should be apportioned to
income from Indonesia and Singapore respectively.

–   Since
tax withheld in Indonesia was higher than the apportioned amount, the tax
credit was to be restricted to the apportioned amount.

–   Since
tax withheld in Singapore was lower than the apportioned amount, tax credit for
entire withheld tax was available.

16. [2016] 76 taxmann.com 341 (Ahmedabad – Trib.) Torrent Pharmaceuticals Ltd vs. ITO A.Y.: 2008-09, Date of Order: 25th October, 2016

Section 9(1)(vi) of the Act, Article 12 of
India-Switzerland DTAA – Since MFN clause in India-Switzerland DTAA provides
for negotiation by both countries for lower tax rate or restricted scope, in
absence of amendment to DTAA, MFN benefit could not be availed. In the absence
of automatic application of MFN clause, make available condition cannot be
drawn into India-Switzerland DTAA.

Facts:

The Taxpayer was an Indian company engaged
in manufacturing and marketing of pharmaceutical products. During the relevant
year, the Taxpayer had made payments, inter alia, to a tax resident of
Switzerland (payee), in consideration for rendering consultancy services. The
Taxpayer did not withhold tax from the payments.

The Taxpayer contended that:

–  the
payee did not part with any technical knowhow which could be used by the
Taxpayer independently on its own;

–   Protocol
to India-Switzerland DTAA contains most favoured nation (“MFN”) clause in
respect of Articles 10 to 12;

–   India-Portugal
DTAA containing ‘make available’ condition in respect to payments made for
technical services was executed and notified subsequent to India-Switzerland
DTAA;

–   although
such ‘make available’ condition in respect of technical services was explicitly
not contained in India-Switzerland DTAA, it was deemed to have been applicable
by virtue of India-Portugal DTAA;

–   accordingly,
scope of FTS under India-Switzerland DTAA should be restricted to the same
scope as that under India-Portugal DTAA; and

–   since
the make available condition is not satisfied, the payments made to the payee
do not qualify as Fee for Technical Services (FTS).

Held

–   India-Switzerland
DTAA or Protocol thereto does not have ‘make available’ provision in respect of
FTS.

–   The
Protocol to India-Switzerland DTAA provides that if, after its execution on
16-02-2000, India enters into any DTAA/Protocol with a member of OECD, and if
India limits its taxation to a rate lower or scope more restricted than that
provided in India-Switzerland DTAA, then Switzerland and India shall enter into
negotiation without undue delay in order to provide similar treatment to
Switzerland as in case of the third State.

–   Since
there is no automatic MFN application, and since Switzerland and India have not
amended DTAA in respect of lower rate or restricted scope, the contention of
the Taxpayer that pursuant to India-Portugal DTAA, ‘make available’ condition
should also be applied to India-Switzerland DTAA cannot be accepted.

Sections 195, 90(2) of the Act, Article 13 of India-Italy DTAA – Withholding tax obligation arises only if income is taxable; as royalty is taxable under Article 13 of India-Italy DTAA only on payment/receipt, section 195 will be triggered only on payment; even if a taxpayer opts for beneficial provision under the Act, withholding tax obligation will be triggered only when income is taxable as per the DTAA.

8.  TS-134-ITAT-2017
(Ahd)

Saira Asia Interiors Pvt. Ltd vs. ITO

A.Y. 2011-12, Date of Order: 28th March, 2017

Facts

The Taxpayer was an Indian company. It was required to make
payment towards technical know-how to FCo, which was a resident of Italy. The
Taxpayer accounted the liability on accrual basis in its books of account for
AY 2011-12. However, it did not withhold and deposit tax in respect thereof
during that year. The Taxpayer made payment in AY 2012-13 and duly withheld and
deposited tax thereon.

According to the AO, withholding obligation of the Taxpayer
arose at the time of credit in the books of account (i.e., AY 2011-12). Hence,
the AO held that the Taxpayer had belatedly withheld tax. Therefore, he raised
demand for interest on delayed deposit of taxes.

According to the Taxpayer, in terms of India-Italy DTAA, royalty
was taxable in the hands of FCo only when it was actually “paid”. Hence, there
was no withholding obligation on the Taxpayer when the payment was accounted in
its books of account.

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

Held

–  Withholding tax liability under the Act is a
vicarious liability. Hence, as held by the Supreme Court in G. E. Technology
Centre Pvt. Ltd. vs. CIT (2010) 327 ITR 456 (SC), if the income embedded in
a payment is not taxable under the Act, the withholding tax liability is not triggered
.

– The withholding tax provision cannot be
applied in vacuum. It should be read in conjunction with the charging
provisions under the Act as well as the provisions of the DTAA, depending upon
whichever is more beneficial.

– In terms of Article 13(1) of India-Italy DTAA,
royalty is taxable only when it is actually paid to the non-resident. Further,
in terms of Article 13(3), the term “royalties” means payments of any
kind “received”. Thus, mere credit does not trigger the tax liability. This view
is also supported by the decision of the Mumbai Tribunal in National Organic
Chemical Industries Ltd. (2005) 96 TTJ 765 (Mum).

–    Since the amount was not taxable at the time
of credit of the amount, the Taxpayer did not have any tax withholding obligation.

–    Article 13(2) restricts the tax liability in
India to 20% whereas section 115A prescribes tax @10%. Hence, in view of
section 90(2), the Taxpayer can exercise the option of adopting the lower rate
of tax under the Act.

–  However, since under the DTAA tax liability is
on payment, adoption of the lower rate under the Act tax liability will not be
triggered on accrual of income.

Article 10 of India US DTAA – Foreign Tax credit (FTC) allowable upto lower of tax withheld or the limit prescribed in DTAA; FTC should be computed separately in respect of each item of income.

7.  TS-130-ITAT-2017
(Ahd)

Bhavin A. Shah vs. ACIT

A.Y. 2009-10, Date of Order: 29th March, 2017

Facts

The Taxpayer was an individual resident in India. He had
invested in shares of US companies and earned dividend therefrom during the relevant
year. Tax was withheld in US from the dividend received by the Taxpayer. The
Taxpayer offered such dividend for tax in India and claimed foreign tax credit
(FTC) aggregating to roughly 30% of the gross dividend in respect of tax
withheld in USA.

The AO rejected the claim of the Taxpayer on the ground that
FTC is available only in respect of actual payment made while filing return of
income (i.e., tax paid directly by the Taxpayer) and not on tax withheld in
USA.

While upholding the order of the AO, the CIT(A) observed that
the documents/ evidence furnished by the Taxpayer in support of the FTC claim
did not mention the name of the Taxpayer and/ or were not signed by the
relevant authorities and further that the taxes withheld were almost 30% of the
gross receipt.

Held

–  In accordance with Article 25 of India-USA
DTAA, if tax is withheld from dividend earned by the Taxpayer from USA, and if
he has offered such dividend to tax in India, FTC may be granted in respect of
tax withheld in the US.

–  Article 10(2) of India-USA DTAA stipulates the
maximum rate of tax chargeable in USA on dividend earned by the Taxpayer from
USA.

–  Thus, the following conditions should be
satisfied for claiming FTC in India in respect of dividend:

–  The Taxpayer should be a resident in India, in
terms of Article 4 of India-USA DTAA and not merely a resident under the Act.

–  Income received by the Taxpayer should be
“dividend” as defined in Article 10(3) of India-USA DTAA.

–  Dividend should have been taxed in USA in accordance
with Article 10(2) of India-USA DTAA.

–  Tax may be either by way of direct payment or
withholding.

–  FTC allowable should be restricted to lower of
tax withheld in USA or tax liability in India respect of such dividend.

– The particulars furnished by the Taxpayer
showed that while aggregate withholding tax rate in USA was higher than 25%, in
some cases tax was withheld at rates higher than 25% and in some cases at rates
lower than 25%. Hence, the contention of the Taxpayer for grant of FTC at blanket
rate of 25% was incorrect.

– Computation of FTC cannot be by way of
generalization. AO should ascertain the withholding tax rate in respect of each
dividend income. In cases where tax was withheld at rate lower than that
stipulated in India-USA DTAA, FTC should be granted at actual. In cases where
tax was paid/withheld at rate higher than that stipulated in India-USA DTAA,
FTC should be restricted to the amount corresponding to that rate.

–  The matter was remanded to the AO
to accordingly compute the eligible amount of FTC.

Section 2(22) of the Act, Article 13 of India Mauritius DTAA – Buyback at artificially inflated price would qualify as a colorable device for avoiding tax; consideration in excess of fair market price of the shares could be deemed as dividend

6. 
TS-110-ITAT-2017(Bang)

Fidelity Business Services India Pvt. Ltd. v. ACIT

A.Y. 2011-12, Date of Order: 22nd February, 2017

Facts

The Taxpayer was an Indian company and a wholly-owned
subsidiary of a Mauritius company (FCo). While FCo held 99.99% of shares in the
Taxpayer, a nominee held the balance shares on behalf of FCo.

During the relevant year, the Taxpayer undertook buyback of
its shares from FCo at price which was substantially higher than the face value
of the shares. FCo treated the income from such buyback as capital gains. In
terms of Article 13(4) of India-Mauritius DTAA, FCo claimed that capital gains
were not chargeable to tax in India.

The AO noted that FCo held 99.99% of shares of the Taxpayer.
Hence, the entire reserves and surplus were distributable only to FCo. The AO
concluded that FCo and the Taxpayer adopted buyback route to distribute
reserves and surplus to FCo as distribution of dividend would have entailed
dividend distribution tax. Accordingly, the AO held buyback as a colorable
device and reclassified the difference between the face value of the shares and
the amount distributed to FCo as deemed dividend u/s. 2(22)(d) of the Act.

The Taxpayer contended that:

– “buyback” is specifically excluded from the
definition of “dividend” under the Act;

–  prior to amendment of section 115QA with
effect from 1st June 2013 distribution by way of buyback was not
subject to tax;

–  Circular No. 3 of 2016 dated 26 February 2016
(2016 Circular) has clarified that buyback consideration between the period 1st
April 2000 and 1st June 2013 would be treated as capital gains
and not as deemed dividend; and

–   even if the transaction was undertaken with
the objective of avoiding taxes, the same cannot be disregarded, unless the Act
vests such power in the tax authority1.

The DRP
upheld the draft order of the AO. 

Held

– Section 2(22)(iv) specifically excludes
buyback consideration from the ambit of “dividend”. Further, tax on buyback is
applicable only from 1st June 2013. The 2016 Circular also clarifies
that buyback consideration between 1st April 2000 and 1st June
2013 should be taxed as capital gains.

–  To the extent of buyback undertaken at fair
market price (FMP), consideration would be treated as capital gains u/s. 46A.
Hence, in terms of India-Mauritius DTAA, it would not have been chargeable to
tax in India. However, a buyback undertaken at artificially inflated and
unrealistic price which does not represent FMP, would be considered as
colourable device particularly where the shareholder holds 99.99% of the share
capital.

–  Since neither the AO nor the DRP
had examined whether buyback price was artificially inflated and unrealistic
vis-à-vis the FMP, the matter was remanded to the AO to ascertain the same.

23. TS-34-ITAT-2017(DEL) GE Energy Parts Inc. vs. ADIT A.Y.: 2001-02, Date of Order: 27th January, 2017

Article 5 and 7 of India USA DTAA – LO of Taxpayer from
where core sales activities of the taxpayer as well as other foreign group
entities are carried on by the expatriates (employed by some of the foreign
group entities) constitute a fixed place PE in India for the Taxpayer as well
as other group entities. An agent who works for more than one entity related to
each other cannot be treated as independent. Such agent who carries on core
sales activities in India constitutes Dependent Agency Permanent Establishment
(DAPE) in India – profit attribution has to consider all the functions performed
and risk taken by the PE

Facts

The Taxpayer was a USA company and tax resident of USA. The
Taxpayer was part of a group engaged in the business of sale of equipment
relating to oil and gas, energy, transportation and aviation business to
customers in India.

Taxpayer had set up a liaison office (LO) in India with the
approval of Reserve Bank of India (RBI), to carry out liaison activities in
India. Taxpayer entered into a service agreement with one of its Indian
affiliate in terms of which the Indian affiliate was required to act as a
communication link with regulatory authorities, provide information of customer
needs, and trends relating to group’s products in India, etc. A survey
under the Act was conducted at the premises of the LO followed by further post
survey enquiry. Following evidences were examined by the Assessing Officer
(AO). 

–   MOU signed with the customers

–   E-mail chains between the employees of
various group entities

–   Commercial proposals to customers and
purchase orders

–  Visa of expatriates

–   Linkedin profiles of personnel in India

–  Letter of awarding of contracts

–   Details of employees working in the liaison
office – like name, job description, self-appraisal report, employment letter

–  Lease deed of liaison office

–  Bank statements

–  Letters filed to RBI

–   Lease agreement in respect of residence of
expatriates

–   Power of attorney granted to expatriates for
issue of cheques

–   Statutory audit report

–   Attendance sheet of employees working in the
LO

Based on the
evidences, following facts were noted

– Various expatriates of foreign group entities
were working in India in leadership roles along with support by team of persons
employed by other group entities (ICo)

–  The expatriates as well as the employees of
ICo (group personnel) undertook various sales and marketing function including
price negotiation, supervision, administration and after sales activities of
the overall lines of businesses of the group irrespective of any specific
entity in India. These activities were carried out from the LO in India.

–   Group personnel managed the business of
foreign group entities, secured orders and did everything possible that could
be done qua the Indian operations of the overseas group in India.

–  Group personnel were fully involved in negotiating
the deal with the customers in India and were not merely acting as
communication channel

•    They made direct offers and entertained
requests of the customers for revision of the offers.

•   They were empowered to change/finalise the
terms and conditions of the customer contracts and hence decision making in
relation to the customer contracts was also done in India.

•    They were in full command of the sales
activities in India and did not tolerate the interference of the overseas group
in deciding the terms to be agreed with the customers or for modifying customer
contracts.

•    Entire correspondence with customers was
done in India by expatriates.

•    They advised overseas group about the manner
in which a proposal is to be sent to customer and this indicated that they
acted as a sales team in India.

–  Specific rooms/chambers in the LO were
allotted to the expatriates at the premises of the LO. Their computer, laptops
and business related documents were all stored in such allotted rooms.

–   Further the group personnel also occupied the
premises of the LO which was evident from the attendance sheet maintained for
people working at the LO premises.

AO contended that in terms of Article 5 of India-USA DTAA, a
sales outlet used for receiving or soliciting orders also constitutes a PE.
Thus the LO from where the sale related activities were carried out and which
was at the disposal of the expatriates resulted in a fixed place PE in India
for the Taxpayer.

Moreover, group personnel, who habitually concluded contracts
and secured orders in India wholly or almost wholly for the overseas group as
well as participated in the price negotiations.

Furthermore, the expatriates and employee also created
Dependent Agency Permanent Establishment (DAPE) in India. Consequently, profits
of Taxpayer making sales in India are liable to be taxed as business income in
India as per Article 5 and 7 of the India-USA DTAA .

Taxpayer argued that the sale consideration in relation to
sale of equipment was not taxable in India since the title in respect of these
equipment was transferred outside India as well as payment was also received
outside India. Moreover, the activities in India were limited to LO activities
as approved by RBI and this is evident by the fact that the RBI approval was
not revoked. Nonetheless, the activities carried out in India were of
preparatory or auxiliary character.

Held

ITAT while upholding the AO’s contention provided the
following justification:

On Fixed place PE

–   Core sales activities of finding the
customers and finalizing the deals with customers including the pre-sale and
post sales activities were done by the expatriates and employees in India. Such
activities being the core activities does not qualify as P&A.

–  The expatriates were constantly using the
premises of the LO, specific chambers/rooms were allotted to them in the LO
premise with their name plates affixed. Though the expatriates were on the
payroll of foreign group entity, they constantly occupied the premises of the
LO and carried out the activities on behalf foreign group entities.

–   Further the employees of ICo also occupied
the premises of LO and worked under the control and supervision of the
expatriates, who in turn worked for the foreign group entities. Evidences found
during the course of survey like attendance sheet maintained at the LO premises
also supported the fact that the premise was used by expatriates and employees
of ICo.

–   Marketing and sales are income generating
activities in themselves, since the core activities in relation to sales and
marketing is carried on in India through the LO, it constitutes a fixed place
PE. 

On Agency PE

–   In the facts of the case expatriates were
working for the foreign group entities who are related to one another. The mere
fact that expatriates work for more than one entity does not make them
independent. The related entities are to be treated as a single unit.

–   Article 5 of the DTAA does not require
negotiating ‘all elements and details of a contract for constitution of a PE it
only requires habitual exercises of an authority to conclude contracts so long
as agent’s activities are not in the nature of P&A

–   Since the activities of the expatriates are
not in the nature of P&A, they clearly have an authority to conclude
contract and hence constitute DAPE.

On attribution of income

–  As espoused by SC in DIT vs. Morgan
Stanley [292 ITR 416], there is no need of any further attribution to PE if
it has been remunerated at ALP.

However, if TP analysis does not adequately
reflect functions performed and risks assumed, there would be a need to
attribute further profits to the PE for those functions/risks which have not
been considered.

– In
the facts of the case, the survey revealed that the activities carried on by
group personnel was not merely liaison activities but extended to commercial
activities however the ALP was determined only on basis the liaison and not the
commercial activities undertaken in India. Since the commercial activities
resulted in a PE in India and such services have not been remunerated at all, there will be
need for further profit attribution to the PE.

Section 92C of the Act – As maximum international transactions were undertaken by Taxpayer with its AEs in Canada and USA where ALP was determined through MAP, and as only two transactions were undertaken with AEs in Australia and UK, margin determined through MAP with respect to major international transactions should be applied for remaining transactions also.

14.  [2017] 81
taxmann.com 169 (Bangalore – Trib)

CGI Information System & Management Consultants (P) Ltd
vs. DCIT

A.Y:2005-06, Date of Order: 21st April, 2017

Facts

The Taxpayer had rendered software development services to
its AEs in US, Canada, Australia and UK. AEs of Taxpayer in USA and Canada had
approached respective competent authorities for resolution of TP adjustment
dispute insofar as it related to software development services provided by the
Taxpayer with regard to international transactions through MAP under DTAA.
Under MAP, arm’s length price was determined at 117.5%. The Taxpayer had
maximum international transactions with its AEs in USA and Canada while those
with its AEs in UK and Australia were minimal.

In respect of International transactions of the Taxpayer with
AEs in Australia and UK, the AO adopted 25.32 % profit margin.

Held

–  In J. P. Morgan Services (P) Ltd vs. Dy
CIT [2016] 70 taxmann.com 228 (Mum. – Trib) held that whatever margin has
been applied through MAP with respect to major international transactions, the
same should be applied for the remaining transactions.

–  The maximum international
transactions were undertaken by the Taxpayer with its AEs in Canada and USA.
Only two transactions were undertaken with AEs in Australia and UK. Therefore,
the same ALP of 117.50 % should be applied with respect to remaining two
international transactions.

19. [2017] 77 taxmann.com 166 (Ahmedabad – Trib.) DCIT vs. Bombardier Transportation India (P.) Ltd. A.Ys.: 2013-14, Date of Order: 3rd January, 2017

Sections – 9(1)(vi) / 9(1)(vii) of the Act,
Article 12 of India-Canada DTAA – Use of certain equipment in course of
rendition of services does not result in any use of or right to use the
equipment for recipient of service. Hence, payment for such services cannot be
treated as royalty

Facts 1

The Taxpayer, an Indian company, was a
member-company of an international Group engaged in the business of
manufacturing and supply of rail transportation system. It was a wholly owned
subsidiary of a Singapore based Group Company. During the relevant assessment
year, Taxpayer had made payments to its Canadian Group Company towards its
share of costs in relation to the information system support services availed
by Canadian company at group level.

Before the AO the Taxpayer contended as
follows.

–  The
payments were made towards information system support services at group level.
The amounts were determined on the basis of cost allocation. The Taxpayer
contended that the since the payments were in the nature of reimbursements,
they could not partake the character of income.

–  Provisions
of section 9(1)(vi) of the Act treating the payments as ‘royalty’ could not be
invoked unless there was transfer of all or any of the rights (including
granting of any license) in respect of copyright of a literary, artistic or
scientific work.

–  Additionally,
in terms of Article 12(3) of India-Canada DTAA, only payments having an element
of use of IPRs could be considered as royalties whereas the impugned payments
were for standard facilities. Further, the Canadian company had not received
any payment for commercial exploitation of copyright embedded in the
applications.

–  Hence,
such payments did not qualify as ‘royalty’.

     However, the AO concluded
that the impugned payments were consideration for “use or right to use any
industrial, commercial or scientific equipment” and hence, taxable u/s.
9(1)(vi) of the Act as well as article 12(3)(b) of India-Canada DTAA. After a
detailed analysis of the payments, he was of the view that a major portion of
the payment was for the use or right to use industrial, commercial or
scientific equipment.

Held 1

(i)  The payments made by the
Taxpayer to Canadian company were in the nature of reimbursements based on cost
allocations and did not involve any income element.

(ii) Though rendition of
service may involve use of certain equipment it does not result in any use of
or right to use the equipment. Even if a part of consideration could be said to
be on account of use of equipment by breaking down all the components of
economic activity for which consideration is paid, it is neither practicable,
nor permissible, to assign monetary value to each of the components and
consider that amount in isolation for deciding character of that amount.

(iii) Even if the payment is
considered as payment for use of software, in absence of transfer of copyright,
it cannot be treated as royalty.

(iv) In Kotak Mahindra
Primus Ltd vs. DDIT [(2007) 11 SOT 578 (Mum)], deciding on a similar issue,
the Tribunal observed that the Indian company did not have any control over, or
physical access to, the mainframe computer in Australia, and that since the
payment was for specialised data processing, there cannot be any question of
payment for use of the mainframe computer.

(v) Thus, even if one were to
proceed on the basis that equipment was used in rendition of services, such
payment, or part thereof, cannot be treated as payment for use of equipment.
Further, details furnished by the Taxpayer support the fact of reimbursement.
Hence, the payment was not FTS. In absence of any income embedded in
reimbursement payment, question of withholding of tax did not arise.

Facts 2

The Taxpayer
additionally availed administrative, marketing and procurement services from
the Canadian company. AO contended that the services rendered by the Canadian
company were technical in nature and such services made available, technical,
knowledge, skill and experience to the Taxpayer. Hence, payment for such
services was covered as FTS under article of India-Canada DTAA.

Held 2

(i)  Article 12(4)(a) could be
invoked only if the services provided, inter alia, “make available”
technical knowledge, experience, skill, know-how, or processes or consist of
the development and transfer of a technical plan or technical design.

(ii) The services provided by
the Canadian company were simply management support or consultancy services
which did not involve any transfer of technology. The AO had also not contended
that the recipient of service was enabled to perform these services on its own
without any further recourse to the service provider.

(iii) In this context the
connotation of the expression ‘make available’ needs to be examined. Technology
is “made available” when the person acquiring the service is enabled to apply
the technology. in CIT vs. De Beers India Pvt. Ltd [(2012) 346 ITR 467
(Kar)], the Court held that the technical or consultancy service rendered
should be such that it “makes available” (i.e., imparts) technical knowledge,
etc. to the recipient whereby he could derive enduring benefit and utilise the
knowledge or know-how on his own in future without the aid of the service
provider.

(iv)  Since
the aforementioned tests were not satisfied in case of the Taxpayer, the
payment for services could not be considered as FIS. The fact that the services
rendered involved provision of certain technical inputs and that such inputs
resulted in providing value addition to the Taxpayer, was not relevant in
determining if make available condition is satisfied or not.

TS-752-ITAT-2016(DEL)-TP Aithent Technologies Pvt Ltd vs. DCIT A.Y.: 2008-09, Date of Order: 21st September, 2016

Sections 92B, 92F of the act – Transaction between indian HO
and foreign BO – is not subject to transfer pricing provisions

Facts

An
Indian company (‘Taxpayer’ or ‘HO’) had a branch office (BO)  in Canada. The taxpayer had entered into
certain transactions with its BO.  The
TPO/AO considered such transactions as ‘international transaction’ and determined
the arm’s length price (ALP) of the transactions.

The
issue before ITAT  was whether the TPO/AO
was justified in treating the transactions between the HO and BO as an
international transaction.

Held

–
According to principle of mutuality, no person can earn income nor suffer
losses from dealings with self. There cannot be a valid transaction of sale
between BO and HO. Hence, profit on such sales is not includible while
computing total income of ho. reliance in this regard was  placed 
on  Calcutta  tribunal’s 
decision  in  the case of Betts Hartley Huett & Co.
Ltd. vs. CIT (1979) (116 ITR 425).

–
A transaction can be treated as an international transaction, only if it is a
transaction between two or more associated enterprises (AEs).   Since BO 
is not a separate enterprise, one cannot treat a transaction between HO and
BO as an international transaction.

–
“Enterprise” has been defined u/s. 92F(iii), to include a  permanent 
establishment.  Thus,   a 
BO   can  be treated as an enterprise. Nevertheless,
the definition of ‘international transaction’ when considered in juxtaposition
to the definition of ‘enterprise’, give prima facie impression that all the
transactions between a BO  and its HO are
to be subjected to the transfer pricing provisions.

–
However, this prima facie impression loses its substance, when  the  HO
in question is an indian entity. This is for the reason that the indian entity
is taxable in india on its worldwide income, including the income earned
outside india through its branch.

–
When the accounts of the indian HO and BO 
are aggregated, income of the HO would be set off with an equal amount
of expense of the BO,  leaving thereby no
separately identifiable income on account of transactions between HO and BO.

–   Thus, 
over or under invoicing between the HO and BO will always be tax neutral
in the case of an indian entity having a PE outside india. ALP adjustment for
such transactions will result in charging tax on income which is more than the
amount legitimately due to the exchequer and hence, impermissible.

–  The aforesaid rationale is restricted only to
transactions between the indian HO and its foreign Bo.  In case where HO is a foreign entity, it is
taxable in india only on its indian income and hence, there may be an allurement
to such foreign entities to resort to over invoicing, to mitigate tax burden in
india. Hence, the above discussion does not apply to a case where the
transaction is between a foreign entity and its BO in india.

–   In 
the present case as the HO is an indian 
entity which offered the income earned from india as well as that earned
by its BO  to tax in india, transactions
between such indian HO and BO are not subject to TP provisions

P.S.:

i.   The ruling does not provide any clarity
about the nature of the transaction between indian HO and BO and the basis on
which ALP adjustment was suggested by the AO

ii.  PE of indian Company is considered as
resident in india. Hence,  transactions
between HO and BO  are unlikely to be
regarded as within the ambit of Indian Transfer Pricing Provisions.

TS-528-ITAT-2016(Mum) Kotak Mahindra Bank Limited vs. ITO A.Y.: 2012-13, Date of Order: 25th August, 2016

Article 13,15  of  India-UK 
DTAA, S.  9(1)(vii) of the act – Fees
paid to UK LLP for legal services in relation to acquisition of banking company
and setting up of USA branch qualifies as payment made for the purpose of
earning income from a source outside india. article 15, being a specific
provision dealing with legal services, overrides the general provisions of
article 13 dealing with technical and consultancy services – fees paid to UK
LLP is not taxable in india under the act 
as also DTAA

Facts

The
taxpayer, an indian company, was engaged in the business of banking. The
taxpayer  was contemplating the option of
acquiring banking company and/or setting up of a branch in US.  For this purpose, the taxpayer entered into
an agreement with a UK LLP to obtain certain legal services.

During
the relevant year, the employees of the taxpayer travelled to the USA.  During their visit, UK LLP made presentations
and discussed various legal or regulatory requirements in the USA in relation
to setting up of branch and acquisition of banking company in the USA.

The   taxpayer 
contended  that  the 
services  rendered by the UK LLP
were utilised for the purpose of earning income from a source outside india.
Hence, it cannot be deemed to accrue or arise in india by virtue of the source
rule exclusion u/s 9(1)(vii) of the act. Further, under the India-UK  DTAA (DTAA), such income is covered under
article 15 on independent Personal Services (IPS) and in absence of
satisfaction of conditions specified therein, the payment made to UK LLP is not
taxable in india even in terms of DTAA.

However,
ao contended that in absence of actual creation of a new source of income, the
source rule exclusion under the act is not applicable in respect of payments
made to UK LLP which is taxable as royalty/FTS under the act. Further, as
services rendered by the UK LLP had made available technical knowledge, skill
and experience to the employees of the taxpayer, the payment made to the UK LLP
qualifies as FTS under the DTAA.

Held

Taxability under the Act

–
The payment was made by the taxpayer to the UK LLP on account of the first
phase of the agreement. Under the first phase, the UK LLP was required to
educate the Taxpayer’s officials on various legal/regulatory requirements of
USA in relation to setting up of a bank branch and acquisition of banking
company.

–
The  nature of services indicated that
the payments were made with a view to carry on business and to create a new
source of income outside india, by way of establishment of new branch or
acquisition of a banking company.

–
The source rule exclusion is not restricted only to a case where there is an
existing source of income. As long as the payment is made for creation of a new
source of income, it is covered by the source rule exclusion.

Taxability under DTAA

–  Article 15, being a specific provision
dealing with independent professional services of    lawyers, overrides the general provisions
of article 13 dealing with a broader category of technical or consultancy
services1.

–
As Held by the Special bench of the tribunal 
in the case of Clifford Chance2, article 15 applies not only to
individuals but also to firms3. As the services were rendered outside india and
none of the employee of the UK LLP was present in india for more than 90 days,
such income is not taxable in india under article 15 of the DTAA.

Section 195 – payments made to non-residents for rent for office outside India, advertisement in foreign journals and exhibition expenses being business profits are not taxable in India in absence of a PE in India

12.  [2016] 74
taxmann.com 191 (Delhi – Trib.)

ITO vs. Brahmos Aerospace (P.) Ltd.

A.Y.:2011-12, Date of order: 14th September, 2016

Facts

The Taxpayer had made payments to certain non-residents
(NRs). The payments pertained to rent for office outside India, advertisements
and expenses for participation in exhibition outside India. Mistakenly, the
Taxpayer had withheld tax on the said payments at minimum rates and hence
Taxpayer applied for rectification u/s. 154 of the Act. However, the AO
contended taxes were required to be withheld @ 20% and rejected rectification
application of the taxpayer. The CIT(A) allowed the appeal of the Taxpayer.
Against the order of CIT(A), the revenue appealed to the Tribunal.

Held

–  The payments made to non-residents were in
respect of rent, advertisement and exhibition expenses. Such payments are in
the nature of business receipts of the payee and are taxable in India only if
the NR has a PE in India in terms of the relevant DTAA2 .

2   The decision does not mention DTAA of any
specific country and also does not refer to any specific Article (such as,
Article 7 read with Article 5) of any DTAA.

 – Since the NR does not have PE in
India, the receipts from the Taxpayer are not chargeable to tax in India.
Consequently, the Taxpayer is not required to withhold tax on such payments.

Subsequently concluded APA which accepted that the taxpayer was not a contract manufacturer for relevant years under appeal have considerable bearing on TP dispute and can be admitted as an evidence before the Tribunal

11.  ITA Nos.
779/Mds/2014, 801 Mds/2015 & 810/Mds/2016

Lotus Footwear Enterprises Ltd (India Branch) vs. DCIT

A.Y.s: 2009-10 to 2011-12,

Date of Order: 21st September, 2016

Facts

The Taxpayer was engaged in manufacture of footwear for its
associated enterprise (AE) in BVI. For FY 2009-10 to 2011-12, assessment orders
were passed basis the directions of the DRP. Certain adjustments were made
under TP by regarding the taxpayer to be a contract manufacturer. It is not
clear as to what was the claim of the taxpayer and basis on which the TPO
concluded that the taxpayer was a contract manufacturer permitting TP
adjustment during the years under appeal.

Taxpayer appealed against the assessment orders before the
ITAT and assailed the additions made on account of transfer pricing
adjustments.

Taxpayer had signed an APA in 2016 for FY 2014-15 to 2018-19,
with a roll back for three years from FY 2011-12 to FY 2013-14.

The APA was signed on the basis that for the years covered by
APA and the three earlier years for which roll back was claimed, the business
model of the taxpayer was that of a contract manufacturer and such change was
effected only after F.Y. 2010-11 (A.Y. 2011-12) due to multiple labour strikes
in its units. It was also claimed that roll back which was applicable for
earlier 4 years including one of the years under appeal viz. F.Y. 2010-11 (A.Y.
2011-12) was not made applicable, as for the relevant year, as per the facts
which the taxpayer could furnish before APA authorities, the taxpayer was not a
contract manufacturer. Thus, for F.Y. 2010-11, APA authorities had accepted the
contention of the taxpayer that it was not a contract manufacturer as against
departmental contention that the taxpayer was a contract manufacturer.

It is in this background that taxpayer relied on APA and
claimed that its contention about it not being a contract manufacturer during
the relevant years of appeal is to be accepted.

Held

Tribunal concurred that APA should be considered while
deciding the appeal of the Taxpayer, for the following reasons:

–   The APA rollback period was reduced to three
years only after considering and accepting the submissions of the Taxpayer that
it was not a contract manufacturer in FY 10-11 and the years prior to it.

–   Nature of business of the Taxpayer as
determined under APA would have considerable bearing on the ALP study of the
international transactions of the Taxpayer for the FYs under consideration.

–   Since the APA was concluded in May 2016, the
Taxpayer did not have the opportunity to submit it to the lower authorities.

Having regard to the above, the additional evidence was
admitted and the matter was set aside for fresh consideration.

Article 5 of India-Switzerland DTAA – on facts, subsidiary company and its managing director (MD) constituted fixed place PE and dependent agent PE of the taxpayer in India

10.  I.T.A.No.1742/Mds/2011

Carpi Tech SA vs. ADIT

A.Y.: 2008-09, Date of Order: 24th August, 2016

Facts

Taxpayer a company resident in Switzerland, was engaged in the
business of water proofing and providing drainage systems. During the relevant
assessment year, the Taxpayer had received certain amounts for undertaking a
project for an Indian company.

The Taxpayer contended that the project was only for 40 days (i.e.,
less than six months), and it did not have ‘continuous presence’ or ‘business
connection’ or ‘permanent establishment’ in India. Therefore, receipts from
such project is not chargeable to tax in India. The Taxpayer also had an Indian
subsidiary1 (“Sub Co”).

In the course of inquiry, the AO found that the Taxpayer had also
executed a project in financial year 2004-05 and 2005-06. The duration of the
said project was 105 days. Between the two projects, the time lag was three
years.

During the intervening period, the MD of Sub Co was making efforts
to secure other projects for the Taxpayer in India. The website of the Taxpayer
mentioned office-cum-residential address of the MD for correspondence. The MD
was given a power of attorney (PoA) to undertake the activities of the Taxpayer
in India. Further Sub Co also had a PoA to represent the Taxpayer in its
projects in India.

Based on these as well as several other facts, the AO concluded
that Sub Co and its MD were dependent agents exclusively acting for the Taxpayer
and that the income was subject to tax under Article 7. The DRP upheld the
order of the AO. 

1   While the decision mentions Indian company
as a subsidiary, the facts appear to indicate that though the name of Indian
company was similar to the name of the Taxpayer, all the shares were held by
two individual shareholders one of whom was MD of the company. Thus, impliedly,
the Taxpayer did not have any shares in the Indian company.

Held

–   The facts and the documents indicates that
all the actions related to the project were undertaken by or routed through Sub
Co or its MD. The MD was also holding PoA from the Taxpayer and signed all
documents on behalf of the Taxpayer.

–  It is not necessary that place of business
should be exclusively available to the Taxpayer. What is required is that to
constitute a PE, business must be located at a single place for reasonable
length of time though the activity need not be permanent, endless or without
interruption. In Sutron Corporation vs. DIT [2004] 268 ITR 156 (AAR) and
in Motorola Inc vs. DCIT [2005] 95 ITD 269 (Del) (SB), residence of
country manager was held to be fixed place of business since it was used as an
office address.

–   The residence of MD from where all activities
of the Taxpayer in relation to Indian project, such as participation in bids,
correspondence with customers, signing of contracts, execution of the project
and closure of the project etc. was carried on triggered a fixed place
PE for the Taxpayer in India.

–   Sub Co incurred all the project-related
expenses. The Taxpayer reimbursed these expenses

–   The activities of the Taxpayer and Sub Co
were intertwined and Sub Co participated in economic activities of the
Taxpayer. Sub Co was the face of the taxpayer in India and had a PoA to
represent the Taxpayer in India. Thus the premises of Sub Co also resulted in a
fixed place PE for the Taxpayer in India.

–   Further the Taxpayer was relying on the skills and knowledge of the
MD. His role was critical to all the aspect of the contract through the stage
of signing to its execution.

–  There was no evidence for the claim of the
Taxpayer that MD of Sub Co was independent agent because he represented other
companies. While an independent agent would be required to have objectivity in
execution of tasks of its principal, role played by MD could not be easily
separated from services of the Taxpayer. MD was acting exclusively or almost
exclusively for the Taxpayer.

–   The functions performed by MD or Sub Co could
not be considered as preparatory or auxiliary in character. The Taxpayer had
not demonstrated that it had a mere passing, transient or casual presence in
India. Accordingly, Sub Co and MD constituted fixed place PE and dependent
agent PE of the Taxpayer in India.

Article 7 & 5 of India-UAE DTAA; – In absence of a specific article on Fee for technical service (FTS), income from services rendered in the normal course of business is to be classified as business income; in absence of a Permanent establishment (PE) in India, income from such services is not taxable in India

9.  [2016] 75
taxmann.com 83 (Bangalore – Trib.)

ABB FZ-LLC vs. ITO

A.Y: 2012-13, Date of Order: 28th October, 2016

Facts

The Taxpayer was a company incorporated in and resident in
UAE. The Taxpayer had entered into an agreement with an Indian company for
providing certain services. In consideration, the Taxpayer received certain
fee.

According to the Taxpayer, in absence of a specific article
on FTS in the India-UAE DTAA, income from services is to be classified as
business profit under Article 7. Further, in absence of a PE in India, the fee
is not chargeable to tax in India. The Taxpayer however, did not dispute that,
the receipt was FTS in terms of section 9(1)(vii) of the Act.

AO however, contended that if a DTAA does not have any clause
for taxation of any item of income, such income is to be taxed in accordance
with the Act. Since the Act has a specific provision for taxing FTS, such
specific provision would prevail over the general provision of DTAA.
Accordingly, AO applied provisions of section 9(1)(vii) of the Act and taxed
the fee as FTS. The Dispute resolution panel (DRP) confirmed the view of the
AO.

Held

–   If royalty or FTS is derived from regular
business activities of the Taxpayer, it is to be regarded as business income
under the Act as well as DTAA. However, if these items of income are separately
classified, then taxation would be as applicable to that classification.

–   Income is derived by the taxpayer from
providing services, which is a regular business activity, and hence such income
from such services is to be classified as business income under the DTAA.

–   Absence of a specific provision in the DTAA
is not an omission but an agreement between the two contracting states not to
separately classify such income as FTS. Once the income is classified as
falling within the ambit of other article of the DTAA, thereafter, scope of
assessing such income cannot be expanded by importing classification from the
Act and taxing such income under that classification in the Act.

–   Accordingly, in absence of specific Article
dealing with FTS in India-UAE DTAA, the fee received by taxpayer would be
taxable in terms of Article 7 and in absence of a PE of the Taxpayer in India,
such income is not chargeable to tax in India.

–    Reliance in this regard can be placed on the
Tribunal decision in the case of IBM India Pvt Ltd vs. DDIT (ITA Nos.489 to
498/Bang/2013), wherein the Tribunal held that even if the payments were
not covered by Article 7, they would be covered under Article 23 (other income)

INTERNATIONAL WORKERS AND SOCIAL SECURITY AGREEMENTS – GROWING SIGNIFICANCE – AN OVERVIEW

In view of significant increase in
the mobility of cross border workers / employees in the recent years, issues
relating to social security benefits to such International Workers [IWs] have
acquired immense importance. Consequently, Social Security Agreements [SSAs],
being bilateral instruments, entered into by various countries to protect the
social security interests of such international workers has assumed lot of
significance. India is not remaining far behind in this respect. In this
article, we have attempted to give an overview of SSAs and social security
issues of International Workers.


 1.  Background

     Foreign nationals coming
for employment in India were earlier excluded from the provisions of the
Employees’ Provident Fund and Miscellaneous Provisions Act, 1952 [EPF Act] as
their remunerations in most cases far exceeded above the statutory threshold
limit.

    On the other hand,
Indian citizens working overseas (other than countries having operational SSA
with India and fulfilling relevant conditions prescribed therein) are subjected
to all contributions to the social security fund of the country where they
work, irrespective of the time spent in another country. Often, the amount so
contributed would stand forfeited, since like the Indian Provident Fund, all
social security schemes are subject to long-term rules of withdrawal, causing
the Indian expatriate or his employer heavy losses.

    In order to create level
playing field and to pressurise other countries to enter into SSAs with India,
‘International Worker’ is introduced as a concept and they are bound to comply
with PF provisions, regardless of their remuneration break-up.

    In October 2008,
Government of India made fundamental changes in the Employees’ Provident Funds
Scheme, 1952 [EPFS] and Employees’ Pension Scheme, 1995 [EPS] by bringing
International Workers [IWs] under the purview of the Indian social security
regime. The Government of India had vide its notifications dated 1st
October, 2008 introduced Para 83 to the Employees’ Provident Fund Scheme, 1952
and Para 43-A to the Employees’ Pension Scheme, 1995 creating Special
provisions in respect of the International workers [Special provisions].

    In September 2010, the
Ministry of Labour and Employment [MoLE)] issued a notification further
amending the EPFS and EPS vis-à-vis the IWs. However, the notification raised a
lot of issues which required clarifications. In May 2012, the MoLE vide its
notification dated 24th May, 2012 made further amendments in the
Employees’ Provident Scheme to clarify various issues.

    An important
clarification is that IWs who are covered under an SSA that India has signed
with other countries and that are in force can withdraw their PF accumulations
immediately on cessation of employment in establishments covered under EPF Act
in India and will not have to wait till 58 years of age to get access to their
PF accumulations. Further, the definition of excluded employee (who need not
contribute to Provident Fund in India) has been expanded to cover exemption
granted under bilateral economic agreements.


 2.  Social Security

     The term ‘Social
Security’ has been explained by the International Labour Organisation as the
protection which society provides for its members, through a series of public
measures, against economic and social distress that otherwise would be caused
by the stoppage or substantial reduction of earnings resulting from sickness,
maternity, employment injury, unemployment, invalidity, old-age and death; the
provision of medical care; and the provision of subsidies for families with
children.

     The key social security
legislations in India with respect to employees are:

 (i)  The Employees’ Provident
Fund and Miscellaneous Provisions Act, 1952; (ii) The Employees’ State
Insurance Act, 1948; (iii) The Employees’ Compensation Act, 1923; (iv) The
Maternity Benefit Act, 1961; and (v) The Payment of Gratuity Act, 1972.

    The Social Security
contributions have significant importance while structuring international
assignments for employees. Any social security benefit payable in the host
country may become an added cost to the employer, especially in situations
where there are restrictions for withdrawal. It is in this context that SSAs
executed between countries come into perspective and they need to be carefully
evaluated to help reduce the financial implications. At times, secondment
arrangements are structured to ensure that the expatriate employee continues to
derive social security benefits in the home country during the period of
assignment.


 3.  Social Security Agreement

a.  Social Security Agreement

    A Social Security
Agreement is a bilateral instrument to protect the social security interests of
workers posted in another country. Being a reciprocal arrangement, it generally
provides for equality of treatment and avoidance of double
coverage/contribution.

 b.  Main provisions covered
in a SSA

     Generally a Social
Security Agreement covers 3 provisions. They are:

 a) Detachment:
Applies to employees sent on posting in another country, provided they are complying
under the social security system of the home country.

b)  Exportability of
Pension: Provision for payment of pension benefits directly without any
reduction to the beneficiary choosing to reside in the territory of the home
country as also to a beneficiary choosing to reside in the territory of a third
country.

c)  Totalisation of
Benefits: The period of service rendered by an employee in a foreign
country is counted for determining the “eligibility” for benefits,
but the quantum of payment is restricted to the length of service, on pro-rata
basis.

 c.  Articles forming part of
a typical SSA

    The brief description of
the Articles contained in the latest India-Australia SSA signed on 18-11-2014,
are as follows:

Sr. No.

Part / Article No.

Description of Part / Article

 

Part I

General Provisions

1.

Article 1

Definitions

2.

Article 2

Legislative Scope

3.

Article 3

Personal Scope

4.

Article 4

Equality of Treatment

5.

Article 5

Export of Benefits

 

Part II

Provisions and Coverage

6.

Article 6

Purpose and Application

7.

Article 7

Diplomats and Government Employees

8.

Article 8

Avoidance of Double Coverage

9.

Article 9

Secondment from Third States

10.

Article 10

Exceptions

11.

Article 11

Certificate of Coverage

 

Part III

Provisions relating to Australian Benefits

12.

Article 12

Residence or presence in India

13.

Article 13

Totalisation

14.

Article 14

Calculation of Australian Benefits

 

Part IV

Provisions relating to Benefits of India

15.

Article 15

Totalisation of Insurance period

16.

Article 16

Calculation of Indian Benefits

 

Part V

Miscellaneous and Administrative Provisions

17.

Article 17

Lodgement of Documents

18.

Article 18

Payment of Benefits

19.

Article 19

Exchange of information and Mutual Assistance

20.

Article 20

Administrative Arrangement

21.

Article 21

Exchange of Statistics

22.

Article 22

Resolution of Disputes

23.

Article 23

Review of Agreement

 

Part VI

Transitional and Final Provisions

24.

Article 24

Transitional Provisions

25.

Article 25

Entry into Force

26.

Article 26

Termination

 


4.  Status of various Operating Indian SSAs

 India presently has 17 operating
SSAs, the brief details of which are given below:

Sr. No.

Country

Date of Signing

Date of entry into Force

Duration of Detachment

Exportability of Pension

Totalisation 
Benefits

1 .

Belgium

03-11-06

01-09-09

60

A

A

2.

Germany

08-10-08

01-10-09

48

N/A

N/A

3.

Switzerland

03-09-09

29-01-11

72

A

N/A

4.

Denmark

17-02-10

01-05-11

60

A

A

5.

Luxembourg

30-09-09

01-06-11

60

A

A

6.

France

30-09-08

01-07-11

60

A

A

7.

Korea

19-10-10

01-11-11

60

A

A

8.

Netherlands

22-10-09

01-12-11

60

A

N/A

9.

Hungary

02-02-10

01-04-13

60

A

A

10.

Finland

12-06-12

01-08-14

60

A

A

11

Sweden

26-11-12

01-08-14

24

[Extendable for additional 24 months]

A

A

 

 

 

 

 

 

12.

Czech

09-06-10

01-09-14

60

A

A

13.

Norway

29-10-10

01-01-15

60

A

A

14.

Austria

04-02-13

01-07-15

60

A

A

15.

Canada

06-11-12

01-08-15

60

A

A

16.

Australia

18-11-14

01-01-16

60

A

A

17.

Japan

16-11-12

01-10-16

60

A

A

 (Abbreviations used:- A:
Available  NA: Not Available.)

 4.1     Administrative
Agreements

          In all cases where
India has signed SSAs except in case of SSA with Switzerland, Canada and
Hungary, Administrative arrangements have been entered into or Administrative
Agreements have also been signed, concerning the implementation of the
agreement on social security.

 4.2     SSAs with Portugal
& Quebec

        In addition to above mentioned 17 operating SSAs,
SSA with Portugal has been signed on 04-03-13 and SSA with Quebec has been
signed on 26-11-13. However, both these SSA have not been notified so far and
have, therefore, not entered into force.

4.3     SSA with Germany

          The SSA with
Germany was executed on 8th October, 2008 and came into effect on 1st October,
2009. This agreement however covered only the detachment provisions, as per
which, individuals on short term contract up to 48 months (extendable to 60
months with the prior consent of the appropriate authority) can avail
detachment from host country social security. Since this agreement did not
address exportability of pension and totalisation of contribution periods, the
Governments of India and Germany have negotiated and signed a comprehensive
social security agreement on 12th October, 2011. This agreement is
to subsume the SSA signed on 8th October 2008. However, a
notification bringing into effect the new agreement is still awaited. The new
comprehensive agreement with Germany envisages the following benefits to Indian
nationals working in Germany:

  (i)   The employees of the home country
deputed by their employers, on short-term assignments for a pre-determined
period of less than 5 years, need not remit social security contribution in the
host country. For example, in case of deputation of an Indian employee to
Germany vide a short term contract of up to five years, no social security
contribution would need to be paid under the German law by the employee
provided he continued to make social security payment in India.

 (ii)  The benefits under the
SSA shall be available even when the Indian company sends its employees to
Germany from a third country.

 (iii)  Indian workers shall
be entitled to the export the social security benefit if they relocate to India
after the completion of their service in Germany.

 (iv)  Self-employed Indians
in Germany would also be entitled to export of social security benefit on their
relocation to India.

 (v)   The period of
contribution in one contracting state will be added to the period of
contribution in the second contracting state for determining the eligibility
for social security benefits (totalisation).

4.4   Negotiations with USA
and UK

USA: USA has
entered into Totalisation Agreements i.e. SSAs with 25 countries including the
UK, South Korea, Australia, Japan and Chile etc. For almost a decade,
India and USA have had talks on the totalisation agreement, however, without
much success. India sends the highest numbers of temporary workers to the USA,
who mostly work for the tech companies.

The current social security laws in
the US, including the Employee Retirement Income Security Act of 1974, allow an
employee to withdraw pension on only after a minimum qualifying period i.e. 10
years while the visa regime does not ordinarily permit the employee to stay
beyond 10 years. Therefore, Indian employees who travel to USA for a period
less than 10 years forego their social security contributions when they return.
This has ended up being a significant issue on account of the large number of
Indian employees in USA.

It however seems that the due to
lack of political will, US is holding back the signing of the agreement since
it believes that India is likely to gain disproportionately from such an
agreement. However, whenever the long pending agreement between India and US is
executed and comes into force, it will benefit a large number of Indians
working in the US, with regard to social security contributions.

UK: The recent maiden visit of the
UK Prime Minister in November, 2016 gave a ray of hope to the supporters of
proposed SSA between India and UK. As the UK is one of the prime destinations
for outbound employees from India, a SSA will favourably impact the cost of
employment for employers in both countries.

 

5.    Some relevant Questions and Answers in respect of IWs and SSAs

 4.1   Who is an International
Worker?

       An IW may be an Indian worker or a foreign
national. IW means any Indian employee having worked or going to work in a foreign
country with which India has entered into a social security agreement and being
eligible to avail the benefits under social security programme of that country,
by virtue of the eligibility gained or going to gain, under the said agreement.

       An employee other
than an Indian employee, holding other than an Indian Passport, working for an
establishment in India to which the EPF Act applies, is also an IW.

 4.2   Is an Indian worker
holding Certificate of Coverage [COC], an International Worker?

      Merely holding the
COC does not make an employee an International Worker. He/she becomes IW only
after being eligible to avail the benefits under social security programme of
any country. After obtaining COC, the employee is exempted from contributing to
the social security systems of the foreign country with whom India has SSA,
hence he/she is not eligible to avail the benefits under the social security
programme of that country.

 4.3   Who is an ‘excluded
employee’ under these provisions?

 a) A detached IW contributing
to the social security programme of the home country and certified as such by a
Detachment Certificate for a specified period in terms of the bilateral SSA
signed between that country and India is an ‘excluded employee’, under relevant
provisions; or

 b) An IW, who is contributing
to a social security programme of his country of origin, either as a citizen or
resident, with whom India has entered in to a bilateral comprehensive economic
agreement containing a clause on social security prior to 1st
October, 2008, which specifically exempts natural persons of either country to
contribute to the social security fund of the host country (e.g. para 4 of
Article 9.3 of CECA between India and Singapore provides that “Natural
persons of either Party who are granted temporary entry into the territory of
the other Party shall not be required to make contributions to social security
funds in the host country).

 4.4   Who all shall become
the members of the EPFS?

 a)  Every IW, other than an
‘excluded employee’- from 1st October, 2008.

 b)  Every excluded employee,
on ceasing the status – from the date he ceases to be excluded employee.

 4.5   Which category of establishments shall take cognizance of provisions
relating to IWs?

       All such
establishments covered/coverable under the EPF Act (including those exempted
under section 17 of the Act) that employ any person falling under the category
of ‘International Worker’ shall take cognisance of relevant provisions.

 4.6   Whether PF rules will
apply to an employee if his salary is paid outside India?

       Yes, the provisions
will apply irrespective of where the salary is paid. The PF contributions are
liable to be paid on wages, DA, and Retaining Allowance, if any, payable to the
employee. Hence, if salary is payable by establishment in India contribution
shall be payable in India and other rules will also apply accordingly.

 4.7   Whether PF will be
payable only on the part of salary paid in India in case of split payroll?

      In case of split payroll
the contribution shall be paid on the total salary earned by the employee in
the establishment covered in India.

 4.8   ‘Monthly Pay’ for
calculating contributions to be paid under the EPF Act?

      The contribution
shall be calculated on the basis of monthly pay containing the following
components actually drawn during the whole month whether paid on daily, weekly,
fortnightly or monthly basis: • Basic wages • Dearness allowance (all cash
payments by whatever name called paid to an employee on account of a rise in
the cost of living) • Retaining allowance • Cash value of any food concession.

 4.9   What portion of salary
on which PF would be payable in case an individual has multiple country
responsibilities and spends part of his time outside India?

      Contribution is
payable on the total salary payable on account of the employment of the
employee employed for wages by an establishment covered in India even for
responsibility outside India.

 4.10 Is there a minimum
period of days of stay in India which the employee can work in India without
triggering PF compliance?

        No minimum period is
prescribed. Every eligible International Worker has to be enrolled from the
first date of his employment in India.

 4.11 Is there a cap on the
salary up to which the contribution has to be made by both the employer as well
as the employee?

        No, there is no cap
on the salary on which contributions are payable by the employer as well as
employee.

 4.12 Is there a cap on the
salary up to which the employer’s share of contribution has to be diverted to
EPS?

        No, there is no cap
on the salary up to which the employer’s share of contribution has to be
diverted to EPS, 1995 and the same is payable on total salary of the employee.

 4.13 Should the eligible
employees from any country other than the countries with whom India has entered
a social security agreement contribute as International Workers?

         Yes, International
Workers from any country can be enrolled as members of EPF.

4.14 Regarding Indian
employees working abroad and contributing to the Social Security Scheme of that
country with whom India has a Social Security Agreement, are they coverable for
PF in India or treated as excluded employees?

        No, only employees
working in establishments situated and covered in India may be covered in
India.

4.15 Regarding Indian
employees working abroad and contributing to the social security scheme of a
country with which India DOES NOT have a Social Security Agreement, are they
coverable for PF in India?

       If an Indian employee
is employed in any covered establishment in India and sent abroad on posting,
he is liable to be a member in India as a domestic Indian employee, if
otherwise eligible. He is not an International Worker.

4.16 Whether foreign
nationals employed in India and being paid in foreign currency are coverable?

       Yes, foreign
nationals drawing salary in any currency and in any manner are to be covered as
IWs.

4.17 Whether foreigners
employed directly by an Indian establishment are coverable?

        Foreigners employed
directly by an Indian establishment would be coverable under the EPF Act as
IWs.

 

4.18 What is the criterion
for receiving the withdrawal benefit for services less than 10 years under EPS,
1995?

       Only those employees
covered by a SSA will be eligible for withdrawal benefit under the EPS, 1995,
who have not rendered the eligible service (i.e. 10 years) even after including
the totalisation benefit, if any, as may be provided in the said agreement. In
all other cases of IWs not covered under SSA, withdrawal benefit under the EPS,
1995 will not be available.

4.19 How long can an Indian
employee retain the status of “International Worker”?

      An Indian employee
attains the status of “International Worker” only when he becomes
eligible to avail benefits under the social security programme of other country
by virtue of the eligibility gained or going to gain, under the said agreement on
account of employment in a country with which India has signed SSA. He/she
shall remain in that status till the time he/she avails the benefits under EPF
Scheme. In other words, once an IW, always an IW.

4.20 Whether the
International Worker will earn interest even after cessation of service after
three years also in view of provisions of inoperative accounts?

      Since the provisions
of inoperative accounts are not applicable in case of international workers,
the restriction of earning interest will not apply. The international worker
shall continue to earn interest upto the age of 58 years or otherwise becomes
eligible for withdrawal.

4.21 Under what circumstances
accumulations in the Fund are payable to an International Worker?

        On retirement from
service in the establishment at any time after the attainment of 58 years. On
retirement on accounts of permanent and total incapacity for work due to bodily
or mental infirmity. A member suffering from tuberculosis or leprosy or cancer.

        In respect of a
member covered under a social security agreement entered into between the
Government of India and any other county on such grounds as may be specified in
that agreement till the time he/she avails the benefits under a social security
programme covered under that SSA.

4.22 Under what condition the
contributions received in the PF account are payable along with interest to
International Worker?

      The full amount
standing to the credit of a member’s account is payable if anyone of the
circumstances mentioned under amended Para 69 of the EPF Scheme, 1952 is
fulfilled, namely: i) on retirement from service in the establishment at any
time after 58 years of age; ii) on retirement on account of permanent and total
incapacity for work due to bodily or mental infirmity, duly certified by the
authorised medical officer; and iii) in accordance with the terms and
conditions provided in an SSA.

 4.23 Is there a cap on the
salary up to which the contribution has to be made under the EDLI Scheme, 1976
by the employer?

       Yes, the amended cap
on the salary up to which contribution has to be made under the EDLI Scheme,
1976 is Rs. 15,000.

 5.    SSA Provisions Explained – Based on India-Belgium SSA

 5.1   How it is that double
coverage is avoided after an agreement?

      When you are employed
either in India or Belgium and sent on a posting to the other contracting
Country, you and your employer would normally have to pay Social Security
Contributions/taxes to both countries for the same work. With the agreement in
place, this double coverage is eliminated and you are required to pay
Contributions/taxes to only one country, provided your posting in the other
country is for no more than 60 months.

 5.2  How does it help
employees who work or have worked in both countries to augment their
eligibility for monthly retirement, disability or survivors benefits?

 a. When you have Social
Security insurance periods in both India and Belgium, you may be eligible for
benefits from one or both countries.

b. Should you have enough
insurance periods under one country’s system, you will get a regular benefit
from that country.

c. If
you do not have enough insurance periods, the agreement may help you augment
your eligibility for a benefit by letting you add together your Social Security
insurance periods in both countries, only for the purpose of deciding your
eligibility.

d. However, each country will
pay a benefit based solely on your periods of insurance under its pension
system.

e. Although each country may
count your insurance periods in the other country, they are not actually
transferred from one country to the other.

f.  Since your insurance
periods remain on your record in the country where you earned them, they can
also be used to qualify for benefits there.

 5.3   What is a detachment
certificate?

      A detachment certificate is otherwise a
“Certificate of coverage” issued by one country (indicating the details of
coverage/membership under its social security system) that serves as proof of
exemption from Social Security contributions/taxes on the same earnings in the
other country.

 5.4   How to obtain a
Certificate of coverage?

      To seek an exemption
from coverage under the Belgian system, the employee must be working in an
establishment covered or coverable under Employees’ Provident Fund Organisation
(EPFO), the Indian Liaison agency. Both the employer as well as the employee
must jointly request a certificate of coverage, in the prescribed format, from
the jurisdictional Regional Provident Fund Commissioner of EPFO.

5.5   I am holding a
Certificate of coverage. When does the date of exemption from the other
country’s social security system start?

      The certificate of
coverage carries a provision for indicating the effective date of your
exemption (based on the information provided in your joint application) from
paying Social Security contributions/taxes in the other country. Normally, this
date shall be on or after the date you started working in the other country but
cannot be a date earlier than the date of effect of the Agreement.

 5.6 Who are all eligible
for applying for a certificate of coverage?

         There are 2
categories of employees eligible for applying for a Certificate of coverage.

a.Those already deputed on a
pre-determined short-term assignment and working in Belgium should apply for a Certificate
of coverage for the period from 1st Sept. 2009 to the date of
completion of the deputation.

b.Those to be deputed on or
after 1st Sept. 2009 should apply for a certificate of coverage for
the entire period of deputation in Belgium.

 5.7   How to ascertain
whether an employee is coverable under the Indian or Belgian Social Security
system?

 a.    
An Indian national working in Belgium

Nature of employment

Coverage under

1.  Sent on
short-term posting by an Indian employer for a period of less than 5 years

Indian system

2.  Sent on
Long-term posting by an Indian employer for a period of more than 5 years

Belgian system

3.  On local
employment by an Indian employer directly in Belgium

Belgian system

4.  On local
employment by a Non-Indian employer directly in Belgium

Belgian system

 

b.    A Belgium
national working in India

Nature of employment

Coverage under

1.   Sent
on short-term posting by a Belgian employer 
for a period of less than 5 years

Belgian system

2.  Sent on
Long-term posting by a Belgian employer for a period of more than 5 years

Indian system

3.  On local
employment by a Belgian employer directly in India

Indian system

4.  On local
employment by a Non- Belgian employer directly in India

Indian system

 

5.8   What benefits are due
to an employee covered under the Indian system administered by EPFO?

S. No.

Benefit

Nature

To whom payable

1.

Provident fund benefit (EPF

A lump sum cash benefit that gets
accrued in a member’s account by way of the contributions remitted and the
interest earned thereon.

1.  Member: on leaving
employment on superannuation or disability.

Or

2.  Survivors, if the
member is not alive.

2. 

Pension benefit (EPS)

A Monthly cash benefit paid into the
credit of the beneficiary’s bank account.

1.  Member: on leaving
employment on superannuation or disability. Or

2.  Widow/widower and
the eligible children: if the member is not alive. Or

3.  Nominee/Parents: if
the member dies without leaving any family.

 

3.

Insurance benefit (EDLI)

A lump sum cash benefit.

1.  To the survivors on
death of the member.

2.  The death should
have occurred during employment.

 


5.9   Whom does the agreement
help?

       The agreement helps the employee,
her/his family and the employer.

5.10 How does the agreement help
the employee?

 The
agreement helps at 3 stages.

a) During the period while the employee is
working;

b) At the time of claiming the benefits and

c) At the time of receiving the benefits.

        While working

a. If both the Indian and Belgian Social Security
systems cover an employee’s work, the employer along with the employee would
normally have to pay Social Security contributions to both countries for the
same work. The agreement eliminates this double coverage so that contributions
are paid to only one system.

 b.Under the agreement, an eligible Belgium
national employed in India will be covered by India, and that employee and the
employer will pay Social Security contributions only to India. If an Indian
national is employed in Belgium, she/he will be covered by Belgium, and that
employee and the employer shall pay Social Security contributions only to
Belgium.

 c.On the other hand, if an employer sends an
employee from one country to work for that employer in the other country for
five years or less, that employee will continue to be covered by her/his home
country and that she/he will be exempt from coverage in the host country. For
example, if an Indian employer sends an employee to work for that employer in
Belgium for no more than five years, the employer and the employee will
continue to pay only Indian Social Security contributions and will not have to
pay in Belgium.

When claiming the benefits

a. An employee may have contributed to the Social
Security systems in both India and Belgium but not have enough insurance
periods to be eligible for benefits in one country or the other. The agreement
makes it easier to qualify for benefits by allowing totalisation of such Social
Security contributory periods in both countries.

b. If an employee has Social Security insurance
periods in both India and Belgium, she/he may be eligible for benefits from one
or both countries. If she/he meets all the basic requirements under one
country’s system, she/he will get a regular benefit from that country. If she/he
does not meet the basic requirements, the agreement may help her/him qualify
for a benefit by allowing totalisation of insurance periods in both the
countries.

c. If she/he does not qualify for regular
benefits, she/he may be able to qualify for a partial benefit from India,
against the contributions made to India, based on totalisation of both Indian
and Belgian insurance periods.

d. Similarly, she/he may be entitled for a partial
Belgian benefit against the contributions made to Belgium, based on totalisation
of both Belgian and Indian insurance periods.

At the time of receiving the benefits

        The benefits under Indian social
security system is not payable outside India. An employee from Belgium was at a
loss being not able to get the due benefits on her/his relocation outside
India. Now, the agreement provides for making payment of benefits to the member
irrespective of whether she/he lives in India or Belgium or a third country.

5.11 Can you tell me an example how the employees
are benefited under the Agreement?

        A member who worked in India and
contributed to EPS, 1995 for 7 years is now living in Belgium after
contributing under the Belgian system for 20 years. He is more than 58 years
old.

 Entitlement

a. Without the Agreement:

        The member has less than the 10 years of
pensionable service required to qualify for member’s pension under EPS, 1995
and hence is not entitled to receive any pension benefit.

 b. With the Agreement

–  Eligibility to Pension under EPS 1995 can be
claimed by totalizing the insurance periods spent under the Indian system (7
years) with the Belgian system (20 years).

–  Since the total insurance period will work out
to 27 years (7+20), which is more than the required minimum eligible service of
10 years, the member becomes eligible to get pension under EPS, 1995.

–  However, this totalised period shall be
considered for deciding the eligibility only and hence, the actual pension will
be sanctioned taking into account the period spent under the EPS, 1995 (7
years) as the pensionable service.

–  Such a pension is payable to the member’s bank
account either in Belgium or in India.

7.    Conclusion

       India’s move to require IWs to
contribute to the Indian social security system has encouraged many countries
to negotiate and execute SSAs with India. The SSAs significantly benefit Indian
workers employed abroad, especially those on short-term contracts.

        In cases where employees are suspended
but their employment is not terminated, in the home country, it is difficult to
ascertain whether the same would trigger provisions of EPF Act and the SSAs. In
some cases, it is difficult to ascertain whether the relationship is in the
nature of employment or assignment and hence whether provisions of EPF Act and
the SSAs would be applicable.

      Application and interpretation of SSAs
and the social security law in India with respect to expatriates is still
evolving. There are open questions when it comes to secondment and deputation
arrangements, especially in light of possible tax implications.

      It is advisable that readers should
carefully examine the provisions of the SSAs before providing any structuring
and other guidance relating to mobility of IWs. _

HOME OFFICE AS PE

Background

Permanent Establishment (PE) confers taxation right
to host country to tax business profits. Once PE is constituted, business
profits are taxable at rate applicable to non-resident. Most common is the
creation of fixed place PE, Agency PE, Service PE, rules of which are designed
to cater to different forms of business. Increasingly, transactions entered
into by non-residents are scrutinised from PE perspective. Often, a foreign
enterprise appoints employees/agents in India to conduct its business. Such employees
use their home as office to work for foreign enterprise. Recently, the Chennai
Tribunal in case of Carpi Tech SA (TS-587-ITAT-ITAT-2016) held that residence
cum office of Indian director creates permanent establishment in India for
activities carried out in India for short period of time. This article proposes
to analyse some of the nuances of the decision.

Facts of the case:

–  The Taxpayer, a company resident in
Switzerland, undertook Geo Membrane waterproofing project for NHPC in India
(the NHPC project). The NHPC project lasted for less than 40 days.

–  Mr. V. Subramanian (Mr. V) is one of the
directors of the Taxpayer since its incorporation. He was designated as project
representative and/or project coordinator of the Taxpayer in India. He held a
Power of Attorney to undertake all activities on behalf of the Taxpayer.

–    I Co was engaged in the same business as the
Taxpayer. Further, I Co was also given a Power of Attorney to represent the
Taxpayer in its projects in India. Additionally, Mr. V is the Managing Director
of I Co.

–    Mr. V’s residential address is also used as
office address of I Co. Further, the same address is also used as communication
address by the Taxpayer in India for all its official purposes.

–   The Taxpayer was of the view that in the
absence of a PE under the India – Swiss DTAA (‘DTAA’), its income from NHPC
project was not taxable in India. Hence, it disclosed NIL income in its tax
return for the tax year under consideration.

The Tax Authority, based on the directions received
by the Dispute Resolution Panel (DRP) in India, held that the Taxpayer created
a PE in India in terms of Article 5 of the DTAA as below:

–  Fixed place PE at the residential-cum-office
address of Mr. V/ I Co

– Agency PE due to functions performed by Mr. V
/ I Co on behalf of the Taxpayer

The Taxpayer filed an appeal before the Chennai
Tribunal against the DRP order.

Issue before the Tribunal

Whether income of the Taxpayer from the NHPC
project was taxable in India under provisions of the DTAA?

Key arguments of the Taxpayer

–   Duration of the NHPC project was very short
(40 days). Such duration also does not meet six months threshold to create a PE
in India. Taxpayer’s earlier projects in India were undertaken three years back
and such previous projects may not be relevant for examining PE in the current
tax year.

–   Type of activities undertaken in India by Mr.
V on behalf of the Taxpayer (i.e. design, manufacture, supply and installation
of exposed PVC Geo composite Membrane) fell under installation PE provisions of
the DTAA. However, the threshold of six months is not fulfilled to create a PE.

–    Mr. V’s residential-cum-office address is
merely a mailing address. Mere existence of books of account and bank account
at Mr. V’s residence-cum-office cannot either conclusively or inferentially
point to emergence of a fixed PE.

–   Mr. V is an independent
agent of the Taxpayer. He is representing other unrelated companies also in
India in the ordinary course of his business and is not exclusively working for
the Taxpayer. The POA provided to Mr. V was a specific one and it did not
provide any continuous or general authority to Mr. V to act on behalf of the
Taxpayer. Hence, it does not create an Agency PE also.

Tribunal’s ruling

Fixed
PE

–   Residence-cum-office premises of Mr. V
created a fixed PE of the Taxpayer, due to the following reasons:

•    Business of the Taxpayer is conducted from
the address of Mr. V.

•   All correspondences related to participation
in bids, correspondence with customers, signing of contracts, execution of the
project and closure of the project etc. were initiated or routed through
the same address.

–   Authority of Advance Rulings (AAR) in the
case of Sutron Corporation (268 ITR 156) supports that residence of country manager
can create a fixed PE if the same was used as an office address by taxpayer.

–   Once Fixed PE test is satisfied, there is no
need to evaluate Construction PE clause under the special inclusion list.

–   In any case, services rendered by the
Taxpayer were more in the nature of repair and supply of material rather than
building site, construction, installation or assembly project to fall under the
Construction PE provisions. Hence, the 182 days threshold of Construction PE
was not relevant.

–   I Co also created a PE of the Taxpayer for
the following reasons:

•    Activities of I Co and the Taxpayer are
interlinked such that the role played by the director as an agent of the
Taxpayer and I Co (which rendered similar services) cannot be easily separated.
Further, I Co participates in the economic activities of the Taxpayer.

•    I Co and the Taxpayer were carrying out
identical nature of work in India. Their names and letter heads were also
similar.

•    I Co was the face of the Taxpayer in India.
I Co held POA and was the authorised representative of the Taxpayer for the
NHPC project.

•    I Co incurred all expenses in India to
execute the NHPC project which were later reimbursed by the Taxpayer. I Co
appointed vendors to render services locally and made payments to them.

Agency PE

–   Mr. V was held to be acting as a dependent
agent of Taxpayer, based on the following:

•    Mr. V was holding a POA on behalf of the
Taxpayer and was also the project coordinator/representative for NHPC project.

•    The Taxpayer was relying on the skills and
knowledge of Mr. V. His role was critical to all the aspect of the contract
through the stage of signing to its execution.

•    Mentioning Mr. V’s address on the website as
well as letterheads of the Taxpayer were indicating the fact that Mr. V was the
face of the Taxpayer in India and was representing the Taxpayer in all
practical matters.

•    No evidence was provided to prove that Mr. V
was an independent agent. On the other hand, he was acting exclusively or
almost exclusively for the Taxpayer. Hence, to that an extent, the same is not
in furtherance of his ordinary course of business.

–      The role of Mr. V for the Taxpayer and I Co
was such that it cannot be separated. There existed a unison of interest to a
great extent, while as an independent agent there would be required an
objectivity in execution of the tasks of the non-resident company.

–      Activities performed by I Co and Mr. V cannot
be said to be of preparatory or auxiliary character to qualify for PE
exclusion.

–   I Co represented by Mr. V or Mr. V himself
created a PE of the Taxpayer in India.

Analysis of The Tribunal decision:

In summary, the Tribunal held that Mr V. as also I Co
constituted PE in India based on following reasoning:

–   Residence-cum-office premises of Mr. V
created a fixed PE of the Taxpayer on account of its usage for business purpose
of Taxpayer.

–   Fixed place PE can be constituted even if its
activities in India are for 40 days.

–  Once fixed place PE is constituted there is
no need to analyse Construction PE. In any case, repair and supply of material
does not fit within Construction PE.

–   I Co created PE of Taxpayer on account of
similarity of activities, identical nature of work and reimbursement of all
expenditure incurred in India by I Co.

–   Mr V. created agency PE as it held POA on
behalf of Taxpayer; Taxpayer relied upon the skills of Mr V; Mr V worked
exclusively or almost exclusively for Taxpayer.

Aforesaid aspects have
been analysed in the ensuing paragraphs-

Place of disposal test:

–   Indian jurisprudence as also OECD Commentary
has considered satisfaction of disposal test as pre-requisite for constitution
of fixed place PE. Disposal test postulates that foreign enterprise has right
or control over premises which constitutes fixed place PE. In this case,
Tribunal has not specifically provided any positive observation on satisfaction
of disposal test. Perhaps Tribunal has presumed satisfaction of disposal test
given the dependence of Taxpayer on Mr V. and use of premises of Mr V for official
purpose/communication.

–    OECD’s revised proposal concerning the
interpretation & application of Article 5 (Permanent Establishment) of the
OECD Model Tax Convention (2011) stated that home office can constitute PE in
limited situations. OECD revised proposal stated that home office of employee
should not lead to an automatic conclusion of PE and would be dependent on
facts of each case. It is further stated that where a home office is used on a
regular and continuous basis for carrying on business activities for an
enterprise and it is clear from the facts and circumstances that the enterprise
has required the individual to use that location to carry on the enterprise’s
business (e.g. by not providing an office to an employee in circumstances where
the nature of the employment clearly requires an office), the home office may
be considered to be at the disposal of the enterprise.

–   Incidentally, disposal test is also not dealt
with by AAR in Sutron Corporation (supra) which is relied upon by
Tribunal.

Duration
Test:

–     A fixed place PE can exists only if place of
business has certain degree of permanence. There is no standard time threshold
provided by treaty and thus duration test involves subjectivity. Much depends
upon individual facts and nature of operations of Taxpayer.

–   Conventionally, it is understood that six
months’ time period should be satisfied for constitution of PE. However, there
are special situations where nature of a business of a foreign enterprise
requires it to be carried on only for a short period of time, then in such
cases a shorter period will suffice duration test.

–   The Tribunal relied upon decision of Fugro (supra)
wherein PE was constituted for 91 days of work carried on in India. As against
that there are other precedents which has held that no PE is constituted in
India in following situations:

•    a foreign enterprise in State S for 27 days
for one project and 68 days for another project [ABC, In re (1999) 237
ITR 798 (AAR)]

•    a vessel in India for 2.5 months [DCIT
vs. Subsea Offshore Ltd, (1998) 66 ITD 296 (Mum) ] or a sailing ship
crossing over to Indian waters for 10 days [Essar Oil Ltd vs. DCIT, (2006)
102 TTJ 614 (Mum)]

•    A foreign enterprise engaged in dredging and
which had its project office in India for 153 days [Van Oord Atlanta B. V.
vs. ADIT, (2007) 112 TTJ 229 (Kol)]

•  The performance of work under an agreement
had been accomplished by the occasional visits of the applicant’s personnel for
site visits and meetings. The nature of service was such that most of the
services were rendered outside India. The aggregate period spent in India by
the personnel was 24 days in the first year and 70 days in the next year. Two
or three employees of the applicant stayed in India for about a month [Worley
Parsons Services Pty. Ltd, In re (2009) 312 ITR 317 (AAR)]

•    The assessee was engaged in the business of
telecasting cricket events. Its employees and representatives (TV crew,
programmer and engineers, other technical personnel, etc.) cumulatively stayed
in India for less than 90 days [Nimbus Sport International Pte. Ltd. vs.
DDIT, (2012) 145 TTJ 186 (Del)]

•    The assessee was engaged in the activity of
supervision of plant and machinery for steel and allied plants in India. For
one project, it deputed foreign technicians to India who stayed in India for
220 days [GFA Anlagenbau Gmbh vs. DDIT, TS-383-ITAT-2014-HYD]

Interplay between fixed place PE and Construction
PE

–   The Tribunal held that once fixed place PE is
constituted there is no need to analyse Construction PE. In other words, the
Tribunal held that fixed place PE overrides Construction PE.

–   Aforesaid observations are not in sync with
following illustrative decisions of the Tribunal and AAR which has held that
Article 5(3) overrides article 5(1). In other words, there cannot be fixed
place PE unless time threshold specified under Construction PE is satisfied.

•    GIL Mauritius Holdings Ltd. vs. ACIT
(2012) 143 TTJ 103 (Del)

•    ADIT vs. Valentine Maritime (Mauritius)
Ltd. (2010) 3 taxmann.com 92 (Mum)

•    Sumitomo Corporation vs. DCIT (2007) 110
TTJ 302 (Del)

•    DCIT vs. Hyundai Heavy Industries Ltd.
(2010) 128 TTJ 4 (Del)

–   The Tribunal additionally held that repair
and supply of material does not fall within the purview of installation,
construction or assembly project. As against that OECD and UN Commentary on
Article 5 at para 17 observed that renovation involving more than maintenance
or redecoration would fall within Construction PE.

Agency PE

–  The Tribunal held that Taxpayer had Agency PE
in India on account of factors like Taxpayer reliance on Mr V’ skills, granting
of POA to Mr V and exclusive service to Taxpayer.

–   Mr V was dependent on the Taxpayer and he was
taxpayer’s Indian representative.

–   Whilst the aforesaid may be sufficient for
creation of dependent agent but for creation of dependent agent PE following
additional condition needs to be satisfied:

         •     agent has and habitually
exercises in that State, an authority to negotiate and enter into
contracts for or on behalf of the enterprise.

–   The Tribunal has not dealt explicitly with
satisfaction of aforesaid conditions of authority to enter contracts by Mr V or
by ICo.

Conclusion

Decision of the Tribunal is likely to create
litigation for foreign enterprise which has a minuscule presence in India and
is dependent upon Indian agent/employee for Indian business. The Tribunal has
considered overall presence of Taxpayer in India as also surrounding circumstances
like commonality of directors; active role paid by Mr V; holding of POA;
exclusive nature of arrangement with Mr V; similarity in names of Indian
company; reimbursement of all expenditure of Indian company by Taxpayer to
reach to the conclusion that Taxpayer has PE in India.

Similar was the decision of Aramex International
Logistics Pvt Ltd (2012) 22 taxmann.com 74 (AAR) wherein AAR held that
dependence of group company in conducting business in India creates PE. In this
case, Taxpayer a Singaporean Company engaged in business of door-to-door
express shipments by air and land entered into an agreement with its Indian
subsidiary (ICO) to look after movement of packages within India, both inbound
and outbound. AAR held that where a subsidiary is created for purpose of
attending business of a group in a particular country, that subsidiary must be
taken to be a permanent establishment of that group in that particular country.

It may be noted that none of the decisions have
dealt with base conditions which are the pre-requisites for constitution of PE.
It will be interesting to see how decisions will be dealt with by higher forums
where satisfaction of fundamental conditions of PE will be tested. _

15. TS-896-ITAT-2016(Rjt)-TP WocoMotherson Advanced Rubber Technologies Limited vs. DCIT A.Y.s: 2006-07 to 2011-12, Dated: 29th September, 2016

Section 92CA of the Act – Provision for
technical assistance does not essentially require the technology to be owned by
the service provider for use of technology – AO has to examine as to how much
is the arm’s length consideration for such services – high tax jurisdiction or
low tax jurisdiction is not relevant for the purpose of determination of arm’s
length price – where group is able to reduce tax burden by locating their units
is not a relevant factor under Indian Transfer pricing provisions

Facts

The taxpayer, an Indian entity, was engaged
in manufacture of high quality rubber parts, rubber plastic parts, rubber metal
parts and liquid silicon rubber parts. The Taxpayer had entered into
international transactions with its Associated Enterprises (AEs) (FCo1 in
Sharjah and FCo2 in Germany). FCo2 had granted non-exclusive licence to the
Taxpayer to manufacture, use, exercise or sell the licensed products at NIL
royalty. FCo1 was to provide technical assistance services in relation to the
licensed products. The Taxpayer made payments to FCo1 in relation to the
technical services.

The Transfer Pricing Officer (TPO) objected
that though the Taxpayer paid technical service fees to FCo1, all the
intangibles associated with manufacturing process were owned by FCo2.
Accordingly, TPO conducted TP adjustment in hands of the Taxpayer considering
the FTS paid to FCo1 as NIL. Taxpayer argued that the technical service
agreement with FCo1 was for achieving operational and technical competencies
relating to know-how and technology licensed by FCo2. For rendering technical
assistance, the service provider need not require be the owner of the
technology.

The Taxpayer filed objections before Dispute
resolution panel (DRP). DRP rejected the same on the ground that the services
provided by FCo2 and FCo1 are not distinct; when the same services were
received by the Taxpayer from FCo2 without any consideration, transaction with
FCo2 was an internal CUP (Comparable Uncontrolled Price). Therefore, the
services received from FCo1 should have been benchmarked at NIL.

Aggrieved, the Taxpayer approached the
Tribunal.

Held

(i)   While agreement with FCo2
was for “use of knowhow and inventions”, the agreement with FCo1 was for
“provision for technical assistance required for use of technology”.The nature
of services under the two agreements was distinct even though somewhat
interconnected.

(ii)  Provision for technical
assistance required for use of technology did not require the technology to be
owned by the service provider for use of technology.

(iii)  It is undisputed that
FCo1 had the requisite expertise and skills available for rendition of
technical services. Once the rendition of services is reasonably evidenced, it
cannot be open to the TPO to disregard the same and come to the conclusion that
these services need not have been compensated for or ought to have been
rendered by FCo2 or some
other person.

(iv) In the course of
ascertaining the arm’s length price (ALP), all that the AO has to examine is as
to how much is the consideration that the Taxpayer would have paid for the
services in arm’s length situation, rather than sitting in judgment over
whether the Taxpayer should have incurred these expenses at all.

(v)  Whether or not the person
entering into transaction is in a high tax jurisdiction or low tax jurisdiction
is also not relevant for the purpose of determination of ALP

(vi) The base erosion, which is
sought to be checked by the transfer pricing provisions in India, is the tax
base in India. Indian transfer pricing cannot be, and is not, concerned with
whether entire Group, as a whole, has been able to reduce their tax burden by
locating their units rendering technical services outside Germany.

(vii)  Further,
even if the services rendered, or believed to have been rendered, by FCo2 are
the same as those rendered by FCo1, the same being an intra AE transaction,
cannot be treated as a valid internal CUP. It is only an uncontrolled
transaction, i.e. between the independent enterprises, which can be used as a
benchmark to ascertain ALP. Thus, a transaction between the AEs cannot be
considered as a valid input for application of CUP method. Relied on a rulings
in the cases of Skoda Auto India Ltd. vs. ACIT [(2009) 30 SOT 319 (Pune)] and
ACIT vs. Technimont ICB India Pvt. Ltd. [(2012) 138 ITD TM 23 (Mum)].

[2016] 67 taxmann.com 47 (Delhi – Trib.) Kawasaki Heavy Industries Ltd. vs. ACIT A.Y.:2011-12, Date of Order: 11th February, 2016

fiogf49gjkf0d
Section 9(1) of the Act and Article 5 of India- Japan DTAA – In absence of authority to undertake core business activity or to conclude contracts, specific authority granted under power of attorney to an employee of LO will not result in constitution of PE of nonresident.

Facts
The Taxpayer, a Japanese Company, was headquartered in Japan. The Taxpayer established a Liaison Office (“LO”) in India. The Taxpayer had executed a Power of Attorney (“POA”) in favor of one of the employees of the LO.

The Taxpayer contended that purchase orders were directly raised by Indian customers on the HO of the Taxpayer, the HO directly sent quotation/invoices to Indian customers and all these documents were signed and executed by the HO directly without any involvement of LO. Further, the POA in favour of the employee was LO specific and did not grant any authority to the employee to undertake any core activities on behalf of the Taxpayer or to sign and execute the contracts. The Taxpayer also submitted documents supporting its contentions.

While the authority granted under POA was LO specific, without rebutting the documents submitted by the Taxpayer or bringing on record any other material, the AO held that the Taxpayer had granted unfettered powers to the employee and hence, the LO constituted PE in India of the Taxpayer. The AO also observed that the LO was operating beyond the scope of permission granted by RBI.

Held
POA showed that the authority granted to the employee was LO specific. Hence, the conclusion drawn by the AO that the authority granted is unfettered was incorrect. The POA did not demonstrate that the employee was authorised to undertake either the core business activity or to sign and execute the contracts. Therefore, AO’s observation that it was beyond the scope of RBI permission was perverse.

While the Taxpayer had supported its contention with documentary evidence, the AO had not rebutted the evidence nor did he bring on record any material in support of the conclusion that the Taxpayer had PE in India.

It has been brought on record that purchase orders were directly raised by Indian customers on the Taxpayer. The Taxpayer directly sent quotation/invoices to Indian customers and all these documents were signed and executed by the Taxpayer directly without any involvement of LO. No material has been brought on record to show that LO carried on core activities in India.

Accordingly, the LO of the Taxpayer did not constitute PE in India of the Taxpayer.

[2016] 67 taxmann.com 105 (Delhi – Trib.) Vertex Customer Management Ltd. A.Y.: 2004-05, Date of Order: 4th March, 2016

fiogf49gjkf0d
Section 9(1)(i) of the Act; Article 5, 13 of India-UK DTAA –Indian company to whom Taxpayer outsources some of its business in a continuous, real and intimate manner results in business connection under the Act; (ii) on facts, the Taxpayer did not have ‘fixed place PE’ or ‘service PE’ or ‘dependent agent PE’ under DTAA Where PE is remunerated on arm’s length basis, no further profit can be attributed; Amount paid as consideration for equipment use, qualifies as royalty, even if it is paid at cost

Facts
The Taxpayer was a company resident in the UK (“UKCo”). It was engaged in providing sales related outsourcing services to its clients. The Taxpayer had a group company, which was resident of India (“ICo”). The Taxpayer had outsourced certain services to ICo. The Taxpayer incurred certain expenses in respect of treasury, taxation, and finance to facilitate ICo in delivering its services to the customer. ICo reimbursed such expenses to the Taxpayer. Taxpayer had claimed that since payments received from ICo were towards reimbursement of expenses and hence not taxable in India.

Further, the Taxpayer had granted ICo right to use certain equipments outside India. In its return of income, the Taxpayer claimed that consideration received from ICo for equipment use was in the nature of royalty in terms of Article 13(3)(b) of India-UK DTAA . It also claimed that since the reimbursement was on cost basis, it was not taxable.

However, the AO concluded that Taxpayer had Permanent Establishment (PE) in India in terms of India-UK DTAA and it also had ‘business connection’ in terms of the Act. Accordingly, he taxed profit attributable to the PE. He also attributed the reimbursement of expenses and royalty in hands of the Indian PE of the Taxpayer.

The questions before the Tribunal were as follows.
(i) Whether the Taxpayer had a business connection in India?
(ii) Whether the Taxpayer had a fixed place PE in India?
(iii) Whether the Taxpayer had a service PE in India?
(iv) Whether the Taxpayer had a dependent agent PE in India?
(v) If a transaction is at an arm’s length price, whether any further profit can be attributed to PE?
(vi) Whether in absence of any income element, mere expense reimbursement could be considered royalty chargeable to tax in terms of India-UK DTAA ?

Held
(i) ‘Business Connection’ in India
On the basis of various decisions on the issue, it is apparent that there should be a continuous, real and intimate connection between the activity carried on by the non-resident (NR) outside India and the activities carried on in India. Further, such activity should contribute to the profits of the NR in his business. The relationship between the NR and the resident should be something more than mere trading on principal-toprincipal basis.

In the present case the Taxpayer secures orders from its customers on behalf of the ICo and outsources the job to ICo. There is a continuous relationship between the Taxpayer and ICo in India. The contract entered by the Taxpayer outside India are carried out in India. The responsibility of the Taxpayer vis-à-vis its customer is concluded in India. The responsibility of the Taxpayer cannot be segregated and will complete only after ICo provides services to the customers. Hence, the Taxpayer had a continuous, real and intimate connection resulting in business connection in India in terms of section 9(1)(i) of the Act.

(ii) Fixed place PE in India
To constitute a fixed place PE, all the following conditions should be satisfied.

(a) There is a place of business.
(b) Such place is at the disposal of the Taxpayer.
(c) Such place is fixed.
(d) Business of the Taxpayer is wholly or partly carried on through such place.

In case of the Taxpayer, it was not established whether the premises of ICo or client was made available to the Taxpayer. Thus, ICo’s premises cannot be said to be at the disposal of Taxpayer since it has no right to occupy the premises but is merely given access for the purpose of work. Also the services provided in India were in the nature of Business process outsourcing (BPO) services and back office operations. Thus, relying on India UK DTAA and the decision in DIT vs. Morgan Stanley & Co. Inc. [2007] 292 ITR 416 (SC), the Tribunal held that the Taxpayer did not have a fixed place PE in India.

(iii) Service PE in India
In the absence any material brought on record to show that of the Taxpayer having deputed its employees to India, question of ‘Service PE’ cannot arise.

(iv) Dependent agent PE in India
An agent is not considered an independent agent if: (a) he performs activities wholly or almost wholly for the non-resident and its group companies; and (b) the transactions between the agent and the non-resident are not on arm’s length basis. In absence of any material on record to show that ICO was a dependent agent of Taxpayer, the Taxpayer cannot be said to have ‘dependent agent PE’ in India.

(v) Attribution of further profit
No further profit can be attributed to the PE in respect of transaction if transfer pricing analysis has fully captured functions performed, assets deployed and risks assumed. Thus even if it is accepted that the taxpayer has PE in India, since the PE is remunerated at arm’s length price, no further profit can be attributed to the PE.

(vi) Reimbursement characterized as royalty.
The reimbursement on cost basis as consideration received for equipment use qualifies as royalty under India-UK DTAA . The amount claimed by the Taxpayer as reimbursement on cost basis is similar to the consideration received for equipment use. Accordingly, the amount should also be treated as royalty.

[2015] 64 taxmann.com 415 (Delhi) Pepsico India Housing (P.) Ltd. v ACIT A.Ys.: 2002-03. Date of Order: 22.12.2015

fiogf49gjkf0d
Section 92C of the Act – if taxpayer has exported goods to AE at cost and AE, in turn, has sold them at its purchase price, the transaction meets arm’s length standard, ALP adjustment addition is not justified.

Facts
The taxpayer was an Indian company and a membercompany of Pepsico Group. During the relevant assessment year, the taxpayer had exported certain goods, which, based on the functions performed by the taxpayer, could be classified in two categories. In respect of the first category of goods, the taxpayer performed all the functions and undertook risks similar to that of a normal trader in ordinary course of business. In respect of second category of goods, the taxpayer acted as mere facilitator and performed the function of a service provider. The taxpayer grouped all the exports together and benchmarked them.

According to the taxpayer, it enjoyed Star Export House status. To retain it, it had to export certain minimum value of goods. The sellers and the prices of the goods that it exported were finalized by the buyers and the taxpayer acted as mere facilitator. Hence, it exported the goods at the same price at which it purchased them. The loss incurred by it was due to forex rate fluctuations.

In his report, the Transfer Pricing officer (TPO) observed that: the taxpayer had incurred losses by exporting the goods to its AE at the same price at which it purchased; the taxpayer had not even recovered cost incurred on storage, transportation and interest; as per OECD transfer pricing guidelines, two or more transactions can be aggregated only if they are closely interlinked or continuous or form one integral whole and cannot be analysed separately.

The TPO further observed that not recovering remuneration from AE amounts to shifting of profits and, there was no justification for the taxpayer to undertake forex risk. Therefore, TPO determined the ALP and the adjustment to the income of the taxpayer.

Held

It was an admitted fact that the loss incurred by the taxpayer was only on account of foreign exchange fluctuation as the commodities were sold to the AE at the same rate at which these were purchased from the local market.

On a similar issue, in DCIT vs. Global Vantedge P Ltd4 (ITA Nos. 1432 & 2321/ Del/2009 and 116/Del/2011) the ITAT held that ALP adjustment cannot exceed  the amount received by the AE from the customer and the actual value of international transactions (i.e. the amount received by the taxpayer in respect of international transactions).

In the present case, the taxpayer had sold goods to AE at the same price at which they were purchased from the local market. The AE, in turn, had sold them to the customers at the same price at which they were purchased from the taxpayer.

Hence, the international transactions with AE met the arm’s length standard. Therefore, addition on account of arm’s length price of international transactions was not justified.

[2016] 65 taxmann.com 247 (AAR – New Delhi) Cummins Ltd. Date of Order: 12.01.2016

fiogf49gjkf0d
Article 13 of India-UK DTAA – Fee for supply management service was neither Fee for Technical Services (FTS) nor royalties in terms of Article 13 of India-UK DTAA – not taxable in India in absence of Permanent Establishment (PE) in India.

Facts
The applicant was a company incorporated in the UK. An Indian company (“IndCo”) was engaged in the production of turbochargers. IndCo purchased turbocharger components directly from suppliers in UK and US. The applicant had entered into Material Suppliers Management Service Agreement with IndCo. In terms of the Agreement, IndCo paid supply management service fee @5% of the base prices of the suppliers to the applicant.

The issues before the AAR were:
(i) Whether supply management service fee was FTS or royalties in terms of Article 13 of India-UK DTAA ?

(ii) Depending on answer to (i), as the applicant did not have PE in India, whether the payments were chargeable to tax in India?

(iii) If supply management service fee was not chargeable to tax in India, whether they were subject to transfer pricing provisions under the Act?

(iv) Depending on answer to (i) and (ii), whether IndCo was liable to withhold tax on supply management service fees?

Held

IndCo engaged the applicant only to ensure market competitive pricing from the suppliers. The applicant maintained contract supply agreement with suppliers after identifying the products availability, capacity to produce and competitive pricing. The applicant did not impart its technical knowledge and expertise to IndCo which enabled it to acquire such skills and use them in future. Therefore, the services did not satisfy the ‘make available’ condition under India-UK DTAA .

Relying on the decisions in De Beers India Minerals Private Ltd. (346 ITR 467) and Measurement Technologies Limited (AAR No.966 of 2010), services in the nature of procurement services can never be classified as technical or consultancy in nature and they do not make available any technical knowledge, experience, know-how etc.

The services rendered in this case were managerial in nature. With effect from 11th February, 1994, managerial services were taken out from the ambit of FTS under India-UK DTAA and ‘make available’ clause was inserted. This clearly showed the intention to exclude managerial services and include ‘make available’ requirement.

As the services were related to identification of products and competitive pricing and not to the use of, or the right to use any copyright, patent, trademark, design or model, plan, secret formula or process etc., they cannot qualify as royalties under Article 13 of India-UK DTAA .

Since the applicant had no PE in India, service fee was not chargeable to tax in India and hence, IndCo was not liable to withhold taxes.

PS: AAR held that the issue whether transfer pricing provisions applies is not applicable.

TS-10-ITAT-2016(Mum) Accordis Beheer B V vs. DIT A.Ys.: 2006-07. Date of Order: 13.01.2016

fiogf49gjkf0d
Article 13(5) of India-Netherlands Double Taxation Avoidance Agreement (DTAA); Section 112 of the Act – Buy-back of shares under a scheme of arrangement was not “reorganisation” as contemplated in Article 13(5) of India-Netherlands DTAA, transfer did not qualify for participation exemption; however, the transfer qualified for concessional rate u/s. 112 of the Act

Facts
The taxpayer was a resident of Netherlands. It held 38.24% of shares of an Indian company (“IndCo”) whose shares were listed on Indian stock exchanges. During the relevant year, IndCo proposed a scheme of arrangement for buy-back of its shares. The said scheme was approved by the jurisdictional High Court. The taxpayer tendered all the shares held by it and received consideration resulting in capital gains. The taxpayer contended that in terms of Article 13(5)3 of India-Netherlands DTAA , the capital gains were not chargeable to tax in India.

According to the Tax Authority, since the taxpayer sold its shares to IndCo, which was an Indian resident, capital gain did not qualify for participation exemption under Article 13(5) of India-Netherlands DTAA . Further, according to him the concessional rate of 10% provided in the second proviso to section 112 of the Act was not applicable in case of the taxpayer and hence levied tax on capital gain @20%.

The moot point before the Tribunal was whether the shares tendered in the scheme by the taxpayer constituted “reorganisation” in terms of Article 13(5) of India-Netherlands DTAA .

Held
As regards whether buy-back is “reorganisation”

Since the scheme was approved by High Court, there was no colourable device.

Reorganisation should involve major change in financial structure of a corporation, resulting in alteration in rights and interests of security holders. In the present case, upon implementation of the scheme there was no change in the rights and interests of the shareholders. Only change was that pursuant to reduction of share capital the percentage of shareholding of the promoter group had gone up. That cannot be considered as change in the rights and interests of shareholders.

The reorganisation contemplated in section 390 of the Companies Act 1956 consists of either consolidation of shares of different classes, or division of shares into different classes, or both.

Transfer of shares pursuant to a buy-back scheme could not fall under the ambit of the term “reorganisation” since the objective of the scheme was not financial restructuring, but providing exit to non-resident shareholders.

As regards rate of tax

Having regard to the decisions in Cairn U.K. Holdings Ltd. (2013)(359 ITR 268)(Del) and ADIT vs. Abbott Capital India Ltd. (65 SOT 121)(Mum Trib), the taxpayer is entitled to the concessional rate of 10% under section 112 of the Act.

[2015] 64 taxmann.com 162 (AAR – New Delhi) Satyam Computer Services Ltd Date of Order: 01.12.2015

fiogf49gjkf0d
Sections 9, 195 of the Act – Payment of penalty decreed by Foreign Court, being payment to Government, not subject to tax and hence, will not be subject to tax withholding under the Act.

Facts
The applicant was an Indian company. The shares of the Applicant were listed on Indian stock exchanges. The Applicant had also issued American depository shares which were listed on New York Stock Exchange. SEC of USA had filed complaint with US Court for violation of American Securities Law by the Applicant. The Applicant filed its consent and undertaking with SEC without admitting or denying the allegations in the complaint and agreed to pay penalty. The US Court levied civil penalty on the Applicant. The Court further decreed that “amount ordered to be paid as civil penalties pursuant to this Judgment shall be treated as penalties paid to the government for all purposes, including all tax purposes”.

The AAR examined the issue whether penalty payable pursuant to decree of US Court, which was paid to US Court/Government of USA was liable to tax withholding under the Act.

Held
Penalty pursuant to the decree of Court will not be subject to tax liability. Consequently, question of tax withholding u/s. 195 of the Act will not arise.

[2016] 65 taxmann.com 246 (AAR – New Delhi) Aberdeen Claims Administration Inc. Date of Order: 19.01.2016

fiogf49gjkf0d
Sections – 4, 5, 9, 45, 48 of the Act –Settlement amounts received by FIIs pursuant to waiver of right to sue for damages caused by fraud in financial statements was compensation for not pursuing the suit and involved surrender of capital asset (viz., “right to sue”); though it was a capital receipt, as the computation provisions failed, capital gains could not be calculated; hence, it was not taxable as capital gains.

Facts
Several FIIs were holding American depository shares and equity shares of an Indian listed company (“IndCo”). There was public disclosure by the CEO of the Indian company about manipulation of financial results of IndCo. As a result, the price of securities of IndCo dropped steeply and the FIIs were forced to dispose of the securities, suffering huge losses. Several investors initiated class action litigation against IndCo. While initially claims of FIIs were also consolidated with those of the other investors, subsequently, the FIIs filed request for exclusion with the Court. The FIIs then separately negotiated the terms of settlement with IndCo and its auditors pursuant to which IndCo and its auditors agreed to pay settlement amount to FIIs.

The issue before the AAR was whether the settlement amount received by FIIs from IndCo and its auditors was taxable in terms of the Act.

The FIIs contended as follows.

As regards sections 4, 5 & 9 of the Act

Since the settlement amounts were not received in the ordinary course of business of the Applicant, and the Applicant is not engaged in the business of suing and seeking settlement from third parties, they would not qualify as “income” for the purposes of the Act.

Since section 9 of the Act refers to only specific streams of income the settlement amounts cannot be said to be deemed to accrue or arise in India in terms thereof.

The settlement amounts were linked to a law suit that arose outside India and was not determined on the basis of value of the underlying shares of IndCo. The suit was linked to allegation of fraud/negligence. The settlement amounts were not sourced in India. Hence, the territorial nexus principle was not fulfilled. This was established from the fact that the FIIs had sold the shares prior to initiation of the action.

Therefore, the settlement amounts cannot be brought to tax u/s. 9 read with Section 4 and Section 5 of the Act. This is on the basis that the settlement amounts were not connected with the Applicant’s business in India but for release of claims of FIIs against IndCo and its auditors. Therefore, the settlement amounts have no territorial nexus with India.

As regards section 45 of the Act
The settlement amounts were received on account of destruction of capital assets (i.e. the right to sue IndCo and its auditors).

Assuming that the settlement amounts were subject to Section 45 of the Act cost of acquisition and cost of improvement of a right to sue cannot be computed. Hence, owing to failure of computation mechanism no Capital Gains could arise under Section 48 and Section 55 (3) of the Act2.

The settlement amounts were received as compensation for the injury inflicted on capital asset of the trading (Equity and ADS shares held FIIs) and therefore not subject to Section 45 of the Act.

A ‘right to sue’ is property (and thus Capital Asset as defined under Section 2 (14) of the Act). Inherently, as a matter of public policy, a ‘right to sue’ is not transferable. Thus, there cannot be any transfer of a right to sue under Indian law. Consequently, any capital receipt arising from a right to sue cannot be considered capital gains u/s. 45 of the Act. The Gujarat High Court has accepted this proposition in Baroda Cement and Chemicals vs. C.I.T. (158 ITR 636). Also, in Vania Silk Mills Pvt. Ltd. vs. C.I.T. (191 ITR 647), the Supreme Court has laid down that receipt on account of destruction of capital assets is not subject to capital gains.

The tax authority contended as follows.
The FIIs were pass-through entities engaged in the business of trading in securities and the loss was incurred by them in the course of that business. The recipients of the settlement amounts were the FIIs (and not participating investors) who were in the business of purchase and sale of securities.

Unlike an investor, Mutual Funds change their portfolios frequently and sometimes prefer even booking losses. The FIIs decide to move out of a market on local as well as international factors. The buying and selling of shares is done very regularly and frequently. These are characteristics of a trader and not of an investor. Merely because in order to attract investments the Government has decided to treat the gains of FIIs as capital gains, the same does not alter the basic character of the activity but only changes the matter of taxability.

Any fall in price of share cannot be regarded as destruction of asset. Rise and fall in prices of securities, be it for one reason or the other, is a normal business incidence and neither the rise in price creates an asset nor the fall in price destroys an asset. Capital receipt arises only when receipt is for destruction of the profit making apparatus or crippling of the recipient’s profitmaking apparatus. However, when the structure of the recipient’s business is so fashioned as to absorb the shock as one of the normal incidents of business activity the compensation received is no more than a surrogatum for the future profits surrendered. Hence, it should be treated as a revenue receipt and not a capital receipt.

The settlement amounts received were not for relinquishment or extinguishment of the right to sue but as a compensation for the loss of potential income suffered in the course of their business operations.

Held

In Union of India vs. Raman Iron Foundry, AIR 1974 SC 265, the Supreme Court has held that the only right which the party aggrieved by the breach of the contract has, is the right to sue for damages, which is not an actionable claim and it is amply clear from the amendment in section 6(e) of the Transfer of Property Act, which provides that a mere right to sue for damages cannot be transferred.

However, in CIT vs. Mrs Grace Collis and other 2001 248 ITR 323, the Supreme Court has held that the expression “extinguishment of any rights therein” does include the extinguishment of rights in a capital asset independent of and otherwise than on account of transfer. Hence, the right to sue can be considered for the purpose of capital gains u/s. 45 of the Act.

In CIT vs. B.C. Srinivasa Setty (1981 128 ITR 294), the Supreme Court has held that the charging section and the computation provisions together constitute an integrated code and a case to which the computation provisions cannot apply was not intended to fall within the charging section. It was further held that none of the provisions pertaining to the head ‘capital gains’ suggests that they include an asset in the acquisition of which no cost of acquisition at all can be conceived. It is clear that if right to sue is considered as a capital asset covered under the definition of transfer within the meaning of section 2(47) of the Act, its cost of acquisition cannot be determined. In the absence of such cost of acquisition, the computation provisions failed and capital gains cannot be calculated. Therefore, right to sue cannot be subjected to income tax under the head ‘capital gains’.

Since the settlement amounts have been received against surrender of right to sue, it cannot be considered for the purpose of capital gains u/s. 45 of the Incometax Act.

The settled legal position is that FIIs are not engaged in trading business. The facts also show that the shares were purchased as investors and not as traders and in the books of accounts also they were treated as capital investment.

While the settlement amounts were relatable to shares (i.e., if shares would not have been purchased the question of class action or right to sue would not have arisen), they were received not as part of business profit or to compensate the future income but as a result of surrender of the claim against IndCo and its auditors. Hence, even in accordance with the principle of surrogatum, such amounts were not assessable as income because they did not replace any business income.

Decoding Residence Rule through not so rhyming POEM – How Melodious is the Indian POEM – an Analysis

fiogf49gjkf0d
“Residence” is one of the primary factors to fasten the tax liability
on any tax payer in a country, be it an individual, a company or any
other entity. Determination of a residential status of an assessee
assumes significant importance in international taxation. Elaborate
rules are prescribed in tax laws of every country and/ or in tax
treaties prevalent worldwide. One of such rules for residence of
companies accepted and followed worldwide is that of Place of Effective
Management. Finance Act, 2015 amended Section 6(3)(ii) of the Income-tax
Act, 1961 dealing with Residence of companies from the “Control and
Management Principle” to the “Place of Effective Management” (POEM).
POEM is dealt with by both, the OECD and UN in their Model Commentaries.
In December 2015, CBDT came out with Draft Guidelines on determination
of POEM for a Company. This write-up highlights crucial aspects
regarding determination of residential status of a company taking into
account the concept of POEM.

Backdrop
Corporate
Residency has been one of the most important issues across the world.
With businesses moving across countries and with digital economy being
the flavour of the 21st century, countries are in a tiff to make sure
that they don’t lose their pie of taxes. The steps taken by the G20
Nations to prevent Base Erosion and Profit Shifting (BEPS) are in this
direction. In case of multinational companies, the structures adopted
are such that it becomes difficult to ascertain where its control and
management are situated. Countries worldwide have introduced various
concepts like POEM, Place of Management (POM), Control and Management (C
& M), Central Control & Management etc. to ascertain the
residency based on overall control and management of the company.

Concept of Corporate Residency before the Amendment

As
per Section 6(3) of the Act before the Amendment, the Income-tax law
was as under – “A company is said to be resident in India in any
previous year, if –

(i) It is an Indian company; or
(ii) During that year, the control and management of its affairs is situated wholly in India.” (Emphasis Supplied)

Hence,
a foreign company was treated as resident only if the control and
management of its affairs were situated wholly in India during that
year. It meant, even if a part of control was outside India, the company
was not regarded as resident and hence, it was subjected to tax only on
income sourced in India.

In the erstwhile definition it was
easy for a foreign company (which was controlled and managed from India)
to avoid Indian taxes on global income by artificially shifting/
retaining part of its C & M outside India. Typically, resident
Indians who have set up overseas companies could use the erstwhile
definition to their advantage.

It may be noted that the term
“Control and Management” was not defined in the Act. However, in general
parlance, it was understood that control and management did not mean
conducting day to day management of the company, but it referred to the
head and brain of the company that take major decisions for effective
functioning and managing of the company.

C & M being not
defined in the Act was a major bone of contention between the taxpayers
and revenue authorities. Let us look at some of the judicial rulings on
the interpretation of C & M:

C & M as per Indian Courts
In
Subbayya Chettiar (HUF) vs. CIT (19 ITR 168) (SC) Honourable Supreme
Court observed that C&M signifies the controlling and directive
power, the head and brain; and “situated” implies the functioning of
such power at a particular place with some degree of permanence.

In Narottam & Pereira Ltd. (23 ITR 454),
the Bombay High Court held that Control of a business does not
necessarily mean the carrying on of the business, and therefore, the
place where trading activities or physical operations are carried on is
not necessarily the place of control and Management. The High Court
disregarded the presence of strong manager overseas in favour of
controlling directors being situated in India. It was held that the
direction, management and control, ‘the head, seat and directing power’
of a company’s affair is situated at the place where the directors’
meetings are held and consequently, a company would be resident in India
if the meetings of directors who manage and control the business are
held in India.

In the case of Radha Rani Holdings (P) Ltd. [2007] 16 SOT 495 (Del),
it is provided that the situs of the Board of Directors of the company
and the place where the Board actually meets for the purpose of
determination of the key issues relating to the company, would be
relevant in determining the place of control and management of a
company1.

The meaning of the expression ‘control and management’
as used in section 6(3) (ii) of the Act was the subject matter of
judicial interpretation in the past. The legal position is well-settled
that the expression “control and management” means the place where the
‘head and brain’ of the company is situated and not the place where the
day-today business is conducted.

Professor Klaus Vogel, in his treatise, has observed that what is decisive is not the place where the management directives
take effect, but rather the place where they are given (Klaus Vogel on
Double Taxation Conventions, 3rd Edition, Para 105 on page 262). Thus,
it is “planning” and not “execution” which is decisive.

Finance Act – 2015 and Explanatory Memorandum on POEM

In
order to protect its tax base and to align provisions of the Act with
the Double Taxation Avoidance Agreements (DTAA s) entered into by India
with other countries, the concept of POEM was introduced vide amendment
to Section 6(3)(ii) of the Income-tax Act, 1961 (‘Act’).

According
to the amended definition, a company would be resident in India if it
is incorporated in India or its ‘place of effective management’ (POEM),
in that year, is situated in India.

POEM has been defined to
mean 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.

The said amendment has significant impact
on various foreign companies incorporated by Indian MNC’s for Outbound
Investments and business operations outside India.

POEM and its Implications

Some
questions which may come to readers’ mind are (i) whether POEM is
different from the concept of C & M and if yes, how? (ii) What is
the impact of such difference? Before answering these questions, let us
analyse the definition of POEM in detail. We may compare and contrast
the concept of C & M while dissecting the definition of POEM.

POEM as defined by the Finance Act, 2015 has four limbs as follows:-

  • Key Managerial and Commercial decisions
  • Necessary for the Conduct of Business
  • Of an entity as a whole
  • in substance made.

Important
Factors relevant to POEM in India 1) Place where Board Meetings are
held O ne of the primary factors which may lead to effective management
rests with the place where the board meetings are held. Key Managerial
and Commercial Decisions are always meant to be understood as strategic
ones taken by the highest authority of the company. The Board of every
company is considered to be the head and brain of the company. However,
mere holding of board meetings might not hold ground if decisions are
made/taken at some other place. C & M Many courts have ruled that
one of the most important factors to determine C & M of a company is
where its head and brain i.e. Board of Directors is situated. Thus
location of board and decisions taken by them was crucial even for
determination of C & M as it is in the case of POEM.

2) Key Managerial and Commercial Decisions:-

The
intention of the legislation becomes clear from the word “key” inserted
in the definition of POEM. It implies that the decisions should be more
of strategic and should be above the day to day operational decisions.
It tries to distinguish the secretarial decisions taken at the board
meetings.

Similar was the stand in determination of C & M.

3) Operational management vs. broader top level management

The
decisions taken by the Chief Executive Officer and Chief Operating
Officer might be managerial and commercial in nature but may not always
“key” in nature. For example, procurement of goods from vendors,
inventory management, offers and discounts for increase in sales etc.
would be classified as managerial and commercial decisions but not
strategic in nature. Such decisions might not be relevant for the
determination of POEM.

However, the decisions of opening a
new branch or launching of a new product, pricing policies, expansion of
the current facilities etc. which would have significant impact on the
business and on the company as a whole might be taken by the Board or
the Top Management of the Company. Such decisions would be more relevant
in establishing POEM.

All these factors are/were relevant in the determination of C & M as well.

4) Other relevant factors

There
are other relevant factors in the determination of POEM. They are the
place where the accounting records are maintained; the Place of
incorporation of the company; the primary residence of the directors of
the company, the details of the stewardship functions by the parent
company etc. The parent company should restrict itself from actual
running of the subsidiary. The guidance or influence of the parent
company should be limited.

All these factors are/were relevant in the determination of C & M as well.

From
the above discussion, one may conclude that POEM is a fact and
circumstance specific concept and hence, all relevant facts and
circumstances must be examined on case by case basis. POEM refers to
comprehensive control over the entity as a whole during the year and is
not the same thing as a part of the control of the entity residing in
India for the whole of the year. It may be possible that a MNC has a
flat structure and shared powers or large scale autonomy in the
organisation where there could be more than one place where C & M
are situated. However, when one looks at the Company as a whole (which
is the requirement under POEM) then, one would be able to narrow down
POEM to one place/country.

OECD/UN perspective on POEM

The
OECD Model Commentary2 states that “The place of effective management
is the place where key management and commercial decisions that are
necessary for the conduct of the entity’s business are in substance
made. The place of effective management will ordinarily be the place
where the most senior person or group or persons (for example Board of
Directors) make its decisions, the place where the actions to be taken
by the entity as a whole are determined”.

According to the UN Model Commentary in determining the POEM, the relevant factors are as follows:–

(i) the place where a company is actually managed and controlled;

(ii)
the place where the decision-making at the highest level on the
important policies essential for the management of the company takes
place;

(iii) the place that plays a leading part in the management of a company from an economic and functional point of view; and

(iv) the place where the most important accounting books are kept.

To summarise, the criteria generally adopted to identify POEM are:

– Where the head and the brain is situated.
– Where defacto control is exercised and not where the formal power of control exists.
– Where top level management is situated.
– Where business operations are carried out.
– Where directors reside.
– Where the entity is incorporated
– Where shareholders make key management & commercial decisions.

Different Shades of POEM, POM and PCMC

POEM
is interpreted differently by different countries. Countries like
China, Italy, South Africa, Russia etc. have adopted the concept of POEM
in their Domestic tax laws. However, countries like The U.K.,
Australia, Germany etc. although do not have the concept of POEM but
they have adopted the concept of ‘Central Management’ and ‘Control or Place of Management’
and control as residence test for companies in their Statutes. Further,
POEM has been interpreted by countries in their own ways. This
interpretation can be observed from the reservations and observations of
various countries to the OECD Commentary.

BEPS and POEM
Final
Report of OECD on Base Erosion and Profit Shifting (BEPS), [Action
Point 6 on “preventing the granting on treaty benefits in inappropriate
circumstances”] prefers that in case of Tie-breaker for the
determination of treaty residence of a person other than individual, be
done by the Competent Authorities of respective states.

Draft Guidelines by CBDT on POEM

The
CBDT released draft guidelines for determination of POEM of a Company
on 23rd December 2015. A brief summary of the principles enumerated in
the draft guidelines is as follows –

POEM adopts the concept of substance over form.

The Company may have more than one place of management but it can have only one POEM at any point of time.

Residential
status of a person under the Act is determined every year. Accordingly,
for the purpose of the Act, POEM must be determined on year to year
basis. The determination would be based on facts and circumstances of
each case.

The
process of determining the POEM would primarily be based on whether a
company is engaged in ‘active business’ outside India or otherwise.

For
this purpose, a company shall be said to be engaged in ‘active
business’ outside India if all of the above conditions are satisfied –

For this purpose, an average of the data of the current financial year and two years prior shall be taken into account.

POEM guidelines for companies engaged in active business outside India:

The
POEM of a company engaged in active business outside India shall be
presumed to be outside India if the majority of meetings of the
company’s Board of Directors (BOD) are held outside India.

However,
in case the Board of Directors are standing aside and not exercising
its powers of management and such powers are being exercised by the
holding company or by any other persons resident in India, the POEM
would be considered to be in India.

Issues: Indian
Guidelines provide both objective and subjective criteria. On the one
hand it provides to look at the objective criteria for operations of
business such as earnings, assets, employee base, etc. (see the diagram)
while on the other hand, it also looks at actual control &
Management by BOD. Worldwide only control & management criteria
(decision making by BOD) are used. Indian Provisions for POEM are a
departure from International practice in that sense. POEM guidelines for
companies other than those engaged in active business outside India For
companies other than those engaged in active business outside India
(i.e. passive business), determining the POEM would be a two-stage
process:

First stage would be identifying/ascertaining person or
persons who are making the key management and commercial decisions for
conducting the company’s business as a whole.

Second stage would be the place where these decisions are being made.

Thus,
the place where management decisions are taken would be more important
than the place where the decisions are implemented. Some guiding
principles for determining the POEM are as follows:

Location where the company’s Board regularly meets and makes decisions can be the POEM of the company, provided the Board:

• retains and exercises its authority to govern the company; and

• in substance, makes key management and commercial decisions necessary for the conduct of the company’s business as a whole.

•
However, mere holding of a formal Board meeting would not be
conclusive. If key decisions by the directors are taken at a place which
is different from the location of the Board meetings, then such place
would be relevant for POEM.

A company may delegate (either
through board resolution or by conduct) some or all authority to
executive committee consisting of key senior management. In these
situations, location of the key senior managers and the place where such
people develop policies and make decisions will be considered as POEM.

The location of the head office
will be very important in considering the POEM because it often
reflects the place where key decisions are made. The following points
need to be considered for determining the location of the head office:

•
The place where the company’s senior management (which may include the
Managing Director, Whole Time Director, CEO, CFO, COO, etc.) and support
staff are located and that which is considered as the company’s
principal place of business or headquarters would be considered as the
head office.

• If the company is decentralised, then the
company’s head office would be the location where senior managers are
predominantly based or normally return to, following travel to other
locations, or meet when formulating or deciding key strategies and
polices for the company as a whole.

• In cases where the senior
management participates in meetings via telephone or video conferencing,
the head office would be the location where the highest management and
their direct support staff are located.

• In cases where the
company is so decentralised that it is not possible to determine its
head office, then the same may not be considered for determining the
POEM.

• Day-to-day routine operational decisions undertaken by
junior/middle management would not be relevant for determining the POEM.

• In the present age, where physical presence is no longer
required for taking key management decisions, the place where the
majority of the directors/ persons taking the decisions usually reside
would be considered for the POEM.

• If the above guidelines do
not lead to clear identification of the POEM, then the place where the
main and substantial activity of the company is carried out or place
where accounting records of the company are kept would be considered.

POEM to be a fact-based exercise: Examples of isolated instances would not necessarily lead to POEM

Issues:
If
a MNC holds its one of the Global Board Meetings in India, where
significant decisions are taken for its worldwide operations say group
policies are framed – can it lead to POEM? Perhaps not, being isolated
or one of its kind of meetings.

Place where accounting records
are kept may be considered for determination of POEM. This may lead to a
practical problem. What if mirror accounts are kept at two places?

Merely keeping accounting records should not lead to establishment of POEM.

Passive
Income: – Trading with a group company is considered as passive income.
When Transfer Pricing Regulations are in place this kind of provision
is uncalled for.

Objective and Subjective Criteria: – Ultimately
nothing seems to be clear. Each provision is with a caveat leaving to
lot of subjectivity and powers to Assessing Officers.

Local
Management: – It is provided that place of local management may not lead
to POEM but what is ‘local management’ is not defined.

As POEM
is sought to be clarified by way of guidelines, a moot question arises
whether guidelines be binding or override the provisions of law? In
fact, it is provided in the guidelines that they are neither binding on
the Income-tax department nor on the taxpayers. In such an event, what
is the sanctity of such guidelines?

Some Silver Linings

A
foreign company being completely owned by an Indian company would not
necessarily lead to POEM in India (Example – TATA Motors owning Jaguar
PLC).

One or some of the directors of a foreign company residing in India would not necessarily lead to POEM in India.

Local management of the foreign company situated in India would not be conclusive evidence for establishing the POEM in India.

Mere
existence in India of support functions that are preparatory or
auxiliary in nature would not be conclusive evidence for establishing
the POEM in India.

Other key points of the Guidelines

Guidelines
provide that the principles enumerated in the guidelines are only for
the purpose of guidance. In such cases, no single principle will be
decisive in itself.

POEM to be a fact-based exercise – a
‘snapshot’ approach cannot be adopted and activities are to be seen over
a period of time and not at a particular time.

In case the POEM is in India as well as outside India, POEM shall be presumed to be in India if it is mainly/ predominantly in India.

Prior
approval of higher tax authorities would be required by the tax officer
in case he proposes to hold a foreign company as resident in India
based on its POEM. The taxpayer must be given the opportunity to be
heard.

Does Guidelines on POEM sound similar to CFC Rules?

POEM, a step closer to CFC rules
Various
efforts have been undertaken by the Government of India to simplify the
Income-tax law in India5. The Finance Minister Shri Arun Jaitley at the
time of scrapping the Direct Tax Code (DTC) had mentioned that there is
no need of introducing DTC. Suitable amendments to the Income-tax law
would be made for the purpose of simplification.

The erstwhile
DTC contained the ‘Controlled Foreign Corporation’ Rules (CFC rules).
CFC rules, in principle, targets the offshore entities which are used to
park income in low or NIL tax jurisdictions. Similarly, POEM too tries
to achieve a similar objective. The guidelines defining ‘active business
outside India’ and ‘passive income’ are akin to provisions or
objectives of CFC Rules. No country in the world has such conditions for
determination of POEM which tries to achieve dual purposes.

Comments on the draft POEM Guidelines

Arbitrary use of powers
–
POEM, as a provision in the law specifically targets the unacceptable
tax avoidance structure(s). The use of shell/conduit companies is
discouraged. Considering subjectivity involved while determining POEM,
the draft guidelines are issued to narrow down its wide scope. However,
it has been specified that the guidelines are not binding on tax
authorities nor it is binding on the taxpayers. In such a case
guidelines are infructuous. Tax payers may fear that the provisions of
POEM may be applied harshly and interpreted in the widest possible sense
in favour of revenue.

Residency assumed, unless proved otherwise?
– The draft guidelines in current form seem to suggest that it’s assumed that you are resident barring a few exceptions.
– The wide subjectivity of guidelines can hamper Indian Entrepreneurship in the long run.
– Subsidiaries of Indian MNC’s particularly wholly owned subsidiaries
outside India would be facing an uphill task of establishing that the
POEM is not in India.
– The definition of passive income seems to be very wide and hamper genuine business transactions.

Whether the guidelines would have a retrospect effect??
–
Considering the wide scope of POEM, it was mentioned in the Explanatory
Memorandum of the Finance Act 2015 that the guiding principles would be
followed soon. However, it is unfortunate that the guiding principles
(in a draft format) have been issued at the fag end of the Financial
Year. In such cases, a question arises that whether these principles
would be applicable with retrospective effect from 1st April, 2015? The
answer seems to be “yes” as these are merely guidelines and not the law.
There is no question of retrospective effect. In fact what guidelines
say is supposed to be followed by companies in the normal course.

Summation
For
the purpose of determining POEM, it is the de facto control and
management and not merely power to control which must be checked. In the
redefined corporate tax residency regime of the domestic tax law (in
line with international principles), place of effective management has
become one of the relevant factors for the purpose of determining
residential status of a company. In such a scenario, the company would
be deemed to be resident of the Contracting State from where it is
effectively controlled and managed. The draft guidelines leave much to
the discretion of the Income-tax Authorities. We hope that the tax au
thorities are made accountable for their actions and certain fundamental
binding principles are laid down so that unnecessary litigation is
avoided. It is expected that the final guidelines will be modified and
litigation prone issues would be addressed. It would be interesting to
see how the Government and Income-tax authorities would view or evaluate
structures of various companies going forward. Prudence suggests that
applicability must be postponed for at least one year so that
unnecessary hardships to tax payers can be avoided. Further, this would
give an opportunity for hygienic check to taxpayers for their outbound
structures.

TS-724-ITAT-2015(DEL) ITO vs. Santur Developers P. Ltd. A.Y.: 2006-07, Date of Order: 24.07.2015

fiogf49gjkf0d
Article 26(4) of India USA DTAA – In absence of similar provision for withholding taxes on payment to a resident Taxpayer on sale of land, there is no requirement to withhold taxes on sale consideration paid to Non-resident (NR) pursuant to non-discrimination Article of India- USA DTAA .

Facts
The Taxpayer, an Indian company, entered into an agreement to purchase a piece of land jointly owned by three parties. One of the co-owner of the land was a citizen of USA and a NR in India. The agreement was executed by an Indian resident who was holding the general power of attorney for the other owners.

The sale consideration was paid to the Indian resident constituted attorney in Indian rupees. The Taxpayer did not withhold taxes on such payment. The Tax authorities contended that the Taxpayer was required to withhold taxes u/s. 195 of the Act and hence, levied penalty for failure to withhold taxes.

The Taxpayer contended that since the agreement as well as payment was made to a resident in India, provision of section 195 of the Act did not apply. Further, section 195 applies only to remittance made in foreign currency, whereas in the present case since payment was made in Indian currency, tax was not required to be withheld under Act. Without prejudice to the aforesaid, it was contended that in absence of any provision relating to withholding of taxes where sale proceeds of an immovable property are paid to a resident person, there should not be any withholding requirement on payments to NRs applying the non-discrimination clause of India-USA DTAA

Held
The Tribunal did not rule on the applicability of section 195 as it was not contested before it.

In absence of a provision requiring Taxpayer to withhold tax on payment of sale proceeds to a resident, pursuant to non-discrimination article of the DTAA, Taxpayer was not required to withhold taxes on payment made to NRs.

TS-28-ITAT-2016(DEL) ACIT vs. NEC HCL System Technologies Ltd. A.Y.: 2008-09, Date of Order: 22nd January, 2016

fiogf49gjkf0d
Section 9(1)(vii) of Act – Outsourcing fees paid by Japanese branch office of an Indian company to a non-resident (NR) and used for business development activities outside India, cannot be deemed to accrue or arise in India

Facts
The Taxpayer is a joint venture between an Indian Company (Indian JV Partner) and a Japanese Company (Japan JV Partner). The Taxpayer was engaged in the business of providing offshore software engineering services and solutions to F Co and its group companies.

The Taxpayer set up a branch office in Japan (Japan BO). The Japan BO was engaged in undertaking extensive sales and marketing activities in addition to bidding for projects and obtaining work from the customers from Japan and outside Japan (business development activities).

The Taxpayer entered into a framework agreement with Indian JV Partner and its group entity in Japan. The framework agreement was to facilitate sub-contract of software development work by Japan BO if the same could not be serviced by the taxpayer or Japan BO. During the relevant financial year, Japan BO paid certain outsourcing fee to another Japanese Company, which was group entity of Indian JV partner, without withholding taxes thereon.

The Tax authority contended that Japan BO was merely an extension of The Taxpayer and the outsourcing was undertaken by Taxpayer from India. Thus, outsourcing fee paid to Japanese Company is deemed to accrue or arise in India and the payment is therefore taxable in India. Hence, it is liable to tax withholding. Consequently, tax authority disallowed such payments made to Japanese Company in the hands of the Taxpayer for failure to withhold taxes on outsourcing fee.

The Taxpayer contended that Japan BO has an independent existence and carries on independent business in Japan. Thus, the outsourcing services are utilised by Japan BO in business carried on in Japan. Therefore, fee for such services cannot be deemed to accrue or arise in India u/s. 9(1)(vii)(c) and hence, no withholding is to be done on the payment of outsourcing fees.

Held
Taxpayer has a BO in Japan which carries on business outside India. Therefore, Japan BO creates a permanent establishment (PE) of the Taxpayer in Japan.

Japan BO had five employees as sales manager for carrying out sales and marketing activities and two managers for general administrative affairs of the company who possessed the technical skills required to understand the requirements of the projects. From the details provided about the employees in Japan and their job profile, it was clear that such employees were engaged in business development activities of Japan BO in Japan. Some of the projects obtained by Japan BO were outsourced by Japan BO as per its own business needs.

Merely because the financial statement of Japan BO is incorporated in the financial statements of the Taxpayer, the same does not conclude that the expenses are borne by the Taxpayer and not it’s Japan BO.

Payments for fee for technical services borne by the Japan BO shall not be deemed to accrue or arise in India and hence was not taxable in India. Therefore, there was no liability to withhold taxes on such outsourcing fees.

TS-72-ITAT-2016(Mum) Goldman Sachs (India) Securities Pvt. Ltd. vs. ITO (IT) A.Y.: 2011-12, Date of Order:12th February, 2016

fiogf49gjkf0d
Article 13 of India Mauritius DTAA – Buyback transaction cannot be treated as colorable device for avoidance of tax – Buyback results in capital gain and is exempt from taxes in India under Article 13 of India-Mauritius DTAA .

Facts
The Taxpayer, an Indian resident company, is a whollyowned subsidiary of a Mauritian company (FCo). The Taxpayer undertook a buyback on account of which shares were bought back at a value higher than its face value.

The Tax Authority contended that the buyback transaction was a colorable transaction to avoid payment of dividend distribution tax (DDT). Therefore, Tax authority regarded such buyback as capital reduction and considered the excess payment over face value of shares as distribution of accumulated profits to shareholders i.e., F Co. It was further held that, since the Taxpayer had not paid DDT, dividend received by FCo would not be eligible for exemption under the Act. Accordingly, Taxpayer was held liable to withhold taxes at the rate of 5% on gross payment to FCo under Article 10 of the DTAA. Since the Taxpayer had failed to withhold taxes, the Taxpayer was held to be an assessee in default and interest was also levied for such failure apart from recovery of tax.

The Taxpayer however contended that the amount remitted under the buyback transaction was in the nature of capital gains which was exempt from taxation in India under India-Mauritius DTAA. Accordingly, neither any tax was deductible nor was there any default in withholding of tax.

Held
Buyback of shares cannot be equated with capital reduction as they are two entirely different concepts as discussed and held in the Bombay High Court (HC) decision of Capgemini India Pvt. Ltd. (Company Scheme Petition No. 434 of 2014).

CBDT Circular No. 779 dated 14th September 1999 specifically states that shareholders would not be subjected to dividend tax but taxed under capital gains provisions upon buy back of shares.

It is true that buyback transactions are subject to Income distribution tax pursuant to amendment by the Finance Act 2013. However, as the transaction under consideration pertained to a period prior to this amendment, there is no ambiguity that those provisions will not apply for buyback under consideration. Hence, the said transaction could not be regarded as deemed dividend but should be subjected to tax as capital gains.

Since Article 13 of the DTAA specifically exempts such transaction from tax in India, the Taxpayer is not liable to withhold tax under the Act. Even if the payment was considered as dividend, the requirement to pay DDT would make the payment exempt in the hands of the shareholder. Accordingly, withholding tax provisions should not apply.

By placing reliance on the observations of the Bombay HC ruling of Capgemini (supra), the Tribunal ruled that if the Taxpayer entered into a transaction which did not violate any provision of the Act, the transaction cannot be termed as a colorable device just because it results in non-payment or lesser payment of taxes in that particular year. The whole exercise should not lead to tax evasion. Non-payment of taxes by an assessee in given circumstances could be a moral or ethical issue.

TS-126-ITAT-2016(Mum) Forbes Container Line Pte. Ltd. A.Y.: 2009-10, Date of Order: 11th March, 2016

fiogf49gjkf0d
Section 44B of the Act and Article 8 of India-Singapore DTAA –Taxpayer providing container services cannot not be treated as engaged in shipping business. Article 8 of the DTAA and section 44B of the Act not applicable Income was liable to be taxed as business income. In absence of PE, such income is not taxable in India

Facts
The Taxpayer was a company incorporated in Singapore and engaged in the business of operating ships in international traffic across Asia and Middle East. The Taxpayer is a wholly owned subsidiary of an Indian Parent Co (ICo).

The Taxpayer filed a return of income claiming that the total income was NIL. However, AO contended that the Taxpayer had a real and intimate business connection in India for reasons that the ICo secured the business for Taxpayer in India and one of the directors of the Taxpayer was also a director in ICo, and such director looked after policy matters of the Taxpayer in India. Further, AO held that taxpayer had a fixed place of business in India. Further as ICO concluded various contracts on behalf of the Taxpayer with various Government agencies for carrying out various functions, ICo created an Agency PE for the taxpayer in India.

AO also contended that Taxpayer being a Non-vessel operating common carrier was not eligible to claim benefits under Article 8 of the DTAA, dealing with shipping income and the income of the Taxpayer would fall within the ambit of Article 7. The computation of such income would be governed by section 44B of the Act. However, the Taxpayer contended that it did not have a fixed place of business in India. Further, it was contended that as an independent entity all its decisions were taken in Singapore and ICo had no role in deciding taxpayer’s policies.

The Taxpayer appealed before First Appellate Authority (‘FAA ’). However, FAA upheld the order of AO.

Aggrieved by the order of FAA , the Taxpayer preferred an appeal before the Tribunal.

Held
On facts and records, it was clear that taxpayer was maintaining books of accounts as well as bank account in Singapore and all banking transactions were made from that account only. Nothing was brought on record to show that the effective control and management of taxpayer was in India.

Factors like staying of one of the directors in India or holding one meeting during the year under consideration or location of parent company would not decide the residential status of the Taxpayer.

The Taxpayer did not own or charter or took on lease any vessel or ship but was merely providing container services to its clients. Thus, the Taxpayer is not engaged in shipping business. This was also accepted by the AO. Therefore the provisions of section 44B dealing with income from shipping business would not be applicable in the present case.

The income of the Taxpayer had to be assessed as per Article 7 which deals with business income. In the absence of PE, such income is not taxable in India.

TS-187-ITAT-2016(Mum) Interroute Communications Limited A.Y.: 2009-10, Date of Order: 9th March, 2016

fiogf49gjkf0d
Article 13 of India UK-DTAA – Payment for Interoute connectivity facility helping in connecting the calls to telecom operators in the end jurisdiction is neither for any scientific work nor for any patent, trademark, design, plan or secret formula or process. Payment is for a service and not for use of scientific equipment. Since service does not satisfy ‘make available’ condition, it does not qualify as Fee for technical services (FTS) under the DTAA .

Facts
The Taxpayer was a company incorporated in, and tax resident of UK. The Taxpayer was engaged in the business of providing international telecommunication network connectivity to various telecom operators around the world. The Taxpayer received certain amount from Indian customers towards the provision of virtual voice network (VVN). VVN is a standard inter-connect service provided to third party carriers. The Taxpayer contented that the income for use of VVN is in the nature of business income and since there was no PE in India, such income is not taxable in India.

The AO held that the Taxpayer provides use of its facilities/equipment/infrastructure to enable customers to interconnect with each other. Such facility includes proprietary software and hardware, technical expertise and other intellectual property. The AO observed that usage of such facilities amounted to usage of the Intellectual property held by the Taxpayer and hence, the payments received by the Taxpayer were in the nature of Royalty, or alternatively, FTS. Hence, the same was taxable in India. On further appeal, the First Appellate Authority also upheld the order of AO.

Aggrieved, the Taxpayer preferred an appeal before the Tribunal.

Held
Essentially, provision of VVN was connecting the call to the end operator, and, in that sense, it worked like a clearing house.

Payment made by the Indian entities can be held to be royalty only when it is payment for scientific work, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience (‘specified items’).

In the present case, the payment is not for a scientific work nor is there any patent, trademark, design, plan or secret formula or process for which the payment is being made. The payment is made for a service, which is rendered with the help of certain scientific equipment and technology. The Taxpayer is providing a facility which is a standard facility used by other telecom companies as well. Also, merely because the payment involves a fixed as also a variable payment, the same does not alter the character of service.

Though the Taxpayer may charge a fixed amount to cover its costs in employing enhanced capacity so as not to incur losses when this capacity is not used, but what the customer is paying for is a service and not the use of equipment involved in additional capacity, nor for any scientific work, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.

The payment for a service can be brought to tax under Article 13 of DTAA only when it makes available the technology in the sense that recipient of service is enabled to perform the same service without recourse to the service provider. Though the service rendered by the Taxpayer requires technical inputs, there is no transfer of technology. Hence, the make available condition is not satisfied. Therefore such payment is outside the ambit of fees for technical services (‘FTS’) taxable under Article 13 of the DTAA .

Further, since there is no dispute that the Taxpayer does not have any permanent establishment (‘PE’) in India, the payment made by Indian customers cannot be brought to tax in India.

TS-131-ITAT-2016(HYD) GVK Oil & Gas Limited A.Y.: 2009-10, Date of Order: 9th March, 2016

fiogf49gjkf0d
Article 12 of India-US DTAA , Article 13 of India UK DTAA – Payment for fixed period, nonexclusive licence to use a dataset consisting of scientific as well as technical information, permitting its use only as a licensee, and not involving transfer of technical knowledge or experience or making available of technology, does not amount to royalty under the DTAA .

Facts
Taxpayer an Indian company was engaged in the business of Oil and Gas exploration. Taxpayer made certain payments to a USA and UK Company (FCo) towards a non-exclusive licence and right to use a dataset for an agreed licence fee.

The Taxpayer contended that the dataset was nothing but a compilation of data and licence was only for the use of data and not for providing any experience, knowledge or skill to the Taxpayer. Taxpayer also contended that

Use of the dataset is not a transfer of the copyright but it is a copyrighted article.

It was contended that the dataset was not customized according to the requirements of the Taxpayer nor was it for the exclusive use of the Taxpayer.

In absence of provision of knowhow, such licence fee does not qualify as royalty.

Against that AO observed that
NR agreed to grant non-exclusive license/right to use certain data and derivatives in consideration for an agreed license fee.

Such information/knowledge is not available in the public domain and available to the taxpayer only on securing a valid license.

Such payment amounts to consideration for information concerning industrial, commercial or scientific experience.

(a) In any case, the Taxpayer had ordered the dataset which was customised for the taxpayer. Accordingly, when such customised data is made available upon request of taxpayer, it becomes know-how as it cannot be used by any other party.

(b) Thus the licence fee amounts to royalty both under the Act as well as the DTAA and held the Taxpayer as an ‘assessee-in-default’ or failure to withhold taxes u/s. 195.

Held
The Taxpayer obtained a fixed period licence to use a dataset which is highly technical and complicated can be accessed only on the grant of a license by the owner.

On the expiry of licence, taxpayer is required to return the product or destroy the data accessed by him during the license period. However, taxpayer is not required to destroy the product produced by him by use of such data. This indicates that the data was made available to the taxpayer to enable it to process and use it for furtherance of its objects.

The definition of ‘Royalty’ under the Act is more exhaustive as compared to the definition under the India-USA and India-UK DTAA . Under the Act, consideration for granting of a license for the use of the property is also treated as royalty whereas, there is no such provision under the DTAA .

Reference was made to principle laid down in various judgments1 wherein it has been held that unless and until the license is given to use the copyrighted property itself, the consideration paid cannot be treated as ‘Royalty’.

In the facts of the case, license is granted to use information contained in the database. Further, the licenses are non-exclusive licenses and therefore, information/ data is not customized to meet the taxpayer’s requirements exclusively.

Though the information in the database is scientific as well as technical, taxpayer is permitted to use the information only as a licensee. It does not involve transfer of technical knowledge or experience. Therefore there is no use of copyright. Thus, under the DTAA unless the license is given to use the copyright itself, the consideration paid cannot be treated as royalty.

It is clear that FCo has only made available the data available with them but are not making available any technology available for use of such data by the taxpayer. Thus, such payments are not in the nature of ‘royalty’ as per the India-USA and India-UK DTAA and hence the provisions of S. 195 are not applicable.

PS: Royalty implications under the Act were not analysed as the royalty definition under the DTAA was considered to be narrower than royalty definition under the Act.

TS-144-ITAT-2016(Mum) Siro Clinpharm Private Limited A.Y.: 2009-10, Date of Order: 31st March, 2016

fiogf49gjkf0d
Section 92B of the Act – Finance Act 2012, inserted explanation to section 92B expanding the scope of definition of international transaction inter alia to include the transaction of guarantee within its ambit should be applicable prospectively

Facts
The Taxpayer, an Indian Company, had given a guarantee to foreign banks on behalf of its associated enterprises (‘AE’). The Taxpayer did not charge any fee or commission for issuance of these guarantees. However, the AEs duly reimbursed the Taxpayer towards the bank charges incurred by the Taxpayer.

TPO held that the corporate guarantees, as provided by the Taxpayer to the bank, were specifically covered by the definition of ‘international transaction’ u/s. 92B and charged fees by imputing at arm’s length price. The same was upheld by the First Appellate Authority (‘FAA ’). Aggrieved Taxpayer appealed before the Tribunal.

Held
Finance Act 2012 inserted explanation to section 92B expanding the scope of definition of international transaction inter alia to include the transaction of guarantee within its ambit. Such amendment was stated to be clarificatory in nature and was made applicable with a retrospective effect.

Legislature may describe an amendment as ‘clarificatory’ in nature, but a call will have to be taken by the judiciary whether it is indeed clarificatory or not. The amendment in question is related to transfer pricing provisions which are in the nature of an antiabuse legislation. An anti-abuse legislation does not trigger the levy of taxes; it only tells you what behaviour is acceptable or what is not acceptable. What triggers levy of taxes, is non-compliance with the manner in which the anti-abuse regulations require the taxpayers to conduct their affairs. In that sense, all anti-abuse legislations seek a certain degree of compliance with the norms set out therein. It is, therefore, only elementary that amendments in the anti-abuse legislations can only be prospective. It does not make sense that someone tells you today as to how you should have behaved yesterday, and then goes on to levy a tax because you did not behave in that manner yesterday. Reliance in this regard was placed on the decision of co-ordinate bench in the case of Micro Ink vs. ACIT (2016) 176 TTJ 8 (Ahd) and Bharti Airtel Ltd. (2014) 161 TTJ 428 (Delhi – Trib) and New skies (2016) 382 ITR 114 (Delhi). Hence, if the amendment increases the scope of international transaction u/s. 92B, then there is no way it could be implemented for the period prior to this law coming on the statute i.e. prior to 2012

Alternatively, the Tribunal held that if the amendment by Finance Act 2012 is considered clarificatory and does not add anything or expand the scope of international transaction defined u/s. 92B, then this provision has already been judicially interpreted in favour of the Taxpayers by the aforesaid Tribunal rulings, till it is reversed by a higher judicial forum.

Hence, Explanation to section 92B, though stated to be clarificatory and effective from 1st April 2002, has to be necessarily treated as effective from at best the AY 2013-14. Hence, the impugned adjustments must stand deleted.

TS-177-ITAT-2016(Mumbai ITAT) Capegemini S.A. A.Y.: 2009-10, Date of Order: 28th March, 2016

fiogf49gjkf0d
Article 23 of India- France DTAA – Guarantee commission paid pursuant to a corporate guarantee agreement executed in France between a French Company and a French Bank, does not arise in India – Such commission is not taxable in India under the ‘other income’ article of the DTAA

Facts
The Taxpayer, a French Company provided a corporate guarantee to a French bank (bank). In lieu of such guarantee, the Indian branch of the bank provided loan to the Indian subsidiaries (ICo) of Taxpayer. ICo paid guarantee commission to the Taxpayer towards the guarantee given to the bank. The AO contended that the guarantee commission paid to the taxpayer arises in India and therefore, was taxable under “Other income” Article 23 of the India-France DTAA , for the following reasons

The guarantee had been provided for the purpose of raising finance by an Indian company

Finance was raised in India and the benefits were availed by Indian subsidiaries

Finance requirement was met by Indian branch of the French bank.

The Taxpayer, however, contended that guarantee commission did not arise in India and accordingly was not taxable in India.

Held
On appeal, ITAT held:

Guarantee commission received by the taxpayer does not accrue or arise in India, nor is it deemed to accrue or arise in India and therefore, it is not taxable in India under the Act.

Guarantee was given by a French company to a French bank in France. Therefore, such guarantee commission arises in France and not in India. Therefore, guarantee commission paid to the Taxpayer is not taxable in India under Article 23(3) of the DTAA .

Revised Procedure for making Remittances to Non Residents – New Rule 37BB u/s. 195(6) of the Income – tax Act, 1961

fiogf49gjkf0d
Every resident payer has a question as to “what is the procedure for making payments to a non-resident?” This question is relevant even for non-resident payer as the obligation for withholding tax1 is cast on every payer (whether resident of India or not) if the income in the hands of the recipient is taxable in India. Recently, CBDT has amended the procedure w.e.f. 1st April, 2016 for issuance and submission of Form 15CA and 15CB which facilitates remittance of money to a non-resident person. This article highlights the salient features of the new procedure for making payment to a non-resident.

1. Purpose of section 195
Section 195 of the Act is a mechanism to deduct tax from any payment (which is chargeable to tax) made to a nonresident. The underlying philosophy behind any withholding tax provisions is “pay as you earn”. The ease and certainty of collection of taxes make such provisions attractive for any tax legislature.

2. Person responsible to deduct tax at source u/s. 195 of the Act
Section 195 casts an obligation on the person who is making any payment to a non-resident to deduct tax at source. The sweeping language of the section brings almost every payment, made to a non-resident, which is chargeable to tax, within its ambit. The only exclusion here is that of a payment of salaries. Section 192 of the Act deals with TDS provisions relating to salary paid to a non-resident, which is chargeable to tax in India.

Section 195 provides that, “Any person responsible for paying to a non-resident not being a company, or to a foreign company, any interest or any other sum chargeable under the provisions of the Act (not being income chargeable under the head “salaries”) shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force.”

The dissection of the above provision reveals that—

(i) The obligation to deduct tax at source is cast on every person making payment, be it individual, company, partnership firm, Government or a public sector bank etc. The term ’person’ as defined in section 2(31) of the Act is relevant here.

(ii) The payee may be any type of entity (i.e. individual, company etc.).

(iii) The payee must be a non-resident under the Act.

(iv) The payment may be for interest or any other sum chargeable to tax except salaries.

(v) Tax has to be deducted at source at the time of credit or payment of the sum to the non-resident, whichever is earlier.

(vi) There is no threshold for deduction of tax at source. It therefore means payment of even one rupee to a nonresident would attract TDS provisions.

3. TDS by a non-resident from payments to another non-resident
This issue had come up for examination in some landmark cases; notable amongst them is the Apex Court’s decision in case of Vodafone International Holdings B.V. vs. Union of India, wherein the Supreme Court held in favour of Vodafone and held that indirect transfer of shares2 by one non-resident to the another non-resident did not result in taxable income in the hands of the transferor and hence, there was no obligation for the payer to withheld tax at source. The Supreme Court followed the “look at” approach, i.e. form rather than substance, and refused to lift the corporate veil to bring the capital gains arising to HTIL to tax in India. In order to discourage such kind of indirect transfers and bring them to tax (especially where such transfers derives its value from assets situated in India) section 9 of the Act was amended retrospectively to bring to tax in India the capital gains arising on transfer of any assets outside India, between two non-residents, if such transfer derives substantial value in respect of any asset situated in India.

Section 195 was also amended, to clarify that the nonresident payer is liable to deduct tax at source, if the income in the hands of payee is taxable in India.

Explanation 2 was inserted to section 195 (1) of the Act vide Finance Act, 2012 with retrospective effect from 1st April 1962, clarifying that the obligation to deduct tax at source u/s. 195 has always been there for any nonresident, whether such person has any place of business or business connection or presence in any other manner. Whether it results in an extra-territorial jurisdiction is a matter of debate. For the sake of understanding, the relevant provision is reproduced herein below:

Explanation 2.—For the removal of doubts, it is hereby clarified that the obligation to comply with sub-section (1) and to make deduction there under applies and shall be deemed to have always applied and extends and shall be deemed to have always extended to all persons, resident or non-resident, whether or not the non-resident person has—
(i) a residence or place of business or business connection in India; or
(ii) any other presence in any manner whatsoever in India.

4. Procedure for furnishing of information of deduction of tax at source u/s 195(6)
Section 195(6) of the Act provides that a person responsible for paying to a non-resident (hereafter referred to as ‘payer’) shall furnish such information as may be prescribed under Rule 37BB. The said Rule 37BB provides that Form No. 15CA and/or Form No. 15CB4 shall be furnished for the purpose of paying to a non-resident. Form No. 15CA is to be filled and submitted online by the deductor i.e. payer. Form 15CB is to be issued by the practicing Chartered Accountant (C.A) certifying (actually expressing his opinion) the taxability (chargeability) of the income in the hands of the payee and the amount of tax required to be deducted by the payer. In order to arrive at the amount of tax to be deducted the CA is required to take into account various applicable provisions of the Act (to compute the income of the non-resident payee) as well as provisions of the applicable Double Tax Avoidance Agreement (DTAA ) and other relevant supporting documents and agreement, if any.

5. Steps while making a Remittance
Form 15CA is required to be furnished by the taxpayers for the purpose of remittance to a non-resident. It may be noted that Form 15CA should be filed in every case whether the remittance amount is chargeable to Incometax or not. However, exemption from filing of Form 15CA is provided in case of certain types of remittances.

Let us first deal with cases where the income is chargeable to tax. 15CA has four parts, namely, A,B,C and D. Following flow chart will be useful in understanding which part is to be filled in and under what circumstances.

6. Procedure where a remittance is not chargeable to tax:

6.1 Such remittances are classified in the following two categories as follows:
i. Non-reportable Transaction
ii. Reportable transaction

Let us first deal with transactions which are not required to be reported, meaning there is no need to file any form with the tax authorities.

6.2 Non-reportable Transactions
In following two cases there is no requirement to furnish Form 15CA or Form 15CB.

(i) Individuals making remittances under the Liberalised Remittance Scheme of FEMA and

(ii) Certain specified remittances as listed herein below.

Specified List of payments for which Form 15CA or Form 15CB are not required to be filed:

The earlier Rule 37BB contained 28 items which did not require submission of Form 15CA or 15CB at the time of the remittance. However, the new Notification No. 93/ 2015 now expands the list to 33 items.–

6.3 Reportable Transactions

Any transaction other than the non-reportable category is considered as reportable transaction. In other words, even if the remittance is not chargeable to tax, information in respect of such remittance is required to be provided in Part D of Form 15CA.

7. What is the difference between earlier Rule 37BB and the new Rule 37BB which is effective from 1st April, 2016?
Amendments in the new Rule 37BB as compared with earlier Rule 37BB are as follows:

Form 15CA and Form 15CB will not be required if an individual is making a remittance, which does not require RBI’s approval under FEMA or under the Liberalised Remittance Scheme (LRS).

The list of items which do not require submission of Forms 15CA and Form 15CB has been expanded from 28 to 33. The newly introduced items are as under –

i. Advance Payments against imports
ii. Payment towards import settlement of invoice
iii. Imports by diplomatic missions
iv. Intermediary trade
v. Imports below Rs. 5 Lakh (For use by Exchange Control Department offices)

Only the payments which are chargeable to tax under the provisions of Act in excess of Rs. 5 Lakh would require Certificate from a Chartered Accountant in Form 15CB.

A new reporting obligation is introduced for the authorised dealers (ADs) (i.e. the Banks). ADs will have to file Form 15CC (quarterly) in respect of the foreign remittances made by them.

8. Some Practical Issues

8.1 Cases where Tax Residency Certificate (TRC ) is required

Under the provisions of section 90(2), it has been provided that provisions of the Act or the DTAA , whichever are more beneficial to the assessee, shall be applicable. This benefit is, however, subject to satisfaction of conditions provided u/s. 90(4) of the Act. In order to claim the benefit of a DTAA , it has been provided that the non-resident payee must furnish a TRC which confirms that the payee is a Tax Resident of the other State. This becomes important from the perspective of the Act as well as DTAA since Article 4 (dealing with “Residence”) of almost all the DTAA s signed by India provides that benefits of the DTAA can be claimed only by such persons who are residents of either of the contracting states. In this connection, the reader may also refer to the Rule 21AB prescribing declaration in Form 10F to be obtained from the Non-resident payee.

8.2 Is there any other alternative other than a TRC since obtaining a TRC may not be feasible sometimes?

Section 90(4) provides for mandatory submission of TRC, issued by the foreign Government or a specified territory, in order to claim benefit of the DTAA. Thus, there is no alternative to submission of TRC.

However, if any foreign Government does not have a format or provision to issue TRC, then the taxpayer at best can get the information prescribed in Form 10F certified by the revenue authorities of the concerned foreign country or territory in order to avail the DTAA benefit.

It may be possible that the format in which TRC is issued by the foreign tax authority does not contain all the details required under Form 10F. For example, US IRS issues TRC in the Form 6166 which does not contain all details required in Form 10F. Therefore, the remitter needs to keep both the documents on record and submit to the Income tax Authorities in India, if and when required.

8.3 What are the details required to be provided in Form 10F?

Form 10F requires the following details –

(i) Name, Father’s name and designation of the person signing the form

(ii) Status (individual, company, firm etc.) of the assessee;

(iii) Nationality (in case of an individual) or country or specified territory of incorporation or registration (in case of others);

(iv) Assessee’s tax identification number in the country or specified territory of residence and in case there is no such number, then, a unique number on the basis of which the person is identified by the Government of the country or the specified territory of which the assessee claims to be a resident;

(v) Period for which the residential status, as mentioned in the certificate referred to in sub-section (4) of section 90 or sub-section (4) of section 90A, is applicable; and

(vi) Address of the assessee in the country or specified territory outside India, during the period for which the certificate, as mentioned in (iv) above, is applicable.

9. How to file Form No. 15 CA electronically

Form 15CA is required to be filed by the tax payer in every case of remittance except where remittance falls within the category of non-reportable transactions. (Refer paragraphs 5 and 6 supra).

In the subsequent paragraphs step by step procedure is given for filling up Form No. 15 CA and filing it electronically:

Note: Before proceeding to e-file Part D of Form No. 15CA, keep the hardcopy duly filled in ready with you to expedite the process.

Step 1. Go to the website of incometaxindiaefiling.gov. in.

Step 2. Login using:
a. User Id- PAN
b. Password- as is used for e-filing the income tax return
c. D ate of Birth/Incorporation- as is already registered with the income tax for e- filing of return of income etc.

Step 3. Next screen will appear:
– Click on ‘e-file’
– Select “prepare and submit online Form other than ITR”.

Step 4. Next screen will appear
– Select Form Name- “15CA”
– Click on “Click here to download the DSC Utility”
– O pen the “DSC Utility” and double click on the utility
– General Instruction Page will appear on the screen
– Click on “Register DSC” tab next to the Instruction tab
– Enter e-filing User- Id- which is PAN of the assessee
– Enter PAN of the DSC- Registered in e-filing which is the PAN of the person authorized to sign Form No. 15 CA
– Go to “Select type of digital signature certificate- Click on “USB token”
– Go to “Select USB token Certificate” and
select the name of the person authorized
to sign Form No. 15CA
– Click on “Generate Signature File”
– E nter the PIN of DSC and click ok.
– Save the “DSC Signature file”
– Come back to e-filing website- Attach “DSC
Signature File”. For this, click on “Browse” and attach the signature file saved and press “continue”.
– Select Relevant Part of Form No. 15CA from the drop down- PART D
– Click on continue and Form No. 15CA will be displayed on the screen.

Step 5. Fill up the details of the Remitter from the Hardcopy of PAR T D- Form No. 15CA.
– Following details are to be selected from the drop down
– State
– Country
– Status of the Remitter
– R esidential status of the remitter

Step 6. Fill up the details of the “Remittee”
– Following details are to be selected from the drop down
– State- Select “State outside India”
– Country- Select the Country of Residence of the remmittee
– Country to which remittance is to be made- Select the country of remittee
– Currency- Select the currency of remittance
– Country to which recipient of remittance is resident if available – Select the country of residence

Step 7. Fill up the details of “Remittance”
– Following details are to be selected from the drop down
– Name of the bank through which the remittance shall be made

Step 8. Fill up the “Nature of Remittance”
– Nature of Remittance as per the agreement / document is to be selected from the list of 65 categories of remittance mentioned in the Drop Down

Step 9. Fill up the “Relevant purpose code as per RBI”
– 1st Drop Down- Select the category of remittance from the list of 24(Twenty Four) categories mentioned
– 2nd Drop Down- Select the purpose code and description of remittance as mentioned in the hardcopy of Part D of Form No. 15CA

Step 10. Click on PAR T D- Verification tab next to Form 15CA on the top of the page.
– Fill up the details of the person authorized to sign “Form No. 15CA”
– Click on “Submit” button on the top of the page.
– Part D – Form No. 15 CA will be uploaded successfully.

Step 11. A fter filing Part D. Click on “My Account” tab nd Click on “View Form No. 15CA”

Step 12. Click on the Acknowledgement No link on the screen and then click on “ITR/FORM”.

Step 13. To open the PDF file enter the password. The password for the same is PAN in small letter with Date of birth/incorporation in continuation without using any special character.

Step 14. After downloading the PDF file, Save and print the same.

10. How to file Form No. 15 CB electronically

Step by step procedure for E-filing of Form Nos. 15 CA and 15 CB is as follows:

PRE-REQUISITES

In order to file Form 15CB, Tax payer must add CA. To add CA, Please follow the steps given below:

Step 1 – Login to e-filing portal, Navigate to: My Account? Add CA”.

Step 2 – E nter the Membership Number of the CA

Step 3 – Select 15 CB as Form Name and click submit.

Once the taxpayer adds the CA, the CA can file Form 15 CB in behalf of taxpayer.

In order to file Form 15CB, Chartered Accountant must follow the below steps.

Step 1 – U ser should be registered as “Chartered Accountant” in e-Filing. If not ready registered, user should click the link Register Yourself in the homepage.

Step 2 – Select “Chartered Accountants” under Tax Professional and click continue.

Step 3 – E nter the mandatory details and complete the registration process.

FILING PROCESS
Note:

Before proceeding to e-file Form No. 15CB keep the hardcopy duly filled in ready with you to expedite the process.

Kindly note that all the amounts to be entered in INR unless and until specifically required to be filled in Foreign Currency.

Step 1 – Go to the website of incometaxindiaefiling.gov.in.

Step 2 – on “Forms Other than ITR” on the Right Hand Side of the Website.

Step 3 – Download “Form No. 15CB”

Step 4 – on “ITD_EFILING_FORM15CB_PR1.jar”

Step 5 – General instruction page will appear on the screen

Step 6 – Click on “Form 15CB” tab on the Top left hand side
– F ill up Form 15CB from the hard copy of the Form 15CB prepared. Step 7 – Point No. 6 of Form 15CB
-1st Drop Down- Select “Nature of remittance” from 65 categories stated in drop down.

Step 8 – Point No. 7 of Form 15 CB
– 1st Drop Down- Select “Relevant Purpose Group Name” of remittance from 24 categories from the drop down.
– 2nd Drop Down- Select “Relevant Purpose Code and Description” of remittance.
– 3rd Drop Down- Select Yes or No for “In case the remittance is net of taxes, whether tax payable has been grossed up”

Step 9 – After filling up the details- Click on “Save Draft”
Step 10 – Click on “Validate”
Step 11 – Click on “Generate XML” and save the XML file.
Step 12– Go to “incometaxindiaefiling.gov.in” website and Login using:

a. User Id- PAN
b. Password- as is used for e-filing the income tax return
c. D ate of Birth/Incorporation- as is already registered with the income tax for e-filing of return of income etc.

Step 12 – Click on “e-file” – “Upload Form”

Step 13 – Fill up the following details
– PAN/TAN of the Assessee (Remitter)
– PAN of CA (for example: Name of CA – PAN of the CA)
– Select Form Name- 15CB
– Select filing type- Original
– A ttach the “XML” file saved
– A ttach “DSC of CA”
– Click on submit- Form No. 15CB will be submitted successfully

Step 14 – After filing Form 15CB Click on “My Account” tab and Click on “e-filed returns/forms”
– Click on PAN/TAN of assessee (Remitter)
– Click on relevant Acknowledgement Number link
– Click on ITR/FORM
– To open the PDF file, enter the password.
The password for the same is PAN in small letter with Date of birth/incorporation in continuation without using any special character.-
– After downloading the PDF file, Save and print the same.
– Click on “Receipt”
– Save and print the same.

11. Summation
Amendments to Rule 37BB though appearing complicated will reduce the compliance burden of the tax payer. It also provides the much needed certainty by specifying various transactions for which reporting is not required. Small value transactions not exceeding Rs. Five lakh per year are exempted from the cumbersome procedure of reporting by e-filing. However, a word of caution here is that the transactions not exceeding Rs. Five lakh per year are exempted only from reporting and not from the obligation of withholding tax wherever applicable. Therefore, the tax payer may have to deduct tax at source in an appropriate case even if the transaction value is less than Rs. Five lakh. Similarly, robust documentation would be required to justify the non-reporting or non-deduction transactions as hitherto. In order to determine whether the tax is deductible or not, the remitter would be required to ascertain the taxability of payment in the hands of the non-resident and that will require knowledge of the legal provisions governing Taxation of Cross Border Transactions. The remitter would be faced with a number of issues such as (i) Classification/ Characteriation of the payment (e.g. Business Income vs. Capital Gains or FTS or Royalty); (ii) Existence or otherwise of a PE (iii) Quantum of Income to be attributed to the PE (iv) Eligibility to access a Tax Treaty, (v) Application of the provisions of a DTAA vs. the Income-tax Act, (iv) issues relating to Interpretation and application of a DTAA , etc. In many cases although prima facie the remitter is not required to deduct tax at source and the new procedure also does not require him to obtain a CA Certificate in Form 15 CB, it would be advisable that he obtains CA Certificate in the Form 15 CB for NIL TDS because the CA would be able to substantiate the non-deduction of tax at source with valid documentation, judicial support and detailed and sound reasoning. In such a case, the remitter may fill up Part C of the Form 15 CA along with Form 15 CB.(However, in view of the language of Part D of Form 15CA, there is ambiguity as to whether Part C has to be filled up or Part D. In our view, once Form 15CB is obtained and uploaded electronically and acknowledgment number of such Form 15CB is filled in by the remitter in Form 15CA, Part C of Form 15CA will be automatically filled in). The issue needs to be clarified by the CBDT about the procedure to be followed by the remitter in case he desires, out of abundant caution, to obtain a CA Certificate in Form 15CB to be absolutely certain about taxability or otherwise of a particular remittance under the provisions of the Income-tax Act and/or the applicable Tax Treaty. Presently, the consequences of non-deduction of tax at source are very serious as it would not only lead to disallowance of the payment u/s. 40(a)(i) but also penalty u/s. 271C and levy of Interest u/s 201 of the Act. Many a time, the Assessing Officers are prone to summarily disallow all remittances from which tax has not been deducted at source and hence it may land the tax payer into a long drawn litigation. However, if the remitter has obtained a CA certificate for non-deduction of tax, it would help him in the Assessment and Penalty Proceedings, if any.

[2016] 68 taxmann.com 336 (Chennai – Trib.) DCIT vs. Alstom T & D India Ltd A.Ys.: 2001-02, 2003-04 and 2004-05, Date of Order: 31st March, 2016

fiogf49gjkf0d
Section 9, 40(a)(i) of the Act – to fall within the second exception provided in section 9(1)(vii) (b) of the Act, the source of income, and not the receipt, should be situated outside India.
Facts

The Taxpayer, an Indian company, was engaged in the business of manufacture of heavy electrical equipment. The Taxpayer had developed prototypes of certain equipment. As per the standards prescribed by the industry regulatory body, prototype development could be complete only after performance of certain design tests on the equipment. These tests were to be performed by an accredited international testing laboratory. The Taxpayer could not have exported the equipment to the international market unless these tests were completed and the results were benchmarked to the standards prescribed. Accordingly, the Taxpayer engaged an international testing laboratory for testing the prototypes and paid testing charges.

The Taxpayer remitted the testing charges to the laboratory without withholding tax.

In the course of the assessment, the AO invoked provisions of section 40(a)(i) of the Act and disallowed the payment. In appeal, CIT(A) relied on decisions in Havells India Ltd v ACIT 47 SOT 61 (URO) (Del) and held that the payment was covered by the second exception in section 9(1)(vii)(b) of the Act and hence, income accrued or arose in India. Consequently, tax was not required to be withheld from the payment. The tax department filed further appeal to the ITAT.

Held

  • Section 9(1)(vii)(b) provides for two exceptions. First exception is where the payment is made is respect of services utilized for business or profession carried on outside India. Second exception requires utilization of services for earning any income from source outside India.
  • For falling within the first exception, it is not sufficient to prove that the services are not utilised for business activities of production in India, but it is furthernecessary for to show that the technical services are utilised in a business carried on outside India. Nothing was brought on record to support this.
  • Without prejudice, the Taxpayer was concluding the export contracts in India. The products were manufactured in India and exported from India in fulfillment of the export contracts. Therefore, the Source of income was created when the export contracts were concluded.
  • Though the importer of the products was situated outside India, the importer was merely the source of money received.
  • The second exception in section 9(1)(vii)(b) requires the source of income, and not the receipt, to be outside India.
  • Since this condition was not satisfied, the payment was taxable in India.

[2016] 67 taxmann.com 138 (Delhi – Trib.) Krishak Bharati Cooperative Ltd vs. ACIT A.Ys.: 2010-11 & 2011-12, Date of Order: 9th March, 2016

fiogf49gjkf0d
Article 25(4) of India-Oman DTAA –ICo is eligible to claim foreign tax credit (FTC) in respect of dividend income received from Omani Company, as dividend exemption was granted in Oman for attracting investments.

Facts
The Taxpayer an Indian co-operative society established a branch office (BO) in Oman. BO created a PE for the Taxpayer in Oman under the DTAA . Taxpayer also held shares in another company in Oman, from which the Taxpayer had received dividend income. Such dividend income was effectively connected with the BO. Such dividend income was exempt from tax in Oman. Vide its letter, Ministry of Finance of Oman clarified that dividend exemption was granted with the object of promoting economic development within Oman by attracting investments.

Taxpayer claimed tax credit for the Omani tax on dividend income which would have been payable in Oman but not paid by reason of exemption granted under the Omani tax Laws.

AO however contended that the dividend exemption exists across the board with no exceptions in Oman, thus it cannot be construed as an incentive granted for economic development and therefore denied such credit.

Held
Article 25(4) of India-Oman DTAA provides that tax payable for the purpose of computing the tax credit shall be deemed to include the tax which would have been payable but not paid by reason of for certain tax incentives granted under the laws of the source state for promoting economic development.

Ministry of Finance of Oman had clarified that the exemption on dividend income was introduced to promote economic development. Omani Tax Law can be clarified only by government of Oman and interpretation given by it must be adopted in India.

Therefore, by virtue of Article 25(4) of the DTAA Taxpayer is entitled to foreign tax credit in respect of tax that would have been payable in Oman but for the exemption.

TS-62-ITAT-2016 (CHNY) Foster Wheeler France SA vs. DDIT A.Ys.: 2008-09 & 2009-10, Date of Order: 5th February, 2016

fiogf49gjkf0d
Section 9(1)(vii) of the Act; Article 12(4) of India-USA DTAA – since monitoring and review services provided to a specialist company by an American company ‘make available’ technical knowledge, etc. the payments made were FTS under India-USA DTAA.

Facts
The Taxpayer was a French company engaged in providing technical and engineering services. The Taxpayer had entered into an agreement with an Indian company for providing technical and engineering services in India. For providing these services, Taxpayer deputed his employees to India. Taxpayer also entered into another agreement with its affiliate, a USA Company (“USCo”) as per which USCo was required to monitor and review the work done by the employees of the taxpayer, deputed to India. As part of its services US Co was required to share best practices in engineering services in the form of written procedure, forms, and specifications to be adopted in execution of the work in India.

Though the TPO did not consider it necessary to make any adjustment, invoking the provisions of section 40(a)(i) of the Act, the AO disallowed the payments to USCo since the Taxpayer had not withheld tax from these payments. AO contended that the payment made to USCo amounts to FTS and is subject to withholding of taxes in India. Taxpayer argued that the services rendered by US Co did not make available any technical knowledge and hence does not qualify as FTS under the DTAA and no withholding is required on such payments.
The issues before the Tribunal were:

(i) Whether, as per the provisions of section 9(i)(vii) of the Act, the services provided by USCo were in the nature of FTS?

(ii) Whether, as per the provisions of Article 12(4)(b) of India-USA DTAA , the payments received by USCo could be characterised as FTS?

Held
As regards the Act
The payments made by the Taxpayer for provision of services in the nature of managerial, technical and consultancy services and utilised by the Taxpayer in its business in India, is liable to tax in India in terms of Explanation 2 to Section 9(1)(vii) as FTS.

As regards India-USA DTAA
To qualify as Fee for included services (FIS) under the DTAA , services should satisfy the “make available” condition.

Taxpayer received best practices in different engineering specifications as well as engineering details from US Co to be adopted in execution of the different phases of the project in India.

U S Co provided the best practices by way of written procedures and specifications and details. When the procedures and specifications are provided to the Taxpayer, which is also a specialized company in engineering and execution of construction, the specifications and details provided can very well be used in the business of engineering and construction.

Moreover, these specifications and procedures made available to the Taxpayer by USCo can very well be used by the Taxpayer for execution of other projects. Also, the Taxpayer was not a layman but was a specialist in engineering and construction.

The information, expertise, execution plan, project budget, technical standards and quality management standards provided by USCo is absorbed by the Taxpayer who is capable of deploying such technology in future without depending on USCo.

Hence, it could very well use these for its future business without any assistance from USCo. Hence, USCo had ‘made available’ its technical knowledge, expertise, knowhow, etc. to the Taxpayer.

ITA No. 1625/Mum/2014 Morgan Stanley Mauritius Company v. DCIT (IT) A.Y.: 2007-08, Date of Order – 29th January, 2016

fiogf49gjkf0d
Article 13 of India-Mauritius DTAA – Additional consideration received for delay in making open offer, being an integral part of share transfer is a part and parcel of sale consideration, is covered by Capital Gains Article of the DTAA . Such payment does not constitute interest income in absence of a debtor- creditor relationship.

Facts
The Taxpayer, a company incorporated in Mauritius held the shares of an Indian Company (ICo). The Taxpayer transferred ICo’s shares to a Mauritius Company (FCo) under a scheme of open offer.

Together with the consideration for sale of shares, the Taxpayer also received additional consideration for delay in processing of open offer by FCo. As per the letter of open offer, it was clear that the initial offer price of the shares for transfer of each share was increased due to the delay in making the open offer. The Tax authority contended that such consideration was received for delay in making payment. Hence, it represented interest and was not part of sale consideration for the open offer. Accordingly, such additional payment would qualify as interest under the India-Mauritius DTAA and liable to source taxation in India.

However, the Taxpayer argued that as FCo had not provided any loan to Taxpayer, additional consideration cannot be said to be received in respect of any monies borrowed or for use of money. In absence of a debtorcreditor relationship between the Taxpayer and FCo, such additional consideration cannot be treated as interest.

Held
It is a fact that the regulatory authority i.e., SEBI, had approved the transaction. Further, since the transaction could not be completed in time due to certain reasons, FCo revised the offer price. The Taxpayer had no control over the decisions of FCo. Business decisions are governed by their own rules and laws and if considering the time factor, FCo agreed to increase the share price, it has to be taken as part of sale.

The Taxpayer owned shares of ICo and in response to the open offer by FCo, the Taxpayer agreed to sell the shares of ICo. It was a pure and simple case of selling of shares by the Taxpayer. The Taxpayer did not enter into any negotiations with FCo and transferred shares as per a scheme approved by SEBI.

Further, there was no debtor-creditor relationship between the Taxpayer and FCo. The Taxpayer had not advanced any sum to FCo and has not received any interest for the delayed repayment of principal amount. Reliance in this regard was placed on the Tribunal decision in the case of Genesis Indian Investment Company (ITA /2878/Mum/2006 dated 14th August 2013) wherein it was held that where the interest is received for delay in processing of buy back of shares in open offer after announcement of the intention of acquiring shares, such additional amount shall form part of consideration towards shares tendered in open offer.

Thus, the additional consideration received is part and parcel of total consideration and cannot be segregated under the head ‘original sales consideration’ and ‘penal interest’. Such additional consideration is not taxable in India by virtue of Article 13 of India-Mauritius DTAA .

TS-15-AAR-2016 Dow AgroSciences Agricultural Products Date of Order : 11th January, 2016

fiogf49gjkf0d
Article 13(4) of India-Mauritius Double Taxation Avoidance Agreement (DTAA ) -Transfer of shares of an Indian company (ICo) by the applicant to its Singapore group entity (SCo) upon re-organisation, not a tax avoidant transaction

Facts
The Applicant is part of a large MNE group (Group) and a company resident and incorporated in Mauritius. The Applicant held majority (nearly 99.99%) of the shares of Indian Co (ICo) which was acquired by it in various tranches over a period of 10 years from 1995 to 2005.

The Group had presence all over the world and was divided into various regions based on their geographical locations. The Applicant belonged to the European region, while ICo belonged to the India, Middle East and Africa (IMEA) region. In the past, the IMEA region was dismantled and entities were realigned with other regions as per the geographical convenience. As a result of this realignment, ICo became a part of the focused Asia-Pacific region.

In order to achieve the objective of operational excellence, better control and administrative convenience, it was proposed to realign the holding of ICo and shift it to an entity in the Asia- Pacific region. Accordingly, it was proposed that Applicant would transfer the shares of ICo to its group entity in Singapore i.e., SCo.

Issues before the AAR were as follows:
Whether the entire arrangement of transfer of ICo’s shares in favor of SCo was a scheme to avoid taxes in India?

Whether the Applicant had a Permanent Establishment (PE) in India?

Whether income arising from such a transfer was taxable in India?

Held
On the issue of whether the arrangement was a tax avoidance transaction For the following reasons, it was held that the transaction of transfer ICo’s shares to SCo by the Applicant was not a tax avoidance transaction –

The Applicant had acquired shares of ICo in various tranches over a 10 year period. Such share acquisition which was carried out around 20 years ago for a substantial cost cannot amount to a scheme to avoid payment of taxes in India. ? T he Applicant had been operating for more than 10 years in Mauritius and hence, it cannot be said to be a shell company. Investment in ICo’s shares was carried out with prior approval of the Department of Industrial Policy and Promotion and Reserve Bank of India. In these circumstances, it cannot be said that shares were acquired with a view to sell them in future.

The need for realignment of the Group arose upon dismantling of the IMEA group in 2010. As a result, and in order to ensure better control, ICO’s holding was shifted to Asia-Pacific region. SCo was an upcoming entity in the Asia-Pacific region and, hence, it was proposed to realign the holding of shares of ICo from the Applicant to SCo. Additionally, all the shares of ICo were acquired five years prior to the present proposed re-organisation of the group. Hence, the proposed transaction is for sound business consideration.

On the issue of PE
It was a stated fact that the Applicant did not have an office or employees or agents in India. Neither did it have any activities in India. A tax residency certificate from Mauritius was also furnished by the Applicant. Further nothing was brought on record to show that Applicant had a PE in India. Therefore, it was held that the Applicant does not have a PE in India. On the taxability of transfer of shares of ICo

Considering the accounting treatment, intention, as also quantum of the transaction, the equity shares held by the Applicant in ICo should be considered as capital asset and not stock-in-trade.

The shares of ICo were held for a very long period of time (10-20 years). The objective of acquiring ICo’s shares as stated by the Applicant was not to trade in them but to hold them as investments. In fact, there was no trading in ICo’s shares by the Applicant, except for the proposed transfer. Hence, the shares of ICo would constitute capital asset in the hands of Applicant. Consequently gains from transfer of shares of ICo would result in capital gains in the hands of the Applicant. Such capital gains are taxable in India under the provisions of the Act

Gains on transfer of ICo’s shares would be covered by Article 13(4) of the DTAA which exempts gains from tax in India.

Taxation of Artistes and Sportsmen

fiogf49gjkf0d
1. Overview
In recent years, it has been observed that various
International sporting events like Formula 1 Race, Indian Premier
League (IPL), Indian Super League (ISL) and I-League etc. are being
successfully held in India year after year. It is worth noting that
India has largest number of very keen cricket fans in the world viewing
various cricket matches. Similarly, there are various Indian films &
advertisements where international artistes are featuring. Many foreign
filmmakers have been shooting films in India such as Life of Pi, The
Bourne Supremacy, Slum Dog Millionaire etc. On various occasions,
concerts by non-resident entertainers are regularly held in India e.g.
concerts/performances by Metallica, Lady Gaga, Katy Perry etc. In
addition, performances by International Artistes & entertainers are
increasingly becoming a part of big Indian theme parties, wedding
extravaganzas and Reality shows etc.

Taxation of such
non-resident Artistes and Sportsmen, corporates and sports
associations/bodies involved in organising, managing and regulating such
events, concerts or performances is gaining increasing importance in
view of huge sums by way of fees and other contract amounts involved. In
this Article, we have attempted to give an overview of the taxation
provisions under the Income-tax Act and various model Tax Treaties.

2. Taxability under the Domestic Law

The relevant provisions and circulars under the Income-tax Act, 1961 [the Act] are as follows:
Section 5 r.w.s. 9 will determine taxability of income of Artistes etc. in India
Section 115BBA – Tax on non-resident sportsman or sports association
Withholding tax provisions u/s. 194E
CBDT Circular No. 787 dated 10.02.2000

2.1 Section 115BBA of the Act reads as follows:
“Tax on non-resident sportsmen or sports associations. 115BBA. (1) Where the total income of an assessee, –

a) being a sportsman (including an athlete), who is not a citizen of India and is a non-resident, includes any income received or receivable by way of –
i. participation in India in any game (other than a game the winnings wherefrom are taxable under section 115BB) or sport; or
ii. advertisement; or
iii. contribution of articles relating to any game or sport in India in newspapers, magazines or journals; or

b) being a non-resident sports association or institution, includes any amount guaranteed to be paid or payable to such association or institution in relation to any game (other than a game the winnings wherefrom are taxable u/s. 115BB) or sport played in India; or

c) being an entertainer, who is not a citizen of India and is a non-resident,
includes any income received or receivable from his performance in
India, the income-tax payable by the assessee shall be the aggregate of —

i. the amount of income-tax calculated on income referred to in
clause (a) or clause (b) or clause (c) at the rate of twenty per cent;
and
ii. the amount of income-tax with which the assessee would have
been chargeable had the total income of the assessee been reduced by the
amount of income referred to in clause (a) or clause (b) or clause (c):

Provided that no deduction in respect of any expenditure or allowance shall be allowed under any provision of this Act in computing the income referred to in clause (a) or clause (b) or clause (c).

2) It shall not be necessary for the assessee to furnish under sub-section (1) of section 139 a return of his income if—
(a)
his total income in respect of which he is assessable under this Act
during the previous year consisted only of income referred to in clause
(a) or clause (b) or clause (c) of sub-section (1); and

(b) the tax deductible at source under the provisions of Chapter XVII-B has been deducted from such income.”

(Emphasis supplied)
2.2 Analysis of Section 115BBA
It applies only to a non-resident and a person who is not a citizen of India

Who is a sportsman (including athlete) and

Earns income from
• Participation in India in any game or sports
• Advertisement
• Contribution of article in newspaper, magazine or journals relating to any game or sport in India

Applies to a non-resident sports association or institution

Who earns income from
• Guarantee money in relation to any game or sport played in India
• Except games referred to in section 115BB

Applies only to a non-resident and a person who is not a citizen of India
• Who is an entertainer and
• Earns income from his performance in India
• Applicable tax rate is 20% on gross income
• Deduction of any expenditure incurred for earning such income is not allowed
• No need to file return if tax deductible at source has been deducted from such income.

3. CBDT Circular No. 787 dated 10-02- 2000 – Income of artists, entertainers, sportsmen etc.

The salient features of the said circular are as under:

Income derived from event or show for entertainment or sports includes:
• Sponsorship money;
• Gate money;
• Advertisement revenue;
• Sale of broadcasting or telecasting rights;
• Rents from hiring out of space, etc.
• Rent from caterers.

Article on “Artistes and Sportsman” will apply to
• Income from personal activities of sportsman or artist in India
• Advertising income and Sponsorship income, if it is related directly or indirectly to performance or appearance in India.

Article on “Royalty” will apply to
• Royalty payment for recorded performance

Article on “Other income” will apply to
• Guarantee money earned by Sports association
• E.g. Tax treaty with U.S, U.K., Japan, Australia, New Zealand, Sri Lanka, France etc.

Illustrations given in the Circular
Income not taxable in India
• Artist performing in India gratuitously without consideration.
• Artist performing in India to promote sale of his records without consideration.
• Consideration paid to acquire the copyrights of performance in India for subsequent sale or broadcast or telecast abroad.

Income taxable in India
• Consideration for the live performance or simultaneous live telecast or broadcast in India.
• Consideration paid to acquire the copyrights of performance in India for subsequent sale or broadcast or telecast in India.
• Endorsement fees (for launch or promotion of products, etc.) which relates to the artist’s performance.

4. Relevant Case Laws – Section 115BBA and 194E
Some of the important case laws are as under:

4.1 International Merchandising Corporation vs ADIT [2015] 57 Taxmann.com 179 (Delhi-Trib)

Issues:
i. Payment made to Association of Tennis Professionals (ATP), whether liable to Tax u/s. 115BBA?
ii. Whether section 194E does not apply as AT P is just a governing body of sport and not a sports association?

Held:
a) 194E read with section 115BBA apply to payments made to a non-resident sports association or an institution.
b)
ATP is undisputedly a governing body of the world wide men’s
professional Tennis Circuit responsible for ranking of its players and
co-ordinating the Tennis tournament in the world.
c) ATP is a
non-resident sports institution and therefore section 194E applies to
the payments made by the assessee to the AT P.

4.2 PILCOM vs. CIT [2011] 198 Taxman 555 (Cal.)
In this case, it was held as follows:
a)
Section 115BBA is completely independent from other sections such as
section 5(2) or section 9 and it has got nothing to do with the accrual
or assessment of income in India as mentioned in section 9.
b) Non-resident individual has to pay the tax, the moment he participates in India in any game or sport.
c)
Once the payment is made to non-resident sports association or
institution or it becomes payable in relation to any game or sports
played in India, there is accrual of income in India.
d) Section 115BBA is to be applied irrespective of place of making payment.
e)
Payment received by any sports association or personalities for the
matches not played in India is not taxable or liable for withholding
tax.
f) Department’s contention that source of payment is from India irrespective of place of game is overruled.

4.3 Indcom vs. CIT (TDS) [2011] 11 taxmann.com 109 (Cal.)

Issues:
Whether
tax will be deductible on amounts paid to foreign teams for
participation as prize money or administrative expenses, is deemed to
accrue in India u/s. 115BBA?

Whether the match referees and umpires will be considered as sportsmen?

Held:
The
amount paid to the foreign team for participation in the match in India
in any shape, either as prize money or as the administrative expenses,
was the income deemed to have accrued in India and was taxable u/s.
115BBA and, thus, section 194E was attracted.

The payments made
to the umpires or match referees do not come within the purview of
section 115BBA because the umpires and match referee are neither
sportsmen (including an athlete) nor are they non-resident sports
association or institution so as to attract the provisions contained in
section 115BBA. Therefore, although the payments made to them were
‘income’ which had accrued in India, yet, those were not taxable under
the aforesaid provision and thus, the liability to deduct u/s. 194E
never accrued.

The umpires and the match referee can, at the
most, be described as professionals or technical persons who render
their professional or technical services as umpire or match referee. But
there is no scope of deducting any amount u/s. 194E for such payment.

The
reader may also refer to the decision in the case of Board of Control
for Cricket in India vs. DIT (Exemption) [2005] 096 ITD 263 (Mum), on
the subject.

5. Scope of the Article 17 of OECD Model Tax Convention

Salient features of Article 17 are as under:
• Primary taxing rights is with the State of Source / State of performance
• It overrides Article 7, 14 and 15.
• It applies to entertainer, sportsperson or any other person

6. Article 17 (1)

6.1 Model Conventions – A Comparison

6.2 Scope of Article 17(1)
a. A pplies to Individual resident of one of the contracting state.
b. I ndividual is either an entertainer or a sportsperson.
c. He derives income from personal activities.
d. Word “personal activities” suggests “public appearance” is necessary.
e. Personal activities/performance are exercised in the source State i.e. country of performance.
f. Performance should be in public or recorded and later produced for an audience.
g. Performance must be artistic and entertaining.
h. Entertainer or sportsperson must be present in the state of source during the performance.
i. It is not necessary to remain present in the Source State for any minimum period.
j. Person performing even for a single event is covered.
k. Person involved in a political, social, religious or charitable nature is covered, if the entertaining character is present.
l. It covers both professional activities and occasional activities.
m. Source State gets right to tax income earned in that state.

6.3 Meaning of ‘Entertainer’
a. There is no precise definition of the term in Model convention or in treaty.
b. Dictionary meaning of “Entertainer”
i.
“A person whose job is amusing or interesting people, for example, by
singing, telling jokes or dancing” – Oxford Advanced Learner’s
Dictionary
ii. “A person, such as a singer, dancer, or comedian, whose job is to entertain others” – Oxford Dictionary of English
iii. “A person who entertains; a professional provider of amusement or entertainment” – Shorter Oxford Dictionary
c.
Term ‘Entertainer’ includes the stage performer, film actor or actor
(including for instance a former sportsperson) in a television
commercial.
d. Entertainer or sportsperson includes anyone who acts as such even for a single event.

6.4 Meaning of “artiste” and “artist”
a. There is no precise definition in Model convention or in treaty.
b. Dictionary meaning of “Artiste” is:
i. “An artist, especially an actor, singer, dancer, or other public performer” Random House Webster’s Dictionary
ii.
“A public performer who appeals to the aesthetic faculties, as a
professional singer, dancer, etc. also one who makes a ‘fine art’ of his
employment, as an artistic cook, hair dresser, etc. Oxford English
Dictionary
iii. “A professional entertainer such as singer, a dancer or an actor” Oxford Advanced Learner’s Dictionary

c. Difference between the word “artiste” and “artist”:
i. “Artist” has a broader meaning compared to “artiste”
ii. Artist includes those who create work of art, such as painter, sculptors etc.
iii. Artist is a person whose creative work shows sensitivity and imagination
iv. A rtiste is restricted to performing arts.
v. Artiste is a person who is a public performer or skilled performer.
vi. A rtiste is the one who has an entertaining character
vii. The word “entertainer” seems to cover the lighter versions of the performing arts.

6.5 Relevant decisions regarding meaning of ‘Artist’ given in the context of Section 80-RR of the Act

a. Sachin Tendulkar vs. CIT [2011] 11 taxmann. com 121 (Mum).
The
Mumbai Tribunal in case of Sachin Tendulkar held that Sachin should be
regarded as an artiste while appearing in advertisements and
commercials, modeling etc. and hence is entitled to deduction u/s. 80RR.

b. Amitabh Bachchan vs. CIT [2007] 12 SOT 95 (Mum)
The
Mumbai Tribunal held that both Amitabh Bach chan receiving income for
acting as an anchor for a TV programme and Shahrukh Khan receiving in
come from endorsement of performance where he has to give photographs,
attend photo sessions, video shoots, etc. are entitled to deduction u/s.
80RR.

The reader may also refer to the following decisions on the subject:

Tarun Tahiliani-[2010] 192 Taxman 231(Bom)
Harsha Ahyut Bhogale vs. ACIT – [2008] 171 Taxman 108 (Mum) (Mag)
David Dhawan vs. DCIT – [2005] 2 SOT 311 (Mum)
Anup Jalota – [2003] 1 SOT 525 (Mum)

6.6 Meaning of ‘Sportsperson’
a. There is no precise definition is given of the term “sportspersons”.
b.
N ot restricted to participants in traditional athletic events (e.g.
runners, jumpers, swimmers). Also covers e.g. golfers, jockeys,
footballers, cricketers and tennis players, as well as racing drivers.
c.
A lso includes activities usually regarded as of an entertainment
character such as billiards, snooker, chess and bridge tournaments
d.
Since sportsperson is grouped with entertainer, Article 17 will apply
only to those who perform in public. Therefore, mountaineers or scuba
divers are not covered.
e. Sportsperson also covers the one whose
activities includes advertising or interviews that are directly or
indirectly related to such an appearance.
f. Sportsperson does not include managers or coaches of the sports team.
g.
Merely reporting or commenting on a sports event in which the reporter
does not participate is not an activity as a sportsperson.
h. Owner
of a horse or a race car is not covered under Article 17 unless the
payment is received on behalf of the jockey or car driver.

6.7 Meaning of “Athlete”
A person who is trained or skilled in exercises, sports, or games requiring physical strength, agility or stamina

Dictionary meaning is one who is engaged in sport more specifically in the field and track events

6.8 Persons covered under Article 17 and regarded as performing entertainers or artistes

6.9 Persons not covered under Article 17 and not regarded as performing entertainers or artistes

6.10 Article 17(1) – Illustrative types of Income covered:

a. Income derived from performance.

b. Income connected with performance such as awards
i. Payment received by a professional golfer for an interview given during a tournament in which he participates.
ii. Payment made to a star tennis player for the use of his picture on posters advertising a tournament in which he will participate.

c. Advertising and sponsorship fee directly or indirectly related to performance in source country

i. Payments made to a tennis player for wearing a sponsor’s logo, trade mark or trade name on his tennis shirt during a match.

d. Income generated from promotional activities of the entertainer during his presence in source country.

e. Payments for the simultaneous broadcasting of a performance by an entertainer or sportsperson made directly to the performer or for his or her benefit (e.g. a payment made to the star-company of the performer).

f. Income from combined activities (for e.g. Steven Spielberg directing and acting in a movie – Predominantly performing nature – Article 17 would apply – Performing element negligible – entire income out of Article 17).

g. Performance based fees/remuneration such as participation fees, share in gate receipts.

h. Income from writing a column in daily newspaper or journals related to performance.

i. Salary income of a member of an orchestra or troupe for his performance.

j. Entertainer earning salary as an employee is liable to pay tax in source country in proportion to his salary which corresponds to his performance.

k. Income of one person company belonging to entertainer if domestic law of Source State permits “look through” approach.

l. Illustration:
• Film actor is performing in India where a film is shot. Article 17 will apply to the income of the film actor.
• If the film is released worldwide except India, Article 17 will apply to the income of Film actor irrespective of where the film is released.

6.11 Article 17(1) – Illustrative types of Income not covered

a. Payments received upon cancellation of a performance are not taxable under Article 17(1).

b. Royalties for intellectual property rights will normally be covered under Article 12 i.e. Income to third party holding IPR for broadcasting rights.

c. Income received by impresarios etc. for arranging the appearance of an entertainer or sportsperson is outside the scope of the Article, but any income they receive on behalf of the entertainer or sportsperson is of course covered by it.

d. Income received by administrative or support staff (e.g. cameramen for a film, producers, film directors, choreographers, technical staff, road crew for a pop group, etc.

e. Income from speaking engagement in conferences.

f. Income as reporter or commentator h. Promoters involved in production of event i. Guest judge in singing competition

j. Income not attributed to performance in source state.

6.12 Items of Income Covered by Other Articles

Taxation of the following types of income is governed by other Articles of a Tax Treaty:

a. Income for Image rights not closely connected with performance

b. Sponsorship and advertising fees not related to performance

c. Merchandising income from sale which is not related to performance

d. Income against the cancellation of performance, since it is compensation for income lost due to cancellation of performance and not associated with performance.

e. Income from restrictive covenants

f. Income earned by a former sportsperson providing commentary during the broadcast of a sport event or reporting on sport event in which he is not participating.

g. Income from repeat telecast

h. Fees for interview with music channel not closely connected with performance.

6.13 Aspects which are not relevant while applying Article 17

a. Location or residence of Payer

b. Number of days stay in the source country

c. Having PE or fixed base of the entertainer in the source country

d. Entertainer or sportsperson performing as an employee or independently on contract

e. Entertainers present directly on the stage or through radio or TV.

f. One time performance or regular performance

g. Indian Treaty examples
i. India-Egypt tax treaty provides time threshold of 15 days during the relevant fiscal year.

ii. India-USA tax treaty – Exception provided where net income derived does not exceed USD 1,500.

6.14 Foreign Judicial Precedents

a) Agassi vs. Robinson – UK Judicial Precedent
• Mr. Andre Agassi, a US-tax resident visited UK for short duration to play in various tournaments and in particular at Wimbledon.

• He controlled a US corporation (Andre Agassi Enterprises Inc) through which he negotiated endorsement contracts with manufacturers of sporting equipment including Nike and Head, neither of which had a tax presence in UK.

• Revenue authorities assessed Andre Agassi for tax in connection with the sponsorship income received by the non-resident corporation.

• UK House of Lords upheld the extra-territorial applicability of the UK domestic tax law provisions and held that endorsement income paid by non-resident UK sponsors to non-resident corporation is liable to tax in UK.

b) Canadian decision in Cheek vs. The Queen (2002 DTC 1283 (Tax Court of Canada))

• Issue: Whether a “radio broadcaster” of baseball games would fall under Article XVI (Artistes and Athletes) of the 1980 Canada–United States Income Tax Convention?

• The radio broadcaster Thomas Cheek, had been the commentator of the Toronto Blue Jays together with a partner-commentator.

• Thomas Cheek was resident in the United States, was not an employee and did not have a fixed base in Canada that would have made him taxable under Article XIV (Independent Personal Services).

• In a baseball game of three hours, only 16-18 minutes are actual “motion”, the rest is “down time”. The challenge facing the broadcaster is to hold the attention of the radio audience, even when there is no activity on the field.

• The court stated that professional sports in itself is entertaining, but doubted whether the broadcaster could be seen as an entertainer, that is, as a “radio artiste”, such as for example the late Bing Crosby. The baseball fan who turns on the radio to hear a particular baseball game wants to know how the players are performing on the field.

• The broadcaster may be able to hold the attention of the fan with his “down time” commentary but he is not the reason why the fan turns on the radio. Therefore the court decided that Thomas Cheek was not a radio artiste, although he was a very skilful and experienced radio journalist.

c) NL: HR, 7 May 2010, 08/02054 (Tax Treaty Case Law IBFD)

• A football player who was resident in Sweden was transferred by a Swedish club to a team resident in the Netherlands.

• He took up residence in the Netherlands after the transfer.

• Pursuant to the terms of his contract with the Swedish club, he received a share of the transfer price paid by the Dutch club;

• He received this payment when he had already become a resident of the Netherlands.

• The taxpayer claimed that this payment related to his past employment activity with the Swedish club and was covered by Article 15 (Income from employment) of the treaty.

• Conversely, the Dutch tax authorities maintained that the payment was within the scope of Article 17 (allowing Sweden the primary right to tax and double taxation should in that case be relieved in the Netherlands via a credit under Article 24(4).

• Held – The payment was clearly related to the past activities of the taxpayer as football player for the Swedish team and that, therefore, Article 17 doubtlessly applied. As a consequence, the taxpayer had to include this payment in his income for Dutch tax purposes and then ask a credit for the taxes paid to Sweden upon that same income.

7.2 India’s DTAA s – Article 17 (2)

• India’s treaties with Egypt, Libya, Syria and Zambia provide that income accrued to another person is not taxable in source country.

• India’s treaty with Zambia provides for deemed PE if the enterprise carries on business of providing the services of public entertainer

• India’s treaty with USA provides that income accrued to another person is not taxable if entertainer establishes that neither the entertainer or athlete nor persons related thereto participate directly or indirectly in the profits of that other person in any manner, including the receipt of deferred remuneration, bonuses, fees, dividends, partnership distributions, or other distributions.

• Paragraph applies when income from personal activities exercised by an entertainer or a sportsperson accrues to another person and not to an entertainer or sportsperson.

• Another person could be a corporate or non-corporate entity

• Such entity may be owned by the performer himself

• Even if another person and entertainer are tax resident of different countries, paragraph applies

• Source state may tax such income.

• It overrides the provisions of Article 7 (Business profit) and 15 (Income from employment).

7.3 Article 17 (2) – Anti Avoidance Rule
• Another person i.e. entity could be a Management Company, team, troupe, orchestra or “renta- star” company.

• “Rent a star” company is controlled by the performer or artist and performer would be the beneficiary of maximum profit of the company

• Income for the performance of entertainer in the source state is received by such entity and not by the entertainer.

• An entertainer or sportsperson is either hired or employed by such entity for the entertainment program to be held in Source State.

• Such entity may pay nominal amount or modest salary to the performer.

• Such entity, in the absence of Permanent Establishment or business connection, may avoid tax in the Source State.

• Income does not accrue to the performer, hence paragraph 1 of Article 17 will not apply.

• Individual performer/entertainer may avoid tax for non-application of Article 15 or may pay tax on modest salary.

• Paragraph 2 deal with such an arrangement and gives taxing rights to the Source State.

7.4 Article 17(2) – Important Points

a. Para 2 does not apply to Prize money that the owner of a horse or the team to which a race car belongs, derives from the results of the horse or car during a race or during races, taking place during a certain period.

b. Does not cover the income of all enterprises that are involved in the production of entertainment or sports events, e.g.:

i. income derived by the independent promoter of a concert from the sale of tickets; and

ii. allocation of advertising space is not covered by paragraph 2.

c. Computation Mechanism – as per the domestic laws of the Source country.

7.5 Computation and rate of tax
Approach for computing income
• Treaty does not provide for method of computing income

• Income is to be computed as per domestic law of the source state (e.g. section 115 BBA of the Act)

• Domestic law may tax only company or the entertainer or both on their respective income

• Non-resident may choose to be governed by the treaty law or the domestic law.

Rate of tax
• Rates are generally not provided in the treaty

• Domestic law may provide for tax on gross income or give an option to be taxed on net income (@20% u/s. 115 BBA of the Act).

7.6 Taxation of Team Performance

A team performance is defined as the exercise of personal activities by more than one entertainer or sportsperson who come together as a group ? Group entity may or may not be a resident or have a permanent establishment in the state of source ? Each team member is classified as entertainer or sportsperson or support staff based on the nature of services rendered

Entertainer or sportsperson of the team are taxed in the state of performance

Support staff, technical personnel and all employees other than artistes or sportsmen are governed by Article 15.

Tax treatment in the state of source is as under:

Payments attributable to entertainer and sportsperson is taxed under Article 17(1)

• Profit earned by the team is apportioned between profit attributable to the performance of entertainer or sportsperson and profits attributable to activities of non-performing members

• Profit attributable to the performance of entertainer or sportsperson is taxed under Article 17(2)

7.7 Relevant Case Law re Article 17(2)

Wizcraft International Entertainment Private Limited vs. ADIT [2014] 45 taxmann.com 24 (Bombay)

• Commission paid to the UK agent was not for services of entertainers/artists.

– The UK agent had not taken any part in the events, nor performed any activities in India. Hence, it was not covered by Article 18 of India- UK DTAA .

• The UK agent did not have any PE in India [Carborandum Co. vs. CIT, (1977) 108 ITR 335 (SC) and CBDT Circular Nos. 17 dated 17.07.1953 and 786 dated 07.02.2000], commission paid to the UK agent was not taxable in India and no obligation on Indian Co to deduct tax at source.

• Reimbursement of expenses – The law is well settled that reimbursement of expense not chargeable to tax and hence, no obligation to deduct tax at source [DIT (IT) vs. Krupp UDHE Gmbh (2010) 38 DTR (Bom) 251 following own decision in CIT vs. Siemens Aktiongesellschaft 220 CTR (Bom) 425].

• Reliance was placed on Circular No. 786 dated 7 February 2000 in respect of non-taxability in India of export commission payable to non-resident agents rendering services abroad.

Note: The aforementioned Circular No. 786 dated 7 February 2000, is withdrawn by Circular No. 7/2009 dated 22nd October, 2009. However, the ITAT and the courts in various cases have held that even after the withdrawal of said circular, export commission payable to non-resident agents rendering services abroad, is not taxable in India.

8. Additional Consideration relating to paragraph 1 & 2 of Article inserted as Article 17(3) in many India’s DTAAs

Article 17 ordinarily applies when the entertainer or sportsperson is employed by a Government and derives income from that Government. However, certain conventions contain provisions excluding entertainers or sportspersons employed in organisations which are subsidised out of public funds from the application of Article 17.

Some countries may consider it appropriate to exclude from the scope of the Article events supported from public funds.

This has been provided as additional consideration in Commentary to Model Convention July 2014 with modifications.

8.1 Such provisions are existing in most of India’s DTAA s and are inserted as paragraph (3) or (4) of Article 17.

8.2 A rticle 17(3) in some of the India’s DTAA s
India – Armenia and India – Japan tax treaty Income taxable only in the resident state, if the event is for approved cultural or sports exchange program.

India – Australia, India – Belgium, India – Indonesia, and India – Mauritius tax treaty Income taxable only in the resident state, if the event is supported by public funds of resident state.

India-Brazil and India – Bangladesh Tax Treaties

Paragraph 1 and 2 will not apply if the activity is wholly or mainly or substantially supported from the public funds of the other contracting state.

9. Conflicts

It is important to note that all the income of the Artistes and Sportsmen may not in all cases be covered by Article 17. It is nature of income which will determine whether the same would fall within the scope of Article 17 or the same would be covered by Article 18 relating to Pensions or Article 19 relating to remuneration in respect of government service.

Conflicts between Article 17 and 18
• Remuneration derived from the entertainment show is governed by Article 17.

• Pension received after termination of performance activity will fall under Article 18.

• Golden handshakes are payment linked to employment and not to the performance, hence does not fall under Article 17.

Conflicts between Article 17 and 19

In case Artists or Sportsperson renders service to Government and receives remuneration then normally Article 17 applies if the activity of the Government is in the nature of business, otherwise Article 19 will apply.

The above article provides just a bird’s eye view of the subject. To gain an in-depth understanding of the subject, the reader would be well advised to study the commentaries on Article 17 of various model conventions and the relevant judicial pronouncements.

AMP: A CONTROVERSY FAR FROM OVER

fiogf49gjkf0d
Background
Over the past decade, Indian Revenue has been the centre of global attention for its positions on controversies surrounding tax and transfer pricing. In the last few rounds of Transfer Pricing assessments, taxpayers promoting international brands in India have been scrutinised for the level of Advertising, Marketing and Promotion (‘AMP’) expenses incurred by them. These issues largely affected multinational enterprises (‘MNEs’) in consumer durables, electronics, automotive and media sectors. The controversy snowballed, leading to constitution of a three-member Special Bench of the Income-tax Appellate Tribunal (‘Appellate Tribunal’), for expert examination of the issues involved. Dissatisfied taxpayers later escalated the issue to the High Court and the same is now pending with the Indian Supreme Court. The most interesting aspect of the AMP controversy is the manner in which this issue has evolved in the judicial hierarchy. While some contentious issues are gradually dwindling as they move up the appellate forums, some issues remain unresolved and with each resolution come new challenges in practical implementation. In the next few paragraphs, we have attempted to summarise the controversy, the evolving judicial elucidation and some unresolved issues.

AMP in the Indian landscape
Under a typical license/distributor arrangement, the Indian entity of a MNE group uses the international brand/ trademark to sell its products in India. For doing so, the Indian entity would pay royalty for using such brand/ trademark. In order to spread awareness of the products and increase/maintain the market share of the products manufactured or distributed by them in India, the Indian entity would incur expenses on advertising, marketing and promotion of such brand/trademark.

During the course of Transfer Pricing assessments, the Indian Revenue has consistently been taking a position that the Indian entity of the MNE group provides assistance to the overseas affiliate, legal owner of the brand/trademark, by enhancing or building the international brand/trademark in India. According to the Revenue, AMP expense beyond the level of expense incurred by comparable businesses (termed as ‘Bright Line Test’ or ‘BLT ’) is non-routine and the same results in creation of marketing intangibles for the legal owner of the brand. Transfer Pricing adjustments have been made on the premise that the Indian entity ought to recover the excess costs along with an appropriate mark-up for such assistance.

Advent of the AMP controversy
The issue of AMP came to limelight in 2010, when the Delhi High Court pronounced a ruling in response to a writ petition filed by Maruti Suzuki1 challenging the show cause notice issued by the Transfer Pricing Officer. The High Court remarked that if the intensity of AMP expenses (defined by a ratio of AMP expense to sales) by the Indian taxpayer is more than what a comparable company would incur, the Indian taxpayer should be compensated at arm’s length, particularly when the use of trademark or logo of the foreign affiliate is obligatory on the part of the Indian taxpayer. With a shot in the arm, the Revenue Authorities made several transfer pricing adjustments in cases of distributors, licensed manufacturers, service providers, etc. using international brands. Without appreciating the difference in functional characterisation, business model and industry life-cycle of the Indian taxpayers, the Indian Revenue painted everyone with the same broad brush and made transfer pricing adjustments for excess AMP expenses.

The Indian Revenue seems to have taken inspiration from the US Tax Court ruling in the year 1998 in the case of DHL2, which was subsequently reversed by Ninth Circuit US Court of Appeal3. In the case of DHL, the Tax Court asked the taxpayer to prove that it incurred more than routine AMP expenses outside US, in order to substantiate that it was the developer of the non-US rights of trademark/brand. However, the Ninth Circuit Court of Appeal rejected the approach of the Tax Court holding that there was no such requirement of comparing the AMP expenses incurred by the taxpayer with comparable companies under 1968 Regulations.

Evolution of Transfer Pricing Jurisprudence on AMP in India:
As the Delhi High Court ruling on Maruti Suzuki’s writ petition led to a plethora of transfer pricing adjustments for AMP spends, affected taxpayers filed appeals to challenge their legality. The Appellate Tribunal, in one such case, deleted the transfer pricing adjustment on the technical ground that the Transfer Pricing Officer had no jurisdiction to assess any transaction which was not specifically referred by the tax officer assessing the case. The Revenue challenged this technical ground before the High Court but failed, with no discussion being recorded on merits of the transfer pricing adjustment. To overturn this defeat in 2012, the Indian Government amended the transfer pricing provisions through Finance Act, 2012. In the amended provisions, the term ‘intangible property’ was defined to include, inter alia, ‘marketing related intangible assets’, such as trademarks, trade names, brand names, logos, etc. Further, Transfer Pricing Officers were bestowed with the right to test transactions even if not specifically referred by the tax officer. After these amendments, the Appellate Tribunals started adjudicating the AMP issue on merit. However, a disparity in the decisions in different cases created uncertainty around the transfer pricing implication of AMP expenses. Considering the conflicting decisions, the importance and the complexity of the issue, a three-member special bench was constituted by the Appellate Tribunal to adjudicate on the transfer pricing aspects of AMP expenses.

Special Bench Ruling in the case of LG Electronics India Private Limited4 (LG India):

The appeal before the Special Bench of the Appellate Tribunal was led by LG India, while other Indian taxpayers5 also affected by the issue joined as interveners to the case. The key findings of the Special Bench were as under:

AMP expenses incurred by an Indian taxpayer result in creating and improving marketing intangibles for the overseas affiliates

Expenses for the promotion of sales directly lead to brand building, the expenses incurred directly in connection with sales are only sales specific

In addition to promoting its products through advertisements, LG India simultaneously promoted the foreign brand

The concept of economic ownership does not find place under the Indian tax law. It is the legal owner of the brand who is benefitted

If the level of AMP expenses incurred by the Indian taxpayer is in excess of that of comparables, the excess AMP ought to be recovered by the Indian taxpayer from the overseas affiliate along with appropriate mark up

Selling expenses which do not lead to brand promotion do not form part of AMP expenses and hence to be excluded for the purpose of benchmarking.

Subsequent to the decision of the Special Bench, most cases pending before the Appellate Tribunal were sent back to the Transfer Pricing Officers with specific direction to follow the principles laid down by the Special Bench in the LG India case. This resulted in transfer pricing adjustments in many cases, barring some relief on account of exclusion of routine sales expenses from the ambit of AMP spends.

Delhi High Court rulings

In the case of Sony Ericsson:
Aggrieved by the order of the Appellate Tribunals following the decision in LG India, taxpayers (including consumer electronics and consumer durables giants like Daikin, Haier, Reebok, Canon and Sony) appealed before the High Court. While adjudicating the case of Sony Ericsson, the High Court laid out the following broad principles:

Upholding the decision in LG India, AMP expenses were treated as an international transaction with associated enterprise (‘AE’) and thus subject to Transfer Pricing Regulations in India

Excess AMP expenses incurred by Indian taxpayers warrant a compensation, but BLT is not well suited for computing the same

Distribution and marketing are intertwined functions and should be analysed in a bundled manner for determining arm’s length remuneration, unless need for de-bundling is adequately demonstrated

If under bundled approach, the gross margins or net margins of the Indian taxpayers are sufficient to cover the excess AMP expenses, then a separate remuneration for such excess from the foreign affiliate is not required

If the distribution and marketing functions are to be debundled then the taxpayer should be allowed a set-off for additional remuneration in one function against a shortfall in the other function

In order to apply bundled approach using an overall Transactional Net Margin Method (‘TNMM’) / Resale Price Method (‘RPM’), it must be ensured that the level of AMP functions in comparables should be similar to that of the Indian taxpayer or the tested entity

An attempt be made to find comparables with similar level of AMP functions and if such comparables cannot be found then proper adjustment be made to even out the differences

All the AMP may not necessarily result in brand building

The concept of economic ownership of intangibles was recognised.

The High Court also suggested that the Appellate Tribunals try to adjudicate the pending cases (rather than remitting the same to the Transfer Pricing Officer) following the broad principles laid down in the case above. However, the Appellate Tribunals have been remitting the issue back to the Transfer Pricing Officer on the ground that no analysis has been carried out in respect of comparability in the level of AMP functions.

In the case of Maruti Suzuki
The case of Maruti Suzuki was also made a part of the appeals heard by the Delhi High Court along with that of Sony Ericsson (supra). However, as against the other appellants alongside Sony Ericsson, who were primarily distributors of their AEs’ products, Maruti Suzuki was a manufacturer. The appeal of Maruti Suzuki was thus de-linked and heard separately by the High Court. In its ruling, the High Court clearly distinguished the facts of the case from its earlier decision in Sony Ericsson. The High Court’s observations were made taking into consideration the specific profile of a manufacturer in the AMP scenario. Further, the High Court re-examined the applicability of Chapter X of the Income-tax Act, 1961 (‘Act’) to the AMP issue, since the existence of an international transaction was specifically questioned by the taxpayer. The observations of the High Court were as under:

The Court noted that Chapter X of the Act makes no specific mention of AMP expenses as one of the items of expenditure which can be deemed to be an international transaction.

Even if the same is considered to be covered under “any other transaction having a bearing on its profits, incomes or losses”, for a transaction to exist there has to be two parties. Therefore, the onus is on the Revenue authorities to show that there exists an ‘agreement’ or ‘arrangement’ or ‘understanding’ between Maruti Suzuki and its AE, whereby Maruti Suzuki is obliged to spend excessively on AMP in order to promote its AE’s brand8.

A transfer pricing adjustment envisages substitution of price of an international transaction with ALP. An adjustment is not expected to be made by deducing that an international transaction exists based on difference between AMP expenses of the taxpayer and comparable entities.

By applying BLT , the Revenue Authorities had deduced the existence of an international transaction on excessive AMP spend of Maruti Suzuki, and then added back the excess expenditure as transfer pricing adjustment. This was contrary to the High Court’s approach, which required the Revenue Authority to examine an international transaction. The High Court observed that the very existence of an international transaction cannot be matter for inference or surmise.

 In the absence of international transaction involving AMP spend with an ascertainable price, neither the substantive nor machinery provisions of Chapter X of the Act are applicable to the transfer pricing adjustment exercise.

In the cases of Honda Siel9 and Whirlpool10

The Maruti Suzuki ruling has apparently set the precedence for the interpretation of AMP spend in the case of manufacturers. Subsequent rulings have followed the distinct perspective of the High Court and questioned the existence of an international transaction merely on account of excessive AMP expenditure:

In the case of Honda Siel:

  •  The High Court observed that the Revenue Authorities ascertained existence of an International transaction only by applying the BLT. Accordingly, the High Court distinguished the case from its earlier Sony Ericsson ruling.

  • The High Court also observed that mere existence of a license for use of the AE’s brand name would not ipso facto imply any further understanding or arrangement between the taxpayer and its AE regarding the AMP expense for promoting the brand of the foreign AE.

  • Further, the High Court also noted that since the taxpayer was an independent manufacturer, it was incurring AMP expenses for its own benefit and not at the behest of the AE.

  • In the absence of any categorical evidence provided by the Revenue Authorities, the High Court followed the Maruti Suzuki decision and ruled out the existence of an International transaction.

In the case of Whirlpool:

  • The High Court observed that the provisions under Chapter X of the Act do envisage a ‘separate entity concept’. Therefore, there cannot be a presumption that since the taxpayer is a subsidiary of the foreign AE, its activities are dictated by the AE.

  • Once again, the High Court put the onus on the Revenue Authorities to factually demonstrate through some tangible material that the two parties acted in concert, and further, that there was an agreement to enter into an International transaction concerning AMP expenses.
  • Regarding the deductibility of AMP expenses u/s. 37 of the Act, the High Court ruled in favour of the taxpayer and held that merely because the AE is also benefitted by the AMP expenses, their allowability is not precluded.


Subsequent cases

The Delhi High Court as well as the Appellate Tribunal have been speedily disposing cases covering AMP issues by following the ratio laid down in the Sony Ericsson and Maruti Suzuki rulings. An unspoken trend seems to have been set in the pattern of disposal – while the Sony Ericsson ruling is being followed in the case of appellant who are distributors, the Maruti Suzuki ruling is being followed in the case of manufacturers.

  • In the case of Haier Appliances11, the Appellate Tribunal observed that for application of RPM, it is necessary to examine the comparability of the AMP functions performed by the Appellant with those of the comparables. In the absence of adequate information to this effect, the case was remanded back to the Revenue Authorities for fresh consideration. However, the Appellant being a distributor, the presence of an international transaction was not negated (following the ruling in Sony Ericsson case).

  •  Similarly, in the case of Johnson & Johnson12, the Appellate Tribunal held that the Revenue Authorities are duty bound to apply the existing methods under the Act (as against BLT, which has been rejected in the Sony Ericsson ruling).

  • The case of Yum Restaurants13, was remitted back by the High Court for further examination of the franchise marketing model in question. The Sony Ericsson ruling was followed in this case as well. However, here the High Court held that once a transfer pricing adjustment has been made for AMP expenses, the said expenses cannot be disallowed again u/s.40A(2)(b) of the Act.
The case of Bausch & Lomb14 involved manufacturing as well as trading activities. Here, the High Court ruled out the existence of an international transaction, following the Maruti Suzuki ruling. Further, the High Court also observed that ‘function’ needs to be distinguished from ‘transaction’ and that every expenditure forming part of a function cannot be construed as a ‘transaction’.

Is It The End Of The AMP Controversy?
The year 2015 witnessed disposal of several cases by the Delhi High Court and various benches of the Appellate Tribunal. While moving steadily ahead in its appellate journey, the AMP controversy still seems to be far from over.

A special leave petition (‘SLP’) has been filed before the Indian Supreme Court by affected taxpayers challenging the ruling of the Delhi High Court in the case of Sony Ericsson. The coming months are likely to reveal the taxpayers’ and Revenue’s responses to the other rulings of the High Court.

The High Court has not negated the existence of an international transaction where there is excessive AMP spend by Indian distributors. In such cases, the High Court has emphasised the need for comparability of the level of AMP function between the taxpayer and the independent comparable companies. If companies with comparable AMP functions cannot be found, the High Court directed necessary adjustment to even out the difference in the AMP functions. However, neither the High Court nor the Appellate Tribunals have provided any guidance on determining the level of AMP function or computing adjustment for difference in AMP functions. In absence of clear guidance, another round of litigation seems inevitable.

In the case of manufacturers, the existence of an International transaction has been ruled out in absence of specific provisions under Chapter X of the Act. The High Court has also explicitly expressed the need for a clear statutory scheme to check arbitrariness and address existing loopholes. In view of the same, one could expect some legislative amendments in the transfer pricing provisions in the upcoming budget.

The key issue that needs consideration and deliberation is whether the Indian taxpayers have incurred the AMP expenses in their capacity as service providers or as entrepreneurs on their own account. The issue of compensating for AMP function at arm’s length would arise only in case where the Indian taxpayer is incurring AMP expenses in the capacity of a service provider. The answer to this may lie in the functional analysis and conduct of the Indian tax payer and the overseas affiliate. Further, indicative facts like exclusivity, longevity of contract, premium pricing and increase in the market share, etc. could be used to demonstrate the economic ownership of the brand. Documentation by the MNE group would play the key role in helping the MNE find answers, determine the course of action and/or build appropriate defense.

Consideration also needs to be given to the mode of remunerating such service. In place of recovering the AMP expenses from the overseas affiliates, MNEs could consider remunerating the Indian taxpayers by way of higher gross margin to cover the AMP expenses. Lastly, while the MNE groups evaluate their value chains in the wake of BEPS, it may be worthwhile to consider the above implications while aligning ownership of intangible property, compensation and related structures.

1. Maruti Suzuki India Limited vs. Addl. CIT TPO [W.P.(C) 6876/2008] [2010] 328 ITR 210 (Del)

2. DHL Corporation & Subsidiaries vs. Commissioner of Internal Revenue (T.C. Memo.1998-461, December 30, 1998)

3. DHL Corporation & Subsidiaries vs. Commissioner of Internal Revenue (Ninth Circuit Court ruling, April 11

4. L.G. Electronics India Private Limited vs. Asstt. Commissioner of Income Tax (ITA No. 5140/Del/2011)

5. Haier Telecom Pvt. Ltd; Goodyear India; Glaxo Smithkline Consumer India;
Maruti Suzuki India; Sony India; Bausch & Lomb; Fujifilm Corporation; Canon
India; Diakin India; Amadeus India; Star India; Pepsi Foods India

6. Sony Ericsson Mobile Communication India Pvt. Ltd vs. Com-missioner of Income-tax (ITA No. 16/2014) (Del)

7. Maruti Suzuki India Limited vs. Commissioner of Income-tax (ITA 110/2014; ITA 710/2014) (Del)

8. With reference to meaning of ‘international transaction’ u/s. 92B(1) if the Act and meaning of ‘transaction’ u/s. 92F(v) of the Act

9. Honda Siel Power Products Limited vs. Deputy Commissioner of Income-tax [2015] 64 taxmann.com 328 (Delhi)

10. Commissioner of Income-tax – LTU vs. Whirlpool of India Limited [2015] 64 taxmann.com 324 (Delhi)

11. Haier Appliances India Limited vs. DCIT, OSD, CIT-IV [2016] 65 taxmann.com 74 (Delhi – Trib.)

12. Johnson & Johnson Limited vs. Addl. CIT – LTU (ITA No. 829/M/2014)

13. Yum Restaurants (India) (P.) Ltd. vs. Income-tax Officer [2016]
66 taxmann.com 47 (Delhi)

14. Bausch & Lomb Eyecare (India) (p.) Ltd. vs. Addl. CIT [2016] 65 taxmann.com 141 (Delhi)

Section 92B of the Act – Issuance of corporate guarantees to compensate for lack of subsidiary’s core strength to raise bank finance being in the nature of quasi capital or shareholder activity and not provision of service, does not constitute ‘international transaction’.

fiogf49gjkf0d
Facts

The Taxpayer, an Indian company, was engaged in the business of ink manufacturing. Taxpayer had a subsidiary company in USA (FCo) which manufactured ink for US markets by using material supplied by the Taxpayer. Taxpayer had issued corporate guarantees on behalf of FCo without charging any consideration for the same.

Taxpayer contended that neither these guarantees cost anything to it nor did it recover any charges for the same from FCo. Further, the guarantees were in the nature of quasi capital and not in the nature of any services. Accordingly, no income was required to be imputed.

However, the TPO computed the arm’s length price (ALP) of the corporate guarantee and proceeded to make Transfer Pricing adjustment in the hands of the Taxpayer.

Held

It is elementary that the determination of arm’s length price can only be done in respect of an ‘international transaction’. As per section 92B of the Act, an International transaction means a transaction between two or more associated enterprises (AE) either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises.

Explanation to section 92B provides that the expression “international transaction”, inter-alia, includes capital financing, including any type of long-term or short-term borrowing, lending or guarantee and provision of services. The Explanation is to be read in conjunction with the main provision. A transaction of capital financing and provision of services can be covered only in the residual part of the definition of international transaction, i.e., “any transaction having a bearing on the profits, income, losses or assets of such enterprises”. In other words, the impact on “profit, income, losses or assets” is a sine qua non and it should be on real basis and not on a contingent or hypothetical basis, for a transaction of provision of service and capital financing to fall under the ambit of ‘international transaction’.

Reliance in this regard was placed on Tribunal decision in the case of Bharti Airtel Limited [(2014)(63 SOT 113)]. It is not correct to compare corporate guarantee and bank guarantee. A bank guarantee is a surety that the bank or the financial institution issuing the guarantee provides by committing that banks, will pay off the debts and liabilities incurred by an individual or a business entity in case they are unable to do so. Even when such guarantees are backed by one hundred percent deposits, the bank charges guarantee fee. However, corporate guarantee is issued without any security or underlying assets. There is no recourse available with the guarantor if there is any default. Such guarantees are issued based upon the business needs and group synergies and not based on the risk assessment or underlying asset which generally the banks ask for.

Corporate guarantees can also be a mode of ownership contribution, particularly where a guarantee given compensates for the inadequacies in the financial position of the borrower. There can be number of reasons, including regulatory issues and market conditions in the related jurisdictions, in which such a contribution, by way of a guarantee, would justify to be a more appropriate and preferred mode of contribution vis-a-vis equity contribution. For these reasons, bank guarantees are not comparable with corporate guarantees.

In the facts of the present case, guarantee has been provided to compensate for lack of core strength of the subsidiary for raising the finances from bank. Nothing was brought on record to contradict the same. Therefore the transaction of issuance of corporate guarantee is in the nature of shareholder activity and not provision of service. A transaction which is in the nature of shareholder activity does not amount to “provision of services”. Hence, it is outside the ambit of international transaction. Even if issuance of corporate guarantee is to be treated as ‘provision for service’, such service would need to be re-characterised in tune with commercial reality, as no independent enterprise would issue a guarantee without an underlying security. Reliance for this was placed on the decision of EKL Appliances [(2012) 345 ITR 241 (Del)]

Further, where the issuance of a corporate guarantee does not have a bearing on the profits, income, losses or assets, it does not constitute an international transaction. In the present case, the taxpayer had extended corporate guarantee to FCo. The guarantee did not cost anything to the Taxpayer and the Taxpayer could not have realised money by giving such guarantee to someone else during the course of its normal business. Thus, such arrangement did not impact the profits, income, losses or assets of Taxpayer. Hence, it falls outside the ambit of international transaction u/s. 92B of the Act.

Article 12 of India-Netherlands Double Tax avoidance Agreement (DTAA) – Payment of composite consideration for various interdependent services rendered as part of the basic refinery service package should be apportioned between chargeable technical services and non-chargeable commercial services.

fiogf49gjkf0d
Facts

Taxpayer, a company incorporated and tax resident of Netherlands, rendered certain services to an Indian Company (ICo), who owned and operated refineries in India. These services contained two parts – basic refinery service package and certain optional services.

As part of the basic services, Taxpayer was required to provide ICo with certain deliverables such as manuals, guidelines, standards, etc., which were developed by the Taxpayer based on its expertise and experience in running refineries. Additionally after referring to the manuals if the employees of ICo required any personal assistance or advice, Taxpayer would render the requisite consultancy services and assistance to ICo.

As part of optional services, Taxpayer, when specifically requested by ICo, was required to provide consultancy services and assistance relating to various commercial or technical aspects of the day to day operations of the refinery.

Taxpayer contended that some part of basic refinery services represented supply of goods in the form of deliverables such as training manuals, guidelines, etc., and consideration for such outright transfer, was not in the nature of fee for technical services (FTS) under the India-Netherlands DTAA .

Further, Taxpayer contended that certain part of basic refinery package which were commercial in nature did not qualify as technical service. In any case, such service did not ‘make available’ any technical knowledge, experience, skill, know-how. By virtue of the MFN clause in the India-Netherlands DTAA , the make available condition contained in the India-USA DTAA can be read into India-Netherlands DTAA and since services rendered by Taxpayer did not satisfy the make available condition, it did not fall within the definition of fees for technical services of India-Netherlands DTAA . Taxpayer offered the balance portion as taxable in terms of India-Netherlands DTAA .

However, Tax Authority contended that the payments made by ICo towards basic refinery services was composite payment for holistic technical services and which cannot be split into technical and commercial services. Also, it is not correct to suggest that some part of services satisfy “make available” condition and other part of service does not satisfy “make available” condition. Accordingly, entire consideration should be treated as FTS even under the DTAA . Tax Authority also contended that India-Netherlands DTAA should be interpreted independently without making reference to the MOU between India-USA.

Held

Most Favoured Nation (MFN) clause of India-Netherland DTAA provides that if under any DTAA , 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 in the India- Netherlands DTAA , the same rate or scope shall apply under the India- Netherlands DTAA also. India-USA DTAA provides a restricted definition of FIS, wherein services can be regarded to fall within the scope of FTS only if the same makes available technical knowledge, skill etc.

By virtue of MFN clause in India- Netherlands DTAA , FTS Article of India-Netherlands DTAA would stand amended in light of the beneficial provisions in India-USA DTAA.

Further, in terms of specific Notification, the MOU between India and USA with reference to Article 12 applies mutatis mutandis to India-Netherlands DTAA .

Certain services rendered as part of the basic refinery services, did not involve any transfer of technology and hence cannot be treated as FTS. Further services in relation to physical delivery of manuals, etc. would also not constitute FTS. The fact that these services or physical deliverables are interlinked with certain technical services does not alter the basic character of these services and physical deliverables.

The mere fact that the overall package is considered as a whole and the services are interlinked cannot be the basis for not apportioning the consideration. The consideration under the composite contract needs to be apportioned between chargeable technical services and non chargeable commercial services.

Framework of Sources of Exchange of Information in Tax Matters – An Overview

fiogf49gjkf0d
Introduction and Need for Exchange of Information [EoI]

Tackling
offshore tax evasion and tax avoidance and unearthing of unaccounted
money stashed abroad have become a pressing concern for governments all
around the world. The information and/or evidence of such tax
avoidance/evasion and the underlying criminal activity is often located
outside the territorial jurisdiction and thus this menace can be
addressed only through bilateral and multilateral cooperation amongst
tax and other authorities. India has played an important role in
international forums in developing international consensus for such
cooperation as per globally accepted norms and continuous monitoring of
their adoption by every jurisdiction including offshore financial
centres.

Initially, the international norms were to provide
assistance to other countries only on satisfaction of the norms of “dual
criminality”, i.e., in cases of drug trafficking, corruption, terrorist
financing etc. which are criminal activities in both countries.
However, at present the cooperation has extended to cases of tax evasion
and avoidance and countries are obliged to exchange information
requested as per provisions of tax treaties/agreements. The third stage
of cooperation would be automatic exchange of financial account
information without countries having to make requests for the same,
thereby enabling the receiving country to verify whether such accounts
indicate tax evaded money and to take necessary action. Despite a global
consensus on coordinated action to tackle the problem of tax evasion
and tax avoidance, foreign governments, particularly offshore financial
centres, are most unlikely to provide information on the basis of just
letters or on a plea regarding their moral obligations to prevent tax
evasion. Among other factors, parting with information without a legal
basis may be challenged in their own Courts and may be against their own
public policy or public opinion of their citizens. Such information
about money and assets hidden abroad and about undisclosed transactions
entered into overseas, can be obtained only through “legal instruments”
or treaties entered into between India and those countries.

Tax
Treaties, which include, Double Taxation Avoidance Agreements (DTAA s),
Tax Information Exchange Agreements (TIEAs), Multilateral Convention on
Mutual Administrative Assistance in Tax Matters (Multilateral
Convention) and SAARC Limited Multilateral Agreement (SAARC Agreement),
are the legal instruments which provide a legal obligation on a
reciprocal basis for providing various forms of administrative
assistance, including Exchange of Information, Assistance in Collection
of Taxes, Tax Examination Abroad, Joint Audit, Service of Documents etc.
Through one or more of these tax treaties, India has exchange of
information relationships with more than 130 countries/jurisdictions
including well known offshore financial centres and these jurisdictions
are legally committed to provide administrative assistance and are
actually providing the same in cases where requests are made.
Information and other forms of assistance can also be requested through
Mutual Legal Assistance Treaties (MLAT s) through Ministry of Home
Affairs, particularly with countries/jurisdictions with which there is
no tax treaty. Information/evidence obtained through MLAT s can also
supplement the information received under tax treaties when a criminal
complaint is made for tax evasion on the basis of information received
under tax treaties. Information can also be obtained through Egmont
Group of Financial Intelligence Units (FIUs) which may be further
supplemented by making further requests under tax treaties/ MLAT s.

Despite
the existence of legal instruments for administrative assistance and
the willingness of India’s treaty partners to provide information, these
provisions are still underutilised, largely because tax officials are
not fully aware of the provisions and need guidance for framing
effective requests for information under appropriate legal instruments.
The taxpayers, their advisers and the tax officers may also not be fully
aware of the recent international developments in transparency
including the global adoption of the new standards on automatic exchange
of information, which will bring about a sea-change in India’s ability
to receive and utilize information regarding Indians having financial
accounts in offshore financial centres.

Thus there are nine major sources of EoI of various kinds relating to tax matters, which are summarised below:

1. EoI Article under the Model Conventions on Income and on Capital

2. Tax information Exchange Agreements [TIEAs]

3.
Automatic Exchange of Information [AEoI] under The Multilateral
Convention on Mutual Administrative Assistance in Tax Matters [CoMAA]
alongwith Multilateral Competent Authority Agreement on Automatic
Exchange of Financial Account Information [MCAA]

4. EoI under
Inter-Governmental Agreement [IGA] and Memorandum of Understanding (MoU)
between India and USA to improve International Tax Compliance and to
implement Foreign Account Tax Compliance Act [FAT CA] of the USA

5. SAARC Limited Multilateral Agreement [SAARC Agreement]

6. Mutual Legal Assistance Treaties [MLAT s]

7. The Egmont Group Financial Intelligence Units (FIUs)

8. Joint International Tax Shelter Information & Collaboration – JITSIC

9. EoI under Base Erosion and Profit Shifting [BEPS] Project.

Brief
outline of nine major sources of EoI of various kinds, is as under: In
this article, we aim to introduce to the readers various sources of EoI
amongst various authorities and various countries. Each one of the above
are discussed below in brief:

Sr. No. Source of EOI
Type of EoI and Purpose
1 Article 26 -OECD
Model Convention 		EoI under bilateral DTAA framework covering
EoI on request, Spontaneous and Automatic
EoI
2 TIEA TIEA facilitates EoI with countries where comprehensive
DTAA is non-existent to promote
international co-operation in tax matters
3 CoMAA EoI including AEoI in tax matters under the
most comprehensive Multilateral Convention.
AEoI is facilitated by MCAA.
4 IGA-FATCA AEoI on a reciprocal basis under the IGA
signed with USA
5 SAARC Agreement Limited Multilateral Agreement incorporating
EoI amongst 7 SAARC member Countries
6 MLATs EoI and mutual assistance in criminal matters,
inter alia, involving tax evasion
7 Egmont group of
FIUs		 International co-operation including EoI against
money laundering and financing of terrorism –
8 JITSIC To enhance collaboration amongst tax administrators
enabling EoI to combat multinational tax
evasion and to counter abusive tax schemes
and tax avoidance structures
9 Action plan 5,12
& 13 – BEPS project		 EoI including automatic exchange of countryby-
country reports, spontaneous exchange of
rulings and exchange of mandatory disclosure
regimes
1. Exchange of Information [EoI] Article under the Model Conventions on Income and on Capital

(a)
1928 Model developed by the League of Nations provided for provision of
Information on request and for Automatic EoI relating to Specific
Categories such as Immovable properties etc. In the London and Mexico
draft models of 1946, a Draft Agreement on Administrative Co-operation
was included. Both the Obligation and Form of Information Exchange were
narrowed during the formalisation of OECD Model after World War-II by
removing the obligation for Automatic Exchange of Information. The Draft
OECD Model was first developed in 1963 which contained Article on EoI.
Until 8th Edition released in 2010, Article 26 of the OECD Model
Convention contained the pre-updated version of Article 26. On 17th
July, 2012 Update to Article 26 and its commentary was approved by OECD
Council which extensively revised the commentary on Article 26. There
are three forms of EoI (On Request, Automatic and Spontaneous). Para 9
of the Commentary on Article 26 provides that all three forms of EoI are
covered by the Article.

In the update, in para 2 of Article 26
the following sentence was added: “Notwithstanding the foregoing,
information received by a Contracting State may be used for other
purposes when such information may be used for such other purposes under
the laws of both States and the competent authority of the supplying
State authorises such use.” Many of India’s DTAA s signed before July
2012 have been amended in recent past by way of Protocols to incorporate
the updated EoI Article. Most of the India’s DTAA s signed before July
2012 contain pre-updated Article 26 and DTAA s signed after July 2012
contain updated Article 26. (b) OE CD Model Convention – Text of Article
26 – Exchange of Information Text of the updated Article 26 of the OECD
Model Convention is reproduced below for ready reference: 1. The
competent authorities of the Contracting States shall exchange such
information as is foreseeably relevant for carrying out the provisions
of this Convention or to the administration or enforcement of the
domestic laws concerning taxes of every kind and description imposed on
behalf of the Contracting States, or of their political subdivisions or
local authorities, insofar as the taxation thereunder is not contrary to
the Convention. The exchange of information is not restricted by
Articles 1 and 2. 2. Any information received under paragraph 1 by a
Contracting State shall be treated as secret in the same manner as
information obtained under the domestic laws of that State and shall be
disclosed only to persons or authorities (including courts and
administrative bodies) concerned with the assessment or collection of,
the enforcement or prosecution in respect of, the determination of
appeals in relation to the taxes referred to in paragraph 1, or the
oversight of the above. Such persons or authorities shall use the
information only for such purposes. They may disclose the information in
public court proceedings or in judicial decisions. Notwithstanding the
foregoing, information received by a Contracting State may be used for
other purposes when such information may be used for such other purposes
under the laws of both States and the competent authority of the
supplying State authorises such use. 3. In no case shall the provisions
of paragraphs 1 and 2 be construed so as to impose on a Contracting
State the obligation: a) to carry out administrative measures at
variance with the laws and administrative practice of that or of the
other Contracting State; b) to supply information which is not
obtainable under the laws or in the normal course of the administration
of that or of the other Contracting State; c) to supply information
which would disclose any trade, business, industrial, commercial or
professional secret or trade process, or information the disclosure of
which would be contrary to public policy (ordre public). 4. If
information is requested by a Contracting State in accordance with this
Article, the other Contracting State shall use its information gathering
measures to obtain the requested information, even though that other
State may not need such information for its own tax purposes. The
obligation contained in the preceding sentence is subject to the
limitations of paragraph 3 but in no case shall such limitations be
construed to permit a Contracting State to decline to supply information
solely because it has no domestic interest in such information. 5. In
no case shall the provisions of paragraph 3 be construed to permit a
Contracting State to decline to supply information solely because the
information is held by a bank, other financial institution, nominee or
person acting in an agency or a fiduciary capacity or because it relates
to ownership interests in a person.” 2. Tax information Exchange
Agreements [TIEAs] The Model TIEA was released in April 2002, containing
Two Models of Bilateral Agreements. The Model TIEA covered only EoI on
Request. A large No. of bilateral agreements have been based on Model
TIEA. In June 2015, OECD approved a Model Protocol to the TIEA for the
purpose of allowing Automatic and Spontaneous exchange of information
under a TIEA. India has so far signed 16 TIEAs with countries with whom
India has not signed a Comprehensive DTAA , namely: Argentine, Bahrain,
Belize, Gibralter, Principality of Liechtenstein, Liberia, Macao SAR,
Monaco, Bahamas,

Bermuda, British Virgin Islands, Cayman Islands, Guernsey, Isle of Man, Jersey and Maldives.

The Model TIEA contains the following Articles:

Article Article heading
1 Object and Scope of the Agreement
2 Jurisdiction.
3 Taxes Covered
4 Definitions
5 Exchange of Information upon Request
6 Tax Examinations Abroad
7 Possibility of Declining a request
8 Confidentiality
9 Costs
10 Implementation Legislation
11 Language [This article may not be required in Bilateral TIEA.]
12 Implementation Legislation
13 Other international agreements or arrangements [This article may
not be required in Bilateral TIEA.]
14 Mutual Agreement Procedure
15 Depositary’s functions [This article may not be required in Bilateral
TIEA.]
16 Entry into Force
17 Termination

3. The Multilateral Convention on Mutual Administrative Assistance in Tax Matters [Co- MAA]

The
CoMAA was developed jointly by the OECD and the Council of Europe in
1988 and amended by Protocol in 2010. The CoMAA was amended to align it
to the international standard on exchange of information on request and
to open it to all countries. The amended Convention was opened for
signature on 1st June 2011.

The CoMAA has now taken an
increasing importance with the G20’s recent call for automatic exchange
of information to become the new international tax standard of exchange
of information.

As of 27-11-2015, 77 countries, including India
have signed the CoMAA and it has been extended to 15 jurisdictions
pursuant to Article 29 of The CoMAA. This represents a wide range of
countries including all G20 countries, all BRICS, almost all OECD
countries, major financial centres and a growing number of developing
countries.

India signed the CoMAA on 26-1-2012 which was notified on 28-8-2012 and which entered into force wef 1-6-2012.

a. Relevance of the CoMAA

  •  Designed
    to facilitate international co-operation among tax authorities to
    improve their ability to tackle tax evasion and avoidance and ensure
    full implementation of their national tax laws, while respecting the
    fundamental rights of taxpayers.
  •  Most comprehensive multilateral instrument available for tax cooperation and exchange of information.
  • Provides for all possible forms of administrative cooperation between states in the assessment and collection of taxes.
  • Co-operation
    includes automatic exchange of information, simultaneous tax
    examinations and international assistance in the collection of tax
    debts.

b.Benefits of the CoMAA

Scope of the Convention is broad: it covers a wide range of taxes and goes beyond exchange of information on request.

  •  Provides
    for other forms of assistance such as: spontaneous exchanges of
    information, simultaneous examinations, performance of tax examinations
    abroad, service of documents, assistance in recovery of tax claims and
    measures of conservancy and automatic exchange of information.
  • Facilitates joint audits.
  • Includes extensive safeguards to protect the confidentiality of the information exchanged.

c. Chapter III Section I – Article 4 to 5 relevant for EoI

The text of the same are given below for ready reference. Article 4 – General Provision

 “1.
The Parties shall exchange any information, in particular as provided
in this section, that is foreseeably relevant for the administration or
enforcement of their domestic laws concerning the taxes covered by this
Convention.

2. Deleted.

3. Any Party may, by a
declaration addressed to one of the Depositaries, indicate that,
according to its internal legislation, its authorities may inform its
resident or national before transmitting information concerning him, in
conformity with Articles 5 and 7.

Article 5 – Exchange of Information on Request

“1.
At the request of the applicant State, the requested State shall
provide the applicant State with any information referred to in Article 4
which concerns particular persons or transactions.

2. If the
information available in the tax files of the requested State is not
sufficient to enable it to comply with the request for information, that
State shall take all relevant measures to provide the applicant State
with the information requested.”

d. The CoMAA and Automatic Exchange of Information

Article
6 of the CoMAA provides for AEoI. It is an ideal instrument to
implement AEoI swiftly and multilaterally. To implement Article 6, an
administrative agreement between the competent authorities of two or
more interested Parties to the Convention is required. It would address
issues such as the procedure to be adopted and the information that will
be exchanged automatically.

Sharing of information with other
law enforcement authorities to counteract corruption, money laundering
and terrorism financing is permissible subject to certain conditions;
information received by a Party may be used for other purposes when

(i) such information may be used for such other purposes under the laws of the supplying Party and
(ii) the competent authority of that Party authorises such use.

e. Main benefits of Automatic Exchange

  • AE
    oI can provide timely information on non-compliance where tax has been
    evaded either on an investment return or the underlying capital sum.
  • Help detect cases of non-compliance even where tax administrations have had no previous indications of non-compliance.
  • Has deterrent effects, increasing voluntary compliance and encouraging taxpayers to report all relevant information.
  • Help
    in educating taxpayers in their reporting obligations, increase tax
    revenues and thus lead to fairness – ensuring that all taxpayers pay
    their fair share of tax in the right place at the right time.
  • Possibility
    to integrate the information received automatically with their own
    systems such that income tax returns can be prefilled.

f. Chapter III Section I – Article 6 to 10 relevant for AEoI

The text of the same are given below for ready reference. Article 6 – Automatic Exchange of Information

“With
respect to categories of cases and in accordance with procedures which
they shall determine by mutual agreement, two or more Parties shall
automatically exchange the information referred to in Article 4.”

Article 7 – Spontaneous Exchange of Information

“1.
A Party shall, without prior request, forward to another Party
information of which it has knowledge in the following circumstances:

a. the first-mentioned Party has grounds for supposing that there may be a loss of tax in the other Party;
b.
a person liable to tax obtains a reduction in or an exemption from tax
in the first mentioned Party which would give rise to an increase in tax
or to liability to tax in the other Party;
c. business dealings
between a person liable to tax in a Party and a person liable to tax in
another Party are conducted through one or more countries in such a way
that a saving in tax may result in one or the other Party or in both;
d.
a Party has grounds for supposing that a saving of tax may result from
artificial transfers of profits within groups of enterprises;
e.
information forwarded to the first-mentioned Party by the other Party
has enabled information to be obtained which may be relevant in
assessing liability to tax in the latter Party.

2. Each Party
shall take such measures and implement such procedures as are necessary
to ensure that information described in paragraph 1 will be made
available for transmission to another Party.”

Article 8 – Simultaneous Tax Examinations

“1.
At the request of one of them, two or more Parties shall consult
together for the purposes of determining cases and procedures for
simultaneous tax examinations. Each Party involved shall decide whether
or not it wishes to participate in a particular simultaneous tax
examination. 2. For the purposes of this Convention, a simultaneous tax
examination means an arrangement between two or more Parties to examine
simultaneously, each in its own territory, the tax affairs of a person
or persons in which they have a common or related interest, with a view
to exchanging any relevant information which they so obtain.”

Article 9 – Tax Examinations Abroad

“1.
At the request of the competent authority of the applicant State, the
competent authority of the requested State may allow representatives of
the competent authority of the applicant State to be present at the
appropriate part of a tax examination in the requested State.

2.
If the request is acceded to, the competent authority of the requested
State shall, as soon as possible, notify the competent authority of the
applicant State about the time and place of the examination, the
authority or official designated to carry out the examination and the
procedures and conditions required by the requested State for the
conduct of the examination. All decisions with respect to the conduct of
the tax examination shall be made by the requested State.

3. A
Party may inform one of the Depositaries of its intention not to accept,
as a general rule, such requests as are referred to in paragraph 1.
Such a declaration may be made or withdrawn at any time.”

Article 10 – Conflicting Information

“If
a Party receives from another Party information about a person’s tax
affairs which appears to it to conflict with information in its
possession, it shall so advise the Party which has provided the
information.”

g. Confidentiality of Information Exchanged under Co- MAA and Protection of taxpayers’ rights

  • The CoMAA has strict rules to protect the confidentiality of the information exchanged.
  • Provides
    that information shall be treated as secret and protected in the
    receiving State in the same manner as information obtained under its
    domestic laws.
  • If personal data are provided, the Party
    receiving them shall treat them in compliance not only with its own
    domestic law, but also with the safeguards that may be required to
    ensure data protection under the domestic law of the supplying Party.

h. Articles of Model CoMAA

The outline of the contents of the Model CoMAA is as under:

i. Standard for Automatic Exchange of Financial Account information in Tax Matters [Standard]

For facilitating the AEoI amongst various countries, OECD has developed a Standard. The Standard sets out

Chapter/Section/
Article		 Chapter / Section/ Article heading
Chapter I Scope of the convention
1 Object of the convention and persons covered
2 Taxes Covered
Chapter II General Definitions
3 Definitions
Chapter III Forms of Assistance
Section I Exchange of Information
4 General Provision
5 Exchange of Information on Request
6 Automatic Exchange of Information
7 Spontaneous Exchange of Information
8 Simultaneous Tax Examinations
9 Tax Examinations Abroad
10 Conflicting Information
Section II Assistance in Recovery
11 Recovery of Tax Claims
12 Measures of Conservancy
13 Documents accompanying the Request
14 Time Limits
15 Priority
16 Deferral of Payment
Section III Service of Documents
17 Service of Documents
Chapter IV Provisions relating to all forms of assistance
18 Information to be provided by the Applicant State
19 Deleted
20 Response to the Request for Assistance
21 Protection of Persons and Limits to the Obligation to provide
Assistance
22 Secrecy
23 Proceedings
Chapter V Special Provisions
24 Implementation of the convention
25 Language
26 Costs
Chapter VI Final Provisions
27 Other international agreements or arrangements
28 Signature and entry into force of the convention
29 Territorial application of the convention
30 Reservations
31 Denunciation
32 Depositaries and their functions
the financial account information to be exchanged, the financial
institutions & intermediaries that need to report, the different
types of accounts and taxpayers covered, as well as common due diligence
procedures to be followed by the financial institutions &
intermediaries. It consists of two components: (I) the CRS, which
contains the reporting and due diligence rules to be imposed on
financial institutions; and(II) the Model Competent Authority Agreement
[Model CAA], which contains the detailed rules on the exchange of
information.

The full version of the Standard, as approved by
the Council of the OECD on 15 July 2014, also includes the Commentaries
on the Model CAA and the CRS, and following seven annexes to the
Standard:

1. M ultilateral Model CAA;
2. N onreciprocal Model CAA;
3. CRS schema and user guide;
4. Example questionnaire with respect to confidentiality and data safeguards;
5. Wider Approach to the CRS;
6. Declaration on Automatic Exchange of Information in Tax Matters; and
7. Recommendation on the Standard.

j. Confidentiality of the Information Exchanged

The
Standard contains specific rules on the confidentiality of the
information exchanged and the underlying international legal exchange
instruments already contain safeguards in this regard.

  • Where the Standard is not met (whether in law or in practice), countries will not exchange information automatically.
  • To
    facilitate the decision making by Global Forum members as to which
    jurisdictions they will automatically exchange information with, the
    Global Forum AEOI Group is undertaking high level assessments of the
    confidentiality and data safeguards of jurisdictions committed to AEOI.
    Centralising this work in the Global Forum will further assist
    jurisdictions in speedily implementing AEOI, by reducing the need for
    each jurisdiction to conduct its own assessment of the information
    security practices of each of the many jurisdictions committed to
    implementing AEOI. The process is now underway with the first batch of
    around 50 assessments due to be finalised by the end of 2015 and the
    assessments with respect to the remaining committed jurisdictions due to
    be finalised by mid-2016.

k. Implementation of Standard at domestic level

  • No particular timelines in the Standard.
  • Implementation at co-ordinated timelines would bring benefits for both business and governments.
  • Over
    95 jurisdictions have already publicly committed to implement the
    Standard, either through the signing of the Multilateral Competent
    Authority Agreement, the G20 or the Global Forum commitment process,
    with first exchanges of information to occur in 2017 or 2018.

 l. Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information [MCAA]

The Agreement contains 8 sections and 6 Annexes as follows:

Section Section heading
1 Definitions
2 Exchange of Information with respect to Reportable Accounts
3 Time and Manner of Exchange of Information
4 Collaboration on Compliance and Enforcement
5 Confidentiality and Data Safeguards
6 Consultations and Amendments
7 Term of Agreement
7 Co-ordinating Body Secretariat
Annex Annex heading
A List of Non-reciprocal Jurisdictions
B Transmission Methods
C Specified Data Safeguards
D Confidentiality Questionnaire
E Competent Authorities for which this is an Agreement in effect
F Intended Exchange Dates

4. EoI under IGA re FATCA

FATCA is a USA law which seeks
to facilitate flow of financial information. FAT CA requires Indian
banks to reveal account information of persons connected to the USA.
Indian financial institutions in India, i.e. an insurance company, bank,
or mutual fund, would be required to report all FAT CA-related
information to Indian governmental agencies, which would then report
these information to Internal Revenue Service (IRS). Indian Financial
Institutions must report account numbers, balances, names, addresses,
and U.S. identification numbers. There is punitive 30% withholding tax
on any financial institution that fails to report.

India signed a
Model 1 (reciprocal) IGA with the U.S which is notified vide
Notification No. 77/2015 dated 30- 9-2015. For effective implementation
of FAT CA, Rules 115G to 115H has been notified vide Notification no.
62/2015 dated 7-8-2015. The IGA would require Indian financial
institutions to report information on U.S. account holders to India’s
CBDT, which would then share the information with the U.S. IRS. The
agreement would provide the IRS, access to details of all offshore
accounts and assets beyond a threshold limit held by American citizens
in India, while a reciprocal arrangement would be offered for Indian tax
authorities as well.

a. Articles of India-USA IGA
The contents of the Agreement are as follows:

Article Article heading
1 Definitions
2 Obligations to obtain and Exchange Information with respect
to Reportable Accounts
3 Time and Manner of Exchange of Information
4 Application of FATCA to Indian Financial Institutions
5 Collaboration on Compliance and Enforcement
6 Mutual commitment to continue to enhance the effectiveness
of Information Exchange and Transparency
7 Consistency in the application of FATCA to Partner Jurisdictions
8 Consultations and Amendments
9 Annexes
10 Term of Agreement
Annex Annex heading
I Due Diligence obligations for identifying and reporting on U.S.
Reportable Accounts and on payments to certain nonparticipating
financial institutions
II List of Entities treated as exempt beneficial owners or
deemed-compliant FFIs and accounts excluded from the
definition of Financial Accounts

Memorandum of Understanding [MoU]
b. Main differences between the Standard and FATCA

  • The Standard consists of a fully reciprocal automatic exchange system from which US specificities have been removed.
  • It is based on residence and unlike FAT CA does not refer to citizenship.
  • Terms,
    concepts and approaches have been standardised allowing countries to
    use the system without having to negotiate individual annexes.
  • Unlike
    FAT CA, the Standard does not provide for thresholds for pre-existing
    individual accounts, but it includes a residence address test building
    on the EU Savings Directive.
  • It also provides for a simplified indicia search for such accounts.
  • It
    has special rules dealing with certain investment entities where they
    are based in jurisdictions that do not participate in automatic exchange
    under the Standard. 5. SAARC Limited Multilateral Agreement SAARC
    Limited Multilateral Agreement (SAARC Agreement) is a multilateral
    agreement amongst SAARC countries and has been in force since 1st April,
    2011. It has provisions for a wide range of administrative assistance
    including EoI on a reciprocal basis. SAARC comprises of 7 countries i.e.
    Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka. The
    text of Article 5 of the SAARC Agreement, relating to EoI is given
    below for ready reference.

“Article 5 – Exchange of Information

1.
The Competent Authorities of the Member States shall exchange such
information, including documents and public documents or certified
copies thereof, as is necessary for carrying out the provisions of this
Agreement or of the domestic laws of the Member States concerning taxes
covered by this agreement insofar as the taxation thereunder is not
contrary to the Agreement. Any information received by a Member State
shall be treated as secret in the same manner as information obtained
under the domestic laws of that Member State and shall be disclosed only
to persons or authorities (including courts and administrative bodies)
concerned with the assessment or collection of, the enforcement or
prosecution in respect of, or the determination of appeals in relation
to the taxes covered by the agreement. Such persons or authorities shall
use the information only for such purposes. They may disclose the
information in public court proceedings or in judicial decisions.

2. In no case shall the provisions of paragraph 1 be construed so as to impose on a Member State the obligation:
(a)
to carry out administrative measures at variance with the laws and
administrative practices of that or of the other Member State;
(b)
to supply information, including documents and public documents or
certified copies thereof, which are not obtainable under the laws or in
the normal course of the administration of that or of the other Member
State;
(c) to supply information which would disclose any trade,
business, industrial, commercial or professional secret or trade
process, or information, the disclosure of which would be contrary to
public policy (ordre public).”

6. Mutual Legal Assistance Treaties [MLATs]

The MLAT s are legal instruments through which the Contracting States agree to provide each other with the

widest measures of mutual legal assistance in criminal
matters emanating out of proceedings under direct taxes
and not for other tax enquiries. India has a MLAT with 39
countries enabling assistance from countries with which
there is no tax treaty such as Hong Kong.

The scope of cooperation is different in various MLAT s
but is normally quite wide and may include the following:

  • Provision of information, documents and other records
  • Taking of evidence and obtaining of statements of
    persons
  • Location and identification of persons and objects Execution of requests for search and seizure
  • Measures to locate, restrain and forfeit the proceeds
    and instruments of crime
  • Facilitating the personal appearance of the persons
    giving evidence
  • Service of documents including judicial documents
  • Delivery of property, including lending of exhibits
  • Other assistance consistent with the objects of the
    MLAT which is not inconsistent with the law of the requested
    State (catch all provision).

7. The Egmont Group Financial Intelligence
Units (FIUs)

The Egmont Group is an informal network of FIUs established
with a view to have international cooperation
including information exchange in the fight against
money laundering and financing of terrorism. As on 1st
May, 2015, FIUs of 147 countries are part of the Egmont
Group. The FIUs of the Group exchange information in
accordance with Egmont Principles for Information Exchange
and Operational Guidance for FIUs, which is
available on the Internet.

The tax authorities may request information available
with FIUs of other countries through FIU-IND (the Indian
FIU) using the information exchange mechanism of the
Egmont Group.

MoU between FIU and CBDT

On 20th September, 2013, a Memorandum of Understanding
(MoU) was entered into between FIU and CBDT
in which it has been provided that if CBDT requires information
from a foreign FIU, a request will be made to
FIU-IND in Egmont prescribed proforma in electronic
format and CBDT shall abide by the conditions that may
be imposed by the foreign FIU on the use of information
provided by the foreign FIU.

Clause Clause heading
1 General
2 Exchange of Information
3 Data Protection and Confidentiality

8. Joint International Tax Shelter Information & Collaboration – JITSIC

The
original Joint International Tax Shelter Information Centre was created
in 2004 as a joint revenue authority initiative of Australia, Canada,
the United Kingdom and the United States to counter abusive tax schemes
and tax avoidance structures. Later on, Japan, Germany, South Korea,
France and China joined the JITSIC. The Competent Authorities of these
countries exchange information through the legal instrument of DTAA s
including sharing expertise relating to the identification and
understanding of abusive tax arrangements. Under the JITSIC framework,
the Competent Authorities are able to put the various international
pieces together to examine complex cross border transactions, such as
non-commercial capital and finance arrangements, aggressive transfer
pricing strategies and foreign tax credit generation schemes. Similarly,
structures involving tax havens and trust structures in connection with
high net wealth individuals also came under JITSIC scrutiny.

Recognising
that the information exchanges should not be limited to the original
JITSIC member countries, on a call from G20, the Forum on Tax
Administration A) of the OECD in its 9th Meeting in Dublin on 24th
October, 2014, determined that the composition of JITSIC would be
expanded and remodeled with a greater focus on collaboration. Reflecting
this change, the taskforce was renamed as the Joint International Tax
Shelter Information & Collaboration (still called JITSIC) with an
emphasis on collaboration on information exchange and a de-emphasis on
the need for exchange to occur through central hubs. The JITSIC Network
is open to all FTA members on a voluntary basis and integrates existing
JITSIC cooperation procedures among tax administrators within the larger
FTA network. India has joined the JITSIC Network and Joint Secretary
(FT&TR-I) has been appointed as the Single Point of Contact for
India.

9. EoI under BEPS Project

Base Erosion and
Profit Shifting refers to strategies adopted by taxpayers having
cross-border operations to exploit gaps and mismatches in tax rules of
different jurisdictions which enable them to shift profits outside the
jurisdiction where the economic activities giving rise to profits
areperformed and where value is created. At the request of G20 Finance
Ministers, in July 2013 the OECD, working with G20 countries, launched
an Action Plan on BEPS, identifying 15 specific actions needed in order
to equip governments with the domestic and international instruments to
address this challenge.

A number of recommendations for
combating BEPS envisage enhanced cooperation amongst the tax
administrations and exchange of information as per the provisions of the
existing network of tax treaties, including the following:

a. Automatic Exchange of Country by Country [CbC] Reports – Action 13

Action 13 of the BEPS Action Plan relates to a three-tiered standardised approach to transfer-pricing documentation comprising:

  • a master file of information relating to the global operations of the MNE Group, which will be filed by all MNE group members,
  • a local file referring specifically to material transactions of the local taxpayer, and
  • a
    CbC report of information relating to the global allocation of the MNE
    group’s income and taxes paid, alongwith certain indicators of economic
    activity. While the master file and local file will be filed by the
    taxpayer in the local jurisdiction, the CbC report will be filed in the
    country where the MNE is resident and will be transmitted on an
    automatic basis to the jurisdictions in which the MNE operates through a
    multilateral instrument modelled on the basis of MCAA, maintaining
    confidentiality and data safeguarding standards.

b. Spontaneous Exchange of Rulings – Action 5

Action
5 of the BEPS Project relates to countering harmful tax practices more
effectively taking into account transparency and substance. To address
this, the taxpayer specific rulings related to tax regimes resulting in
BEPS need to be mandatorily exchanged on a spontaneous basis.
Taxpayer-specific rulings for this purpose would include both
pre-transaction, including advance tax rulings or clearances and advance
pricing agreements, and post transaction.

c. Exchange of Mandatory Disclosure Regimes – Action 12 Under

Action
12, modular rules for mandatory disclosure of aggressive or abusive
transactions, arrangements, or structures would be recommended to enable
tax administrators to receive information about tax planning strategies
at an early stage so as to respond quickly to tax risks either through
timely and informed changes to legislation and regulations or through
improved risk assessment and compliance programmes (targeted audits).
Under these rules, the “international tax schemes” would also be
disclosed and the same may be shared by tax administrators using the
mechanism of EoI

This Article gives only a brief overview of the
framework of the Exchange of Information in Tax matters. The subject is
receiving increasing attention of the Governments and Tax
Administrations of various countries. It is very important for the
taxpayers & their advisors to gain an in-depth understanding of the
evolving subject. Therefore, the reader needs to study the relevant
Agreements / MOUs / Protocols / Standards in greater detail.

TS-113-ITAT-2016 (Mum) Rheinbraun Engineering Und Wasser GmbH v DDIT A.Y. 2002-03, Date of Order: 4th March, 2016

fiogf49gjkf0d
Article 7, 12 of India-Germany DTAA – provision of consulting services for exploration, mining and extraction do not constitute PE in India under India-Germany DTAA.

Facts
The Taxpayer was a German company engaged in providing consulting services in relation to exploration, mining and extraction. During the relevant year, the Taxpayer had received remuneration from three Indian companies (ICo) for rendering Consultancy services in relation to exploration, mining and extraction projects undertaken by ICo. The Taxpayer offered the income from such services to tax as Fee for technical services (FTS) under Article 12 of India-Germany DTAA .

In the course of assessment, the AO observed that the project undertaken by ICo lasted for more than six months. Accordingly, the AO held that the services rendered by the Taxpayer being supervisory in nature, constituted a PE in India in terms of Article 5(2)(i) of India-Germany DTAA . Since income was effectively connected with the PE, the same had to be taxed as business income under Article 7. However, such business income had to be taxed on gross basis u/s. 44D (as subsisted for the relevant year).

However, the Taxpayer argued that the tenure of supervisory services should be considered independently and since the duration such services was less than 180 days, it did not create a PE in India. Even if a PE is triggered in terms of the specific provisions in the protocol to India-Germany DTAA such services would constitute FTS and not business income.

Held
The Taxpayer had rendered consultancy services and hence shall be governed by the provisions of in terms of Article 12 of the DTAA .

For the purpose of reckoning continuous stay for determination of PE, actual stay of employees should be considered and not the entire contract period1 .

While the Taxpayer had deputed one employee to India, that employee had not stayed in India for more than 180 days. Further, in two of the contracts, no supervisory charges were rendered.

Since Article 12(4), which deals with FTS, mentions ‘services of managerial’, technical or consultancy nature, payments received by the Taxpayer should be assessed in terms of Article 12 and not Article 7 of the DTAA .

Protocol to India-Germany DTAA provides that with respect to Article 7, income derived from a resident of a Contracting State from planning, project construction or research activities as well as income from technical services exercised in other State in connection with a PE situated in that other State, will not be attributed to PE. Hence, even if it is assumed that the Taxpayer had a PE in India, having regard to the Protocol, the income will not be treated as business income.

Accordingly, the payments received by the Taxpayer were to be taxed @10% and further, the provisions of section 115A of the Act were also not applicable.

TS-568-ITAT-2015(Del) Cincom System Inc vs. DDIT A.Ys: 2002-07. Order dated: 30.09.2015

fiogf49gjkf0d
Section 9(1)(vi) of the Act, Article 12(3) of India- USA DTAA – Payment for access to networking facilities involving use of embedded software, is ‘royalty’ under the Act as well as India-US DTAA .

Facts
The Taxpayer, the US Company, was engaged in the business of providing software solutions including creating personalised document, management of solutions, managing complex manufacturing operations and building and maintaining personalised e-business software, development and solutions.

The Taxpayer entered into an agreement with its Indian Group Company (ICo), as per which the Taxpayer was required to provide ICo with an access to its internet and other email and networking facilities. For these services, ICo paid certain amounts to the Taxpayer. While for the first year under consideration, ICo claimed the payment was ‘fees for included services’, for subsequent years, it claimed they were not taxable in India. The Tax Authority, however, concluded that the payments were in the nature of royalty. However, the Taxpayer contended that such income is not taxable in India.

Held:
In the facts of the case, the Taxpayer provided ICo with access to its embedded software or Gateway for the purpose of enabling the customer from India to call the residents of USA or vice-versa. Therefore, the payment made by ICo to the Taxpayer would amount to payment for use of software and hence, would qualify as royalty u/s. 9(1)(vi) of the Act as well as under Article 12(3) of the India-US DTAA .

The Tribunal relied on the ratio of AAR decision in P. No. 30 of 1999, In re (1999) (238 ITR 296)(AAR), wherein it was held that payments made for access to US based global central processing unit would amount to royalty as such access allowed use of embedded secret software developed by Taxpayer.

levitra

TS-342-ITAT-2015(Mum)-TP Aegis Ltd vs. ACIT A.Y. 2009-10. Date of Order: 27.07.2015

fiogf49gjkf0d
Subscription of shares cannot be recharacterised as a transaction of
loan without any material exceptional circumstance highlighting that the
real transaction has been concealed.

Facts
The
Taxpayer, an Indian Company, was engaged in the business of providing IT
enabled business processing outsourcing services to its associated
enterprises (AE) for the third party contracts and in-house receivable
management services.

The Taxpayer subscribed to the redeemable
preference shares of its subsidiary outside India. Subsequently,
Taxpayer redeemed some of the preference shares at par.

The Tax
Authority observed that preference shares issued by subsidiary were
non-cumulative and redeemable at par without any dividend. Thus. the Tax
Authority recharacterized the transaction of subscription of preference
shares into a transaction of advancing of unsecured loan and imputed
interest thereon.

The Taxpayer contended that subscription of
preference shares represents an investment transaction for acquiring
participation interest in subsidiaries and hence, it should not be
characterised as a transaction of loan.

Held
The Tax
Authority is incorrect in recharacterising the transaction of
subscription of shares into a transaction of loan. One cannot disregard
any apparent transaction and substitute it, without any material of
exceptional circumstance highlighting that the real transaction has been
concealed or the transaction was a sham.

In absence of
evidences and circumstances to doubt facts of the case, The Tax
Authority cannot question the commercial expediency of any transaction
entered into by a Taxpayer. Thus, the transaction of investment in
shares cannot be given different colour so as to expand the scope of
transfer pricing adjustments by recharacterising it as interest-free
loan.

Since recharacterisation of share subscription into loan
cannot be done even in case of an independent enterprise, such
recharacterisation is not warranted even in the facts of the case.
Therefore, no interest should be imputed on such transaction. Reliance
in this regard was placed on Mumbai HC decision in the case of Dexiskier
Dhboal SA (ITA No. 776 of 2011).

levitra

TS-588-ITAT-2015(RJT) GAC Shipping India Pvt. Ltd. as agents for Alabra Shipping Pte Ltd. vs. ITO (IT) A.Y: 2011-12. Date of Order: 09.10.2015

fiogf49gjkf0d
Article 24 of the India-Singapore DTAA – Since income was taxable in Singapore on accrual basis, LOB Article could not be applied even though income was not repatriated to Singapore

Facts
The Taxpayer, a Singapore Co (FCo) owned a ship. FCo filed a tax return in India, through its representative assessee in India, in respect of freight earned from ship. Freight income of FCo was remitted to FCo’s bank account in UK.

In terms of Article 24 of India-Singapore DTAA provides that where an income is exempt from tax in a contracting state or where it is subject to beneficial rate of tax in a contracting state in terms of the DTAA and such income is subject to tax in that contracting state with reference to amount remitted to or received in the said contracting state, then the DTAA benefits would be available only with respect to amount remitted or received.

The Tax Authority contended that remittance to Singapore is a sine qua non for availing the benefits of the India- Singapore DTAA . Since the freight was remitted to UK, Tax Authority denied the benefits of DTAA.

FCo contended, freight income was taxable in Singapore on accrual basis by virtue of residence therein. This was confirmed by Singapore Tax Authority. Hence, the DTAA benefits should not be denied on freight income.

Held
Plain reading of Article 24 of the India-Singapore DTAA , indicates that provisions of Article 24 would apply only to the income which satisfies of the following two conditions
• Income should be exempt or taxed at reduced rate in source jurisdiction (i.e., India),
• Income should be taxed in residence jurisdiction (i.e., Singapore) only on receipt basis.

Scope of LOB Article should be appreciated in the background of a tax jurisdiction following territorial method of taxation. In such a case, the DTAA benefit must be confined to the amount which is actually subjected to tax in the home jurisdiction. The decision in Abacus International Pvt Ltd vs. DDIT (2013) 34 taxmann.com 21 (Mumbai – Trib.) can be distinguished since the onus is on the Taxpayer to show that income is taxable in Singapore on accrual basis, which the Taxpayer had not established in that case.

In this case, there is no dispute that the Taxpayer has offered its global income to tax in Singapore, on accrual basis, which is also confirmed by Singapore Tax Authority. Hence, Tax Authority cannot rely on the decision in case of Abacus. Accordingly, the LOB Article does not apply to the facts of the present case and DTAA benefit should be available in respect of freight income.

levitra

TS-580-AAR-2015 Guangzhou Usha International Ltd. Date of Order: 28.09.2015

fiogf49gjkf0d
Article 12 of India-China DTAA – Procurement services involving market research and providing technical advice on product or process upgradation, rendered from outside India, falls within the ambit of Fee for Technical Services (FTS) under Article 12 of India-China DTAA

Facts
The Taxpayer, a Chinese Company, entered into an agreement with its Indian Parent (ICo) for provision of services in relation to procurement of goods from vendors in China. Such procurement services were rendered by the Taxpayer from China. ICo considered the payment as FTS and while paying the fee, suo motu withheld tax @10% from the fee.

The Taxpayer argued that the payment received for procurement services does not accrue or arise in India nor can it be treated as deemed to accrue or arise in India. Further, since the fee for such services is not received in India, income is not taxable in India under the Act. Under Article 12(4) of India-China DTAA , such payment for procurement services does not qualify as managerial, technical or consultancy services. Additionally, since the services are performed in China and not in India, such services would not fall under the definition of FTS under the DTAA .

The issue before the AAR was whether fee paid by ICo to The Taxpayer is taxable in India in terms of Article 12 of India-China DTAA .

Held
FTS is defined in Article 12(4) of India-China DTAA to mean any payment for the provision of services of managerial, technical or consultancy nature by a resident of a Contracting State in the other Contracting State.

Procurement services rendered by The Taxpayer included not only identification of the products but also generating new ideas for ICo post conducting market research. It also involved evaluating the credit, organisation, finance, production facility, etc. and giving advice in the form of a report to ICo. The Taxpayer also provided information on new developments in China with regard to technology/ product/process upgrade. These are specialised services requiring special skill, acumen and knowledge.

Further, in GVK Industries vs. ITO [(2015) TIOL-10(SCIT) l-10(SC-IT)], SC had noted that “Consultant” is a person who gives professional advice or services in a specialised field. Services rendered by Taxpayer clearly indicate that the Taxpayer has the skill, acumen and knowledge in the specialised field of evaluation of credit, organisation, finance and production facility, in conducting market research and in giving expert advice with regard to technology/product/process upgradation. Such specialised service clearly falls within the ambit of consultancy services. Accordingly, the payment was FTS in terms of the Act as also the DTAA .

The China-Pakistan DTAA uses the phrase “provision of rendering of services”, whereas the India-China DTAA uses the phrase ‘provision of service’. The present case relates to the India-China DTAA . Any other DTAA cannot influence the scope of India-China DTAA. It is not correct to suggest that income is not sourced from India.

It is not correct to suggest that source rule of the treaty is limited to services rendered in India. The treaty refers to, the phrase ‘provision of service’ which has not been defined anywhere in the DTAA. The phrase “provision of services” has a very broad meaning when compared to the phrase “provision of rendering of services” and it covers services even when they are not rendered in a contracting state (India in this case). As long as services are used in India, they would be included in the phrase “provision of service”. Reliance in this regard was placed on decision of AAR in the case of Inspectorate (Shanghai) Limited (AAR No 1005 of 2010) and Mumbai ITAT decision in the case of Ashapura Minichem (ITA No.2508/Mum/08).

Since the services rendered by the Taxpayer were consultancy services, fee paid by ICo was FTS under Article 12 of the India-China DTAA and was chargeable to tax in India @10%.

levitra

Digest of recent important foreign Supreme Court decisions on cross border taxation

fiogf49gjkf0d
In this article, some of the recent important foreign Supreme Court decisions on cross border taxation are covered. In view of increasing globalisation, movement of Capital, Technology and Personnel, various issues arising in taxation of Cross Border Transactions are increasingly becoming similar. The various issues discussed in these Foreign Supreme Courts’ decisions have a global resonance due to common terminology used in Model Tax Conventions and various Double Tax Avoidance Agreements. These decisions represent useful accretion to the jurisprudence on the respective topics/issues. The compilers hope that these decisions would be useful in guiding taxpayers, tax advisors, Revenue Officials and the Judiciary when similar issues come up for consideration in the Indian context.

1. France – Treaty between France and India – French Administrative Supreme Court rules on tax sparing/ matching credit provisions

In a decision (No. 366680, SA Natixis) given on 25th February 2015, the French Administrative Supreme Court (Conseil d’Etat) ruled on the tax sparing/matching credit provisions of the France – India Income and Capital Tax Treaty (1992) (the Treaty). The Court ruled that, for a French resident receiving interest from India to benefit from a tax sparing/matching credit, such interest must either have been subject to taxation in India or exempted by virtue of the laws of India referred to in article 25(3)(c)(i) or article 25(3)(c)(ii) of the Treaty.

(a) Facts. The French-resident bank SA Natixis (formerly SA Natexis Banques Populaires) received interest income from residents of India in 1998 and 1999. This interest income was exempt from tax in India. The tax authorities granted a tax credit for this income. However, considering that the tax credit was not calculated in accordance with the Treaty provisions, the French bank filed a claim. The first-instance Tribunal (Tribunal administratif) rejected its claim.

Confirming the judgment from the first-instance Tribunal, the administrative court of appeal (Cour administrative d’appel) ruled that the tax sparing/matching credit provided for by the Treaty regarding interest shall be granted only where such interest income was subject to tax in India. Where the interest income was not subject to any tax in India, it shall not entitle the French resident to a tax sparing/ matching credit, except where an Indian tax might have been payable but was not levied on the basis of one of the laws of India referred to in article 25(3)(c)(i) or article 25(3) (c)(ii) of the Treaty.

Thus, the administrative court of appeal found that the French bank was not entitled to any tax sparing/matching credit as the French bank:
– neither proved that the Indian-source interest income was subject to Indian tax;
– nor proved that the Indian-source interest income was exempt from Indian tax by virtue of one of the laws of India referred to in the Treaty.

Thus, the court first applied the interpretation given by the French Administrative Supreme Court regarding matching credit provisions contained in the Brazil-France Tax Treaty and then took into account the exception provided for in the Treaty.

(b) Issue. Whether interest income that was fully exempt from tax in India entitle its French recipient to a tax sparing/ matching credit under article 25 of the Treaty?

(c) Decision. The French Administrative Supreme Court ruled that:
– in general, a French resident receiving interest from India may benefit from a tax credit only where such interest was subject to taxation in India; and
– as an exception, a French resident receiving interest from India that was exempt from Indian tax may still benefit from a tax credit where a Indian tax would have been payable but for a full exemption granted under one of the laws of India referred to in article 25 of the Treaty.

The French Administrative Supreme Court then noted that the French bank:
– neither proved that the Indian-source interest income was subject to Indian tax;
– nor proved that the Indian-source interest income was exempt from Indian tax under one of the laws of India referred to in article 25 of the Treaty, and specify the law in question.

The French Administrative Supreme Court therefore concluded that the bank, which bore the burden of proof, was not entitled to any tax sparing/matching credit, and dismissed its claim.

2. Japanese Supreme Court decision – Bermuda LPS is not a corporation

On 17th July 2015, the Japanese Supreme Court disallowed an application by the tax authorities to appeal a Tokyo High Court decision, in which a limited partnership (LPS) registered in Bermuda was held not to be a corporation for Japanese tax law purposes.

(a) Facts. The taxpayer (Tokyo Star Holdings LP) is an LPS based on Bermuda law (Partnership Act 1902 and Limited Partnership Act 1883). The taxpayer is also an exempted partnership (EPS) based on Bermuda law (Exempted Partnerships Act 1992), which is not subject to tax on income in Bermuda.

A Delaware LLC and two Cayman corporations entered into several silent/sleeping partnership agreements with the former as silent/sleeping partners (tokumei kumiaiin) and the latter as business operators (eigyousha). The Cayman corporations as eigyousha had branches in Japan and were in the business of collecting claims.

The Delaware LLC then sold the interests in the silent/ sleeping partnerships to an Irish corporation. The taxpayer and the Irish corporation (as tokumei kumiaiin) subsequently entered into a swap contract under which the business profits of the eigyousha were distributed to the tokumei kumiaiin and, in turn, to the taxpayer.

The Japanese tax authorities argued that the distribution received by the taxpayer from the tokumei kumiai constituted domestic source income under article 138(11) of the Japanese Corporate Tax Act (CTA ). The taxpayer argued that since, as a Bermuda LPS, it was not a corporation within the meaning of the CTA , it was not a taxable entity.

(b) Issue. The first issue was whether the taxpayer was a corporation for Japanese tax law purposes. If not, the second issue was whether the taxpayer was a “non-judicial association, etc.” (jinkaku no nai shadan tou) within the meaning of article 3 of the CTA , which provides that such an association is treated as a corporation.

(c) Decision. The Tokyo District Court, in its decision of 30th August 2012, case number Heisei 23 (2011) gyou-u No. 123, reported in Kinyû Shôji Hanrei 1405-30, ruled that the taxpayer was neither a corporation nor a “non-judicial association, etc.”, and that taxation of the taxpayer was not void but illegal.

The tax authorities appealed, but the Tokyo High Court, in its decision of 5th February 2014, case number Heisei 24 (2012) gyou-ko No. 345, reported in Kinyû Shôji Hanrei 1450-10, upheld the Tokyo District Court’s decision.

The Supreme Court did not allow the tax authorities’ further appeal of the respondent, whereupon the matter was finalised.

With respect to the first issue, article 36(1) of the Japanese Civil Code provides that “…, no establishment of a foreign juridical person shall be approved; provided, however, that, this shall not apply to any foreign juridical person which is approved pursuant to the provisions of a law or treaty.” The courts held that whether a business entity is considered a “foreign corporation” (a foreign judicial person under the Civil Code) is determined with reference to the relevant foreign law governing the corporate legal personality of the business entity in question. In this case, the courts held that Bermuda law did not provide the taxpayer with a corporate legal personality, so that the taxpayer was not a “foreign judicial person” under civil law; therefore, the taxpayer was also not a “foreign corporation” under the CTA.

For the second issue, the courts held that a “non-judicial association, etc.” (jinkaku no nai shadan tou) under the CTA was equivalent to an “association without capacity to hold rights” (kenri nouryoku naki shadan) under civil law, which had been defined by the Supreme Court decision of 15th October 1964, case number Shouwa 35 (1960) o No. 1029, reported in Minshû 18-8-1671. In the 1964 Supreme Court case, it was stated that an “association without capacity to hold rights” must have (1) an organisation as a body, (2) a decision by majority, (3) continuation of the body despite the change of the members, and (4) a defined rule concerning representation, operation of a general meeting, management of properties, etc. In this case, the courts held that the requirements of (1), (2) and (4) were not satisfied; therefore, the taxpayer was not a “non-judicial association, etc.” and was not subject to Japanese corporate tax.

In conclusion, the tax authorities erred in taxing the Bermuda LPS; instead, the partners of the LPS (being corporate entities) should have been subject to tax.

Note: The Supreme Court, in its decision of 17th July 2015 ruled that a Delaware LPS was a corporation. In that case, the Supreme Court applied a “second stage of determination” where the attribution of rights and duties was concerned. Although the attribution of rights and duties was argued by the tax authorities in this Bermuda LPS case, the Tokyo District Court and High Court explicitly rejected this in arriving at their decisions on 30th August 2012 and 5th February 2014, respectively. Since the Supreme Court, in disallowing the appeal, did not mention the second stage of determination, it is reasonable to assume that the Supreme Court would have found that the Bermuda LPS was not a corporation, even if the second stage of determination in the Delaware LPS case had been applied.

3.    Argentina – Supreme Court decision on application of substance-over-form principle and CFC rules

On 24th February 2015, the Supreme Court gave its decision in the case Malteria Pampa S.A. concerning the application of the substance-over-form principle (realidad económica) and controlled foreign company (CFC) rules. Specifically, the Court dealt with the difference between a foreign subsidiary and foreign permanent establishment (PE) of a resident company, and the timing of income taxation. Details of the case are summarised below:

(a)    Facts. Malteria Pampa, a resident company, had a wholly-owned subsidiary based in Uruguay. The tax authority reassessed the company’s tax returns for 2000 and 2001 to include the profits derived by the non-resident subsidiary. The subsidiary had not paid any dividend; however, the tax administration applied the substance-over-form principle in order to disregard its legal form and to treat it as a foreign PE of the resident company. The tax authority based its position on the resident company’s control of the non-resident subsidiary in the form of capital ownership, voting power and company board appointment power.

(b)    Legal Background. The CFC regime generally applies when a foreign subsidiary is a resident of a blacklisted jurisdiction and the passive income derived by that subsidiary is more than 50% of its total income.

The Income Tax Law (Ley de Impuesto a las Ganancias, LIG) contains detailed provisions distinguishing between a subsidiary and a PE by providing for a different tax treatment, i.e. article 69 of the LIG lists different taxable entities, explicitly stating PEs as taxable entities different from the subsidiaries. Articles 18, 128, 133, 148 of the LIG set out the timing for taxation of income accrued by PEs and subsidiaries, regulating situations where CFC rules apply.

(c)    Decision. The Court upheld the taxpayer’s position based on the application of the provisions of the LIG, rejecting the application of the substance-over-form principle. In particular, it underlined the relevance of the legal form and confirmed that income derived by a foreign subsidiary may be taxed in the hands of a resident only when dividends are paid, unless CFC rules are applicable.

4    Finland Supreme Administrative Court – Profits of foreign PEs included when calculating FTC although no tax was actually paid abroad

The Supreme Administrative Court of Finland (Korkein hallinto-oikeus, KHO) gave its decision on 31st October 2014 in the case of KHO:2014:159.

(a)    Facts. A company resident in Finland (FI Co) exercised its business activities in Finland and through permanent establishments (PEs) abroad, including PEs in Estonia (EE

PE) and the United Kingdom (UK PE). The PE profits, in general, were included in the taxable income of FI Co.
In addition, the PE profits were taxed in the country where they were located. However, UK PE did not have any taxable profits due to the losses from previous tax years which were set off against the profits. EE PE, on the other hand, did not pay any tax due to the Estonian tax system which does not tax undistributed profits.

(b)    Legal Background. Under Law on Elimination of International Double Taxation (Laki kansainvälisen kaksinkertaisen verotuksen poistamisesta), double taxation is eliminated by crediting the tax paid on the foreign income in the source country. The foreign tax credit (FTC) is limited to the amount of Finnish tax payable on the foreign-source income.

(c)    Issue. The issue was whether or not the PE profits from

EE PE and UK PE should be taken into account when calculating the maximum credit for the tax paid abroad.
(d)    Decision. The Supreme Administrative Court held that the PE profits of EE PE and UK PE are to be included in the profits of FI Co when calculating the maximum credit for the taxes paid abroad. The Court pointed out that, when calculating the base for the FTC, it is not required that tax has actually been paid for such income. What is essential is that the income is taxable in Finland and in its source country. The fact that the moment of taxation has been deferred, as in the case of EE PE, has no relevance.

5.    Norway – Supreme Court allows use of “secret comparables” in TP assessment

The Supreme Court of Norway (Norges Høyesterett) gave its decision on 27 March 2015 in the case of Total E&P Norge AS vs. Petroleum Tax Office (case 2014/498, reference number HR-2015-00699-A)

(a)    Facts. Between 2002 and 2007, the taxpayer Total E&P Norge AS (NO Parent) sold gas to 3 foreign related companies. The tax authorities regarded that the sales prices were not at arm’s length based on a comparison between the sales by NO Parent and similar transactions executed by third-party taxpayers (the Third-party Sales). The tax authorities refused to disclose details of the

Third-party Sales due to confidentiality rules. NO Parent appealed on the assessment.

(b)    Issue. The issue was whether the tax authorities could base their assessment on comparables which are not fully disclosed to the taxpayer.

(c)    Decision. The Court rejected the appeal and ruled that the tax assessment could be based on “secret comparables”. The use of secret comparables was deemed necessary to ensure an effective control of the transactions. Even though NO Parent was not given access to all the Third-party Sales used as comparables, NO Parent obtained enough information to have an adequate opportunity to defend its own position and to safeguard effective judicial control by the courts, as stated in the OECD Transfer Pricing Guidelines.

6.    France – Administrative Supreme Court rules that individual with French income only is resident of France

In a decision given on 17th June 2015 (No. 371412), the Administrative Supreme Court (Conseil d’Etat) ruled that an individual living outside France, but whose only income is a French-source pension has the centre of his economic interests in France. Such an individual is thus a resident of France under domestic law.

(a)    Facts. Mr. Georges B. is a French pensioner who lived in Cambodia from 1996 to 2007, working there as a volunteer for non-governmental organisations. His only income during these years was a French pension paid to a French bank account.

The pension was subject to withholding tax applicable to pensions paid to non-resident individuals. As the withholding tax was higher than the income tax that he would have paid as a resident, Mr. Georges B. claimed a tax refund. The tax authorities, however, considered that Mr. Georges B. could not be regarded as a resident of France and that the withholding tax was applicable to his case. The Court of First Instance (tribunal administratif) as well as the Administrative Court of Appeals (cour administrative d’appel) confirmed the tax authorities’ position. The Administrative Court of Appeals considered that the mere payment of a French pension to Mr Georges B. was not sufficient to retain the centre of his economic interests in France insofar as:

– the payment of the pension to a French bank account was merely a technical method chosen by the taxpayer himself;

– parts of the pension were transferred to Cambodia to cover the needs of Mr. Georges B. and his new family there;

– Mr. Georges B. administered his French bank account from Cambodia; and
– the pension was not a remuneration derived from an economic activity carried out in France.

(b)    Issue. Under article 4 B(1) of the General Tax Code (Code général des impôts, CGI), resident individuals are persons who:

– have their home or principal abode in France; or

– perform employment or independent services in France (unless such activity is only ancillary); or
– have the centre of their economic interests in France.

In this case, the issue was whether an individual living and working outside France but whose only income is a French-source pension has the centre of his economic interests in France.

(c)    Decision. The Administrative Supreme Court ruled that the elements on which the lower courts based their judgments did not prove that the centre of the economic interests of Mr. Georges B. shifted out of France. As his only income was French-sourced, Mr. Georges B. still had the centre of his economic interests in France between 1996 and 2007. Thus, Mr. Georges B. was a resident of France under domestic law.

The French Administrative Supreme Court thus confirmed that the centre of the economic interests of an individual must be assessed mainly with regard to his income, irrespective of the exercise of an economic activity.

Note: Cambodia and France did not conclude a tax treaty.

Consequently, only domestic law was applicable.

7.    Netherlands Supreme Court – business motive test also applies to external acquisitions

On 5th June 2015, the Netherlands Supreme Court (Hoge Raad der Nederlanden) (the Court) gave its decision in the case of X1 BV and X2 BV v. the tax administration.

(a)    Facts. Two Dutch resident companies (X1 BV and X2 BV) were part of a South African Media group. In 2007, the listed parent company of the group issued shares. Thereafter, the parent company lent part of the proceeds from the share issue to its subsidiary, which was a South African resident holding company. This holding company subsequently contributed the funds to a holding company located in Mauritius. The Mauritius-based holding company then lent the funds to the financing company of the group, which was also resident in Mauritius.

In 2007, the two Dutch resident companies acquired several participations. Those acquisitions were partially financed by funds received from the Mauritian finance company. Those funds originated from the issue of shares by the parent company of the group.

Due to the financing structure, the Dutch resident companies took on a related party debt for financing the acquisition of the participations.

Reasoning that both the acquisitions and the loans were based on commercial reasons, the companies claimed a deduction of interest paid to the Mauritius finance company.

(b)    Issue. The issue was whether the interest on the related party debt was deductible.

(c)    Decision. The Court began by observing that article 10a of the Corporate Income Tax Act (CITA) limits the deduction of interest on funds borrowed from another group company. This restriction, inter alia, applies in the case of funds borrowed for the acquisition of shares in a company. Thereafter, the Court emphasised that it is for the taxpayer to prove that a decision to borrow funds from a related party to finance acquisitions of participations is predominantly motivated by commercial reasons.

However, in this context the Court decided that not only the taxpayer’s motives are decisive, but that the reasons of all parties involved in a transaction must be taken into account for the determination of whether the business purpose test is met.

Consequently, an interest deduction cannot be justified with the argument that there was no alternative than to accept a loan offer from a related party.

Thereafter, the Court repeated its consistent case law that a parent company can freely decide to fund its subsidiaries with debt or equity. This rule implies that the Dutch legislator has to accept a direct funding through a low-taxed group finance company.

The Court rejected the taxpayer’s argument that both the loan and the acquisitions were predominantly based on commercial reasons. In this context, the Court held that a reference to case law based on the abuse of law doctrine was irrelevant in the case at hand, because this case law is not relevant for the application of the Dutch base erosion rules.

The Court also rejected the reasoning of the taxpayers which was based on legislative history. The taxpayers indicated that the obtaining of a related party debt was based on commercial reasons because debt arose from the issuance of shares. Furthermore, the proceeds from the share issue were not received from the finance company to obtain a specific acquisition but only to obtain acquisitions in general. The Court judged that the moment when a taxpayer decides to purchase a specific acquisition is not decisive for the determination of whether a borrowed loan from a third party is based on commercial reasons.

Due to the fact that it was not shown that all transactions involved in the transaction were based on commercial reasons, the Court denied the interest deduction. In addition, the case was referred to another lower court to determine if funds provided by the Mauritius company to the financing company of the group determined whether the construction was based on commercial reasons.

Note: The importance of the case is that the Court has clarified that a re-routing outside the Netherlands must be based on business motives to claim an interest deduction. In addition, the Court, however, decided that the interest deduction restriction of article 10a CITA does not always apply when an acquisition is financed with an intra-group loan based on tax motives, if the taxpayer shows that business motives exist.

8.    Japanese Supreme Court decision – Delaware LPS is a corporation

The Japanese Supreme Court held in its decision dated 17th July 2015, case number Heisei 25 (2013) gyou-hi No.166, that a Delaware limited partnership (LPS) is, for Japanese tax purposes, a corporation.

(a)    Facts. The plaintiffs (Japanese resident individuals) participated in a LPS pursuant to the Delaware Revised Uniform Limited Partnership Act (hereafter, DRULPA). The LPS invested in the leasing of used collective housing in the US states of California and Florida, which incurred losses. The plaintiffs filed their individual income tax returns treating the LPS as transparent and taking the losses arising into account when reporting their taxable income as per article 26 of the Income-tax Act (ITA).

The Japanese tax authorities, however, argued that the LPS was in fact a corporation (and opaque) and therefore the losses did not belong to partners, but to the corporation.

(b)    Issue. The issue was whether the Delaware LPS was a corporation.

(c)    Decision. The Supreme Court overturned the Nagoya High Court’s decision on 24th January 2013 (case number Heisei 24 (2012) No. 8) which had ruled in favour of the taxpayers.

Instead, the Supreme Court held that article 2(1)(7) of the ITA defines a “foreign corporation” as “a corporation that is not a domestic corporation”, but does not go on to define a “corporation”. Therefore, whether or not a foreign entity is a “corporation” (houjin) is based on whether it would be considered a “corporation” in Japanese law.

There are two stages to this. Firstly, it is scrutinised whether the wordings or mechanics of the incorporating law explicitly (meihakuni) gives, without question, legal status to the entity as a corporation or explicitly does not give it. If it is neither, then, at the second stage, it is scrutinised whether the entity is a subject to which rights and duties attribute.

In this case, at the first stage, DRULPA uses the wordings of “separate legal entity”, but it is not clear whether a “legal entity” in Delaware constitutes a “corporation” in Japan.
 

Additionally, the General Corporation Law of the State of Delaware uses “a body corporate” to mean a “corporation” in Delaware. Therefore it is not explicitly clear whether a “separate legal entity” in Delaware has the same legal status as a “corporation” in Japan.

At the second stage of determination, it is clear that the LPS is a subject to which rights and duties attribute. The partners of the LPS only have abstract rights on whole assets of the LPS, they do not have concrete interests on the respective goods or rights belonging to the LPS.

Therefore, the losses in the leasing business did not belong to Japanese partners. Stating that an LPS in the USA was generally treated as transparent, it remains to be seen by the Nagoya High Court if the taxpayers had “justifiable grounds” in understating their income. Article 65(4) of the Act on General Rules for National Taxes provides that additional tax for understatement will not be charged if a taxpayer has justifiably understated his taxable income.

9.    Italy – Supreme Court rules on application of transfer pricing rules to interest-free loans between related companies

The Italian Supreme Court (Corte di Cassazione) gave its Decision No. 27087 of 19 December 2014 (recently published) on the application of transfer pricing rules to interest-free loans between related companies.

An Italian company granted an interest-free loan to its Luxembourg and US subsidiaries in order to optimise the available resources and maintain the market share. The Italian Tax Authorities (ITA) reassessed and included in the corporate income tax basis of the Italian company interest income calculated at the normal value, on the basis of article 110(7) of Presidential Decree No. 917 of 22nd December 1986. Precisely, the ITA defined the Italian company’s choice to grant an interest-free loan as “abnormal” and claimed that, by obtaining the interest–free loan, the non-resident subsidiaries were in a more favourable position compared to other companies operating in the open market.

The Supreme Court noted that the Italian company’s choice to grant an interest-free loan to its non-resident subsidiaries was aimed at addressing their temporary economic needs and, therefore, it did not constitute an unlawful or elusive conduct. Furthermore, the Supreme Court held that article 110(7) of Presidential Decree No. 917 of 22nd December 1986 does not provide for the absolute presumption that any cross-border transaction with related parties must be onerous, but only provides for the valuation of components of income deriving from onerous cross-border transactions, on the basis of the normal value (article 9(3) of Presidential Decree No. 917 of 22nd December 1986) of the goods transferred, services rendered, and services and goods received.

10.    Brazil Supreme Federal Court confirms income tax on accumulated income calculated on accrual basis

On 23rd October 2014, the Supreme Federal Court (Supremo Tribunal Federal, STF) confirmed that the income tax levied on accumulated income received at a later stage as a lump-sum payment (rendimento recebidos acumuladamente) must be calculated on an accrual basis (regime de competência) and not on a cash basis (regime de caixa). The STF gave its position in Appeal 614406 (Recurso Extraordinário 614406), lodged by the tax authorities against a decision given by the lower court in favour of the taxpayer.

Since the STF recognised the “general repercussion” (repercussão geral) of the case (see Note), the decision will have an impact on more than 9,000 similar cases currently examined in lower courts.

(a)    Background. The National Institute of Social Security (Instituto Nacional de Seguridade Social, INSS) paid a debt it owed to a taxpayer as a lump-sum payment. Tax authorities calculated the income tax due on a cash basis, i.e. on the basis of the accumulated income (i.e. the lump-sum payment) and according to tax brackets and rates applicable at the moment of the payment. The taxpayer requested the calculation he would have been entitled to if the amounts had been correctly paid by the INSS, that is, on an accrual basis. Accordingly, the income tax due would be calculated on the basis of monthly instalments and according to the tax brackets and rates applicable at each month.

(b)    Decision. The STF stated that the income tax must be calculated according to the rules existing at the time the income should have been paid. As a result, income tax must be levied on the amount that was due per month and according to the tax brackets and rates applicable at each respective month. The Court stated that the levy of the income tax on the accumulated income would be contrary to the ability to pay and proportionality principles.

Note: The STF may recognise the “general repercussion” (repercussão geral) in cases of high legal, political, social or economic relevance. Once “general repercussion” is recognized in a case, the decision given by the STF on the matter must be subsequently applied by lower courts in similar cases. The purpose of the “general repercussion” procedure is to reduce the number of appeals lodged at the STF.

11.    Belgium – Supreme Court – Principles of good governance and fair trial govern admissibility in court of illegally obtained evidence


On 22nd May 2015, the Supreme Court (Hof van Cassatie/ Cour de Cassation) rendered a decision (No. F.13.0077N)    in respect of the Issue whether and under which circumstances illegally obtained evidence in matters of taxation is admissible in court.

(a)    Facts. The Special Tax Inspectorate requested from the Portuguese VAT authorities information concerning certain intra-Community supplies of goods to Portugal and Luxembourg. The information was used to levy VAT, penalties and late interest payments because the information revealed that the goods were not transported to and thus delivered in Portugal and Luxembourg.

The tax payers challenged the levies and argued that the information was obtained illegally.

(b)    Legal Background. The information request was based on article 81bis of the Belgian VAT Code and the Mutual Assistance Directive [for the exchange of information] (77/799) (now Mutual Assistance Directive

[on administrative cooperation in the field of taxation]

(2011/16)). Both Directives deal with the mutual assistance by the competent authorities of the Member States in the field of direct taxation and taxation of insurance premiums.

In Belgium, however, the expression “competent authority” means the Minister of Finance or an authorised representative, which is the Central Unit for international administrative cooperation, and not the Special Tax Inspectorate, merely acting in this case on the basis of an internal circular concerning the Netherlands.

Before the Court of Appeal, the taxpayers repeated their argument that illegally obtained information cannot be used. Any unlawful action by the tax authorities should be considered a breach of the principles of good governance and fair trial, leading to the nullification of the assessment.

(c)    Decision. The Supreme Court confirmed the decision of the Court of Appeal. Belgian tax legislation does not contain any specific provision prohibiting the use of illegally obtained evidence in determining a tax debt, a tax increase or a penalty.

The principles of good governance and the right to a fair trial indeed govern the question whether illegally obtained evidence should be disallowed or is admissible in court. Unless the legislator has provided for specific sanctions, illegally obtained evidence in tax matters can, however, only be disallowed if the evidence is obtained in a manner contrary to what may be expected from a properly acting government. As a result, the use of such evidence is in all circumstances deemed unacceptable, particularly if it jeopardises a taxpayer’s right to fair trial.

While assessing this issue, the Court may take into account one or more of the following circumstances: the purely formal nature of the irregularity, its impact on the right or freedom protected by the norm, whether the committed irregularity was intentional by nature and whether the gravity of the infringement by the taxpayer far exceeds the illegality committed by the tax authorities.

Note: This decision, which has received some strong criticism from tax lawyers and advisers, is fully in line with the “prosecution-friendly” Antigoon case law in criminal matters since the decision of the Supreme Court of 14th October 2003, as converted into law on 24th October 2013. Since then, the inadmissibility of illegally obtained evidence has no longer been an automatic sanction in criminal matters. Neither the Belgian Constitutional Court nor the European Court on Human Rights (ECHR) has considered the case law of the Supreme Court in criminal matters to be in conflict with the European Convention on Human Rights.

Some commentators state that, notwithstanding the fact that there are certain limits the tax authorities must respect, it is clear that this judgment will give them less incentive to follow the rules and procedures, thereby decreasing legal certainty. Others, however, feel that, on the contrary, pursuant to this decision, lower courts must determine whether the principles of good governance and the right to fair trial were respected by the tax authorities while collecting the evidence, providing the taxpayer with additional defences.

12.    Canada – United Kingdom Treaty – Supreme Court of Canada denies Conrad Black’s leave to appeal

Conrad Black made an application for leave to appeal the decision of the Federal Court of Appeal upholding an earlier decision of the Tax Court of Canada. No reasons were given. The earlier Tax Court decision held that Black was deemed to be a resident of the United Kingdom under the Canada-United Kingdom Income Tax Treaty (1978) but was also a Canadian resident subject to tax.

Treaty between Canada and UK – Tax Court of Canada decides that individual resident in Canada and the United Kingdom, but not liable to UK tax, is subject to tax in Canada

The Applicant, Conrad Black, made an application for the determination of a question of law u/s. 58 of the Tax Court of Canada Rules (General Procedure) prior to the hearing of his case.

(a) Issue. The issue was:

– whether or not article 4(2) of the Canada – United Kingdom Income Tax Treaty (1978) (the Treaty), which deemed Black (according to the tie-breaker rule) to be a resident of the United Kingdom for the purposes of the Treaty overrides the provisions of the Canadian Income-tax Act so as to prevent the applicant from being assessed under the Canadian Income-tax Act on certain amounts as a resident of Canada; and

– whether or not article 27(2) of the Treaty allows for the assessment of such tax as a resident of Canada on any assessed items.

(b)    Facts. Black was assessed tax, as a resident of Canada, on certain items of income received by virtue of an office or employment. From 1992 onwards, he was also a resident of the United Kingdom. By virtue of article 4(2) of the Treaty, he was a deemed resident of the United Kingdom, however, he was not domiciled in the United Kingdom and, therefore, was only subject to tax in the United Kingdom on a remittance basis. The amounts at issue were never remitted and, therefore, not subject to tax in the United Kingdom. If Canada were not able to tax him on the income at issue, a situation of double non-taxation would arise.

(c)    Decision. The Tax Court adopted a liberal and purposive approach to interpreting the Treaty. Based on this approach, it found that there is no inconsistency between finding that a taxpayer is a resident of the United Kingdom for the purpose of the Treaty and a resident of Canada for the purpose of the Canadian Income Tax Act. Whether someone is a resident of Canada for the purposes of the Income-tax Act is a question of fact. Further, the Commentaries on the OECD Model provide that treaties do not normally concern themselves with the domestic laws of the contracting states that determine residency. Where a treaty gives preference to one state, deeming the taxpayer to be a non-resident of the second state, it is only for the purpose of the distributive rules in the treaty and thus the taxpayer continues to be generally subject to the taxation and procedural provisions of his state of secondary residence that apply to all other taxpayers who are residents thereof. The Court noted that there is no objective provision of the Treaty that being a resident of Canada would contravene, as the assessment of tax in Canada would not give rise to double taxation, which the purpose of treaties is to prevent, given that the amounts were never remitted to the United Kingdom or taxed therein. Therefore, the Court found that Black could be taxed as a resident of Canada on the income at issue.

Further, under article 27(2) of the Treaty, when a person is relieved from tax in Canada on income and, under UK law, that person is subject to tax on a remittance basis only, Canada will relieve that person from tax only in respect of income that is remitted to or received in the United Kingdom. The tax authorities argued that since no income was remitted to the United Kingdom, Canada is not required to relieve the Applicant from taxation in Canada. The Applicant, however, argued, inter alia, that this provision only relates to income that is sourced in Canada. Some of the income was sourced in third countries. The Court found that there was no basis to read words such as “arising in Canada” into the provision and, therefore, even if the Court was incorrect on the first issue, Black would still be taxable on the income at issue under article 27(2) of the Treaty.

[Acknowledgment/Source: We have compiled the above summary of decisions from the Tax News Service of the IBFD for the period August, 2014 to September, 2015]

Transfer Pricing – Use of Range and Multiple Year Data for Determining Arm’s Length Price

fiogf49gjkf0d
Background:
Presently, over 60 jurisdictions the world over have transfer pricing provisions in place, to curb the erosion of their tax bases by potential mispricing of intra-group transactions. While India has had limited generic provisions in place to check price manipulations, the formal “transfer pricing regulations”, as we have today, are also fifteen years old now. Right from the time of introduction, these provisions were built upon the international experience and yet, were relatively more restrictive than most of their counterparts.

Two of the areas where Indian transfer pricing regulations (‘TPR’) glaringly deviated from international best practices were use of inter-quartile range and multiple year data for benchmarking. Till less than a year ago, the TPR suggested the use of arithmetic mean of multiple comparable prices with a deviation of a small percentage (a mere 5%, further brought down to 1% in case of wholesalers and 3% for other assessees) for calculation of the arm’s length price (‘ALP’). It also did not permit the use of multiple year data, unless such data was shown to have a bearing on the determination of the transfer prices.

These provisions were challenged time and again in practice and before the appellate authorities, but in vain. While the learning curve of the Indian legislature and the tax authorities in transfer pricing has been quite steep, the need for use of range of arm’s length prices and multiple year data was acknowledged only in the finance minister’s budget speech in 2014, followed by necessary amendments to the law, applicable to transactions undertaken on or after 1st April 2014, i.e., from A.Y. 2015- 16 onwards. The enabling rules for the same, however, were notified only on 19th October 2015.

Need for the amendment:

Multiple year data –
Although broadly comparable companies are identified based on the functions, assets and risks (‘FAR ’) analysis, their profits will be a result of the returns normally commensurate with such FAR , coupled with any factors affecting the returns of the industry as a whole, as well as the returns of the individual company. The company specific factors, say merger, demerger or any other corporate action, which are normally restricted to a single year, will result in the rejection of an otherwise comparable company. Alternatively, these factors will distort the profits of that particular comparable, impacting the overall ALP calculation.

Assuming no material variation in the FAR of the comparable companies, the use of multiple year data helps to eliminate or “iron out” the impact, if any, of the extraordinary factors occurring in any of the years, yielding the normal profit margins of the industry and thereby, producing more reliable results.

Range concept –
While the transfer pricing methods try to objectively compute the ALP, it will seldom be the case that the actual price of the transaction will exactly match a single ALP. Deriving arithmetic mean in case of multiple comparable prices, with a small range of deviation, implies that the transaction price must nearly match with the mean, often leading to inequitable results. On the contrary, as per the international practice of adopting the inter-quartile range, the transaction price has to be compared to a range of prices between the start of the second quarter and the end of the third quarter of the comparable prices, when arranged in an ascending order.

For instance, say eight comparable prices – P1 to P8 are obtained as a part of the benchmarking exercise. As per the arithmetic mean concept, the simple average of P1 to P8 will be considered to be the ALP, with an allowable deviation of 1/3%, as the case maybe. However, as per the concept of inter-quartile range, these eight prices will be divided into 4 quarters and the entire range of second and third quarter (i.e., P3 to P6) will be considered to be arm’s length. Evidently, a range of prices is a better measure of the ALP than the arithmetic mean.

Draft Rules:
The draft scheme for applying the range concept and use of multiple year data, inviting comments, was released on 21st May 2015. Its highlights were as under –

Multiple year data –
Applicable only if, and mandatory if, the most appropriate method (‘MAM’) used for computation of ALP is Resale Price Method (‘RPM’) or Cost Plus Method (‘CPM’) or Transactional Net Margin Method (‘TNMM’).

Data for three years, including the year of transaction or current year should be considered.

Data for two out of the three years shall be used in case the data for the current year is not available at the time of filing of return of income, or a comparable does not clear the quantitative filter in any one year, or data is available only for two years on account of commencement or closing down of operations.

If the data for current year becomes subsequently available, the same can be used at the time of the assessment by the assessee as well as the department.

Applies irrespective of whether range concept or arithmetic mean is used.

Range concept –

Applicable only if the MAM used for computation of ALP is RPM or CPM or TNMM.

At least nine comparable companies, based on FAR analysis, should be available.

Weighted average margins of last three years (or two years in certain circumstances), shall be calculated using the denominators of the Profit Level Indicator (‘PLI’) as the weights.

Arranging the above margins in an ascending order, the values between 40th and 60th percentile of such margins shall be considered as the arm’s length range.

If the transaction price is within such range, then no adjustment shall be made. However, if the transaction price is outside the range, then the entire difference between the transaction price and the median or central value of the range shall be adjusted in the income.
In cases where the range concept does not apply, i.e., in case of benchmarking as per Comparable Uncontrolled Price (‘CUP’) Method or Profit Split Method (‘PSM’) or any other method as per Rule 10AB, or where number of comparable companies is less than nine, the earlier computation as per arithmetic mean and the tolerance range shall continue to apply.

Final Rules:
The final rules on the subject have been notified vide Notification No. 83/2015 dated 19th October 2015. The implications of these rules are as under –

Multiple year data –
A second proviso has been added to sub-rule (4) of Rule 10B to provide that the first proviso, dealing with the use of earlier years’ data where it has a bearing on the determination of the transfer prices, shall not apply in case of transactions entered into on or after 1st April 2014.

Also, sub-rule (5) has been inserted to provide that where, in respect of transactions entered into on or after 1st April 2014, the MAM selected is either RPM or CPM or TNMM, then, the comparability of an uncontrolled transaction with the controlled transaction shall be analysed based on the data pertaining to the current year (i.e. the year in which the transaction was entered into, say F.Y. 2014-15) or the immediately preceding financial year (F.Y. 2013-14) if the data for the current year is not available at the time of furnishing the return of income for that year.
Further, the proviso to sub-rule (5) states that if the data relating to the current year (F.Y. 2014-15) becomes subsequently available at the time of assessment of the said year, then, such data shall be used for computation of ALP, even though it was not available at the time of furnishing the return of income. This proviso intends to settle the persisting issue of inappropriateness of the use of that data at the time of assessment, which was not available to the assessee at the time of filing of return of income.

Rule 10CA, inserted by the above notification, deals with the application of range concept as well as multiple year data, in detail along with illustrations. The provisos to sub-rule (2) of Rule 10CA lay down the following mechanism for use of multiple year data –

i)    Where the comparable uncontrolled transaction has been identified using current year (F.Y. 2014-
15) data as per Rule 10B(5), and the comparable entity (and not the assessee) has entered into same or similar uncontrolled transaction in either or both of the immediately preceding financial years (F.Y. 2012-13 and F.Y. 2013-14), then,

•    the price of the uncontrolled transactions for the preceding financial years (F.Y. 2012-13 and F.Y. 2013-14) shall be computed using the same method as is applied for the current year (F.Y. 2014-15), and

•    weighted average price shall be computed by assigning weights to the sales/costs/assets employed or the respective denominator, used in computing the margins as per the MAM.

ii)    Due to non-availability of current year data (F.Y. 2014-15) at the time of filing of return of income, if the comparable uncontrolled transaction has been identified using the data for the immediately preceding financial year (F.Y. 2013-14) as per Rule 10B(5), and the comparable entity (and not the assessee) has entered into same or similar uncontrolled transaction in the immediately preceding financial year of that year (F.Y. 2012-13), then,

•    the price of the uncontrolled transactions for that preceding financial year (F.Y. 2012-13) shall be computed using the same method as is applied for the financial year immediately preceding the current year (F.Y. 2013-14), and

•    weighted average price shall be computed in the same manner as above.

iii)    Further, where data for current year was not available at the time of filing the return of income but was subsequently available at the time of assessment, and it is found that the uncontrolled transaction of the current year (F.Y. 2014-15) is not same or similar or comparable to the controlled transaction, then, that entity shall be excluded from the set of comparables, even if it had carried out comparable uncontrolled transaction in any of the preceding two financial years (F.Y. 2012-13 and F.Y. 2013-14).

In other words, an entity selected as comparable on the basis of comparable uncontrolled transaction entered into in the year preceding the current year (F.Y. 2013-14), shall be outright rejected if it is later found out that it does not have comparable uncontrolled transaction during the current year (F.Y. 2014-15).

The above calculation of weighted average prices of multiple year data will apply in all cases where RPM, CPM or TNMM have been selected as the MAM and comparable uncontrolled transactions are available in the current year as well as any or both of the immediately preceding two financial years, irrespective of whether the range concept or the arithmetic mean is applicable.


Range concept –

As per sub-rule (4) of Rule 10CA, the concept of range shall apply in case of transactions where the MAM selected is not PSM or any other method and where the dataset of prices of comparable uncontrolled transactions consists of at least six entries. The entries in the dataset will be the weighted average prices of the comparable uncontrolled transactions where RPM, CPM or TNMM was selected as the MAM and comparable uncontrolled transactions were also entered into during the preceding financial years. In other cases, i.e., where CUP is selected as the MAM or where no comparable uncontrolled transactions are available in the preceding financial years, the prices calculated using the MAM for the current year will form part of the dataset.

To apply the range concept, the dataset has to be first arranged in an ascending order and the prices starting from the thirty-fifth percentile and ending with the sixty-fifth percentile shall be considered to be the arm’s length range. If the transaction price is within the above arm’s length range, it shall be considered to be at arm’s length. However, if the transaction price is outside the range, then, the median or central value or fiftieth percentile of the dataset will be considered to be the ALP and the difference between the transaction price and such ALP shall be the amount of adjustment.

As a corollary to sub-rule (4), the range concept shall not apply where the dataset has less than six entries or where PSM or any other method is selected as the MAM. In such cases, sub-rule (7) states that the existing computation of arithmetical mean of the values in the dataset and tolerance range of 1/3%, as the case may be, will apply.

The chart on the next page, summarises the provisions relating to range concept and use of multiple year data – (In the chart, Year 3 refers to the current year)

At the end of Rule 10CA, three illustrations have been provided to explain the calculation of weighted average price, selection and rejection of comparable where current year data is not available and calculation of percentile. These are self-explanatory and hence, are not covered in this article.

Issues:

Some of the issues that arise from the rules are as set out below the chart .

Chart: Use of Range concept and Multiple year data

i)    Use of earlier years’ data in cases not covered under Rule 10B(5):

Rule 10B(4), prior to the amendment, provided that only data pertaining to the year, in which the transaction has been entered into, should be used for the purposes of benchmarking, unless earlier years’ data has a bearing on the determination of transfer prices. As per the second proviso to Rule 10B(4) now inserted, the provision relating to use of earlier years’ data shall not apply to transactions entered into after 31st March 2014. Further, sub-rule (5) provides for use of data of current year or immediately preceding financial year in case of transactions entered into after 31st March 2014, where RPM, CPM or TNMM is selected as the MAM. Thus, it appears that earlier years’ data cannot be used for transactions entered into after 31st March 2014, where CUP, PSM or Rule 10AB has been selected as the MAM, even though earlier years’ data is shown to have a bearing on the transfer prices.

ii)    Chaos during assessments:

The use of data relating to immediately preceding financial year at the time of filing return of income and use of current year data at the time of assessments will invariably lead to changes in comparables. Consequently, if the number of comparables reduces below six, or a different MAM is adopted during the course of the assessment, the ALP computation may show wild variations, especially due to parallel usage of range concept and arithmetic mean. This will only increase the uncertainty surrounding transfer pricing.

iii)    Acceptance of consistent loss making companies: It is nearly a settled principle that companies that are consistently loss making cannot be accepted as comparable companies since it indicates improper functioning or inefficiencies or discrepancies, etc.

Similarly, several tribunals have held that high profit making companies should also be rejected. With the use of multiple year data, the year on year aberrations are meant to even out. Would it then imply that loss making or high profit making companies can be accepted? It is worth noting that an entity with losses in two out of three years has been accepted as a comparable illustration 1. Logically, consistently loss making or high profit making companies will still need to be excluded, as these entities will have operational differences that cause the substantial deviations, which in turn will translate into differences in FAR.


Conclusion:

The attempt to align the Indian TPR with international practices by introducing provisions for use of the long debated range concept and multiple year data is a welcome move. The final rules are even slightly more liberal as compared to the draft scheme released a few months ago. However, it appears that the complicated drafting of the rules and possibility of re-doing the entire benchmarking process during assessment may end up doing more harm than good.

[2015] 60 taxmann.com 432 (Mumbai – Trib.) IMG Media Ltd vs. DDIT A.Y..: 2010-11, Order dated: 26th August, 2015

fiogf49gjkf0d
Article 13(3) and 13(4) of India-UK DTAA, s. 9(1)(vi) and 9(1)(vii)
–payment made to a UK Company for capturing and delivering live audio
and visual coverage of cricket matches was: neither FTS since
broadcasters or BCCI had not acquired technical expertise which enabled
them to produce the live coverage feeds on their own; nor Royalty since
there was no transfer of all or any right.

Facts:
The
Taxpayer was a Company incorporated in the UK and a tax resident of UK
having a tax residency certificate for the relevant year. The Taxpayer
was engaged in the business of multimedia coverage of sports events
including cricket. BCCI engaged the Taxpayer for capturing and
delivering live audio and visual coverage of cricket matches. The
Taxpayer had contended that since the cumulative period of stay in India
of personnel of the Taxpayer exceeded the threshold limit of 90 days in
the ’12 month’ period, from March 22, 2008 to March 21, 2009, service
PE of the Taxpayer was constituted in India under Article 5(2)(k) of
India-UK DTAA. Accordingly, the payment made by BCCI to the Taxpayer
constituted business income, taxable on net basis

The Tax
Authority contended that the amount received by the Taxpayer was in the
nature of FTS and Royalty and assessed the entire amount on gross basis.

Held:
On FTS
Having regard to the following facts, the Tribunal held that payment received by the Taxpayer was not FTS.

  • The
    Taxpayer had delivered the final product (i.e., program content)
    produced by it by using its technical expertise which was altogether
    different from provision of technology itself.
  • In the former
    case, the recipient would get only the product which he can use
    according to his convenience, whereas in the latter case, the recipient
    would get the technology/knowhow which would enable him to produce other
    program content on his own and thus, know-how would be made available
    and would constitute FTS.
  • The Tax Authority had not established
    that the broadcasters (acting on behalf of the BCCI) or the BCCI itself
    had acquired the technical expertise from the Taxpayer which would
    enable them to produce the live coverage feeds on their own after the
    end of contract.
  • Since the essential condition of “make
    available” clause was not satisfied, the amount received by the Taxpayer
    for delivering live audio and visual coverage of cricket matches was
    not FTS in terms of Article 13(4) (c) of India-UK DTAA.

On Royalty
Having regard to the following facts, the Tribunal held that payment received by the Taxpayer was not Royalty.

In
order to constitute ‘royalty’, the payment should have been made “for
the use of, or the right to use any copyright etc”. In the instant case,
the payment made to the Taxpayer was for producing the program content
consisting of live coverage of cricket matches.

The job of the
Taxpayer ended upon the production of the program content. BCCI was the
owner of the program content produced by the Taxpayer. The broadcasting
was carried out by some other entity licensed by BCCI.

Thus,
there was no question of transfer of all or any right. Therefore, the
payment received by the Taxpayer could not be considered ‘royalty’
either under India-UK DTAA or u/s. 9(1)(vi) of the Act.

levitra

TS-501-ITAT-2015- (Mum) Lionbridge Technologies Private Limited vs ITO A.Y.: 2007-08, Order dated: 5th August 2015

fiogf49gjkf0d
Section 195 – on facts, amount reimbursed towards allocation, without any mark-up, of cost of off-the-shelf software purchased from vendors, being not chargeable to tax in India, payer was not obliged to deduct tax u/s. 195

Facts:
A company incorporated in USA (“USCo”) had entered into global agreement with certain software vendors for purchase of standard off-the-shelf software to be used by its group entities across the globe including India. USCo made payments to the vendors and allocated the cost of the software, without any mark-up, amongst various group entities based on the number of desktop in each group entity. The Taxpayer, an Indian company, also reimbursed the allocated cost to USCo.

According to the Taxpayer, since the software was purchased off-the-shelf, and was acquired for use, the payment did not result in ‘royalty’ or ‘income’ in the hands of the recipient. Further the payment was merely reimbursement of cost without any mark up.

However, according to the Tax Authority, the payment was in the nature of ‘royalty’.

Held:
USCo had made the allocation at cost without charging any mark-up. There was no dispute about the reimbursement amount paid to USCo being not chargeable to tax in India.

It was not a case where USCo had developed software which was given for use to the Taxpayer. The software was purchased from vendors and cost was allocated. It was a case of pure reimbursement of cost without any mark-up.

Thus, there was no dispute that the amount paid to USCo, being purely a reimbursement, was not chargeable to tax in India. Thus, relying on the decision of the Supreme Court in G E India Centre Technology Ltd vs. CIT [339 ITR 587], it was held that there was no obligation on the Taxpayer to withhold tax u/s. 195

levitra

TS-511-ITAT-2015 (Mum) Reuters Limited vs. DCIT A.Y.: 1997-98, Order dated: 28th August 2015

fiogf49gjkf0d
Article 5(5) and 5(2)(k) of India-UK DTAA – income from distribution of
news and financial information products was not taxable in India in the
absence of dependent agent PE, and service PE under India-UK DTAA ?
Facts: The Taxpayer was a UK tax resident engaged in the business of
providing worldwide news and financial information products (“Reuter
Products”). The Taxpayer entered into three agreements with its Indian
Subsidiary (“ICo”) – License Agreement, Product Distribution Agreement
and Distributor Agreement (“DA”) – for independent distribution of
Reuter Products to Indian subscribers. In terms of DA, the Taxpayer
provided Reuter Products to ICo, which independently distributed it to
Indian subscribers.

While there was no dispute on the first two
agreements, in respect of DA, the Tax Authoroty held that the Taxpayer
had a PE in India in the form of ICo, as it was dedicated for the
business of the Taxpayer; and secondly, the Taxpayer had also deputed
its own employee as Bureau Chief during the relevant period, for
rendering services to ICo on its behalf. Accordingly, the entire
distribution fee was taxable on gross basis @20% u/s. 44D r.w. section
115A.

Held:

On Agency PE

Having regard to the following facts, the Tribunal held that ICo did not constitute agency PE of the Taxpayer.

  • Perusal
    of DA showed that ICo did not have any authority to negotiate or
    conclude contracts which would bind the Taxpayer nor to act as an agent
    of the Taxpayer qua distribution to Indian subscribers.
  • Perusal
    of contract between ICo and Indian subscribers showed that it was an
    independent principal-toprincipal arrangement and ICo had initiated
    litigation for recovery of debts from Indian subscribers.
  • Any news and material supplied by ICo to the Taxpayer was on principal-to-principal basis.
  • Income of ICo from subscription fee was far in excess of service fee.
  • Under DA, ICo had not earned any commission.
  • ICo
    was not subject to instructions or comprehensive control of the
    Taxpayer. It was bearing the business risk and was not acting only on
    behalf of the Taxpayer. Further, it was not “wholly or almost wholly”
    dependent on the Taxpayer in any manner since it was independently
    earning subscription fees, which were far in excess of service fees
    earned from the Taxpayer.

On Service PE
The
employee deputed by the Taxpayer was only acting as chief reporter and
text correspondent in India in the field of collection and dissemination
of news. There is no furnishing of services by the employee to ICo and
the employee had no role in providing Reuter Products to ICo, which
earned distribution fee. Thus Taxpayer did not trigger Service PE in
India.

Accordingly, distribution fee earned by the Taxpayer in India was not taxable in India.

levitra

TS-390-ITAT-2015 (Del) Mitsui & Co. India Pvt. Ltd vs. DCIT A.Y.: 2007-08. Order dated: 20th August 2015

fiogf49gjkf0d
Section 92C – Support services cannot be recharacterized as trading transaction and cost of sales to be excluded while computing Arm’s Length Price (“ALP”); No adjustment to be made where the difference between ALP and price charged is within ±5%.

Facts:
The Taxpayer, an Indian Company, was a wholly owned subsidiary of a Japanese Company (“JCo”). JCo was a general trading company) in Japan playing an important role in linking buyers and sellers of wide range of products. The Taxpayer was engaged in the business of providing support services to various group entities of JCo. The Taxpayer was a facilitator for the transactions entered into by JCo and its group entities.

During the relevant financial year, the Taxpayer had entered into various transactions, which included provision of services, purchase of goods (including capital goods), reimbursement of expenses (payments and receipts) and receipt of interest. The Taxpayer used Transactional Net Margin Method (“TNMM”) as the most appropriate method and used ‘Berry Ratio’ as the Profit Level Indicator (“PLI”) for benchmarking the transaction. It calculated the Berry Ratio by taking into account operating profit and operating expenditure. The Taxpayer contended that its average berry ratio was 1.34 as against 1.09 computed on the basis of the 20 comparables set out in the transfer pricing study and hence the transactions entered into were at arm’s length price.

The tax authority was of the view that data was to be used only for the relevant financial year and cost of sale should be included in the denominator of the PLI used and not the operating expenses.

As regards the support services, the tax authority held that it should be treated equivalent to trading and the income received therefrom should be considered as trading income and comparison should be made accordingly. However, the Taxpayer was of the view that Function, Asset and Risk (“FAR”) analysis of the service business is different from trading business. Hence, the Taxpayer approached DRP. DRP upheld the order of the tax authority. Aggrieved, the Taxpayer appealed before the ITAT.

Held:

Relying on judgment of Delhi High Court in Li & Fung India Pvt. Ltd. vs. CIT [361 ITR 85 (Delhi)], and in Mitsubishi Corporation India (P) Ltd vs. DCIT [ITA No. 5042/Del/11 dated 21.10.2014], it was held that it is impermissible to make notional addition in the cost base and then take into account the costs which are not borne by the Taxpayer. Thus, it was not correct on the part of the tax authority to include the cost of sales incurred by the Associate Enterprises (“AEs”) in respect of which the Taxpayer has rendered services and then to work out the profit for determination of the arm’s length prices1. Thus, Tax Authority was not right in including the cost of sales of AEs while determining ALP.

As per the provisions of section 92C, first the most appropriate method should be determined. Based on that, ALP should be determined by using various comparables. Further, when the difference between the ALP and the cost paid or charged is within the permissible range, no adjustment is required to be made.

Therefore as the margin was within the permissible range of 5%, the adjustment made to ALP was not sustainable and was to be deleted.

levitra

Automatic Exchange of Information

fiogf49gjkf0d
Every country in the world is concerned about its tax base. The Organization of Economic Development (OECD) has drawn comprehensive action plan to address the issue of the Base Erosion and Profit Shifting (BEPS) which has been endorsed by G20 leaders and their finance ministers at their summit held in St. Petersburg in September 2013. Exchange of Information is the key to prevent erosion of the tax base.

The Foreign Account Tax Compliance Act (FATCA) was enacted by the Government of the United States in 2010, to combat offshore tax evasion and for detecting tax noncompliance by US individuals and US owned entities having foreign financial accounts and offshore assets. On July 9, 2015, India signed an Inter-Governmental Agreement (IGA) with the US to implement FATCA and improve tax compliance. This IGA obliges qualifying financial institutions (QFIs) in India to report about the financial accounts held by US persons in India to the Indian competent authority who in turn shall share the information with the US IRS. The agreement is reciprocal in nature i.e. US IRS is also obliged to provide India with information regarding accounts/assets held by Indian persons in the US.

On the other hand, OECD along with G-20 countries, on similar lines as FATCA, has developed a Standard for automatic exchange of Financial Account Information, Common Reporting Standard (CRS).

An attempt is made in this article to highlight the need, manner and impact of exchange of information under various types of agreements/frameworks.
1. Introduction

1.1 Article on Exchange of Information under a Tax Treaty

Exchange of Information between two jurisdictions can be made in several ways. Article 26 of the United Nations Model Convention (UNMC) and the OECD MC deal with provisions relating to the Exchange of Information (EOI). Almost all comprehensive tax treaties signed by India contain Article on Exchange of Information whereby Tax Authorities in India can obtain information about specific query from its counterpart in the other contracting State.

1.2 Tax Information Exchange Agreement (TI EA)

Countries (especially Tax Havens) with which India does not have a full-fledged tax treaty, an agreement to share information known as “Tax Information Exchange Agreement” (TIEA) has been entered into by India with 15 countries including Saint Kitts and Nevis, Bahamas, Bermuda, Liechtenstein, Gibraltar, British Virgin Islands, Isle of Man, Cayman Islands, Jersey, Macau, Liberia, Argentina, Guernsey and Monaco, San Marino.

The nature and type of information that can be requested under the TIEA include identity and ownership information, accounting information and banking information among other things.

Under a TIEA, the Contracting States are not required to provide administrative assistance and exchange information in cases of “fishing expedition”, i.e. speculative requests that have no apparent nexus to the inquiry or investigation in the requesting State. Thus, the information about all Indians having bank accounts in a particular country cannot be requested as it would amount to a fishing expedition.

1.3 Limitations of EOI under a Treaty and TIEA

Exchange of Information, both under a Tax Treaty or a TIEA has a major limitation and i.e. these instruments cannot be used for fishing expedition. In other words, information in respect of a specific person or case/ matter can only be obtained under these agreements. Therefore, perhaps a need was felt by India for more comprehensive and a broad framework whereby information flows continuously on an automated basis and that too in respect of all overseas transactions by residents/tax payers in India to unearth illicit deals or black money stashed abroad. In the above background, automatic exchange of information under FAT CA and Multilateral Agreement under the framework of CRS by OECD would prove to be crucial sources of information to Indian Revenue Authorities.

Let us deal with both these frameworks in some more detail.

2.0 Foreign Account Tax Compliance Act (FATCA)

2.1 Manner of Reporting under FATCA

The FATCA guidelines specify two types of Inter Governmental Agreements (IGA) that countries are expected to enter into with the US – Model 1 and Model 2. Under the Model 1 IGA, all foreign financial institutions (FFI) in the participant country (for instance, an insurance company or a bank operating in India) would be obliged to report all FAT CA related information to its specified competent authority (which, in India is the Central Board of Direct Taxes), who would then report this information to the US authorities. Under the Model 2 IGA, all foreign financial institutions are required to report information directly to IRS.

In each of such models, the foreign financial institutions will need to get itself registered with the IRS. However, in case of Model 2 IGA, these financial institutions will also need to sign an FFI agreement with the IRS. Switzerland is one such country that has adopted Model 2 IGA. India has executed the Model 1 IGA. As a result, qualifying Indian institutions need not sign an FFI agreement, but will have to register on the FAT CA Registration Portal or file Form 8957 of the IRS and obtain a Global Intermediary Identification Number.

Basic framework of IGA signed by India

(For further information on FATCA, you may refer to an article by CA. Sunil Kothare published in March 2015 issue of BCAJ) 2.2 I nformation reporting and disclosure under the IGA by Qualifying Financial Institutions (QFIs) in India As per the IGA, all financial accounts with QFIs in India such as banks accounts, investment in mutual funds or hedge funds, insurance policies etc. come under the purview of reporting under FAT CA. However, there are certain accounts which are not required to be reported by the QFIs to the Indian Competent Authority and in turn to the US IRS under FAT CA. They are as follows: ? List of Accounts exempt from reporting under FATCA A. C ertain Savings Accounts i. N on-Retirement Savings Accounts established in India under the Senior Citizens Saving Scheme of 2004 to provide Indian senior citizens savings and deposit accounts. ii. Retirement and Pension Account maintained in India that satisfies the following conditions: – T he account is subject to regulation as a personal retirement account or is part of a registered or regulated retirement or pension plan for the provision of retirement or pension benefits (including disability or death benefits); or is subject to regulation as a savings vehicle for purposes other than for retirement as the case may be;
– The account is tax-favored (i.e. contributions to the account that would otherwise be subject to tax under the laws of India are deductible or excluded from the gross income of the account holder or taxed at a reduced rate, or taxation of investment income from the account is deferred or taxed at a reduced rate);
– Annual information reporting is required to the tax authorities in India with respect to the account;
– Withdrawals are permitted only on reaching a specified retirement age, disability, or death, or on specific criteria related to the purpose of the savings account or penalties apply to withdrawals made before such specified events; and
– Either Annual contributions are limited to $50,000 or less or there is a maximum lifetime contribution limit to the account of $1,000,000 or less.

iii. Non-Retirement Savings Account that is maintained in India (other than an insurance or Annuity Contract) and satisfies following conditions:

– The account is subject to regulation as a savings vehicle for purposes other than for retirement;
–    The account is tax-favored (i.e., contributions to the account that would otherwise be subject to tax under the laws of India are deductible or excluded from the gross income of the account holder or taxed at a reduced rate, or taxation of investment income from the account is deferred or taxed at a reduced rate);

–    Withdrawals are permitted on meeting specific criteria related to the purpose of the savings account (for example, the provision of educational or medical benefits), or penalties apply to withdrawals made before such criteria are met; and

–    Annual contributions are limited to $50,000 or less and subject to certain rules laid down.

B.    Term Life Insurance Contracts satisfying the following conditions:

–    Maintained in India with a coverage period that will end before the insured individual attains age 90;
–    On which periodic premiums are paid which do not decrease over time and are payable at least annually during the period the contract is in existence or until the insured attains age 90, whichever is shorter;
 

–    The contract has no contract value that any person can access (by withdrawal, loan, or otherwise) without terminating the contract and is not held by a transferee for value.

C.    Account maintained in India, and is held solely by an estate if the documentation for such account includes a copy of the deceased’s will or death certificate.

D.    Escrow Accounts maintained in India established in connection with any of the following:

–    A court order or judgment;

–    For a sale, exchange, or lease of real or personal property subject to fulfillment of certain conditions;
–    An obligation of a Financial Institution servicing a loan secured by real property to set aside a portion of a payment solely to facilitate the payment of taxes or insurance related to the real property at a later time;

–    An obligation of a Financial Institution solely to facilitate the payment of taxes at a later time.

E.    Partner Jurisdiction Accounts

It refers to an account maintained in India and which is excluded from the definition of Financial Account under an agreement between the United States and another Partner Jurisdiction1 to facilitate the implementation of FATCA. However, such account should be subject to the same requirements and oversight under the laws of such other Partner Jurisdiction as if such account were established in that Partner Jurisdiction and maintained by a Partner Jurisdiction Financial Institution in that Partner Jurisdiction.

2.3 Due Diligence thresholds in case of new and pre existing accounts

FATCA requires full compliance by QFIs in India for “new accounts” (i.e. accounts opened after 30th June, 2014) as well as “pre-existing accounts” (i.e. accounts existing as on 30th June, 2014). This involves review, identification and reporting of relevant financial accounts. However, certain exemption thresholds are laid down by virtue of which no review or reporting of such accounts is required.

Account
balance

FATCA
compliance

USD 50,000 or less as at the end

Out of scope for FATCA, only in

of the
calendar year date

case of
Cash Value Insurance

 

contract

PRE-EXISTING
ACCOUNTS

 

Account
balance

FATCA
compliance

(as
of 30th June, 2014)

 

 

USD 50,000 or less

Out of scope for FATCA

USD 250,000 or less

Out of scope for FATCA, only in

 

case of
Cash Value Insurance

 

contract or an Annuity Contract

> USD
50,000 (USD 250,000 for

–   Referred as ‘Lower value

a Cash
Value Insurance Contract

 

account’

or
Annuity Contract) up to USD

–

Review of
electronically

1,000,000

 

searchable
data required by

 

 

the
reporting Indian financial

 

 

institution for US Indicia2

> USD 1,000,000

–

Review of electronically

 

 

searchable
data required by

 

 

the
reporting Indian financial

 

 

institution
for US Indicia,

 

–   If the electronic databases

 

 

do not
capture all of the

 

 

requisite
information, then

 

 

paper
record search

 

–   findings of the relationship

 

 

manager (if applicable).

2.4    Impact of the IGA signed by India

2.4.1 Impact on US Citizens and Green card Holders living in India

Starting calendar year 2011, FATCA has subjected all US persons to report on Form 8938 their Bank, investment and brokerage accounts as well as other specified financial assets including but not limited to cash value of life insurance contracts and accumulation in certain retirement plans. Reporting of global income on US income tax return, including income earned in India, has undoubtedly been an important legal obligation of all US persons living in India. This is in addition to the long-standing requirement for US persons in India to report their bank accounts on Form TD 90.22-1 i.e. “Report of Foreign Bank and Financial Accounts (FBAR)”.

(For further information on FBAR, the reader may refer to Q.14 of our Article published in this column in April 2015 issue of BCAJ)

FATCA will have a direct impact on the US Citizens and green card holders who qualify to be US persons. Such persons may be holding accounts with QFIs in India which shall now be reported to the Indian Competent Authority and in turn to the US IRS. It may happen that they have not reported/ disclosed such accounts to the IRS and as a consequence of such reporting, they are exposed to heavy financial penalties and even criminal prosecution under the US tax laws. Such individuals may however opt to disclose the said accounts under the 2014 Offshore Voluntary Disclosure Program (OVDP) to avoid prosecution and limit their exposure to civil penalties.

2.4.2 Impact on Indian residents

With the Black Money Law now in force, the IGA signed by Government of India can further have adverse implications for the Indian resident taxpayers who are holding undisclosed assets in the US. The reciprocal nature of the IGA will oblige US to provide India with information regarding accounts/assets held by Indian persons in the US and which may happen to be undisclosed to the authorities in India.

Such information will provide more teeth not only to the Indian tax authorities but also to the RBI for detecting assets held by Indian residents/ taxpayers in the US.

2.4.3 Impact on Financial Institutions in India

The Inter-Governmental Agreement between India and US is based on Model-1 of FATCA guideline. Hence, the QFIs in India need not report directly to the IRS.

The IGA would result into following implications for FIs in India:

  •     QFIs in India need to upgrade and expand their existing ‘Know Your Customer’ (KYC) procedures to identify US persons and impose additional reporting requirements on them;

  •    Banks and other financial bodies may also need to get waivers from account holders to report information collected from them to the Indian competent authority;

  •   Section 285BA of the Income-tax Act 1961 has been amended so as to serve as a broad enabling provision for reporting by QFIs in India for the purposes of tax information regimes such as FATCA. However, due to confidentiality clauses under different laws in India, appropriate regulations may need to be introduced which will enable and empower qualifying Indian institutions to comply with FATCA requirements and to mandate the US account holders to provide the requisite information.

  •   Both FATCA and CRS require Indian financial institutions to make changes to their systems, processes and documentation to capture information for identification of account-holders and for reporting to the Indian government. This is an uphill task involving manpower training, system changes, changes to new client on-boarding, remediation of pre-existing account-holders, classification of entity accounts as per FATCA taxonomy, etc., which have an attached cost.

  •     Non-compliant FIs would be liable to a penal withholding tax of 30 per cent of their US sourced income.

3.0    Multilateral Automatic Exchange Of Financial Account Information

The Organization of Economic Development (OECD) along with G-20 countries, on similar lines as FATCA model 1 IGA, has developed a framework for multilateral automatic exchange of financial account information, known as Common Reporting Standard (CRS). CRS sets out a standard basis for automatic financial account information exchange between member countries.

As of 4th June 2015, 61 countries are signatories to the Multilateral Competent Authority Agreement (MCAA) committed to reciprocal tax information exchange. India is an early adopter and agreed for the implementation of CRS by January 1, 2016. India signed the MCAA AEOI CRS on 3rd June 2015. Compliance with CRS becomes mandatory from 1st January 2016.

More than 50 countries of the world have committed to exchange tax information on an automatic basis with effect from 2017 which includes notable tax havens and many developed nations as well. Some of the notable jurisdictions include Barbados, British Virgin Islands, Cayman Islands, Cyprus, Gibraltar, Guernsey, Isle of Man, Jersey, Liechtenstein, Luxembourg, Malta, Bahamas, UAE, Andorra, Bahrain, Panama, Cook Islands, Mauritius, UK, France, Germany and host of other countries including India.

4.0    Summation

Automatic Exchange of Information between US and India would hopefully start flowing from 1st October 2015 under FATCA. Information from more than 50 countries including notable tax haven would start flowing to India from 1st January 2016. Under the scenario, Indian tax officials will be better equipped to tackle the menace of Black Money and illicit/unreported transactions. Unprecedented powers are given to the Tax Administration under the Black Money (Undisclosed Foreign Income & Assets) and Imposition of Tax Act, 2015. There is a fear amongst citizens about misuse of powers without corresponding accountability on the part of the tax officials. It is high time that Government bring about Tax Administration Reforms as per the recommendations by the Parthasarthi Shome Committee’s Report.

[2015] 62 taxmann.com 318 (Hyderabad – Trib.) St. Jude Medical India (P) Ltd vs. DCIT A.Y.: 2009-10, Date of Order: 18-9-2015

fiogf49gjkf0d
Section 92C, the Act – TPO cannot reject method consistently adopted by the taxpayer in past years for determination of ALP (which was not disputed by the tax authority) and apply another method without providing detailed reasons.

Facts
The taxpayer was engaged in the business of trading of medical devices. It had entered into international transactions with its AE for purchase of certain medical devices from its AE. The taxpayer was selling these devices in India to non-related parties. In its TP study, for determination of the ALP the taxpayer had adopted RPM and had adopted 4 companies as comparable companies.

According to the TPO RPM could be applied only where: the products were closely comparable; and where enterprise purchases a property or services from AE and then resells the same to unrelated enterprises. Further, one should ascertain the functions performed by the tested party before it resold the property or the services and also the cost incurred for performing these functions. Therefore, the TPO considered TNMM as more appropriate method in case of the taxpayer and proceeded to determine ALP accordingly.

Held
The taxpayer had been purchasing medical devices from its AEs even in the earlier years. This is evident from order of Tribunal in earlier year where tax authority has not disputed the method adopted by the taxpayer during its TP study.

Hence, there is no reason to dispute the same method during the relevant year. the order of the TPO merely reproduces the parameters to be taken into consideration for adopting the RPM for comparability analysis, but does not give detailed reasoning as to why the said method is not applicable.

Further, the TPO has not brought on record any evidence to support why the products sold by the comparable companies are not similar to the products sold by the taxpayer.

If the TPO desires to reject the method consistently being followed by the taxpayer and desires to adopt a different method, he is required to give his reasoning which he failed to provide in the present case.

Accordingly, the issue was remanded to the TPO for determination of the most appropriate method for determination of the ALP with directions that if he finds the RPM as the most appropriate method, then he shall also take into consideration the comparable companies selected by the taxpayer in addition to the companies selected by him for determination of the ALP.