BCAJ | Bombay Chartered Accountant Journal

Hess ACC Systems B. v In re [2012] 24 taxmann. com 297 (AAR New Delhi) A. A. R. No 1033 of 2010 Date of Order: 27-08-2012 Before P K Balasubramanyan (Chairman)

Where the Applicant had entered into two separate contracts – one for supply of plant and another for erection and installation services, and the period between supply of plant and commencement of erection and installation services was considerable, the services could not be said to fall under the exception in Article 12(6)(a) of India-Netherlands DTAA.

Facts:
The Applicant was a company incorporated in, and resident of, Netherlands (“DutchCo”). The Applicant entered into two contracts with an Indian company (“IndCo”) on the same day. The first contract was for supply of machinery, spare and technical documentation for production of certain products. The second contract was for supply of project services for erection and installation of the machinery supply under the first contract. DutchCo supplied machinery under the first contract and thereafter, approached AAR for its ruling on the issue whether the payments made by IndCo towards project services were chargeable to tax, either under I T Act or under India- Netherlands DTAA.

DutchCo contended that both the contracts were entered into on the same day, they were part of the same transaction, the consideration was also dependent on each other and the contract for project services was ancillary and inextricably linked to the supply contract. Accordingly, in term of Article 12(6) (a) of DTAA, it would not be FTS. The tax authority countered that once DutchCo and IndCo having treated the two contracts as separate contracts, it was not open for DutchCo to plead otherwise.

Held:
The AAR observed hand held as follows.
? The DutchCo did not dispute that the payments were FTS, but claimed that the payments were for services that were ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property.
? It was really an indivisible contract which was artificially split up, possibly, to avoid tax.
? It was hence, not open for DutchCo to claim that the project services contract was for services that were ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property.
? While the supply of plant was completed on 5th December, 2009, the supply of services was ‘expected to commence from March 2011’, which showed lack of proximity between the two contracts.
? Therefore, the payments under the second contract were fees for technical services not falling within the exception in Article 12(6)(a) of India-Netherlands DTAA.

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Rajeev Sureshbhai Gajwani v. ACIT ITA No. 1807 & 1978/Ahd./2006 & 3111/Ahd./2007 (SB) (Unreported) Article 26 of India-US DTAA; Section 80HHE

US resident carrying on business activity through PE in India is to be treated at par with resident Indian enterprises carrying on similar business activity for the purpose of taxation.

US resident can invoke PE non-discrimination clause of the treaty and is entitled to claim tax holiday u/s.80HHE for export of software outside India.

Facts:
The taxpayer was an individual tax resident of the USA and a non-resident (NR) in India. The taxpayer was engaged in the business of software export through its Permanent Establishment (PE) situated in India.

Relying on the PE non-discrimination clause under Article 26(2) of the DTAA, the taxpayer contended that PE of an American enterprise cannot be treated less favourably than Indian resident enterprise and thus, claimed deduction u/s.80HHE in respect of the profits earned by PE.

The Tax Department rejected the contention of the taxpayer and held:

Tax holiday u/s.80HHE specifically permitted deduction only to residents or Indian companies. As the taxpayer was a NR, such deduction was not permissible.

In the case of Automated Security Clearance Inc4 (Automated), Pune ITAT has held that NR taxpayers were not entitled to tax holiday provisions as they were restricted to resident Indian enterprises. Such differentiation was reasonable as section 80HHE deduction was granted to augment foreign exchange reserves and while residents will receive and retain export proceeds in India, a non-resident will be able to remit funds outside India.

The OECD Model Convention Commentary too supports that NRs are not entitled to tax advantages attached to activities which are reserved on account of national interest, defense, protection of the national economy to resident Indian enterprises and that there can be a reasonable discrimination.

The taxpayer contended that: (a) If a US tax resident carried on business in India in the same line in which a resident Indian enterprise carried on business and if tax holiday was available to the Indian enterprise, then the US tax resident too should be permitted to claim the tax holiday.

(b) Once US enterprise is permitted to carry on business through PE, US enterprise cannot be denied the deduction on any count. In fact, sections 10A/10B benefits are extended to all assessees including non-residents. Also, OECD model commentary relied on by tax authority supports that non-discrimination is restricted only to critical activities of national importance where NR cannot even carry on the business.

Considering divergent views taken by Mumbai5 and Pune ITAT6 on PE non-discrimination, ITAT constituted a Special Bench to examine whether taxpayer was entitled to invoke the PE non-discrimination clause under Article 26(2) of the DTAA.

Held:
The Tribunal held as follows:

Article 26(2) of the DTAA provides that taxation of PE of an American enterprise shall not be less favourable than the taxation of resident Indian enterprise carrying on the same activities. It follows automatically that exemptions and deductions available to Indian enterprises would also be granted to the US enterprises if they are carrying on the same activities.

The fact that the taxpayer has been allowed to export software shows that the business does not fall in the prohibited category. Accordingly, the taxpayer’s case has to be compared with the case of an Indian enterprise engaged in the business of exporting software. If this is done, the taxpayer would be entitled to deduction/ tax holiday under the Act on the same footing and in the same manner as the deduction is admissible to a resident taxpayer.

The decision of the Pune ITAT in the case of Automated is not in conformity with the provisions contained in Article 26(2) as more importance was placed on the Commentary of the OECD MC and the Technical Explanation. The plain meaning of the provisions was not considered.

The decision of the Mumbai ITAT in Metchem, though rendered in the context of HO expenses, harmonised the provisions of the Act and the relevant DTAA. Similar exercise is involved in the current case as the provisions of the Act and the DTAA are required to be interpreted in a harmonious manner. Therefore the ratio of the decision is applicable to the facts of the present case.

As a result, taxpayer is entitled to deduction/ tax holiday u/s.80HHE of Act on the same footing as it is available to a person resident in India.

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Toshiba Plant Systems and Services Corporation v. DIT (2011) TII 1 ARA-Intl. Section 44BBB Dated: 22-21-2011

Consideration received by holding and subsidiary companies for independent contracts in respect of power projects, respectively, for offshore supply of equipments and for erection of equipments, cannot be clubbed for the purpose of section 44BBB of the Act.

Consideration received for offshore supply of machinery is not taxable in India.

Facts:
The applicant was a Japanese company. It was a subsidiary of TC, another Japanese company. An Indian company setting up a power project, which was approved by the Government, had invited bids in respect of two projects in connection with the power project. Pursuant to the bid contract, the applicant and its holding company were awarded two different projects. The parent company was to undertake offshore supply of plant and machineries and the applicant (subsidiary company) was to undertake installation and erection of the plant, depute personnel for execution of project and for turnkey completion and commencement of the power project. The respective roles and responsibilities were as per the following diagram:

The applicant raised the following issues before AAR:

Whether consideration received by the applicant is eligible for presumptive rate of taxation in terms of section 44BBB, and accordingly whether 10% of the contract amount would be deemed to be profits chargeable under the head Profits and Gains from Business or Profession.

If the applicant engages services of a related party or third party for supply of labour for executing the work under the contract with the condition that overall responsibility would remain with the applicant, would the applicant be eligible for presumptive taxation u/s.44BBB of the Act.

The Tax Authority contended that though the two contracts were separately awarded to the holding company and the applicant, they represented a composite contract and hence its taxability should be determined by clubbing transactions of supply and erection of machines.

As regards the second question, the applicant contended that, in essence, the applicability of section 44BBB would be conditional upon verification of master documents along with the facts as to whose employees would render services to the applicant. The applicability of section 44BBB would also depend on whether skilled labour or employees would work under the control and supervision of the applicant.

The applicant contended that:

(a) Both contracts represented two distinct and independent contracts for which separate considerations were fixed.

(b) Applicant was engaged in the business of erection of plant in connection with turnkey power projects. Income of the applicant was taxable u/s.44BBB of the Act.

(c) Parent company merely supplied the equipments which were installed as per required specifications. Consideration for offshore supply was not taxable in view of the Supreme Court’s decision in the case of Ishikawajima Harima Heavy Industries Ltd. v. DIT3.

Held:
The AAR held as follows:

The Indian company had executed two contracts, one with the parent company (for supply of plant) and the other with the applicant (for erection of plant and machinery) for the turnkey power project in India.

Consideration received by parent company is not taxable in India as it pertains to offshore supply and reliance on the Supreme Court’s decision by the applicant to that extent is valid.

Section 44BBB was applicable as the applicant was in the business of erection of plant and machinery in approved turnkey power project.

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Transworld Garnet Company Ltd. v. DIT (2011) TII 02 ARA-Intl. Article 24 of India-Canada DTAA; Sections 48, 90(2), 197 of Income-tax Act Dated: 22-2-2011

Residence-based discrimination is not prohibited under Article 24 of India-Canada DTAA.

Facts:
Taxpayer, a Canadian company (CanCo) held 74% shares in TGI, an Indian company. Shares of TGI were acquired by CanCo in various lots and at different points in time by remitting foreign currency. CanCo transferred shares of TGI to VV Minerals (VV) a partnership firm registered in India and made significant profits. There was no dispute that:

(a) Shares were long-term capital asset in the hands of CanCo.
(b) Income arising on transfer of shares was income chargeable to tax in India.

CanCo computed capital gain by applying both the provisos to section 48. Capital gain in terms of the first proviso to section 48 (i.e., neutralising exchange fluctuation gain), worked out to Rs.14 crore and in terms of the second proviso it worked out to Rs.7 crore (i.e., considering indexation benefit). Since indexation benefit was more beneficial, CanCo claimed that:

(a) Resident taxpayers under comparable circumstances are provided benefit of indexation for the cost of acquisition, whereas non-residents are denied such benefit;

(b) Such treatment results in discrimination of a Canadian National vis-à-vis Indian National, which is violative of provisions of Article 24(1). The Tax Department contended that: (a) The second proviso to section 48 of the Act provides that benefit of indexation is not available to ‘non-resident’ covered by the first proviso. (b) The non-residents stand protected from the vagaries of exchange fluctuation under the first proviso to section 48 of the Act. (c) Hence, in terms of clear language of the sections, no benefit of indexation can be granted.

Held:
The AAR held as follows: Discrimination is understood to be unequal treatment in identical situations. Different treatment does not constitute discrimination unless it is arbitrary. Article 24(1) of DTAA seeks to prevent differentiation solely on the ground of nationality and against nationals as such. Discrimination on account of nationality alone may be prohibited but a discrimination based on residence is permitted.

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Export profit: Company: MAT: Section 80HHC and section 115JB of Income-tax Act: When income of company is assessed u/s.115JB, assessee is entitled to deduction u/s.80HHC computed in accordance with Ss.(3) and (3A) of section 80HHC: Restriction contained in section 80AB or section 80B(5) cannot be applied and carried forward business loss or depreciation cannot be first set off leaving gross total income nil.

[CIT v. Kerala Chemicals & Proteins Ltd., 239 CTR 24 (Ker.) (FB)]

Dealing with the scope of computation of amount deductible u/s.80HHC of the Income-tax Act, 1961, while assessing the income of a company u/s.115JB, the Full Bench of the Kerala High Court has held as under:

“(i) The short question arising for consideration is whether the assessees, whose gross total income after setting of business and depreciation carried forward from previous years is nil, are entitled to deduction u/s.80HHC in the computation of book profits u/s.115JB(2) (iv) of the Act?

(ii) After hearing both the sides and after going through the decisions, particularly that of the Supreme Court [Ajanta Pharma v. CIT; 327 ITR 305 (SC)], we feel that the assessees are entitled to deduction u/s.80HHC computed in accordance with Ss.(3) and (3A) of section 80HHC of the Act because it is expressly so provided under clause (iv) of section 115JB(2) of the Act.

(iii) All what the Supreme Court has held is that the ceiling contained in section 80HHC(1B) is not applicable for the purposes of granting deduction under clause (iv) above in the computation of book profits. However, there is nothing to indicate in the Supreme Court decision that eligible deduction of export profit under clause (iv) above in the computation of book profit can be computed in any other manner other than what is provided in Ss.(3) and (3A) of section 80HHC of the Act. What is clearly stated in clause (iv) is that deduction of export profit in the computation of book profit is the same ‘amount of profit eligible for deduction u/s.80HHC’ computed under clause (a) or clause (b) or clause (c) of Ss.(3) or Ss.(3A) of the said section.

(iv) So much so, computation of export profits has to be done only in accordance with the method provided u/s.80HHC, which is in fact done in the computation of the business profit if the assessment was on the total income computed under the other provisions of the Act. MAT assessment is only an alternative scheme of assessment and what is clear from clause (iv) above is that even in the alternative scheme of assessment u/s.115JB, the assessee is entitled to deduction of export profit u/s.80HHC. In other words, export profits eligible for deduction u/s.80HHC is allowable under both the schemes of assessment. So much so, the assessees are certainly entitled to deduction u/s.80HHC, but it is only by following the method provided under Ss.(3) and (3A) of section 80HHC.

(v) However, by virtue of the above-referred decision of the Supreme Court, we feel the restriction contained in section 80AB or section 80B(5) could not be applied inasmuch as carry forward of business loss or depreciation should not be first set off leaving gross total income nil, which disentitles the assessees for deduction under other provisions of Chapter VIA-C which includes section 80HHC also.

(vi) But the assessees’ contention that export profit has to be computed with reference to the P&L a/c prepared under the Companies Act is equally unacceptable, because there is no such provision in section 80HHC to determine export profit with reference to P&L a/c maintained under the Companies Act.”

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Frontier Offshore Exploration (India) Ltd. v. DCIT ITA No. 200/Mds./2009 (Unreported) Sections 40(a)(i), 44BB, 195 of Income-tax Act (Act) A.Y.: 2004-05. Dated: 4-2-2011

Since payment to non-resident is covered under the special regime of section 44BB, withholding of appropriate tax by payer without approaching the AO does not lead to any violation of withholding tax provisions, expenses cannot be disallowed u/s.40(a) (i) on the ground of short deduction of tax.

Facts:
ICO (ICO), an oil field services provider, took drilling units on bareboat hire from two Norwegian companies. ICO was advised that bareboat charges were covered under special regime of presumptive taxation of section 44BB of the Act. Accordingly, ICO deemed income at the rate of 10% of gross bareboat charges and withheld tax @ 4.1% on the same.

The AO held that there was short deduction of tax at source and hence payment was disallowable u/s.40(a)(i) by observing that:

(a) Once amount is chargeable to tax, the payer is obligated to make an application to the Tax Department for determination of appropriate proportion of income chargeable to tax.

(b) The payer cannot on its own decide the proportion of income chargeable to tax either by applying any special or general provisions stipulated under the Income-tax Act.

(c) In ICO’s own case1 for an earlier year, ITAT had held that the determination of the applicability of special provisions of section 44BB to a payee cannot be made by ICO itself while discharging its withholding obligation and that TDS w.r.t. 10% presumed income resulted in disallowance u/s.40(a)(i).

ICO contended that:

Section 40(a)(i) applied only to the cases of absolute failure and not to short deduction.

The obligation to deduct tax is to be limited to appropriate portion of income chargeable under the Act forming part of the gross amount payable to the non-resident.

In terms of non obstante provision in section 44BB, the maximum appropriated portion of income chargeable under the Act in the hands of recipient Norwegian company was 10%.

ICO had rightly deducted tax at source on such statutorily presumed income of 10%.

Held:
The Tribunal held as follows:

In terms of SC decision in case of Transmission Corporation2, if payment represents sum chargeable to tax, ordinarily, ICO is required to withhold tax on gross basis unless there is appropriate quantification of income by the AO.

Although normally the payer cannot quantify the income of a non-resident which is subjected to withholding, section 44BB being a presumptive taxation provision stands on a different footing as it overrides the provisions of sections 28 to 41 and 43.

The recipient need not file the return of income if he is not desirous of assessment lower than what is contemplated by presumptive rate of section 44BB.

Where the statute has provided a special provision for dealing with a particular income, such a provision would exclude general provisions for dealing with incomes accruing or arising out of any business connection.

ICO’s own case for the earlier year is no longer a valid precedent in view of SC decision in case GE India Technology, which held that TDS obligation is limited to appropriate portion of income chargeable under the Act.

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State Bank of Mauritius Ltd v DDIT [2012] 25 taxman.com 555 (Mumbai) Article 7(3) of India-Mauritius DTAA; Sections 14A, 43B of I T Act Asst Year: 1999-2000 Decided on: 03 October 2012

S/s. 43-B, 14-A – Article 7(3) of India Mauritius DTAA not restrictive – No disallowance u/s. 43-B – Section 14-A operates at threshold and to be considered while computing income

Facts:
The taxpayer was a banking company incorporated in Mauritius and entitled to benefit of India-Mauritius DTAA.

The taxpayer had claimed deduction in respect of bonus. However, tax auditors had reported that a part of the amount was not paid on or before the due date of filing of return of income. Accordingly, the AO disallowed the same u/s. 43B of I T Act. Further, the taxpayer had borrowed funds from RBI and invested in tax-free bonds and claimed exemption in respect of interest from the same. Hence, the AO disallowed certain amount u/s. 14A of I T Act as interest on the borrowed funds despite the taxpayer having provided funds flow statement to the AO to demonstrate that it had adequate interest free funds available with it and hence no disallowance should be made.

Held:
The Tribunal observed and held as follows.

(i) Disallowance u/s. 43B

In terms of Article 7(3) of DTAA, for determining profits of a PE, all the expenses incurred for the business of the PE are to be deducted3. Unlike several other DTAAs where Article 7(3) is restrictive, as India-Mauritius DTAA does not have such restrictive clause, expenditure incurred for the purpose of a PE is to be allowed in full. Accordingly, disallowance cannot be effected u/s. 43B.

(ii) Disallowance u/s. 14A

There is a fundamental distinction between disallowance u/s. 14A and other disallowance provisions under business income head, since the other disallowances are in respect of expenses which are otherwise deductible. However, in contrast, section 14A at the threshold snatches away deductibility of expenses incurred in relation to an exempt income.

For instance, in terms of Article 7(4), profits cannot be attributed to a PE by reason of mere purchase of goods. The question is, if no profit can be attributed, whether expenses can be claimed? Obviously, if no profit is included in ‘business profits’, no expenses can be deducted. On the same logic, as interest on tax free bonds is not included in ‘business profits’, expenses pertaining to that cannot be allowed as deduction.

Since the taxpayer borrowed funds for investing in tax free bonds and on the next day repaid the interest bearing funds out of its interest free funds, and also since the taxpayer had sufficient profit from business operations for the year, disallowance of interest should be restricted to interest for only one day.

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National Petroleum Construction Company v ADIT (International Taxation) [2012] 26 taxmann.com 50 (Delhi – Trib.) Asst Year: 2007-08 Date of Order: 05-01-2012 Before Shamim Yahya (AM) and A D Jain (JM)

Section 44BB – Article 5 of India – UAE DTAA – In a composite contract part of which is sub-contracted time spent by sub-contractor is time spent by contractor – PE exists from date of award of contract – Parties to contract could abandon part of contract without making entire payment or refunding amount received – Contract divisible –Attribution of Profits –No PE in respect of fabrication and profits attributable thereto not taxable in India – Facility in connections with prospecting for or extraction or production of mineral oils does not fall u/s. 44 BB

Facts:
The taxpayer was a company incorporated in, and a tax-resident of, UAE. The taxpayer was awarded a contract by ONGC under international competitive bidding. The contract had two distinct components: (i) designing, fabrication and supply of platform to be carried out exclusively in Abu Dhabi and (ii) installation and commissioning of the erected platform in India. RBI had granted its approval to the taxpayer to set up a project office (“PO”) in India to undertake the entire project. In earlier years as well as in the year under consideration, the taxpayer had shown its PO as its PE.

The taxpayer fabricated the platform in Abu Dhabi and got it certified by ONGC’s approved surveyors. Thereafter, it was brought to India and handed over to ONGC. The taxpayer had engaged a consultant for gathering information, representation and other related services and constituted its dependent agent’s PE.

According to the taxpayer, the work relating to designing, fabrication and supply of platform was performed and completed outside India. Further, it did not have an installation PE in India since installation and commissioning activity was carried out for less than nine months. Hence, the income relating to designing, fabrication and supply was not taxable in India.

The issues before the tribunal were as follows.
(i) Whether the taxpayer had a PE in India?
(ii) Whether a composite contract can be divided in different parts?
(iii) Whether income from offshore supplies was taxable in India?
(iv) Whether section 44BB of I T Act applied to the taxpayer?

Held:
The Tribunal observed and held as follows.

(i) PE in India

Fixed base PE

In earlier years as well as in the year under consideration, the taxpayer had shown its project office, which was approved by RBI to undertake entire project, as its PE. Under India-UAE DTAA, a PO is not a PE if it is involved in ancillary and auxiliary activity. The taxpayer had not adduced any evidence, to establish that the PO had undertaken only such activities.

During the negotiations, employees of the taxpayer had attended meeting s with ONGC and the taxpayer has not disputed that they were employees of its PO. The taxpayer was a non-resident and had undertaken a contract which continued for almost two years1. It was not possible to execute contract of such duration without having any fixed place of business in India.

Hence, the project office was the PE.

Dependent Agent PE

The AO had found that the consultant was actively involved in the project since pre-bidding meetings, hard core marketing and business development and till finalisation of the contract and was not merely assisting in collecting information as claimed by the taxpayer. Further, the employees of the consultant were attending meetings on behalf of the taxpayer2. Also, there was considerable cogency in the AO’s arguments that the consultant worked wholly and exclusively for the assessee, which is a precondition for dependent agent permanent establishment.

Hence, the consultant was dependent agent PE of the taxpayer in India.

Installation PE

In terms of the OECD commentary, if a contractor subcontracts parts of a project to a sub-contractor, the period spent by the sub-contractor must be considered as being time spent by the main contractor itself. The taxpayer had sub-contracted pre-engineering and preconstruction surveys. Hence, the performance of the taxpayer commenced with establishment of project office and pre-engineering/pre-construction surveys. Accordingly, the PE existed from the date of award of the contract to the taxpayer as the site was available since then for survey, etc.

Hence, the contention of the taxpayer that PE existed only after the platform landed in India was not correct and accordingly, the taxpayer had installation PE in India.

(ii) Whether contract was divisible

While the contract could be construed as an umbrella contract, it was a divisible contract since the consideration for various activities was separately stated. Also, either party could withdraw or abandon the contract without making entire payment or refunding the amount received. ONGC had the discretion to take the platform without having it installed by the taxpayer. In such a case, the taxpayer would not be entitled to the consideration for installation and commissioning. Similarly, if the taxpayer abandoned the contract, it would not be bound to refund the amount received towards executed work. All these factors indicated that it was not a turnkey contract.

(iii) Income attributable to PE

The scope of work involved sequential activities and the contract provided separate payment for these activities. Design, engineering, procurement and fabrication operations were carried on outside India.

The platform was fabricated in Abu Dhabi. Though possession was handed over to ONGC in India, the title passed outside of India and in the event of loss during transportation, the payee under the insurance policy was ONGC .

While the taxpayer had a PE in respect of installation and commissioning, it did not have a PE in respect of installation and fabrication. Only income from activities carried on in India could be attributed to PE in India. Hence, only profits in respect of installation and commissioning could be attributed to the PE and the profits attributable to fabrication of platform outside India were not taxable in India.

(iv) Applicability of section 44BB

As installation of the platform cannot be regarded as a “facility in connection with the prospecting for, of extraction or production of mineral oils”, it does not fall u/s. 44BB of I T Act.

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Tax Residency Certificate [TRC]

1. Background

The Finance Act, 2012
introduced new provisions viz Section 90(4) and 90A(4) in the Income-tax
Act, 1961 (the Act) which states that a non – resident tax payer to
whom a tax treaty is applicable shall not be entitled to claim relief
under such tax treaty unless a certificate, containing prescribed
particulars stating that he is resident in any country outside India is
obtained by him from the government of that foreign country.

The
memorandum explaining the provisions of the Finance Bill, 2012 (the
memorandum) specified that the amended Section 90(4) and 90A(4) will
come into effect from 1st April, 2013 i.e. Assessment Year 2013-14.

The
following sub-section (4) inserted after sub-section (3) of section 90
and 90A by the Finance Act, 2012, w.e.f. 1st April, 2013, reads as
under:

Section 90 – “(4) An assessee, not being a resident, to
whom an agreement referred to in sub-section (1) applies, shall not be
entitled to claim any relief under such agreement unless a certificate,
containing such particulars as may be prescribed, of his being a
resident in any country outside India or specified territory outside
India, as the case may be, is obtained by him from the Government of
that country or specified territory.”

Section 90A – “(4) An
assessee, not being a resident, to whom the agreement referred to in
sub-section (1) applies, shall not be entitled to claim any relief under
such agreement unless a certificate, containing such particulars as may
be prescribed, of his being a resident in any specified territory
outside India, is obtained by him from the Government of that specified
territory.”

Thus, it is observed that the language of sections 90(4) and 90A(4) is identical.

2.Objective

The
objective behind the introduction of the amendment is explained in the
Memorandum explaining the provisions of the Finance Bill, 2012, as
follows:

“It is noticed that in many instances that, taxpayers
who are not tax residents of a contracting country do claim benefit
under the DTAA entered into by the Government with the country. Thereby,
even third party residents claim unintended treaty benefit.

Therefore,
it is proposed to amend Section 90 and Section 90A of the Act to make
submission of Tax Residency Certificate containing prescribed
particulars, as a necessary but not sufficient condition for availing
benefits of the agreements referred to in these sections.”

Thus, the object is to prevent unintended recipients from availing of the benefit of a DTAA.

The
amendments come into force w.e.f. 1st April, 2013. The Explanatory
Memorandum clarifies that the provisions are applicable with effect from
Assessment Year 2013-14. Hence, it should not be applicable to
assessments up to Assessment Year 2012-13, even if the assessment is
pending as on 1st April, 2013.

3. Effective date of introduction of Rule 21AB

In
view of contradictory and confusing rules of interpretation regarding
effective date of amendment of / introduction of a rule and varying
judicial interpretations thereof, the effective date of the requirement of obtaining TRC with prescribed details, is a matter of confusion and uncertainty in the minds of the tax payers. Queries have been raised by non-residents, resident payers and their tax consultants with regard to effective date of the TRC requirements imposed w.e.f. 1st April, 2013 by the said notification dated 17th September, 2012.

As pointed out earlier, section 90(4) and 90A(4) have been made effective from assessment year 2013-14, but the relevant rules in respect thereof have been notified on 17th September, 2012 providing that the same would be effective from 1st April, 2013. If it is interpreted that the newly inserted rule 21AB is effective from assessment year 2013- 14 [financial year 2012-13] then for the period 1st April, 2012 to 16th Septemberr, 2012, it is impossible for any tax deductor to obtain the TRC having prescribed particulars for the aforesaid period, as the same were notified only on 17th September, 2012. Therefore, a more prudent and plausible interpretation of the effective date of the rule 21AB should be that it would be applicable for the assessment year 2014-15 [previous year 2013-14] onwards.

The CBDT would do well to clarify that the requirement would apply for remittances to be effected on or after 1st April, 2013 i.e. assessment year 2014-15, so as not to cause hardships and the consequent litigation for the tax payers/ tax deductors and in particular, to provide a window of time to the non-residents to obtain the TRC.

4. Impact of Introduction of Sections 90(4) and 90A(4)

4.1 The requirement applies to all Non Residents, whether Individuals, Companies, LLPs, etc., irrespective of the quantum of relief to be obtained. The requirement would apply only if a relief is to be obtained under a tax treaty. A TRC is not required if no relief is to be obtained under a Tax Treaty. To illustrate, if a resident of UK is to receive royalty from an Indian resident, section 115A provides that the royalty will be charged to tax @ 10% and the India-UK DTAA provides for a tax rate of 15%; the provisions of the Act will be applicable since they are more beneficial to him [Section 90(2)] and the assessee will not be obtaining any relief under the DTAA. In such a case, he will not be required to obtain a TRC.

4.2 Consequences of obtaining a TRC

If a Non-resident obtains and furnishes a TRC, what are the consequences? Are the Tax Authorities debarred from making any further enquiries regarding his residential status? Can the A.O. further examine as to whether the non – resident is really a resident of the Foreign Country under Article 4 of the Tax Treaty with that country? There are 2 views in the matter. According to one view, in spite of the TRC, the A.O. is empowered to make further enquiries to reach a conclusion that the Non-resident is not a Resident of the Other Country issuing the TRC as there is nothing in Section 90(4) to explicitly provide that the TRC will be sufficient for establishing the Residential Status of a Non-resident. According to the other view, the A.O. is required to accept the TRC as conclusive and that he cannot go behind it so far as the Residential Status is concerned. The second view seems to be supported by the decision of the Supreme Court in Union of India vs Azadi Bachao Andolan (2003) 263 ITR 706 (SC) upholding the validity of CBDT Circular No. 789 dated 13th April, 2000.

4.3 Net of Tax Payment

In case of net of tax payment due under a contract with a Non-resident, it is the duty of the payer to calculate the tax liability correctly. Therefore, it would appear that the payer needs to obtain a TRC from the payee, in such cases also. However, in case of absence of Payee’s PAN No., if the payer is discharging his liability under the provisions of Section 206AA, it would appear that the payer need not obtain a TRC from the payee, since no relief is being claimed under the relevant Tax Treaty.

4.4 Time for obtaining the TRC for resident tax deductors u/s 195

In a case where a resident is required to make a payment to a non-resident after deducting tax u/s 195 after 17th September, 2012, in order to avoid confusion relating to effective date of the rule 21AB regarding TRC requirements and consequent litigation, it would be prudent for a tax deductor to insist that the non-resident payee furnishes TRC containing prescribed particulars before the remittance is made by the tax deductor, allowing any relief under the applicable tax treaty.

In a situation, where the non-resident payee has applied for the TRC but the TRC could not be obtained by it prior to effecting the remittance, due to procedural requirements or delays, in view of the language of section 90(4)/90A(4), would it be proper for the tax deductor to rely on a self-declaration furnished by the non-resident payee containing relevant particulars available with the payee and after receiving the TRC the same is submitted to the tax deductor? Would it be in order for a Chartered Accountant to issue a certificate u/s 195(6) in Form 15CB based in any such self declaration?

On a strict interpretation of the language of section 90(4)/90A(4) which provides that the non-resident “shall not be entitled to claim any relief under such agreement unless a certificate, containing such particulars as may be prescribed, of his being a resident in any country outside India or specified territory outside India, as the case may be, is obtained by him”, it appears that neither a certificate can be issued by a Chartered Accountant in Form 15CB considering the relief under relevant DTAA, nor the payer can consider the provisions of a DTAA at the time of making the remittance.

This could cause practical difficulties in a large no. of cases of remittance to non-residents and also seriously impact the smooth conduct of business. An immediate clarification by the CBDT in this regard would go a long way in reconciling compliance with the statutory requirements and facilitating the remittance without causing hardships to the concerned business entities.

5. CBDT Notification

To operationalise the said amendments, the Central Board of Direct Taxes (CBDT) has issued notification No. S.O. 2188 (E) dated 17th September, 2012 w.e.f. 01st April, 2013 which prescribes that certain details should be included in the TRC to be obtained by the non – resident to claim tax treaty benefit. Further, the CBDT also notifies the Form 10FA and Form 10FB for resident of India to obtain TRC from the Assessing Officer (AO).

5.1 Non Resident to obtain TRC from respective foreign country / specified territory

i) The prescribed Rule 21AB does not provide for any specific or standard format for the TRC. However, it provides that the TRC issued should contain the following particulars, namely:

(a) Name of the taxpayer

(b) Status (individual, company, firm etc.) of the taxpayer.

(d) Country or specified territory of incorporation or registration (in case of others)

(e) Taxpayer’s tax identification number in the country or specified territory of residence or in case 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.

(f) Residential Status for the purposes of tax

(g) Period for which the certificate is applicable

(h) Address of the applicant for the period for which the certificate is applicable.

ii) The Certificate shall be duly verified by the Government of the country or the specified territory of which the taxpayer is a resident for the purposes of tax. However, the format of the verification has not been prescribed.

The contents of a TRC to be obtained by a Non Resident are rather simple and straight forward and do not appear to be very intrusive or onerous. The Non Resident can easily furnish the particulars required to obtain the TRC from his country / territory of residence. Further, it appears that the TRC can be obtained in advance for a given period.

However, as the requirement of obtaining TRC may be construed to be applicable from the Accounting Year commencing from 1st April, 2012, the questions may arise about the fate of transactions which have been concluded without obtaining the TRC prior to 17th September, 2012. The CBDT needs to clarify that it would be in order if the Non Resident payee obtains and furnishes the TRC to the payer after the transaction is concluded or the payment has been made to him by the Resident payer.

5.2 Resident to obtain TRC from Indian Government

Rule 21AB of the Rules also prescribes specified form for residents to obtain a TRC from the respective AO. The taxpayer, being resident of India, shall, for obtaining a TRC for the purposes of the tax treaty, make an application in Form No. 10FA to the A.O., giving the following particulars:

(a) Full Name and address of the assessee

(b) Status (state whether individual, Hindu undivided family, firm, body of individuals, company etc)

(d) Country of incorporation/registration

(e) Address of the assessee during the period for which TRC is desired

(f) Email ID

(g) Permanent Account Number/Tax Deduction Account Number (if applicable)

(h) Basis on which the status of being resident in India is claimed

(i) Period for which the TRC is applicable

(j) Purpose of obtaining TRC

(k) Any other detail.

The application form along with supporting documents (not specified) has to be submitted to the AO. The New Rule provides that the AO, on receipt of the application and on being satisfied of the particulars contained therein, should issue the TRC to the resident assessee in Form 10FB. Time limit for issue of the TRC by the A.O. has not been specified.

It is worth noting that there is no mandatory requirement in the various tax treaties signed by India for obtaining a TRC by the Non Residents containing prescribed particulars. Is it proper for the Government of India to unilaterally impose such a requirement upon the non-residents?

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Digest of Recent Important Foreign Decisions on Cross- Border Taxation – part one

1. Australia: Taxation in Australia of non-resident investment manager of acting for non-resident shareholders:

Federal Court holds non-resident manager of portfolio of Australian shares for non-resident companies liable to tax in Australia:

The Federal Court on 8th September 2010 handed down a decision in Leighton v. FCT, (2010) FCA 1086 that dealt with taxation in Australia of a non-resident manager who was managing a portfolio of Australian shares for two non-resident companies.

Briefly, Mr. Leighton was, during the relevant period, a resident of Monaco and was not a resident of Australia. He was engaged by two companies, who were not tax resident in Australia and were incorporated in the British Virgin Islands and the Bahamas, to manage a portfolio of Australian shares for them and to provide other services incidental to the management services. Mr. Leighton opened a bank account in Australia and engaged a number of Australian brokers and an Australian custodian. The trading instructions were given by Mr. Leighton, on behalf of the two companies, from Monaco. The trading activities generated taxable income during the relevant period.

Non-residents are subject to tax in Australia only on income sourced in Australia. The judgment does not discuss whether the relevant income has a source in Australia and, presumably, assumes that it does.

After considering the facts, the judgment concludes that Mr. Leighton, in acting as a manager, was, during the relevant period, a trustee of a trust for the non-resident companies as beneficiaries. As such, he is liable for tax for the taxable profits under former section 98(3) of the Income Tax Assessment Act, 1936.

2. France: Foreign Tax Credit:

Limitation or denial of FTC following repo transactions on shares — Administrative Supreme Court opinion:

The Administrative Supreme Court has recently disclosed in its annual report an opinion rendered on 31 March 2009 (No. 382545), in answer to a prejudicial question from the French Tax Authorities (FTA). It dealt with the treatment of foreign-sourced dividends, where the distribution is made in between a sale-repurchase transaction on shares (i.e., dividend stripping). The FTA asked the Court to clarify the legal basis on which, for corporate income tax purposes, the use by resident companies of FTC attached to such dividend coupons could be denied or limited. Key elements of the opinion are summarised below.

(a) Clarification on the limitation applicable to the use of foreign tax credits (FTC), the so-called ‘règle du butoir’. Under Art. 220 of the General Tax Code, the use of a FTC by a resident company is limited to the ‘amount of French corporate income tax assessed on the corresponding income’, i.e., the FTC may only be deducted from that portion of French tax which corresponds to the income sourced in that particular foreign country. No provision, however, specifies whether the foreignsource income, used for the computation of the above-mentioned limitation, should be assessed on a net or gross basis.

In respect of foreign-source dividends, the Court’s opinion is that the income should be assessed on a net basis. This rule covers only expenses that (i) are directly related to the foreign-source income, and (ii) do not increase the value of any asset of the resident company. As a result, foreign withholding taxes and collection expenses directly related to the dividend coupon are deductible. Conversely, loan interest related to the purchase of the foreign shares are not. As a result, such expense will not reduce the portion of ‘corresponding income’ which limits the resident company’s entitlement to FTC.

In addition, the Court rejected the FTA’s position that the capital loss incurred on the resale of the shares should be deducted from any related dividend derived in between the purchase-resale transactions. Such capital losses are not expenses directly related to the foreign-sourced income (i.e., the dividend coupon).

(b) Clarification on the application of the ‘beneficial ownership’ clause. The Court opined that the beneficial ownership clause under a tax treaty (i) enables the FTA to deny the application of the reduced withholding tax rates on outbound payments under certain conditions (see TNS:2007-01-30:FR-1), but (ii) does not allow the FTA to deny (or limit) the use of FTC attached to foreign-sourced dividend coupons. Only the domestic general anti-avoidance rule (GAAR) set forth by Art. L 64 of the Tax Procedure Code (abus de droit) may authorise, where the related buy-sell transaction is ‘artificial’ and/or ‘seek to benefit from a literal application of legal provisions or decisions in contradiction with the objective set forth by the author of such provisions’, such a denial.

Note: Recently, the Administrative Supreme Court rejected the application of the GAAR to tax motivated buy-sell transactions on shares, insofar as the dividend accrues to a taxpayer who actually bears the risk attached to the status of a shareholder (see Administrative Supreme Court, 7 September 2009, No. 305586 and No. 305596, Axa and Sté Henri Golfard, respectively).

3. Belgium: Fixed base under Article 14:

Treaty between Belgium and Luxembourg — Court of Appeal Ghent decides Belgian-rented dwelling of Luxembourg resident self-employed business trainer constitutes fixed base:

On 20th October 2009, the Court of Appeal Ghent decided a case (recently published) X. v. Tax Administration concerning whether a rented dwelling in Belgium of a Luxembourg resident self-employed business trainer constitutes a fixed base under Art. 14(1) of the Belgium-Luxembourg tax treaty on income and capital of 17 September 1970 (the ‘Treaty’). Details of the case are summarised below.

(a) Facts:

The taxpayer was a resident of Luxembourg, who carried out activities as a self-employed business trainer in Belgium, where he visited Belgian companies. He stayed in a rented dwelling in Brugge, which he used as his contact address. The Belgian Tax Administration regarded the dwelling as a fixed base, but the taxpayer took the opposite view.

(b) Legal background:

Art. 14(1) of the Treaty provides that income derived by a resident of one of the contracting states in respect of professional services or other independent activities of a similar character shall be taxable only in that state, unless he has a fixed base regularly available to him in the other state for the purpose of performing his activities. If he has such a fixed base, the income may be taxed in the other state, but only so much of it as is attributable to that fixed base.

The Court followed the view of the Belgian Tax Administration.

The Court observed that the term ‘fixed base’ is neither defined in the Treaty, nor under Belgian domestic law. In addition, the Court considered that the term cannot be interpreted by means of the Commentary to Art. 7 (business profits) of the OECD Model Convention, because under the Treaty more detailed requirements apply for the existence of a permanent establishment than for a fixed base. Therefore, the term ‘fixed base’ has a wider scope.

The Court based its decision that the rented dwelling constitutes a fixed base on the presumption that the taxpayer does a substantial part of his study and preparation work in that dwelling. In this context, the Court held as decisive that the taxpayer has no other place to do his preparatory work and he used the dwelling as his contract address for his clients; moreover:

— the taxpayer receives specialist journals and documentation at, and had purchased office equipment for, that dwelling;

— the Belgian address was stated on his invoices, as a result of which the Court presumed that the administrative formalities wer

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Armayesh Global v ACIT(2012) 21 taxmann.com 130 (Mum) Articles 7, 13 of India-UK DTAA; Sections 5, 9, 40(a)(i), 195 of I T Act Asst Year: 2007-08 Decided on: 4 May 2012 Before B. Ramakotaiah (AM) & V. Durga Rao (JM)

(i) Since the services were rendered outside India, section 5 could not be applied to commission and further, section 9(1)(vii)(b) excluded fee payable for making or earning income from any source outside India and therefore, commission did not accrue or arise in India.
(ii) Since definition of ‘fees for technical services’ in Article 13 of India-UK DTAA did not include managerial services, the commission should be considered as business income and as the nonresident did not have a PE in India, in terms of Article 7 of DTAA, the commission could not be taxed in India.
(iii) As commission did not accrue or arise in India, tax was not required to be withheld and consequently, commission could not be disallowed u/s 40(a)(i) of I T Act.

Facts
The taxpayer was engaged in the business of manufacture and export of hand embroidery and handicraft items. The taxpayer had exported certain items to several countries. The orders in respect of these exports were secured through, or pursuant to information received from, a non-resident commission agent. The agent was entitled to the commission upon execution of the export order.

CBDT Circular No. 23 dated 23rd July 1969, clarified that no tax was deductible on export commission payable to a non-resident for services rendered outside India. Relying on the said Circular, the taxpayer did not withhold tax on the commission paid to the non-resident agent.

The AO noted that as per the decision of the Supreme Court in R.Dalmia v. CIT [1977] 106 ITR 895, management includes the act of managing by direction, or regulation or superintendence. Since the non-resident agent involved himself in the broad gamut of services pertaining to client identification, soliciting, constant feedback and ensuring timely payments, the payments made to him were towards managerial services and not commission simpliciter. The AO also noted that Circular No. 23 relied upon by the taxpayer had been withdrawn by CBDT vide Circular No. 7 of 2009 dated 22nd October 2009. The AO thus concluded that such payments were ‘fees for technical services’ covered u/s 9(1)(vii) read with Explanation 2 thereto and since the assessee had not deducted tax at source on the payments, they were disallowable u/s 40(a)(i) of IT Act.

Held
The Tribunal observed and held as follows:

As regards taxability under I T Act

As per the agreement, the non-resident was only acting as an agent on commission basis and had not provided any managerial/technical services nor was there any evidence of its having provided any technical/managerial services. The agent was responsible for the timely payment from the customers and the commission was payable only after receipt of the payment from the customers. Since the services were rendered outside India, provisions of section 5 cannot be applied to the commission paid.

In terms of section 9(1)(vii)(b) of I T Act, fee payable for making or earning income from any source outside India is excluded and hence, it should be considered as business income. Since the services were rendered outside India, the amount paid is not taxable, as it did not accrue or arise in India.

As regards taxability under India-UK DTAA

The definition of ‘fees for technical services’ in Article 13 of India-UK DTAA did not include managerial services. Hence, the commission paid should be considered as business income. Since the non-resident did not have a PE in India, in terms of Article 7 of DTAA, the commission could not be taxed in India.

As regards disallowance u/s 40(a)(i) of I T Act

As the commission did not accrue or arise in India, tax was not required to be withheld and consequently, commission could not be disallowed u/s 40(a)(i) of I T Act.

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shailesh.kwebmaker

SKF Boilers and Driers(P.) Ltd., In re (2012) 18 taxmann.com 325 (AAR) Sections 5, 9 of I T Act Decided on: 22 February 2012 Before P.K. Balasubramanyan (Chairman) & V.K.Shridhar (Member)

Commission payable to non-resident agent on export of goods is taxable in India in terms of section 5(2)(b), read with section 9(1)(i), of I T Act since right to receive the commission arose in India upon execution of the export order.

Facts
The Applicant payer of commission was an Indian company engaged in manufacture and supply of Rice, Par Boiling and Dryer Plants. Through two agents situated in Pakistan, the applicant received order for supply of plant to a Pakistani company. The Applicant exported the plant and, as per the agreement, the commission became payables to the non-resident agents.

The issue before AAR was: whether the income of non-resident agent can be deemed to accrue or arise in India.

According to the Applicant, though CBDT had withdrawn Circular No 786 dated 2nd February 2007, Section 5(2) and Section 9 of I T Act had not undergone any change and accordingly, the commission on exports did not accrue or arise in India. Hence, there was no tax liability in India.

According to the tax authority, income had accrued in India when the right to receive income became vested and hence, it was covered within the ambit of section 5(2)(b) of I T Act.

Held
The Tribunal observed and held as follows.

Sections 5 and 9 of the Act thus proceed on the assumption that income has a situs and the situs has to be determined according to the general principles of law.
The terms ‘accrue’ or ‘arise’ in section 5 have more or less a synonymous sense and income is said to accrue or arise when the right to receive it comes into existence. What matters is the source of income of two non-resident agents. Though the agents rendered services abroad, right to receive commission arose in India when the order was executed by the applicant in India and hence, the place of performance of service was wholly irrelevant for the purpose of determining the situs of their income.
Following ruling of AAR in Rajive Malhotra, In re [2006] 284 ITR 564 (Delhi), in view of the specific provision of Section 5(2)(b) read with section 9(1)(i) of I T Act, the commission income arising to the two non-resident agents was deemed to accrue and arise, and was taxable in India.

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shailesh.kwebmaker

John Wyeth & Brother Limited v ACIT (ITA No 6772 & 6773/Mum/2002) Section 44C of I T Act Asst Year: 1981-82 and 1982-83 Decided on: 25 July 2012 Before P Jagtap(AM) & Dinesh Kumar Agrawal (JM)

Laboratory expenditure incurred by the HO for R&D, which was attributable to the Indian branch was fully allowable and was not subject to the restriction in section 44C.

Facts
The taxpayer was a company incorporated in the UK, which was engaged in manufacturing pharmaceutical products. The taxpayer had a separate and independent research laboratory in India and the head office of the taxpayer had research laboratory in the UK.

While computing its income, the taxpayer claimed deduction in respect of laboratory expenditure incurred by the HO for R&D in UK, which was attributable to Indian Branch.

According to the AO, the R&D was centralised in UK and further, the R&D was connected with executive and general administration. Therefore, as it was merely general administrative and executive expenditure, it was subject to restriction u/s 44C of I T Act .

The issue before the Tribunal was whether the laboratory expenditure incurred by the HO for R&D in UK, which was attributable to India Branch was in nature of general administrative expenditure mentioned in section 44C of I T Act.

Held
The Tribunal observed and held as follows.

The financial statements filed by the taxpayer show that the HO has separately shown executive or general administration expenditure and thus, the taxpayer has proved beyond doubt that the expenditure claimed did not include any executive or general administrative expenditure.
Though the taxpayer filled all the details, without examining the same or without pointing out any item of disallowable nature, the tax authority disallowed the said expenditure on the ground that it was in the nature of general administration and executive expenditure mentioned in section 44C.
In the absence of any contrary material brought on record by the tax authority, the laboratory expenditure could not be disallowed.

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shailesh.kwebmaker

D B Zwirn Mauritius Trading No. 3 Ltd. AAR No. 878 of 2010 Article 13(4) of India-Mauritius DTAA; Section 195 of Income-tax Act Dated: 28-3-2011

Capital gains arising from sale of shares of an Indian company by a Mauritius company are not chargeable to tax in India in terms of Article 13(4) of India-Mauritius DTAA.

Facts:
The appellant was a company incorporated in Mauritius (‘MCo’). Mauritius tax authority had issued Tax Residence Certificate (‘TRC’) to MCo. MCo held equity shares of an Indian company. MCo sold the shares to another Mauritius company resulting in capital gains.

MCo sought ruling of AAR on the following questions:

Whether MCo was liable to tax on capital gain under Income-tax Act and India-Mauritius DTAA?

Whether the sale of shares was subject to withholding tax u/s. 195 of Income-tax Act?

MCo contended that in terms of Article 13(4) of India-Mauritius DTAA, capital gain arising from sale of shares was not liable to tax in India and that TRC constituted valid and sufficient evidence of residential status under India-Mauritius DTAA. MCo also relied on Supreme Court’s decision in Union of India v. Azadi Bachao Andolan, (2003) 263 ITR 706 (SC) and Circular No. 789 of 2000 of CBDT.

Held:
In terms of Article 13(4) of India-Mauritius DTAA, power of taxation of gains is vested only in the state of residence (i.e., in this case, Mauritius). If the provision in DTAA is more beneficial, the taxpayer is entitled to seek benefit under DTAA. Hence, MCo was not liable to pay tax in India on capital gains.
Sale of share is not subject to withholding tax u/s. 195 of T I Act.

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shailesh.kwebmaker

Limitation of Benefits Articles — Concept and its Application in Indian Tax Treaties – Part – 2

Conclusion:

From the above, it is clearly evident that the significance of articles relating to Limitation of Benefits clause cannot be undermined. All concerned parties would need to pay specific attention to LOB clauses in India’s Tax treaties. India is increasingly including Limitation of Benefits clause in the new treaties and in some cases including the same in the existing treaties by renegotiating existing treaties through the protocols as in the cases of Singapore and UAE. A taxpayer would be well advised to look for and examine relevant LOB clauses very minutely before taking any decisions ‘in relation to the relevant DTAAs.

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I. T. A. No. 700/ Mum/ 2009 [Unreported] Valentine Maritime (Gulf ) LLC vs ADIT A.Ys.: 2005-06, Dated: 27 November 2013 Counsel for assessee: Hero Rai; Counsel for revenue: Ajay Srivastava

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Section 44BB of the Act – laying/installation of pipes for offshore oil exploration being ‘business of providing services and facilities in connection with extraction of mineral oils’, the payments assessable u/s. 44BB.

Facts:
The taxpayer was a non-resident company engaged in the business of providing technical/engineering services. During the relevant assessment year the taxpayer executed a contract with an Indian company (“ICo”) for laying/installation of pipes for three pipeline projects for offshore oil exploration (“the Contract”). The taxpayer contended that it was a company incorporated in UAE and accordingly, was entitled to qualify as tax resident under India UAE DTAA.

During the relevant assessment year, the taxpayer had received payments under the Contract towards materials, mobilisation, installation, etc. The taxpayer had contended that since it was engaged in the business of providing services and facilities in connection with prospecting, extraction or production of mineral oils, the payments received by it were assessable in terms of section 44BB of the Act. The AO concluded that the taxpayer did not qualify to claim benefits under India-UAE DTAA. The AO considered the payments received by the taxpayer in light of the Contract as well as original bidding documents and observed that having regard to the various clauses of the Contract pertaining to the scope of services performed by it, the taxpayer was also providing technical services. The AO further observed that in terms of the decision in Sedco Forex International Inc vs. CIT [2008] 170 Taxman 459 (Uttarkhand), deduction in respect of mobilization, demobilisation expenses was not available. The AO bifurcated the payments received by the taxpayer for assessability under two heads, namely, as deemed income section u/s. 44BB and as FTS. The CIT(A), however, concluded that the entire amount was assessable u/s. 44BB of the Act.

The issue before the Tribunal was: whether part of the payment received by the taxpayer can be assessed as FTS and whether the other part could be assessed u/s. 44BB of the Act.

Held:
the taxpayer was given a turnkey project for laying and installation of pip lines. It is a settled proposition of law that when a contract consists of a number of terms and conditions each condition does not form separate contract. The contract has to be read as a whole as laid down by the Supreme Court in case of Chaturbuj Vallabhdas [AIR 1954(SC) 236].

Perusal of various decisions cited by the taxpayer shows that works/services performed by the taxpayer do not come within the purview of section 9(i)(vii) of the Act (i.e. FTS). The AO grossly erred in considering part

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Nirav Shah

[2015] 63 taxmann.com 11 (Ahmedabad – Trib.) ADIT vs. Adani Enterprise Ltd A.Y.: 2010-11, Date of Order: 2-9-2015

Sections 5, 9, the Act – since funds raised by issue of FCCBs were utilised for investment in foreign subsidiary carrying on business outside India, interest paid to bond holders was covered under exclusion in section 9(1) (v)(b) of the Act

Facts
The taxpayer had raised funds from certain nonresident investors by issuing FCCBs to them. The funds were invested in a company which was incorporated outside and which was carrying on business outside India. The taxpayer remitted interest to the bond holders without withholding tax on the ground that interest was neither received by non-resident bond holders in India nor had it accrued in India. Even if it was deemed to have accrued in India, the same was eligible for source rule exclusion as the borrowed funds were utilised for the purpose of earning income from source outside India.

According to the AO, the interest accrued or arose to non-resident bond holders in India. Consequently, the income was primarily subject to section 5(2). Accordingly, resorting to section 9 was not permissible. Therefore, the AO held that the income was chargeable to tax under section 5(2) and exclusion u/s. 9(l)(v)(b) was not relevant.

Held
Identical issue was considered in case of the taxpayer in earlier year. The Tribunal had observed that funds raised by issue of FCCBs were invested in foreign subsidiary which was involved in financing of businesses abroad.

The term “business” is wide enough to include investment in subsidiaries or joint ventures which are further involved in business or commerce. Therefore, the AO’s observation that the taxpayer was not earning out of business carried on outside India was not correct. Exclusion clause will not have any purpose unless the income is covered within the provision to which exclusion clause applies. Hence, the presence of exclusion in section 9(1)(v)(b) proves that the income is falling within the ambit of deeming provision. Thus, it cannot be accepted that the same income can also fall within the ambit of income which has accrued and arisen in India.

Since nothing contrary was brought on record in the relevant tax year, following the order of the Tribunal in case of the taxpayer, interest earned by non-resident bond holders was not chargeable to tax in India.

Nirav Shah

India’s Double taxation Avoidance Ag reements [DTAAs] & Ag reements for Exchange of information [AEIs] – Recent Developments

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In the last 3 years since our last Article on the subject published in
the December, 2012 issue of BCAJ, India has signed DTAAs with 8
countries and has entered into revised DTAAs with 4 countries. India has
also amended few DTAAs by signing Protocols amending the existing
DTAAs. In this Article, our intention is to highlight the salient
features of such DTAAs or Protocols amending the DTAAs. The purpose is
not to deal with such DTAAs or Protocols extensively or exhaustively. It
will be seen that the recent treaties/protocols follow more or less a
similar pattern.

Further, the DTAAs with certain countries have
been modified primarily to include ‘Limitation of Benefits (LOB)
Clause’. Further, Articles on ‘Exchange of Information’ and ‘Assistance
in Collection of Taxes’ have been included or the scope of such existing
Articles has been extended.

The reader is advised to refer the text of the relevant DTAA or the Protocol while dealing with facts of a particular case.

Nirav Shah

Indian Employees senT on deputation abroad — Determination of Residential Status in the year OF return upon completion of assignment under Domestic Law — A Case Study

International Taxation

Nowadays Indian companies, particularly those engaged in
software development, IT-enabled services, financial & professional services,
are deputing their Indian employees for rendering onsite services at the
workplace of their customers or associates. Period of deputation could be
short-term i.e., less than 12 months spread over two financial years or
medium-term or long-term i.e., more than a year. Short-term deputation of
employees creates tax issues as the employee could be Resident of India in terms
of S. 6(1) of the Income-tax Act, 1961 (the Act) and hence, his remuneration
received in the foreign country is taxable in India in accordance with S. 5 of
the Act (subject to Double Taxation Relief pursuant to Article 23 of the
applicable DTAA or S. 91 of the Act).

As the taxpayers and their tax advisors are regularly faced
with this issue and in view of conflicting judicial decisions in the matter,
this simple case study seeks to highlight the issues which arise in such a
situation and how, in an appropriate case, the affairs can be better
planned/managed from the tax perspective.

In this case study, we have not dealt with Articles 4 and 16
of Indo-German DTAA as they were not relevant in light of the facts of the case
study.

1 Facts of the case :

(a) Mr. A, working as a software engineer with an Indian
software development and services company (‘the assignee’), was deputed outside
India for the first time, for the purpose of working on a short-term assignment
with a group company in Germany. He was paid remuneration by the German company
during the period of his deputation with the German company.

(b) The assignee (the querist) left India on 25th March 2009
(F.Y. 2008-09) and returned to India after finishing the assignment on 5th
December, 2009 (F.Y. 2009-10). In between, he visited India for 9 days for
attending a social event in the family from 5th May 2009 to 13th May, 2009.
Thus, he was present in India for 126 days during the financial year 2009-10.

(c) The querist contends that Explanation (a) to S. 6(1)(c)
which extends the period of stay in India from 60 days to 182 days in the case
of a person who leaves India for the purposes of the employment outside India,
is applicable in his case as he left India on 25th March, 2009 for the purposes
of his deputation to Germany. Placing reliance on the decision of the Hon’ble
Authority for Advance Ruling in the case of British Gas India (P.) Ltd., In re
(2006) 285 ITR 218, where it was held that for the purposes of employment
outside India, covers the cases where an assessee is sent outside India on
deputation by an Indian employer, the querist contends that clause (a) of
Explanation to S. 6(1)(c) will be applicable and, therefore, he is to be treated
as a person being non-resident of India.

(d) The querist further contends that clause (b) of
Explanation to S. 6(1)(c) is also applicable in his case as he came on a
visit to India. The fact that he came to India permanently, is not relevant.
Since the querist has come on visits to India for less than 182 days during the
F.Y. 2009-10, as per S. 6(1)(c) read with Explanation (b), his status should be
taken as non-resident.

(e) The querist is of the view that once a citizen of India
or person of Indian origin, who is outside India and who comes on a visit to
India, Explanation (b) to S. 6(1)(c) of the Act gets
attracted and the 60 days’ period referred to in S. 6(1)(c) of the Act
gets extended to 182 days. The fact that the querist came back permanently to
India does not alter this position.

(f) The querist, relying upon favourable advance ruling in
the case of Shri Anurag Chaudhary (2010) 322 ITR 293, contends that he was
non-resident during the F.Y. 2009-10 and, therefore, the salary earned by him on
account of his deputation outside India, would not be taxable in India.

(g) However, his colleagues expressed doubts on his
contentions and also on the correctness of the advance ruling and hence, he has
approached for guidance in the matter.

(h) Mr. A has also raised a hypothetical question that
whether his tax situation would have been different if he could have planned to
be sent abroad on or after 1st day of April, 2009 or had managed to return to
India on completing the assignment on or after 1st day of February, 2010.

2 Provisions of S. 6 :

The residential status is to be determined as per the
provisions of S. 6(1) of the Act. S. 6(1) along with Explanation is reproduced
below for ready reference :

“1 An individual is said to be resident in India in any
previous year, if he :

(a) is in India in that year for a period or periods
amounting in all to one hundred and eighty-two days or more; or

(b) ** ** **

(c) having within the four years preceding that year been
in India for a period or periods amounting in all to three hundred and
sixty-five days or more, is in India for a period or periods amounting in
all to sixty days or more in that year.

Explanation — In the case of an individual, :

(a) being a citizen of India, who leaves India in any
previous year as a member of the crew of an Indian ship as defined in clause
(18) of S. 3 of the Merchant Shipping Act, 1958 (44 of 1958), or for the
purposes of employment outside India, the provisions of sub-clause (c) shall
apply in relation to that year as if for the words ‘sixty days’,
occurring therein, the
words ‘one hundred and eighty-two days’ had been substituted;

(b) being a citizen of India, or a person of Indian origin
within the meaning of Explanation to clause (e) of S. 115C, who, being
outside India, comes on a visit to India in any previous year, the
provisions of sub-clause (c) shall apply in relation to that year as if for the
words ‘sixty days’, occurring therein, the words ‘one hundred and eighty-two
days’ had been substituted.” (Emphasis supplied.)

3 Legislative history :

3.1 Explanations (a) and (b) were introduced by the Direct
Tax Laws (Second Amendment) Act, 1989. By the amendment effected by the 1989
Amendment Act, it was provided that the words ’60 days’ occurring in S. 6(1)(c)
will be read as ‘150 days’ in case a citizen of India comes on a visit to India
in the previous year. In the statement of objects and reasons, it was mentioned
as under :

“One of the prime needs of the country is to ensure proper balance of payment and encourage inflow of foreign exchange into the country. With a view to achieve this, it is proposed to amend S. 48 of the Income-tax Act in order to provide for computation of the capital gains in the case of non-resident Indians by calculating the cost price and the sale price in the foreign currency in which the investment was made instead of taking the value in Indian currency as at present. This will make investments in shares by non-resident Indians more attractive and thereby encourage inflow of foreign exchange into the country.

S. 6 of the Act is also being amended with the same objective. It will liberalise the criterion for detetmining the residential status so as to facilitate non-resident Indians to stay in India for a longer period in order to look after their investments without losing their ‘non-resident’ status. Besides, S. 195 of the Act is also proposed to be amended to provide for deduction of tax at source on payment of interest to non-residents by the Government, public sector banks and public financial institutions only at the time of payment instead of at the time of credit of such income.”

3.2 Period of 150 days or more as occurring in Explanation (b) to S. 6(1) was further increased to the period of 182 days by the Finance Act, 1994. In the Memorandum explaining the provisions of the Finance Bill, 1994, in respect of the fact as to why the period of stay is being increased from 150 days to 182 days, it was mentioned as under :

“Extending the period of stay in India in the case of the non-resident Indians without their losing the non-resident status.

Under the provisions of clause (1) of S. 6 of the Income -tax Act, an individual is said to be resident in India in any previous year, if he has been in India during that year, :
i. for a period or periods amounting to one hundred and eighty-two days or more, or
ii. for a period or periods amounting to sixty days or more and has also been in India within the preceding four years for a period or periods amounting to three hundred and sixty-five days or more.

However, the period of sixty days is increased to one hundred and fifty days in the case of a non-resident Indian, i.e., a citizen of India or a person of Indian origin within the meaning of Explanation to clause (e) of S. 115C of the Act, who, being outside India, comes on a visit to India.

Suggestions have been received to the effect that the aforesaid period of one hundred and fifty days should be increased to one hundred and eighty-two days. This is because the non-resident Indians who have made investments in India, find it necessary to visit India frequently and stay here for proper supervision and control of their investments. The Bill, therefore, seeks to amend clause (b) of the Explanation to S. 6(1)(c) of the Income-tax Act, in order to extend the period of stay in India in the case of the aforesaid individuals from one hundred and fifty days to one hundred and eighty-two days, for being treated as resident in India, in the previous year in which they visit India. Thus, such non-resident Indians would not lose their ‘non-resident’ status if their stay in India, during their visits, is up to one hundred and eighty-one days in a previous year.

The proposed amendment will take effect from 1-4-1995 and will, accordingly, apply in relation to the A.Y. 1995-96 and subsequent years, i.e., each previous year commencing on or after 1-4-1994.”

Analysis and discussion on provisions of S. 6(1)(c) r/w Explanation thereto in respect of A.Y. 2010-11 (F.Y. 2009-10) :
Let us now examine the provisions of S. 6(1)(c) and the Explanation thereto :

4.1   Re-applicability of Explanation (b) to S. 6(1)(c) :
   It is very clear that S. 6(1)(a) is not applicable and, therefore, the status of the querist is to be determined as per provisions of S. 6(1)(c) of the Act. S. 6(1)(c) along with Explanation has been reproduced above.
   There is also no doubt that the querist was in India for a period amounting to 365 days and more during the four years preceding the F.Y. 2009-10.
   As the querist had left India on 25th March,2009, i.e., during the previous year 2008-09, in our opinion, the Explanation (a) will not be applicable as he has not left India during the previous year 2009-10. Explanation (a) applies only to an individual in relation to the previous year in which he leaves India. As the querist has left India on 25th March, 2009, i.e., previous year relevant to the A.Y. 2009-10, Explanation (a) cannot be applied while determining his residential status for A.Y. 2010-11.

In our view, the above-referred Explanation (a) is applicable to that previous year in which the assessee, being a citizen of India, leaves India. It is true that the word ‘any previous year’ is mentioned when an assessee, a citizen of India, leaves India; but then, it is clearly mentioned that provisions of sub-clause (c) of S. 6(1) shall apply in relation to ‘that year’. (Emphasis supplied.) The word ‘that year’ refers to the previous year in which the assessee has left India for the purpose of employment outside India. Hence, clause (a) of Explanation to S. 6(1)(c) will not be applicable in the case of the querist because he has left India in the previous year relevant to the A.Y. 2009-10.

4.2 Re-applicability of Explanation (b) toS. 6(1)(c) :
   Let us now consider the querist’s main contention that in case a person has made a visit to India in any previous year, then the words ‘60 days’ as appearing in S. 6(1)(c) should be substituted as 182 days, irrespective of the fact that the assessee came to India permanently upon completion of the assignment during the same previous year. Let us again read Explanation (b) which is as under :

“(b) being a citizen of India, or a person of Indian origin within the meaning of Explanation to clause (e) of S. 115C, who, being outside India, comes on a visit to India in any previous year, the provisions of sub-clause (c) shall apply in relation to that year as if for the words ‘sixty days’, occurring therein, the words ‘one hundred and eighty-two days’ had been substituted.”

Considering the legislative history of amendments and the purpose for which the amendments were introduced, one has to consider the purpose of entry of the person in India during the previous year. If all the entries are in India for the purposes of visit, then the period of 60 days as mentioned in S. 6(1)(c) will be substituted to 182 days. However, in our opinion, if in the previous year, the assessee has come to India permanently after completing his assignment outside India, then the Explanation(b) will not be applicable. In other words, if a person returns to India for stay in India after complet-ing his assignment/employment outside India, he cannot be considered to have come to India ‘on a visit’ and therefore, the criterion of 182 days as pre-scribed in explanation (b) to S. 6(1)(c) would not be applicable.

4.3 Thus, in our opinion, the querist is not entitled to the benefit of either Explanation (a) or Explanation (b) to S. 6(1)(c). Since he was in India for a pe-riod amounting to more than 365 days in the four years prior to 1st April, 2009, and more than 60 days during F.Y. 2009-10, he is a resident of India in F.Y. 2009-10 and, therefore, his salary received for the period of employment outside India is taxable in India, subject to Double Taxation Relief under Article 23 of India-Germany DTAA.

4.4 Our view is strongly supported by the decision of the Bangalore Bench of the Tribunal in the case of Manoj Kumar Reddy v. ITO, (2009) 34 SOT 180 (Bang.). It is also supported by the decision of the Punjab and Haryana High Court in the case of V. K. Ratti v. CIT, (2008) 299 ITR 295/(2007) 165 Taxman 177 (P & H).

4.5 The following important observations of the Bangalore Tribunal in Manoj Kumar Reddy’s case (supra) are also worth noting :

Considering the legislative history of amendments and the purpose for which the amend-ments have been introduced, one has to consider the entry of the person in India during the previous year. If all the entries are in India for the purpose of a visit, then the period of 60 days as mentioned in S. 6(1)(c) will be substituted to 182 days. However, if in the previous year, the assessee has come to India permanently after leaving his employment outside India, then the Explanation (b) will not be applicable. (Para 3.15)

We had already pointed out that a visit to India does not mean that if he comes for one visit, then Explanation (b) to S. 6(1) will be applicable, irrespective of the fact that he came permanently to India during that previous year. Looking to the legislative intention, we hold that the status of the assessee cannot be taken as resident on the ground that he came on a visit to India and, therefore, the period of 60 days as mentioned in S.6(1)(c) should be extended to 182 days by ignoring his subsequent visit to India after completing the deputation outside India. (Para 3.16)

During the course of proceedings before us, the learned AR has raised an alternative contention regarding the status given as resident. The learned AR submitted that 60 days referred to in S. 6(1) should exclude the period of stay in India on visit. If this is not accepted, then it will lead to absurd result as stated in para 2.1 of rejoinder to remand report. The learned AR has tried to explain the absurdity in case the period of stay in India on visit is not excluded. In Example A, the learned AR submitted that a person comes on visit and his stay in India on visit is 120 days. He will be treated as non-resident as per clause (b) of the Explanation. In Example B, if a person comes on visit and stays in India for 90 days and returns abroad and, later on, comes back to India permanently and he stays in India for a period of 30 days, he will become a resident according to the

Assessing Officer. This is because his stay in India has exceeded 60 days if period of visit is also included. In both the cases, the stay is only 120 days. However, in Example B, a person becomes a resident while in Example A, he remains non-resident. (Para 3.17)

Advance ruling in the case of Shri Anurag Chaudhary, (2010) 322 ITR 293 :
Since the querist has strongly relied upon the afore-said advance ruling, let us examine the ruling :

5.1 Brief facts :
In this case, the applicant, an individual, left India for the USA, on deputation to an associate company in the USA on 31st March, 2008 and came back to India, after completion of the assignment on 29th November, 2008. Thus, during the F.Y. 2008-09, he was in India for 122 days. The issue before the AAR was, whether the applicant was non-resident in the F.Y. 2008-09.

5.2 We reproduce the important operative paragraphs of the Ruling :
“From a reading of S. 5(1)(c) it is clear that for the income earned by the applicant on account of employment in the USA to be taxable in India, the applicant should have been resident of India during the relevant previous year. In other words, if the applicant is held to be a ‘resident’ of India during the F.Y. 2008-09, then, his salary income from employment in the USA would be taxable under the Income-tax Act, 1961. S. 6 Ss.(1), which determines the residential status of an individual, requires that either the applicant should have been in India for 182 days [vide clause (a)] or for 60 days or more, if he was in India for 365 days or more in four preceding years [(vide clause (c)]. The Explanation to this sub-section provides that a citizen of India who leaves India for the purpose of employment outside India can be considered as resident of India, if he has been in India for 182 days or more even though he may have been in India for more than 365 days in 4 preceding years. The net effect of S. 6(1) read with the Explanation is that for an individual who has left India for employment outside India, he should be treated as resident of India only if he was in India during the relevant period/year for 182 days or more. In other words, if an individual has spent less than 182 days in India during a previous year and was outside India for the purposes of employment, then regardless of his being in India for 365 days or more during 4 preceding previous years, he cannot be treated as a resident of India.

There is no information regarding the applicant’s stay in India during 4 preceding years. If the applicant was not present in India for more than 365 days in 4 preceding years, then clause (a) of Ss.(1) of S. 6 would apply and it requires stay of 182 days or more in India to be treated as resident. On the other hand, if the applicant was present in India for 365 days or more during 4 preceding few years, then clause (c) of Ss.(1) to S. 6 read with Explanation (a) would apply and it requires stay of 182 days or more for a person who leaves India for employment outside, to be treated as resident of India.

From the facts available in the application, the applicant satisfies neither clause (a), nor clause (c) of S. 6(1) so as to merit treatment as a resident of India during the relevant period. It necessarily follows that the applicant was

‘non-resident’ during the relevant period. Consequently his income that accrued outside India in the USA by reason of his employment there cannot form part of the total income taxable in India. The Department in its comments dated 28-1-2010 has also clarified that the applicant may be treated as NRI as he remained in India for 123 days during the F.Y. 2008-09.

In the light of the foregoing, the question is answered in the negative. To elaborate, the applicant being a non-resident during the previous year 2008-09, the income earned by him from his employment in the USA cannot be taxed under Income-tax Act, 1961.”

5.3 With respect, we are not in agreement with the conclusions of the AAR, as the AAR has not advanced any cogent reasons for arriving at its conclusions. We may mention that the ap-plicant was not present before the AAR and the Tax Department submitted that the applicant may be treated as a non-resident during the F.Y. 2008-09. In our opinion, the decision of the Bangalore Tribunal in Manoj Kumar Reddy’s case (supra) represents a correct and better interpretation of the applicable legal provisions in respect of Explanation (a) and (b) to S. 6(1)(c).

Planning possibilities :
With regard to the hypothetical situation presented by the querist, if the querist would have been deputed to Germany on or after 1st day of April, 2009, Explanation (a) to S. 6(1) would have been applicable and the querist would have been a non-resident in F.Y. 2009-10.

Alternatively, if the querist would have returned to India on or after 1st February, 2010, he would be a non-resident in India in F.Y. 2009-10, as he would have not met the criteria/tests laid down in S. 6(1)(a) or 6(1)(c) for being considered as resident in India.

Summation :
Explanation (a) to S. 6(1)(c) applies only to an individual in relation to the previous year in which he leaves India for the purpose of employment outside India. As the querist had already left India 25th March, 2009, i.e., previous year relevant to the A.Y. 2009-10, Explanation (a) cannot be applied while determining his residential status for A.Y. 2010-11. Hence, clause (a) of Explanation to S. 6(1)(c) will be applicable for the previous year in which an assessee leaves India for the purpose of his employment.

Therefore, in our view Explanation (a) is not applicable in the case of the querist for A.Y 2010-11.

Considering the legislative history of amendments and the purpose for which the amendments have been introduced, one has to consider the purpose of entry of the person in India during the previous year. If all the entries in India are for the purpose of visits, then the period of 60 days as mentioned in S. 6(1)(c) will be substituted to 182 days. However, in our opinion, if in the previous year, as the querist had returned to India permanently after completing his assignment outside India, the Explanation (b) will not be applicable in his case.

Thus, in our opinion, the querist is not entitled to the benefit of either Explanation (a) or Explanation (b) to S. 6(1)(c). Since he was in India for a period amounting to more than 365 days in the four years prior to 1st April, 2009 and present in India for 126 days during F.Y. 2009-10, in our opinion he is a resident of India in F.Y. 2009-10 and, therefore, his salary received for the period of employment out-side India is taxable in India, subject to Double Taxation Relief under Article 23 of India-German DTAA.

Nirav Shah

Residential status of a foreign company owned by Indian residents

International Taxation

‘Residence’
is one of the primary factors to fasten the tax liability on any taxpayer in a
country, be it an individual, a company or any other entity. Determination of a
residential status of an assessee thus assumes significant importance in
international taxation. Elaborate rules are prescribed in tax laws of every
country and/or in tax treaties prevalent worldwide. Liberalisa-tion of exchange
regulations in India has opened up many opportunities for Indian residents to do
business through global companies incorporated overseas. Many a time, a
controversy arises about the residential status of such companies. In this
write-up, the authors have highlighted crucial aspects of determination of
residential status of a company where control and management assumes
significance over other tests.

1.0 Residential Status under a Tax Treaty :

In order to take advantage of a tax treaty, a company should
be resident of either of the contracting states. Article 4 of the UN Model
Convention (UN MC) and the OECD Model Convention (OECD MC) provide almost
similar definitions except that UN MC also includes place of incorporation as
one of the decisive criteria that may be used for determination of the
residential status in case of entities other than individuals.

Paragraph 1 of Article 4 of the UN MC provides “for the
purposes of this Convention the term ‘resident of a Contracting State’ means any
person who, under the laws of that State, is liable to tax therein by reason of
his domicile, residence, place of incorporation, place of management or any
other criterion of similar nature . . .”

Paragraph 3 of Article 4 further provides that “where by
reason of the provisions of paragraph 1, a person other than an individual is a
resident of both the Contracting States, then it shall be deemed to be a
resident of the Contracting State in which its place of effective management is
situated.”

The place of effective management would be relevant only if
the entity is resident of both the Contracting States.

The position is the same in majority of Indian Tax Treaties.

Thus, a reading of Article 4(1) would show that to determine
the residential status of an assessee in a Contracting State, one has to
necessarily look to the applicable laws of that state and ascertain whether the
assessee is a resident of that Contracting State within the meaning of the laws
of that State1.
Therefore, it is imperative for us to know the provisions of the Income-tax Act
in this regard.

2.0 Residential Status of a Company under the Income-tax Act, 1961 :

U/s.6(3) of the Income-tax Act, 1961, the residential status
of a company is to be determined for the purpose of the said Act in the
following manner :

“(3) 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 India2.”

U/s.6(3)(ii) of the Act, a company can be said to be a
resident in India if during that year, the control and management of its
affairs is situated wholly in India. Therefore, in the case of a foreign
company, even if some control and management is exercised from outside India, it
would not fall within the ambit of S. 6(3)(ii) of the Act and the company would
be treated as a non-resident. This concept is opposite to the concept of
determining a residential status of HUF, firm or AOP in terms of S. 6(2) of the
Income-tax Act, wherein the entities shall be resident in India even if partial
control and management of their affairs is situated in India. While in the case
of HUF, firm or AOP, it is incumbent on the assessee to establish that control
is wholly outside India for them to be treated as a non-resident, in the
case of a company the Income-tax Department has to establish that the control
and management of its affairs is situated wholly in India for the company to be
treated as a resident in India. The above view finds support from the decision
in the case of Narottam & Pereira Ltd. v. CIT, (1953) 23 ITR 454 (Bom.).

2.1 Meaning of the term ‘Control and Management’ :

The meaning of the expression ‘control and management’ as
used in S. 6(3)(ii) of the Act was the subject-matter of judicial interpretation
in the past. The legal position is now well settled that the expression ‘control
and management’ means control and management and not carrying on a day-to-day
business3.

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, Para 105 on page 262) Thus, it is ‘planning’ and
not ‘execution’ which is decisive.

Control and management signifies the controlling and
directive power, the head and brain. The head and brain of a company can be
considered to be located at the place where the company does business which
yields profits. [Narottam and Pereira Ltd. v. CIT, (supra)].

In the case of V.V.R. N. M. Subbaya Chettiar v. CIT,
(1951) 19 ITR 168, the Supreme Court held that even a partial control of the
company outside India is sufficient to hold the company as a non-resident.

In the case of CIT v. Nandlal Gandalal, (1960) 40 ITR 1, the Supreme Court has given guidelines as to how the expression ‘control and management’ would operate in different cases. The guidelines in respect of determination of control and management for individuals and companies as mentioned in Nandlal’s case are given below for the benefit of our readers:

The words’ control and management’ have been figuratively described as ‘the head and brain’.

In the case of an individual, the test is not necessary because his residence for a certain period is enough; it being clear that within the taxable territories he would necessarily have his ‘head and brain’ with him.

The head and brain of a company is the Board of Directors and if the Board of Directors exercise complete local control’, then the company is also deemed to be resident.

In the case of Radha Rani Holdings (P.)Ltd.”, it was held that “since the Board of Directors, subject to the overall supervision of shareholders, actually control and manage the affairs of a company effectively as against the day-to-day operation of the company, the situs of the Board of Directors of the company should determine the place of control and management of the company. This does not mean where one or more of the Directors normally reside, but where the Board actually meets for the purpose of determination of the key issues relating to the company.”

In the case of Saraswati Holding Corpn. Inc, the Delhi Tribunal held that “the law is well settled that control and management of affairs does not mean the control and management of the day-to-day affairs of the business. The fact that discretion to conduct operations of business is given to some person in India would not be sufficient. The word ‘control and management of affairs’ refers to head and brain, which directs the affairs of policy, finance, disposal of profits and such other vital things consisting the general and corporate affairs of the company.”

From the above discussion, it is clear that under the provisions of the Income-tax Act, 1961, even if a part of the company’s affairs are controlled and managed from outside India, then such a company would be regarded as a non-resident of India.

3.0 Tie-breaking in case of Dual Residence of a Company:

As seen earlier in terms of Paragraph 3 of Article 4 of the UNMC, when an entity is resident of both the Contracting States, then it shall be deemed to be a resident of the Contracting State in which its place of effective management is situated. However, this presupposes that the entity is resident of both Contracting States. However, in case of Saraswati Holding Corpn. Inc (supra), the Assessing Officer applied the tests of place of effective management to a company which was resident only of Mauritius. The observations of the Delhi Tribunal are worth noting here:

“In the present case it is noticed that the asses-see is a company incorporated in Mauritius. The assessee is not an Indian company. Therefore, the residential status of the assessee has to be determined on the basis of the test laid down in S. 6(3)(ii) of the Act, which provides that during the previous year the control and management of the affairs of the company should be situated wholly in India. It is only when the above test is satis-fied that the provisions of Article 4(3) of the DTAA between India and Mauritius will stand attracted. It is only in such a situation that the test of determining the residential status of the company by looking at the place of day-to-day management of the company can be resorted to. The Assessing Officer as well as the CIT (Appeals) in total disregard of the above legal position have proceeded to analyse the place of effective management of the assessee. This was impermissible in law.”

It must be understood that the test laid down in S. 6(3)(ii) of the Act is different from the test of place of effective management contemplated by Article 4(3) of a tax treaty. While the former deals with the fact of ascertaining the place of ‘control and management’ (in the Indian context whether the same are being situated wholly in India or not ?), the latter deals with ‘place of effective management’. In every treaty situation, before invoking provisions of Article 4(3), in respect of a non-resident company for its source of income in India, one has to first satisfy the test laid down u/ s.6(3)(ii) of the Act. By doing so the non-resident company would be regarded as resident of both the Contracting States, namely, (State of Source and Residence) and then the ‘place of effective management’ criteria would be used to break the tie.

In other words, a tax treaty requires the test of ‘place of effective management’ to be applied only for the purposes of the tie-breaker clause in Article 4(3) which could be applied only when it is found that a person other than an individual is a resident of both Contracting States. There is no purpose or justification in applying treaty provisions in this respect in any other situation.

4.0 Meaning of the term ‘Place of Effective Management’ :

The OECD Model Commentary? 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) makes 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 place of effective management, the relevant criteria are: (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, 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 Place of Effective Management under the treaty are:

Where the head and the brain is situated.

Where de facto control is exercised and not where ultimate 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.

According to Dr. Klaus Vogel, place of effective management exists where management directives are given and not where they take effect.

The place of residence of a manager who exercises control could also be relevant.

As stated earlier in case of Radha Rani Holdings (P.) Ltd. (supra), it is 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, which would be relevant in determining the place of control and management of a company.

5.0 Summation:

The residential status of a company first has to be determined under the domestic tax law of the relevant country. In the Indian context what is relevant is the place of control and management. In order for a foreign company to be resident of India, its control and management should be situated wholly in India. Even if some control and management is situated outside India, then the company cannot be treated as resident of India. By applying the criteria under the domestic tax laws, if the company is found to be resident of both the Contracting States of a Tax Treaty, then and then only the tie-breaking test in terms of ‘Place of Effective Management’ should be applied. 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 place of management of a company exists where management directives are given and not where they take effect. It is also important to note that what is contemplated is de facto control and management and not merely power to control.

Nirav Shah

Part 2. Recent Global Developments in International Taxation

International Taxation

In continuation of our article in the month of October 2010,
in this article we have again given brief information about the recent global
developments in the sphere of international taxation which could be of relevance
and use in day-to-day practice and which would keep the readers abreast with
various happenings across the globe in the arena of international taxation. We
intend to keep the readers informed about such developments from time to time in
future as well.

A. Developments in respect of tax treaties :

A-1 Bermuda-India :

Exchange of information agreement between Bermuda and India
signed :

On 7 October 2010, Bermuda and India signed an exchange of
information agreement relating to tax matter.

A-2 India-Mozambique :

Treaty between India and Mozambique signed :

On 30 September 2010, India and Mozambique signed an income
tax treaty.

A-3 Russia-United States :

Treaty between Russia and United States — PE : Russia
clarifies dependent agent :

The Ministry of Finance clarified in the Letter of 9
September 2010 (N 03-08-05) the dependent agent permanent establishment for the
purposes of the income and capital tax treaty between Russia and the United
States (the Treaty).

A Russian company solicits purchasers in Russia for a US
company, receives money from such purchasers and transfers it to the US company.
The goods are shipped from the US to the clients. The Russian company receives a
remuneration from the US company.

Article 5 of the Treaty stipulates that persons entitled to
conclude and habitually concluding contracts on behalf of the foreign company,
or creating legal consequences for the foreign company, can be treated as
dependent agents.

According to the Ministry, insufficient participation of the
US company in the activities of the Russian company deems the Russian company as
a dependent agent; for example, if under contract with the US company, the
Russian company has ‘wide powers’ (e.g., in terms of dealing with
purchasers’ complaints, return of goods, etc.), the activity of the Russian
company is deemed to be a dependent agent and the US company is deemed to have a
PE in Russia in respect of any activities which the agent undertakes in Russia.

A-4 Jersey-India :

Exchange of information agreement between Jersey and India
initiated :

According to the information published by the Government of
Jersey, Jersey and India have initialled an exchange of information agreement
relating to tax matters.

A-5 Uruguay-India :

Treaty between Uruguay and India : negotiations concluded :

It has been reported that Uruguay and India successfully
concluded negotiations for a tax treaty in August 2010.

A-6 Israel-OECD :

Israel becomes member of OECD :

On 7 September 2010, Israel deposited its instrument of
accession to the OECD Convention, thereby becoming a member of the Organisation.

A-7 Russia-India :

Treaty between Russia and India — Russia clarifies DTR :

The Moscow Department of the Russian Federal Tax Service
clarified in the letter of 5 March 2010 (N 16-15/023294@) the application of
double taxation relief (DTR) to business profits under the tax treaty between
Russia and India. Under the treaty, the income of a Russian company, which
carries out business activity in India, which does not amount to a permanent
establishment there, is taxable only in Russia. Thus, the tax withheld in India
cannot be credited against Russian corporate income tax.

A-8 Finland-India :

Treaty between Finland and India enters into force :

The income tax treaty and protocol between Finland and India,
signed on 15 January 2010, entered into force on 19 April 2010. The treaty
generally applies from 1 January 2011 for Finland and from 1 April 2011 for
India. From these dates, the new treaty and protocol generally replaces the
Finland-India income and capital treaty of 10 June 1983 as amended by the 1997
protocol.

A-9 United Kingdom :

Double Tax Treaty Passport Scheme to be launched :

HMRC have announced the launch of a Double Taxation Treaty
Passport (DTTP) Scheme. The Scheme will be available to overseas corporate
lenders resident in a territory with which the United Kingdom has a tax treaty
with an interest or income from debt claims article. Such a lender may apply to
HMRC for a ‘Treaty Passport’.

The Scheme will take effect from 1 September 2010. However,
with effect from 1 June 2010, overseas lenders may register for the Treaty
Passport.

Holders of the Treaty Passport will be entered onto a public
register with a unique DTTP number. The register will be available for
consultation by prospective UK-resident corporate borrowers.

Where a UK-resident corporate borrower enters into a loan
agreement with an overseas lender holding a Treaty Passport, the lender will
furnish the borrower with its reference number. Using the new form DTTP2, the
borrower should, within 30 days of the passported loan, notify HMRC of the loan.

HMRC will then issue a direction to the borrower to deduct
from its interest payments, an amount equivalent to income tax at the treaty
rate.

For non-passported loans, the normal ‘certified DT claim’
method remains in place.

A-10 OECD accepts Estonia and Slovenia as members :

OECD countries agreed on 10 May 2010 to invite Estonia and
Slovenia to become a member of the OECD.

A-11 United States-Belgium :

Treaty between US and Belgium — MAP on qualification of
pension plans for treaty benefits signed :

The United States and Belgium have signed a mutual agreement
procedure (MAP) that specifies the types of pension plans that will qualify for
benefits under Article 17 (Pensions, Social Security, Annuities, Alimony, and
Child Support) of the 2006 US-Belgium treaty.

The MAP lists the specific types of plans in Belgium and the United States that will qualify. It also states, however, that the listing is not intended to be exclusive and that any US or Belgian pension plan of a type not mentioned, including any type of plan established pursuant to legislation enacted after the date of signature of the MAP, or any participant in a type of plan not mentioned, may ask the competent authority of the other Contracting State for a determination that the plan generally corresponds to a pension plan recognised for tax purposes in that other State.

A-12 Mexico-India:
Treaty between Mexico and India enters into force:

The income tax treaty and protocol between Mexico and India, signed on 10 September 2007, entered into force on 1 February 2010. The treaty generally applies from 1 January 2011 for Mexico and from 1 April 2011 for India.

Domestic tax developments in foreign jurisdictions:

B-1 United States:
B-1.1 Small Business Jobs Act of 2010 signed:
President Obama signed the Small Business Jobs Act of 2010 (H.R. 5297) into law on 27 September 2010. Significant business tax measures in the Act are summarised below?:

— The Act temporarily excludes 100% of the gain from the sale of qualified small business stock held at least 5 years.

— The Act extends the carry-back period for eligible small business credits from 1 year to 5 years.

— The Act allows eligible small business credits to offset both regular and alternative minimum tax liability.

— The Act temporarily reduces the recognition period to 5 years for built-in gains of Subchap-ter S corporations that convert from prior

Subchapter C status.

— The Act increases the maximum amount a tax-payer may elect to deduct in connection with the cost of qualifying S. 179 property placed in service in 2010 and 2011 to USD 500,000. The maximum amount is phased out by the amount by which the cost of qualifying property exceeds USD 2 million. The Act temporarily expands the definition of qualifying S. 179 property to include certain real property, i.e., qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. The maximum amount of deduction for such real property is USD 250,000.

— The Act extends the additional first-year depreciation deduction which is allowed equal to

50% of the adjusted basis of qualified property placed in service through 2010.

— The Act increases the maximum amount that a taxpayer may deduct in connection with trade or business start-up expenditures from USD 5,000 to USD 10,000. The maxi-mum amount is phased out by the amount by which the cost of start-up expenditures exceeds USD 60,000, increased from USD 50,000.

— The Act revises the penalties that may be imposed for failure to disclose a reportable transaction to the IRS.
— The Act allows self-employed individuals to deduct the cost of health insurance for themselves and their spouses, dependents, and any children under age 27 for purposes social security and Medicare taxes imposed by the Self-Employment Contribution Act (SECA).

— The Act removes cell phones and similar telecommunications equipment from the definition of listed property so that the height-ened substantiation requirements and special depreciation rules do not apply.

— The Act imposes the same information reporting requirements (i.e., IRS Form 990-MISC) on taxpayers who are recipients of rental income from real estate as are imposed on taxpayers engaged in a trade or business, with a few exceptions.

— The Act treats as US-source income amounts received, whether directly or indirectly, from a non-corporate US resident or a US domestic corporation for the provision of a guarantee of indebtedness of such person.

— The Act increases the amount of the required estimated tax payments otherwise due by large corporations in July, August, or September, 2015, by 36 percentage points.

A complete description of the provisions of the Act is included in the Technical Explanation prepared by the US Joint Committee on Taxation (JCX-47-10). The White House also issued a press release with a summary of the principal business provisions that are included in the Act.

B-1.2 Proposed regulations issued on treatment of series LLCs:
The US Treasury Department and Internal Revenue Service (IRS) have issued proposed regulations on the treatment of a series limited liability company (LLC), a cell of a domestic cell company, or a foreign series or cell that conducts an insurance business.

The proposed regulations were issued to address the tax classification of segregated groups of assets and liabilities (referred to as ‘series’ or ‘cells’) for US federal income tax purposes. The regulations generally provide that such series or cells will be treated as separate entities.

The proposed regulations were issued in response to the enactment of statutes by a number of US states that permit the creation of entities that may establish separate series, including limited liability companies (series LLCs). These statutes may provide conditions under which the debts, liabilities, obligations and expenses of a particular series are enforceable only against the assets of that series.

The preamble to the proposed regulations states that the classification of a series or cell that is treated as a separate entity for federal tax purposes is determined under the same rules that govern the classification of other types of sepa-rate entities.

The preamble further states that the proposed regulations will affect domestic series LLCs, domestic cell companies, foreign series or cells that conduct insurance businesses, and their owners.

The proposed regulations will be effective on and after the date the regulations are published as final. A transition rule is provided for existing se-ries that satisfy specified conditions, including that they were established and conducted business or investment activity prior to 14 September 2010.

B-1.3 IRS announces further exemptions from FTC disallowance rules in cross-border back-to-back transactions?:
The US Internal Revenue Service (IRS) has announced further exceptions for claiming foreign tax credits on back-to-back cross-border transactions. The excep-tions were announced in Notice 2010-65.

The new notice addresses the scope of S. 901(l)

of the US Internal Revenue Code (IRC), which disallows an FTC for gross basis withholding taxes where the taxpayer fails to meet a holding period requirement for the property with respect to the foreign taxes that are imposed [S. 901(l)(1)(A)], or is under an obligation to make a related payment with respect to positions in substantially similar or related property [S. 901(l)(1)(B)].

Notice 2010-65 is a follow-up to earlier Notice 2005-90, in which the US Treasury Department and IRS stated that they intended to issue regulations setting forth an exception to IRC S. 901(l)

(1)(B) for foreign gross-basis withholding taxes imposed on payments in back-to-back computer program licensing arrangements in the ordinary course of the licensor’s and licensee’s respective trades or businesses. New Notice 2010-65 states that the US Treasury Department and IRS will provide exemptions from FTC disallowance in the regulations as follows?:

— S. 901(l)(1)(B) will not apply to disallow an FTC for foreign gross-basis withholding taxes with respect to back-to-back licensing arrangements involving certain intellectual property or copyrighted articles entered into in the ordinary course of business; and

— S. 901(l)(1)(A) will not apply to disallow an FTC for foreign gross-basis withholding taxes with respect to retail distribution arrangements for certain copyrighted articles entered into in the ordinary course of business.

Notice 2010 -65 sets out the conditions necessary for meeting the above exceptions. The exceptions will apply to amounts paid or accrued after 23 September 2010. Taxpayers are permitted to rely on the guidance given in Notice 2010-65 until the regulations are issued.

B-1.4 Final regulations issued on US exemption for international operation of ships and aircraft:
The US Treasury Department and the Internal Revenue Service (IRS) have issued final regulations on the US exemption for income derived from the international operations of ships and aircraft.

The final regulations are issued u/s.883 of the US Internal Revenue Code, which provides a US tax exemption for foreign corporations organised in countries that grant an equivalent tax exemption to US corporations for shipping and air income.

The final regulations adopt the proposed and temporary regulations issued on this topic on 25 June 2007.

The final regulations include several modifications to the proposed regulations. A particular modification relates to the types of activities that will be considered as incidental to shipping and air-craft activities, and thus also covered by the US exemption. An additional modification specifies the conditions under which bearer shares can be taken into account for purposes of satisfying the stock-ownership test that applies to foreign corporations.

The final regulations also include guidance on the treatment of shipping and aircraft corporations that are controlled foreign corporations (CFCs) under the US Internal Revenue Code.

The final regulations apply generally to taxable years of foreign corporations beginning after 25 June 2007, with additional application to open taxable years beginning on or after 31 December 2004. The modification with respect to the treatment of bearer shares applies to taxable years beginning on or after 17 September 2010.

B-1.5 Treasury Department and IRS issue relief guidance for erroneous check-the-box elections:

The US Treasury Department and Internal Revenue Service (IRS) have issued Revenue Procedure 2010-32 with relief guidance for foreign business entities that make erroneous elections under the US check-the-box regulations (Treas. Reg. §§ 301.7701-1 through 3).

The guidance applies to foreign entities that file IRS Form 8832 (Entity Classification Election) and make an invalid election as to the status of the entity as a partnership or disregarded entity under the US check-the-box regulations due to an incorrect assumption as to the number of owners of the entity.

The Revenue Procedure states that the Treasury Department and IRS are aware that foreign entities have made invalid elections on this basis and that relief guidance is being issued in order to alleviate concerns and simplify tax administration in this area.

Revenue Procedure 2010 -32 notes that an invalid election can occur if the entity elects partnership status, on the assumption that there are two or more owners of the entity, or if the entity elects to be treated as a disregarded entity (i.e., as a sole proprietorship, branch, or division) on the assump-tion that there is a single owner, and in either case the elected status is not available due to an incorrect assumption as to the number of owners.

Revenue Procedure 2010-32 provides that if the conditions set out in the procedure are followed, taxpayers may make a corrective election and the IRS will treat the entity in the desired manner, i.e., as a partnership or disregarded entity, as the case may be, and not as an association taxable as a corporation. The procedure is effective for qualified entities that meet the necessary requirements as of 7 September 2010.

B-1.6 US Treasury Department re- issues list of boycott countries that result in restriction of US tax benefits:

The US Treasury Department has re-issued its list of the countries that require cooperation with or participation in an international boycott as a condition of doing business. The countries listed are Kuwait, Lebanon, Libya, Qatar, Saudi Arabia, Syria, the United Arab Emirates, and the Republic of Yemen. The Treasury Department stated that Iraq is not included on the list, but that its future status remained under review. The new list is dated 23 April 2010 and was published in the Federal Register on 29 April 2010.

The listed countries are identified pursuant to S. 999 of the US Internal Revenue Code (IRC), which requires US taxpayers to file reports with the Treasury Department concerning operations in the boycotting countries. Such taxpayers incur adverse consequences under the IRC, including denial of US foreign tax credits for taxes paid to those countries and income inclusion under Sub-part F of the IRC in the case of US shareholders of controlled foreign corporations that conduct operations in those countries.

B-1.7 IRS updates Publication 519?: US Tax Guide for Aliens:
The US Internal Revenue Service (IRS) has updated its Publication 519 (US Tax Guide for Aliens). The publication is intended for use in preparing tax returns for 2009.

Publication 519 provides detailed guidance and information for residents and non-residents to determine their liability for US federal income tax. This includes the rules for determining US residence status, i.e., the US green card test and the US substantial presence test, and the general rules that apply to determine and compute US tax liability. The requirements to file US income tax returns are also discussed, and information is further provided regarding benefits under US income tax treaties and social security agreements.

B-1.8 IRS updates Publication 901 on US income tax treaties:
The US Internal Revenue Service (IRS) has updated its Publication 901 on US income tax treaties. The publication includes a list of all current US income tax treaties together with the general effective date of each and a table with the tax rates for interest, dividends, capital gains, royalties, copyrights, rents, pensions, and social security payments.

Also included are summaries of the relevant provisions of each US treaty regarding taxation of personal services income, taxation of income received by professors, teachers and researchers, taxation of income received by students and ap-prentices, and taxation of wages and pensions paid by foreign governments.

The publication carries a revision date of April 2010, and was updated to include information for the new US income tax treaty with Italy, the new US protocol with France, both of which entered into force at the end of 2009. The publication includes a Reminder section that notes that:

— US taxpayers must disclose treaty-based return positions to the IRS, i.e., positions that US tax is reduced or eliminated by a US tax treaty;

— the US-USSR income tax treaty remains ef-fective for certain members of the Common-wealth of Independent States (i.e., Armenia, Azerbaijan, Belarus, Georgia, Kyrgyzstan, Moldova, Tajikistan, Turkmenistan, and Uz-bekistan);

— the US-China treaty does not apply to Hong Kong; and

— the US-Iceland treaty signed 23 October 2007 was generally effective on 1 January 2009, subject to an election to apply the prior treaty for a 12-month period.

B-1.9 Updated IRS Publication 593 issued — Tax

Highlights for US Citizens and Residents Going Abroad:
The US Internal Revenue Service (IRS) has released the 2010 revision of Publication 593 (Tax Highlights for US Citizens and Residents Going Abroad). The publication is dated 22 January 2010.

Publication 593 explains the provisions of US federal income tax law that apply to US citizens and resident aliens who live or work abroad and who expect to receive income from foreign sources.

The publication discusses the applicable US tax return filing requirements, the treatment of income earned abroad, including the S. 911 earned income exclusion and housing exclusion or deduction, tax withholding and estimated taxes, claiming a credit or deduction for foreign income taxes, claiming tax treaty benefits, and information on how to obtain tax help from the IRS.

Publication 593 also refers to the other IRS publications that are relevant in this context, including IRS Publication 54 (Tax Guide for US Citizens and Resident Aliens Abroad), IRS Publication 514 (Foreign Tax Credit for Individuals), and IRS Publication 901 (US Tax Treaties). The latter publication discusses in detail the treatment of foreign income, the foreign tax credit, and tax treaty benefits.

B-2 Netherlands Antilles:

Corporate income tax rate reduction for Curaçao and St. Maarten planned:

In a Dutch Parliamentary Document (32.276, No. of 6 September 2010 and a recent letter (No. 2010Z07793) of the Minister of Finance of the Netherlands Antilles, it was announced that after the dismantling of the Netherlands Antilles, which will take effect on 10 October 2010, Curaçao and St. Maarten are planning to reduce the corporate income tax to 15%. Currently, the rate is 34.5% (inclusive island surcharge).

The new rate may become effective on 1 Janu-ary 2012.

B-3 United Kingdom:

B-3.1 New scheme for DTR on inter-company loan interest and inter-company royalties:

HMRC has announced that with regard to double taxation relief on inter-company loan interest and inter-company royalties, from 1 September 2010, HMRC’s Provisional Treaty Relief Scheme (PTRS) has been replaced in its entirety by the Syndicated Loan Scheme (SLS).

B-3.2 Reform of CFC regime?: summary of main proposals:
The main proposals in HM Treasury’s discussion document http://online2.ibfd.org/linkresolver/static/ tns_2010-01-27_uk_1 on the reform of the CFC regime are summarised below.

Scope?:

— The rules will operate on an ‘entity basis’.

— There will be objective tests to exclude subsidiaries where there is low risk of artificial diversion.

— The rules will be drafted on an ‘exemption’ basis. Thus, a CFC meeting certain prescribed criteria is exempted from the regime.

— Chargeable gains of a CFC remain excluded.

— A new test will replace the ‘lower level of tax’ test. The effect of the new test should be to exclude companies in territories with tax rates and tax bases similar to the UK. If implemented as expected, the HM Treasury hopes that this would obviate the necessity for a white list.

Exemptions:

— There will be objective tests that will exclude from the regime CFCs undertaking genuine trading activities. Here, special attention will be given to intra-group activities. The legislation will need to be drafted carefully to ensure that such activities are not caught if they do not pose a risk to the UK tax base.

— Extension of the ‘trading company exemption’ to bring within its ambit genuine offshore treasury operations and the active manage-ment of intellectual property.

— Extension of the ‘trading company exemption’ to non-trading income of a trading company where such income is incidental or ancillary to the trade.

— Specific exemption for particular activities where there is no artificial diversion of profits from the UK, e.g., certain reinsurance subsid-iaries and property subsidiaries.

— Increase in the de minimis limit from GBP 50,000.

— Two further routes to exemption, to apply where other exemptions are not available. One will apply where exemptions are narrowly missed, or where a one-off transaction results in a test being failed. The intention is to leg-islate for some flexibility in these areas. The second avenue is a reformed motive test.

— Proposals to extend the current ‘period of grace’ motive clearance arrangements.

B-3.1 HMRC issue revised International Tax Manual

— Interaction between self-assessment re-gime and treaty non-residence (company) rules?:

HMRC have revised their International Tax Manual (INTM), in particular, the section dealing with treaty non-residence.

A new paragraph (INTM120075) has been added. INTM120075 deals with the interaction between the self-assessment regime and the treaty non-residence rules. A dual-resident company, or a potential dual-resident company, should comply with the normal self-assessment rules where applicable. Where a determination is currently underway of its tax residence status, the company should, nevertheless, continue submitting its tax returns while awaiting the outcome of the determination.

A company must self-assess its place of effective management where there is a relevant standard tie-breaker clause. Where the outcome of the tie-breaker depends on agreement between the competent authorities, the company must self-assess, while awaiting the outcome of the deliberations. The self-assessment should be based on relevant information, including any relevant treaty provisions.

In addition, INTM120070 has been revised. That paragraph addresses the following:

— residence under a tax treaty;
— a list of the UK’s tax treaties in force at 1 December 2009 showing separately those which contain a tie-breaker for companies and those which do not;

— tax treaties with standard tie-breakers;

— tax treaties with non-standard tie-breakers;

— how to deal with cases where a company is treated as not resident in the United Kingdom, as a result of the tie-breaker rules (‘S. 249 cases’);

— compliance considerations;

— place of effective management;

— UK holding companies;

— other effects of S. 249; and

— Companies which were already treaty non-resident on 30 November 1993.

B-4 Australia:
B-8.1 Framework Rules for Sovereign Investments:

Consultation Paper released:

On 23 June 2010, the Government released Consultation Paper that deals with the Framework Rules for Sovereign Investments. It seeks to clarify and provide certainty as to the Australian tax consequences for certain investments made by foreign governments, and the withholding tax obligations for Australian residents.

The Paper states that the policy objective behind the proposed law is to enhance Australia’s attractiveness as a destination for foreign government investment, but also to make sure that the concessional tax treatment afforded under sovereign immunity does not shelter the commercial operations of foreign governments.

Briefly, the framework seeks to exclude from the exemption from Australian taxation (including with-holding tax) of activities of ineligible entities, gains from carrying on a business or from profit-making undertakings. The Paper discusses the definition of eligible entities, including sovereign funds and eligible activities, and provides a number of examples.

B-8.2 Tax treaties — ATO automatic exchange audit report released:

The Australian National Office released on 18 May 2010 a 110-page report that deals with the management and use of information collected under the automatic exchange of information (AEOI) mechanism with the tax treaty partners.

The report notes that while the ATO is increasingly reliant on its data-matching capabilities, the ATO faces a number of challenges and limitations in establishing and using the information exchange as part of its compliance programme activity, including differences in language, legal systems, time zones, financial year- ends and the organisational priority afforded to automatic information ex-changes in different jurisdictions. Notwithstanding the difficulties, the report finds that the manage-ment of the programme has been sound.

The report notes that the ATO has a generally non-discriminatory approach to sending the AEOI date to treaty partners, even where the partner does not reciprocate with sending data to the ATO — the report states that approximately 40% of treaty partners regularly sent AEOI to the ATO over the last five years.

The report says that the ATO receives largest amount of information (by dollar value) from New Zealand (37%), Canada (19%), Denmark (16%), Norway (8%), France (5%), Japan (4%) and the UK (3%). The number of annual data records received by the ATO fluctuates between 200,000 and 500,000.

The outgoing AEOI (by dollar value) were provided to the US (36%), the UK (24%), New Zealand (7%), Japan (6%), Singapore (5%) and the Netherlands (4%). The annual number of data records fluctuates between 1.1 and 1.9 million.

B-8.3 Draft anti-roll-up provisions
— Further clarification?:

Following an earlier release of the Draft Legislation that will implement the anti-roll-up rules, the Treasury on 7 May 2010 released the Draft Explanatory Memorandum to the Draft Legislation that provides important explanations of the operation of the proposed anti-roll-up rules.

By way of background, as part of a review of the Australia’s anti-deferral regimes, the Foreign Investment Fund (FIF) provisions will be repealed and replaced by the anti-roll-up (ARU) provisions. The FIF provisions are designed to supplement the CFC rules and apply to investments of residents to foreign entities that are primarily engaged in finance-like and passive investment activities, providing that the Australians do not control the foreign entity. (If the foreign entity is controlled by Australian residents, the CFC provisions apply instead.)

In contrast, the proposed ARU provisions will target investments by residents in foreign accumulation funds that reinvest interest-like returns. The ARU provisions will apply to “foreign accumulation funds” which are entities that are foreign resident,

not a CFC, do not distribute substantially all profits and gains and have investment returns that are subject to a low level of risk.

The Draft Explanatory Memorandum explains when the returns are considered to be subject to a low level of risk.

The returns will be subject to a low level of risk where?the?return on investments held by the foreign entity is sufficiently certain, such as interest paid on government bonds or bank call deposits. Specifically, a return will be considered to be sufficiently certain if it is reasonably expected that the foreign entity will receive returns on the assumption that it will hold the instrument till maturity and at least some amount of the return is fixed or determinable with reasonable accuracy at the time of the investment. This is tested on an annual basis.

B-8.4 MITs — New tax system:

The Assistant Treasurer announced on 7 May 2010 the new taxation regime for Managed Investment Trusts (MIT) that aims to provide certainty and simplification and to end the confusion between trust and tax law. The proposed changes will commence from 1 July 2011.

At present, taxation of beneficiaries in any trust, including managed investment schemes, is determined on the basis of their present entitlement which may result in double taxation in some cases. Further, there has been significant divergence between the rules dealing with the taxation of the trusts and their practical enforcement and application by the industry.

The proposed regime aims to correct these out-comes by implementing the following measures:

— Unitholders in MITs will be taxed on the taxable income that the trustee allocates to them (rather than on their present entitlement under the trust deed);

— Unders and overs, that is minor corrections to the calculation of the net income of an MIT will be allowed to be carried to the following year and taken into account in the calculation of the net income in the following year (rather than effectively allowing this treatment under the ‘industry practice’);

— Cost base of units in MITs will be increased by amounts that have been taxed to the unitholder, but not yet received (this will eliminate the current potential for double taxation on the disposal of the units before the distribution is received);

— Corporate trust rules in Division 6B of the Income Tax Assessment Act, 1936 will be repealed (at present, these rules may require certain trusts to be taxed as companies, but the reason for the existence of these rules have long been abolished).

B-8.5 Taxation laws to be reviewed to facilitate

Islamic finance:

The Assistant Treasurer announced on 26 April 2010 that the Board of Taxation would undertake a comprehensive review of Australia’s tax laws to ensure that they do not inhibit the development of Islamic finance, banking and insurance products. He mentioned that the review is not about grant-ing a special treatment of concessions for Islamic finance or its providers, but about ensuring that the tax system does not unfairly disadvantage or preclude such instruments.

B-8.6 ATO comments on classification of US

LLC:

The ATO released an interpretative decision dealing with the classification of US Limited Liability Companies (LLC). In its Interpretative Decision ATO ID 2010/77, the ATO confirmed that a single- member US LLC may qualify as a foreign hybrid company for the purposes of Australia’s foreign hybrid provisions in Division 830 of the Income Tax Assessment Act, 1997. In particular, it notes that while a single-member LLC cannot be treated as a partnership for the US tax purposes, it is nevertheless treated as an entity disregarded as an entity separate from the owner and therefore the condition in Ss.830-15(2) will be satisfied.

B-8.7 Treaty between Australia and US — ATO comments on classification of US LP?:

The ATO has released an interpretative decision dealing with the classification of US Limited Partnerships (LP).

Interpretative Decision ATO ID 2010/81 states that a US LP established under the State law of Delaware is not treated as a ‘company’ for the purposes of Art. 10 of the tax treaty between Australia and United States, but is treated as a partnership.

In particular, the ATO ID 2010/81:

— confirms that a US LP may qualify for treaty benefits, as it is a ‘person’ and a ‘resident’ under the treaty;

— however, it states that dividend distributions to the US LP will not qualify for a reduction of the Australian withholding tax rate under Art. 10 of the treaty, as the distributions are not received by a ‘company’;

— in reaching this conclusion, the ID considers the definition of a ‘company’ under the treaty and notes that a US LP is neither a ‘body corporate’ or ‘an entity treated as a company for tax purposes’;

— the ID notes that a US LP is, prima facie, a ‘body corporate’ under the ordinary meaning of the term in Australia, even though a US LP does not enjoy a continued existence;

— however, the ID states that the definition should be interpreted in light of the context of the treaty and refers to the Commentaries to Article 3 of the OECD Model Convention that requires the examination of the rules of the State in which the entity is organised and not those of the source State. In the US, a LP is not a ‘body corporate’ and therefore it should not qualify as such under the treaty;

— further, the ID notes that a US LP is not treated as a company for tax purposes under the tax laws of the US, as an LP cannot qualify for the check-the-box election.

B-8.8 Subordinated notes are debt for tax purposes — Regulations issued:
The Income Tax Assessment Amendment Regulations, 2010 (No. 3) were registered on 14 April 2010 that apply to the relevant payments after 1 July 2001 (i.e., from the introduction of the debt/ equity rules).

Briefly, the debt/equity rules in Division 974 of the Income Tax Assessment Act, 1997 operate to classify financial arrangements as either debt or equity for income tax purposes. A financial arrangement may be classified as debt if there is

non-contingent obligation to provide financial benefits under the arrangement.

However, term cumulative subordinated notes could not formally qualify as debt as the obligations under the notes were subject to insolvency or capital adequacy conditions, i.e., the payments under the note were contingent on the payer remaining solvent or satisfying the capital adequacy requirements. Such conditions are common for banks and other regulated entities (e.g., bond traders).

While the note could not qualify as debt, it would also not qualify as equity and returns on the notes could be non-deductible under the principle set up by the St. George case [St. George Bank v. FCT, (2009) FCAFC 62].

The Regulations allow disregarding the subordination and treating the note as a debt interest, subject to the note satisfying other relevant conditions.

B-5 Sweden:

Amendments to CFC rules proposed:

On 14 April 2010, the Swedish Tax Agency published its report on the controlled foreign company (CFC) rules (the Report). The Report proposes amendments to the current CFC rules. The main proposals are summarised below.

White list — IP income:
Under the general rule, income of a CFC is deemed to be subject to low taxation and subsequently taxable in the hands of the owner of the CFC, if it is not taxed, or is subject to a tax rate lower than 14.5%. The income is, however, not considered to be subject to low taxation if the foreign legal entity is a tax resident and liable to income tax in one of the countries listed in a ‘white list’, provided that the income in question has not been expressly excluded.

Currently, financial income has been excluded for some of the countries in the ‘white list’. The Report proposes that income from patents, trademarks, licences and other similar IP rights would also be excluded in respect of the following countries in the ‘white list’:

CFC resident in EEA:

Furthermore, the Report proposes to abolish the exemption applicable to income from a CFC resident in an EEA state. This exemption currently applies if the shareholder can prove that the foreign entity (i) is established in the other country for business reasons, and (ii) is engaged in real economic activities there.

B-6 Saudi Arabia:

New procedure of withholding tax refund:

The Department of Zakat and Income Tax (DZIT) issued on 23 May 2010, Circular No. 3228/19 to clarify the procedure of claiming withholding tax refund where a tax treaty applies.

Under the procedure, which applies to resident companies and to permanent establishments in Saudi Arabia of non-resident companies, where payment is made to a non-resident with no PE in Saudi Arabia, the payer must withhold tax at the rates provided for in the Income Tax Regulations.

Such rates apply even if an effective tax treaty provides for lower rates (or for an exemption). In such a case, the payer is required, under the procedure, to submit a letter to the DZIT requesting the refund of the overpaid tax. The letter must be accompanied with the following:

— a letter from the non-resident recipient requesting the refund of the overpaid tax;

— a certificate of residence issued by the competent authorities of the country of residence of the recipient proving that the latter is a resident of that country under the treaty and that the amount paid is subject to tax in that country; and

— a copy of the withholding tax form submit-ted to DZIT by the payer, together with the receipt of payment of tax.

The Circular does not specify an effective date, but it may reasonably be expected that it applies to payments made after its date of issuance (i.e., 23 May 2010). The Circular also does leave a number of other questions unanswered particularly with respect to the consequences of non-application of the procedure (i.e., direct application of treaty rates by the payer), the time frame of refund, etc.

Further details will be published as soon as they become available.

B-7 France:

New limited liability entity for sole proprietorship — law adopted and published?:
On 16 June 2010 the Law No. 2010-658, providing for a new limited liability entity for sole proprietorship [enterprise individuelle à responsabilité limitée (EIRL)], was published in the official journal. This publication follows the adoption of the law by the Parliament on 12 May 2010, and its approval by the Constitutional Council on 10 June 2010. However, this law will not become effective until the government enacts further regulations. Key elements of this new legal structure are summarised below:

Introduction of a separate capital allocated to the enterprise. A sole proprietorship will be entitled, by filing an official declaration stating the creation of an EIRL, to benefit from a capital allocated to its enterprise distinct from its private capital. The assets allocated to that separated capital (patrimoine d’affectation) will be listed on a distinct balance sheet and, consequently, deemed solely dedicated to the business and liabilities of the enterprise. As a result, the individual entrepreneur will no longer be personally liable for all debts of the enterprise, especially in case of liquidation.

Introduction of an election to corporate income tax. For tax purposes, the EIRL will be allowed to elect for assessment under the corporate income tax rules. By doing so, the disparity between the tax treatment of sole proprietorship and companies will be removed. In particular?:

— the profits realised by the EIRL will be subject to a reduced rate of 15% up to EUR 38,120, and to a flat rate of 33.33% for the excess;

— the salary payments paid by the EIRL to the individual entrepreneur, in consideration of his work, will be deductible;

— the social contributions will only be levied on such remuneration, and not on the whole profits realised by the EIRL; and

— any capital gains (or loss) that may arise from the disposal of the assets included in the EIRL’s capital (i.e., shown on its balance sheet), will be subject to the corporate income tax rules.

B-8 China (People’s Rep.):
B-8.1 Taxation on interest derived by foreign branches of Chinese financial institutions
— Treaty treatment clarified:

The State Administration of Taxation (SAT) issued a ruling on 2 June 2010 [Guo Shui Han (2010) No. 266] clarifying the taxation on interest derived by foreign branches of Chinese financial institutions. The content of the ruling is summarised below.

A branch established in a third country by a foreign financial institution, which is exempt from income tax under the tax treaty concluded between China and the country of the foreign financial institution, may receive the same treaty benefit (exemption) unless the treaty expressly states that only the head office is entitled to the exemption. The exemption is subject to the administrative rules on the approval procedure in respect of granting treaty benefits [Guo Shui Fa (2009) No. 124].

A foreign branch (non-legal entity) established by a Chinese resident bank is treated as a Chinese resident. The tax treaty between China and the country where the branch is located does not apply to the interest derived from Chinese source by such a branch. The interest must be taxed under the Chinese domestic laws and regulations, by reference to the ruling on the taxation of interest derived by non-residents [Guo Shui Han (2008) No. 955], regardless of whether the interest is paid by a Chinese resident or a Chinese branch of a non-resident.

B-8.2 Technology transfer — Treaty treatment clarified:
The State Administration of Taxation (SAT) issued a ruling on implementation of treaty articles on 26 January 2010 [Gui Shui Han (2010) No. 46]. The ruling supplements a previous ruling regarding the article on royalties [Guo Shui Han (2009) No. 507]. The content of the new ruling is sum-marised below.

As a general rule, technical services related to the transfer of the right to use proprietary technology constitutes part of the technology transfer; hence, the income arising from these services is to be classified as royalties for the purposes of the treaty. However, if the beneficial owner of the royalties carries on business through a permanent establishment (PE) in the state in which the royalties arise and the royalties received are effectively connected with that PE, and if the transferor of the technology seconds personnel to the user of the technology to provide technical services which due to the duration of the services constitute a PE according to the tax treaty, Article 7 (business profits) of the relevant treaty shall apply to that income and Article 15 (employment income) shall apply to the personnel providing the services. Where there is no PE and the income arising from such services cannot be attributed to a PE, such income remains subject to Article 12 (royalties).

In cases where the fees for technical services are paid by the user immediately after the conclusion of the contract on the technology transfer, and it cannot be established in advance whether the provision of services will continue long enough to constitute a PE, Article 12 shall apply. However, if it is subsequently established that there is a PE and the royalty income is effectively connected with that PE, the tax treatment has to be ad-justed according to the Article 7 and Article 15, as described above.

For contracts entered into before 1 October 2009 which are still being executed, this Ruling and the Ruling [Guo Shui Han (2009) No. 507] will apply as long as the tax treatment of income from the contract has not been determined. If the tax treatment of the contract was determined before 1 October 2009 according to Article 15, there will be no adjustments.

B-9 Finland:

Tax administration publishes handbooks on inter-national and individual taxation?:
On 12 May 2010, the tax administration published the following 2 handbooks which provide up-to-date information on the tax legislation currently in force with references to recent case law?:

— Handbook on international taxation 2010 (Kan-sainvälisen verotuksen käsikirja 2010); and

— Handbook on individual taxation 2010 (Hen-kilöverotuksen käsikirja 2010).

The handbooks are published in Finnish. The Hand-book on international taxation, however, includes a Finnish-English tax glossary.

B-10 Germany:

Ministry of Finance publishes guidance on application of tax treaties regarding partnerships?: Recently, the Ministry of Finance published guidance in the form of an official letter dated 16 April 2010, regarding the application of tax treaties to partnerships.

The guidance comments on various forms of partnerships, and the qualification of the partners profit shares. The guidance covers both the treatments of:

— non-resident partners of domestic partnerships, and

— resident partners of foreign partnerships.

The guidance in particular deals with:

— the partnership’s entitlement to treaty benefits;

— the qualification of partnership income as profits under Article 7 of the OECD Model Convention;

— the application of the permanent establishment proviso [Article 10(4), Article 11(4), Article 12(3)];

— the treatment of conflicts of qualifications.

The guidance also:

— contains a separate chapter on the treatment of special payments, i.e., remuneration derived by a partner (i) for activities performed for the partnership, (ii) for the granting of loans, or (iii) for the use of the partner’s assets by the partner-ship. The guidance stipulates that such payments qualify as business profits within the scope of

Article 7 of the OECD Model Convention;

— provides for an overview of specific provisions of certain treaties concluded by Germany re-garding a partnership’s entitlement to treaty benefits and comments on specific forms of foreign partnerships.

The guidance can be downloaded on the website of the Ministry of Finance (www.bundesfinanzministerium.de).

B-11 Belgium:

Circular on tax amnesty and voluntary additional declaration for individuals published:

Recently, the tax administration published Circular CIRH 81/562.220 ET 118.235 (AOIF no. 28/2010) of 1 April 2010 to clarify:

— the tax amnesty regime with respect to income from foreign savings accounts introduced by the Program Law 2005;

— the submission of a voluntary additional declaration; and
— related matters.

Note?: The matters below apply only to individuals.

Tax amnesty:

— It is possible to request for an amnesty period of 3, 5 or more years;

— Tax amnesty cannot be requested in case of money laundering.

— The tax amnesty does not preclude a tax audit with respect to the income concerned, which may result in a re-classification of the income concerned and the imposition of additional tax (but not result in penalties or tax increases).

Voluntary additional declaration:

— Generally, interest will be charged and a pen-alty will be imposed. A penalty will, however, be waived if (i) the non-declaration was the result of a mistake, minor negligence or lack of knowledge, and (ii) the penalty would have been at least 10%.

— A voluntary additional declaration can also be made with respect to foreign savings income in cases where a withholding tax was withheld under the Savings Directive (2003/48). If so, the foreign withholding tax can be credited with the additional tax and penalties imposed.

Statute of limitations:

— In cases where the term of limitation to issue an additional assessment has expired, a criminal procedure could nevertheless still be initiated.

B-12 Russia:

Central?Region?Federal?Arbitrary?Court?—?individual’s day of arrival disregarded for residence test?: An individual is deemed to be a resident of Russia for income tax purposes if he is physically present in Russia for at least 183 days during any 12-month period. On 11 March 2010, the Central Region Federal Arbitrary Court confirmed that an individual’s day of arrival in Russia is disregarded for these purposes.

B-13 Chile:

Amendments improve protection of taxpayer’s rights:

Law 20.420, published in the Official Gazette of 19 February 2010, introduced amendments to the Tax Code, which include a list of the taxpayer’s rights, e.g.:

— the right to be informed, at the start of a tax control or audit, of its nature and subject, and to know at any moment the situation of his tax affairs and of relevant proceedings;

— the right to know the name and position of the tax officials responsible for the proceedings in which the taxpayer is involved;

— the right to refuse the filing of documents which are already in the hands of the tax administration, and to get them back once the proceeding is finalised; and

— the right that the intervention of the tax administration is carried out without unnecessary delays, requests or waiting, once the official in charge has received all the necessary documentation.

The acts or omissions of the tax administration that violate any of the rights listed in the Tax Code may be the object of a complaint with the new independent tax tribunals (see TNS?: 2009-01-07?:?CL-1). In those regions where the new judges are not yet operative, the complaint may be filed with the ordinary civil court.

The taxpayer may opt for the serving of notices from the tax administration by electronic mail.

When a tax audit or control begins with the request of documents, the tax administration will have 9 months, from the filing of all the docu-ments, to either ask for a clarification under Article 63 of the Tax Code, assess the tax that may be due, or charge that tax (where assessment is not necessary). The term is 12 months (instead of 9) in the following cases?:

— a tax audit on transfer pricing;

— an assessment of taxable income of taxpayers with sales or receipts above 5,000 monthly tax units;

— a control of tax consequences of a company reorganisation; and
— a control of transactions with related enter-prises.

The terms referred to are not applicable when information from a foreign authority is necessary or in cases of tax crimes.

The tax administration must audit and decide refund requests originating on loss-offset within 12 months.

B-14 New Zealand:
Taxation of non-residents investors in PIEs — Is-sues Paper released:
On 14 April 2010, an officials’ Issues Paper, entitled ‘Allowing a zero percent tax rate for non-residents investing in a PIE’, was released jointly by the In-land Revenue and the Treasury. The Paper invites comments from interested parties on proposals to exempt from New Zealand income tax foreign-sourced income derived by a non-resident through a portfolio investment entity (PIE).

New Zealand operates a typical income tax system under which a New Zealand resident is taxed on both domestic and foreign-sourced income, and a non-resident is taxed only on income derived from New Zealand. However, non-residents investing in foreign assets through a PIE, are subject to New Zealand tax on all income from the PIE.

The Issues Paper puts forward two proposals, which exempt from tax foreign-sourced income derived by a non-resident through a PIE?:

— For a PIE with resident and non-resident investors that derives only foreign-sourced income, the non-residents would have a zero portfolio investor rate of tax (PIR) for all income of the PIE, whereas standard PIRs would apply to residents.

— For a PIE with both resident and non-resident investors earning New Zealand and foreign-sourced income in which the PIE tracks each type of income and apportions expenses to that income, the non-resident investors would be subject to tax according to the type of income derived by the PIE, as follows:

Income type

Rate

Foreign-sourced income

Dividends

0%, if the underlying income has

been taxed at 30%; otherwise,

30% or 15% depending on a

relevant double tax treaty

Interest

Income from investment

30%

in land and other income

The Issues Paper sets out a number of advantages and disadvantages associated with each option, and also invites public submissions on them. Sub-missions should be made by 4 June 2010.

B-15 Singapore:
Abolishment of withholding tax on management fees:

It has been reported that withholding tax will no longer apply on management services rendered by non-residents entirely outside of Singapore on or after 29 December 2009, even if the service fees contain a mark- up element. Previously, the withholding tax did not apply only where the service fees represented a reimbursement of costs incurred by non-residents without any profit mark-up.

It should be noted that management services rendered before 29 December 2009 and paid at a later date continue to be subject to with-holding tax where they contain a profit mark-up element.

This development follows the passing of the Income Tax (Amendment) Act, 2009 which was gazetted on 29 December 2009.

C. Developments in respect of transfer pricing:
C-1 Indonesia:

Introduction of transfer pricing regulations?: The Director General of Taxation (DGT) has introduced transfer pricing (TP) regulations for Indonesian taxpayers, via Regulation No. PER-43/ PJ/2010 which took effect on 6 September 2010. The Regulation is based significantly on the OECD’s TP Guidelines, and its main contents are summarised below.

Scope?:

The Regulation applies to transactions between related parties which have an impact on the reporting of income or expenses for corporate tax purposes, including?:

— the sale, transfer, purchase or acquisition of tangible goods and/or intangible goods;

— payments of rental fees, royalties, or other payments for the provision of or use of both tangible and intangible property;

— income received or costs incurred for the provi-sion of or utilisation of services;

— cost allocations; and

— the transfer or acquisition of property in the form of a financial instrument, as well as income or costs from the transfer or acquisition of the financial instrument.

Arm’s-length principle?:

Taxpayers who earn income or incur expenses of IDR 10 million and above must implement the ALP according to the following steps?:

— perform a comparability analysis;

— determine the most appropriate TP method;

— apply the ALP to the tested transaction based on the result of the comparability analysis and the selected TP method; and

— document each step of the process in determin-ing the ALP or profit in consideration of the prevailing tax regulations.

The comparability analysis to be undertaken is consistent with that outlined in the OECD’s guidelines and internal comparables are preferred over external comparables.

The Regulation also endorses the five OECD TP methods, and specifically states that the hierarchy is as follows?:

— comparable uncontrolled price (CUP) method;

— resale price method (RPM);
— cost plus method (CPM);

— profit split method (PSM); and

— transactional net margin method (TNMM).

Special transactions:

a) Services: In order for services transactions to be in compliance with the ALP, it is necessary to confirm that the service is actually rendered, that it provides the recipient with a commer-cial or economic benefit, and that the value of the service fee is in line with comparable arm’s-length service fees or with the costs that would have been incurred by the recipient had it performed the activities itself. No service fee should arise where a parent company performs an activity in its capacity as shareholder of the group.

b) Royalties: In case of royalties, it is necessary to confirm that the transaction actually takes place, that the intellectual property provides a commercial/economic benefit to the licensee, and that the royalty paid is consistent with comparable arm’s-length royalties. A compa-rability analysis for royalty transactions should consider:

— the geographical coverage;

— exclusive or non-exclusive character of any rights granted; and

— whether the licensee has the right to participate in further developments of the property by the licensor.

Documentation:

A taxpayer’s TP documentation must at least include:

— an overview of the company, such as group structure, organisation chart, shareholding structure, business operations, list of competitors and a description of its business environment;

— price policy and/or cost allocation policy;

— comparability analysis;

— list of selected comparables; and

— application of the selected TP method.

Other:

The Regulation states that the DGT is empowered to make primary and secondary TP adjustments, and that mutual agreement procedures and advance pricing arrangements are available to taxpayers.

C-2 United States:

IRS confirms withdrawal of proposed transfer pricing regulations on controlled services transactions and intangibles:

The US Internal Revenue Service (IRS) has issued Announcement 2010-60 confirming its withdrawal of proposed regulations issued on 10 September 2003 regarding the treatment of controlled services transactions and the allocation of income from intangibles u/s.482 of the US Internal Revenue Code.

The proposed regulations were withdrawn due to the subsequent issuance of final regulations on these topics on 4 August 2009.

The withdrawal was previously announced on 7 September 2010 in the US Federal Register.

C-3 Brazil:

New transfer pricing rules (resale price method) revoked — PM 478/2009 terminated: Provisional Measure 478/2009 was not converted into law by the Congress. PM 478/2009 was officially terminated through the enactment of the National Congress Declaratory Act 18/2010, published in the Official Gazette of 15 June 2010.

Note?: PMs are issued by the President of Republic without the intervention of the legislature power. It is valid for a 60 calendar-day period, which may be extended for 60 days. After this period, the PM loses its effect, unless it is approved and converted into law by the Congress. Accordingly, the measures reported at TNS?: 2010-02-26?:?BR-1 have lost their effect.

C-4 Australia:

Draft ruling on business restructures and transfer pricing released:

The Australian Taxation Office released on 2 June 2010 for discussion Draft Taxation Ruling TR 2010/ D2 that deals with the application of transfer pricing provisions to business restructures. The Draft Ruling:

— defines ‘business restructuring’ as an arrange-ment where assets and/or risks of a business are transferred between jurisdictions, such as a conversion of a distributor into a sales agent or transfer of ownership and management of intangibles. However, the Draft Ruling does not deal with permanent establishment issues that a restructuring may give rise to or the application of general anti-avoidance rules.

— requires that the arm’s-length approach is used for business restructuring, which may require that all of the circumstances relevant to the arrangement are taken into account to compare the arrangement to dealings between indepen-dent parties and arm’s length. Specifically, the Draft Ruling states that the ATO does not accept the view that the transfer pricing provisions can only have regard to a specific transaction when deciding whether the parties were dealing at arm’s length.

— Notes that restructures are often conducted to obtain a tax benefit and existence of such benefit would not, by itself, show that the re-structure was not done at arm’s length.

— Does not prescribe a specific arm’s-length pricing method that should be applied to business restructures, and states that the most appropriate method should be applied.

C-5 Vietnam:
Transfer pricing regulations amended:

The Ministry of Finance has issued Circular 66/2010/ TT-BTC, which amends the current transfer pricing regulation Circular 117/2005/TT-BTC. Circular 66 will take effect on 6 June 2010.

Scope:

Circular 66 limits the application to transactions between enterprises and their affiliated parties and, unlike Circular 117, does not cover individuals.

Related parties:

Under Circular 66, the definition of ‘related parties’ includes limited liability companies.

Under Circular 117, there was a test of affiliation whereby a 20% ownership of ‘total assets’ in another company will render the parties as being related. Circular 66 has replaced this test with these criteria in determining related party relationships, i.e., two companies are related if:

— one provides the other with a guarantee or grants a loan which constitutes at least 20% of the owner’s equity of the guaranteed party/ borrower, and that loan accounts for more than 50% of the total value of long and medium term loans of the guaranteed party/borrower; or

— they both hold, either directly or indirectly, at least 20% of the owner’s equity of a third party.

Material difference:

Under Circular 66, any factor that triggers at least a 1% increase/decrease in the unit price of transacted products, or 0.5% increase/decrease in the gross profit ratio or profitability ratio, is considered as a ‘material difference’, for which appropriate adjustments in the financial information of the comparable transactions should be made.

Comparative analysis:

Circular 66 emphasises that, for aggregated transactions:

— the sale price is the highest price; and

— the purchase price is the lowest price.

Arm’s-length price:

Circular 66 provides guidance on how to determine arm’s-length prices in unique sale and purchase transactions. An adjustment of the transfer price shall be made as follows:

— Sales transaction?: if the price, gross profit ratio or profitability ratio is lower than the median of the inter-quartile range, the arm’s-length value is a value equal to or higher than the median of the range. This aims to ensure that the Viet-namese seller charges the highest possible price within the arm’s-length range with respect to cross-border controlled transactions.

— Purchase transactions: if the price is higher than the median of the inter-quartile range, the arm’s-length value is a value equal to or lower than the median of the range. This limits the purchase price that the Vietnamese purchaser can purchase goods or services to a value equal to or lower than the median of the arm’s-length range with respect to cross-border controlled transactions.

C-6 Indonesia:

C-6.1 Transfer pricing — Increased focus (Documentation):
It has been reported that the Tax Office has stepped up its scrutiny of transfer pricing cases in Indonesia.

In July 2009, the Tax Office imposed a requirement that taxpayers submit 3 related party forms along with the corporate income tax return beginning fiscal year 2009. This requirement is introduced under DGT Regulation No. PER-39/PJ/2009 dated 2 July 2009, as follows?:

— Form 3A requires full details of all related-party transactions;

— Form 3A-1 requires a list of 15 yes and no questions regarding documentation prepared to support related-party transactions and to demonstrate arm’s-length compliance; and

— Form 3A-2 requires details on related-party trans-actions with companies in tax haven countries.

C-6.2 Transfer pricing — Increased focus (Bench-marking ratios):
It has been reported that the Tax Office has stepped up its scrutiny of transfer pricing cases in Indonesia.

On 5 October 2009, the Tax Office issued Circular Letter SE-96/PJ/2009 which provides guidance on benchmarking ratios that they would expect to see within certain industries, such as palm oil, pharmaceuticals, construction, real estate, cigarettes, food and beverages and others.

The benchmarking ratios include gross profit margins, operating profit margins, pre-tax profits, dividend pay-out ratios etc., which may be used by the Tax Office in selecting taxpayers for transfer pricing audits and queries.

Acknowledgment:

We have compiled the above information from the Tax News Service of the IBFD for the months of January to June, 2010 and for the month of September, 2010.

Nirav Shah

India’s stand on OECD Model Commentary Update 2008

International TaxationEver since India figured in the report of the World Bank on
BRIC economies (BRIC = Brazil, Russia, India and China), it has got world’s
attention. And rightly so, if one were to look at the growth figures of Indian
economy in past few years. India’s forex reserves at $ 280 billion plus1
reflects very comfortable position even amidst global financial crisis. India’s
growing economic strength has an impact on other areas as well. One such area is
recognition of India in the International tax field. Recently India along with
other BRIC economic countries has been included as an OECD non-member observer.
On 17-7-2008, OECD adopted changes to its commentary on the OECD Model
Convention. For the first time the updated edition of the Model Commentary
carries India’s position/reservations on various Articles of the MC. This
article deals with some of the important positions taken by India along with its
probable implications.

1.0 Introduction :

The 2008 update to the Model Tax Convention is divided in
three parts. Part A contains amendments to Article 25 on Mutual Agreement
Procedure. Part B contains amendments to commentary (which inter alia
include positions/reservations by member countries of OECD) and part C lists
positions of non-member countries.

India’s positions/reservations are included in part C. What
are the implications of the position taken or reservations expressed by India in
OECD MC ? Even though India is not a member of OECD, courts in India have been
relying on the OECD commentary. Even UN Model Commentary draws heavily on OECD
Model Commentary. Thus, OECD Model Commentary has a great persuasive value in
Indian jurisprudence. If India has taken a stand or a firm position, then it may
amount to India’s interpretation which is different from the interpretation in
the OECD Model Commentary. At several places India has expressed reservations
and asserted that it would reserve its right for change of provisions (from that
of OECD MC) in its bilateral tax treaties.

Let us proceed to examine some of the important positions
taken by India on the OECD Model Tax Convention. It may be noted that India has
taken position or expressed reservation on the entire Model Convention,
irrespective of whether a particular Article has been amended or not. In other
words, commentaries on some of the Articles are amended just to include
positions/reservations of non-member countries, which were hitherto not included
in the earlier versions of the Commentary.

2.0 India’s position on various articles :

2.1 Article 1 Persons covered :

2.1.1 Amendments :

The amendment merely changes the reference to paragraph 8.7
of Article 4 from the existing reference to para 8.4 of Article 4. Both
paragraphs (the old and the new one) are the same, which provide that if a
partnership is denied the benefits of a tax convention, its members are entitled
to the benefits of the tax conventions entered into by their State of Residence.

2.1.2 India’s stand :

India believes that such a treatment is possible only if
provisions to that effect are included in the bilateral convention.

2.1.3 Probable implications :

The strict interpretation contemplated by India could result
in denial of treaty benefits to transparent entities from the Indian perspective
and may result in double taxation.

2.2 Article 3 General Definitions — Person :

2.2.1 India’s position :

India reserves the right to include in the definition of
‘person’ only those entities which are treated as a taxable unit under the
taxation laws in force in the respective Contracting States.

2.3 Article 4 Resident :

2.3.1 Amendments :

(i) It is now provided that the term ‘resident’ does not
exclude companies and other persons who are resident of a State under its
domestic laws, but are considered to be resident of another Contracting State
pursuant to a tax treaty between the two Contracting States.

(ii) Competent authorities of both the Contracting States may
determine the residential status of persons other than individuals.

(iii) Place of effective management

The Model Commentary provides that the place of effective
management criteria is to be applied to determine the State of residence in case
of persons other than individual, if they are found to be resident
of both the States. 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 as a whole, are, in substance, made.

2.3.2 India’s position :

India is of the view that the place where the main and
substantial activity of the entity is carried on should also be taken into
account while determining the ‘place of effective management’.

India has also reserved the right to include a provision for
reference under Mutual Agreement Procedure for determining the place of
effective management in case of persons other than individual who happen to be
resident of both the Contracting States.

India has also reserved the right to amend the Article in its
tax conventions to provide that partnerships must be considered as residents of
the respective Contracting States in view of country’s legal and tax
characteristics.

2.3.3 Probable implications :

The significant stand of India regarding determination of
place of effective management would result in Indian tax administration applying
the ‘place of main and substantial activity test’ in addition to the ‘place of
management and decision making’ test in case of dual residency situation.

2.4 Article 5 Permanent Establishment :

2.4.1 Service PE :

The major amendment is regarding introduction of the Service
PE Article in the Model Convention for the first time. This is a remarkable
departure by the OECD where taxing rights of ‘Source State’ have been extended
in the fast growing service sector.

Paragraph 42.23 of the ‘2008 Update’ provides a model Paragraph on Service PE Article. According to the said Paragraph in the following situations Service PE comes into existence:

Notwithstanding the provisions of Paragraphs 1,2 and 3, where an enterprise of a Contracting State performs services in the other Contracting State

(a) through an individual who is present in that other State for a period or periods exceeding in the aggregate 183 days in any twelve-month period, and more than 50% of the gross revenues attributable to active business activities of the enterprise during this period or periods are derived from the services performed in that other State through that individual, or

(b) for a period or periods exceeding in the aggregate 183 days in any twelve-month period, and these services are performed for the same project or for connected projects through one or more individuals who are present and performing such services in that other State the activities carried on in that other State in performing these services shall be deemed to be carried on through a permanent establishment of the enterprise situated in that other State, unless these services are limited to those mentioned in Paragraph 4 which, if performed through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph. For the purposes of this paragraph, services performed by an individual on behalf of one enterprise shall not be considered to be performed by another enterprise through that individual, unless that other enterprise supervises, directs or controls the manner in which these services are performed by the individual.

Some other key features of Service PE provision in OECD MC:

(i) Only profits would be taxed in respect of Service PE and not the gross receipts.

(ii) It is clarified that connected projects are those projects which have some commercial coherence. Therefore, two different projects performed for the same client would not fall under connected projects.

(iii) The source rules provide that mere payment or utilisation of services would not give Source State right to tax.

(iv) Income derived from services performed by a non-resident outside the territory of a State would not be taxed in that State. There should be minimum level of presence in a State before such taxation is allowed.

(v) It is also provided that Service PE will not come into existence if services are confined for internal use. In other words to constitute a Service PE, services must be provided by the enterprise to a third party.

India’s position:

India does not agree to almost all the above interpretations. India has raised some conspicuous reservations on the OECD commentary on Service PE. The same are as follows:

(i) India is of the view that physical presence or performance of services is not necessary in the Source State to constitute a PE.

(ii) India is of the view that taxation rights may exist in a State even when services are furnished by the non-residents from outside that State. It is also of the view that the taxation principle applicable to the profits from sale of goods may not apply to the income from furnishing of services.

(ill) India does not agree that only the profits derived from services should be taxed. It is also of the view that bilateral Conventions may allow States to tax services on gross basis.

(iv) India is of the view that for furnishing of services in a State, physical presence of an individual is not essentiaL

(v) India is of the view that a foreign enterprise (say Entp. A) outsourcing services to an enterprise resident of the source country, (say Entp. B), which are being performed by the employees of ‘Entp. B’, under the direction and supervision of ‘Entp. A’ and which includes servicing of clients of ‘Entp. A’, then such services could be considered to be performed by ‘Entp. A’ in the Source Country.

(This particular provision could make captive BPOs/Call Centres/KPOs Service PEs in India unless their activities are regarded as preparatory and auxiliary in nature)

(vi) India does not agree to include scientific research in the list of examples of activities indicative of preparatory or auxiliary nature.
(This position would have far-reaching impact on captive BPOs engaged in research activities)

(vii) India has reserved the right to treat an enterprise as having a permanent establishment if the enterprise furnishes services, including consultancy services through employees or other personnel engaged by the enterprise for such purpose, but only where such activities continue for the same project or a connected project for a period or periods aggregating more than a period to be negotiated.

(This position is in line with India’s tax treaties wherein consultancy services do constitute Service PE)

2.4.2 Fixed Place PE :

India’s positions/reservations:

(i) India has reserved the right to include following sub-paragraphs in Para 2 of the Model Convention in the list of specific inclusions in the definition of a PE :

(a) a warehouse in relation to a person supplying storage facilities for others;

(b) a sales outlet and a farm, plantation or other place where agricultural, forestry, plantation or related activities are carried on.

(ii) Consistent to its view in the UN MC, India has reserved its position to delete the word ‘delivery’ appearing in Para 4 of the MC, which deals with specific exclusions from the definition of PE. It means the use of facilities or maintenance of stock only for the purpose of delivery would not result in PE under the OECD MC, but it may result in PE in case of Indian tax treaties.

(iii) India has expressed its disagreement with the words ‘The twelve-month test applies to each individual site or project’ found in Paragraph 18 of the Commentary. It considers that a series of consecutive short-term sites or projects operated by a contractor would give rise to the existence of a permanent establishment in the country concerned.

(This position is in variance with the existing interpretation that time spent on different projects was not to be aggregated to determine PE. If one were to accept the new position, then one would be required to determine PE qua contractor and not qua project as hitherto).

(iv) India has reserved the right to replace ‘construction or installation project’ in Para 3 of the MC with’ construction, installation or assembly project or supervisory activities in connection therewith’ and reserves its right to negotiate the period of time for which they should last to be regarded as a permanent establishment.

(This inclusion is in line with India’s stand on its tax treaties which include supervisory activities as part of PE.)

2.4.3 Agency PE :

India’s position on agency PE is in line with provisions appearing in UN MC as well as India’s tax treaties.

(i) India reserves the right to treat an enterprise of a Contracting State as having a PE in the other Contracting State if a person habitually secures orders in the other Contracting State wholly or almost wholly for the enterprise.

(ii) India reserves the right to make it clear that an agent whose activities are conducted wholly or almost wholly on behalf of a single enterprise will not be considered an agent of an independent status.

[It may be interesting to note here that in terms of S. 9(1) of the Income-tax Act, 1961 (the Act), a business connection exists even when an agent’s activities in India are devoted mainly or wholly (as opposed to wholly or almost wholly in MC) on behalf of a foreign enterprise.]

(iii) OECD Commentary provides that mere attending or participating in negotiations by a person by itself would not be sufficient to conclude that such person has the authority to conclude contract in the name of the enterprise. However, India does not agree with this interpretation. India is of the view that the mere fact that a person has attended or participated in negotiations in a State between an enterprise and a client, can in certain circumstances, be sufficient, by itself, to conclude that the person has exercised in that State an authority to conclude contracts in the name of the enterprise. India is also of the view that a person who is authorised to negotiate the essential elements of the contract, and not necessarily all the elements and details of the contract, on behalf of a foreign resident, can be said to exercise the authority to conclude contracts.

2.4.4 Subsidiary PE :

OECD MC provides that a company cannot have a PE in another country only on the ground that it purchases goods from an affiliate company in that country or that affiliate supplies the services.

India does not agree with the above interpretation and is of the view that where a group company manufactures or provides services on behalf of a foreign enterprise, then it may constitute a PE of that enterprise, provided however that other conditions of Article 5 are satisfied.

2.4.5 E-Commerce :

MC provides that a website per se would not constitute a PE. Further it clarifies that an activity of merely hosting a website on a particular server at a specific location may not be regarded as ‘place of business’.

India does not agree with this interpretation and is of the view that depending on the facts, a website itself or hosting of a web site on a particular server at a particular location may constitute a PE.

2.5 Article 7 Business Profits:

Attribution to or Computation of Profits of a PE

(i) India has reserved its right to add a paragraph in its bilateral treaties to provide that business deductions to be allowed as per tax treaty would be subject to the limitations provided under the domestic tax laws.

(For example, S. 44C of the Act limits deduction of Head Office expenses to 5% of the adjusted net profit of the Indian branch)

(ii) OECD discourages formula-based approach to determine profits attributable to a PE as it may lead to incorrect results. It provides that such a method may be used in rare circumstances. However, India does not agree with this interpretation.

(Rule 10 of the Act confers power to the Assessing Officer to compute the income of a non-resident by applying certain formulae)

(iii) India has reserved the right to provide that any income or gain attributable to a PE during its existence may be taxable even if the payments are deferred until after the PE has ceased to exist.

[Furthermore, India also reserved the right to apply such a rule under Articles 11 (Interest), 12 (Royalties), 13 (Capital Gains) and 21 (Other Income).]

2.6 Article 8 Shipping, Inland Waterways Transport and Air Transport:

(i) India has reserved the right not to extend the scope of the Article to cover inland waterways transportation in bilateral conventions.

(ii) India has reserved the right to treat profits from leasing ships or aircraft on a bare charter basis as royalty and not as profits from shipping or aircraft business.

2.7 Article 10 Dividends:

India has reserved the right to modify the definition of the term ‘dividends’ as also to include certain payments/distributions in the definition of dividends. It has also reserved the right to settle the rate of dividends in bilateral negotiations.

2.8 Article 11 Interest:

(i) India has reserved the right to treat the interest element of sales on credit as interest (i.e., part of the purchase consideration which may be attributable to the credit period). Under the OECD MC the same is treated as part of the purchase price and not treated as interest.

(ii) Premium on redemption of debentures is regarded as interest under the OECD MC, where-as India has reserved its right to tax the same as per provisions of the domestic tax laws.

2.9 Article 12 Royalties:

(i) General:

India reserves the right to tax royalties and fees for technical services at source; define these, particularly. by reference to its domestic law and define the source of such payments. Such source rules may be wider in scope compared to the Model Convention.

(ii) India reserves the right to include in the definition of royalties payments for the use of, or the right to use, industrial, commercial or scientific equipment.

(In fact, many of Indian tax treaties already include such payments within the definition of royalty.)

(iii) India has reserved its position vis-a-vis the interpretation of the OECD MC by way of important illustrations dealing with consideration for transfer of property with full ownership covered under the Article on Royalty. Whereas such payments are not regarded as royalties, India does not agree with such interpretation and may regard them as royalties.

2.10 Article 23 Methods for Elimination of Double Taxation:

India has reserved its right to include tax-sparing provisions in its tax treaties.

2.11 Article 25 Mutual Agreement Procedure:

OECD MC has suggested the use of MAP to settle disputes arising on account of transfer pricing adjustments where corresponding adjustments are not explicitly provided in the tax treaty. India does not agree with this interpretation and is of the view that in the absence of any specific provision (Paragraph 2 in Article 9), economic double taxation arising on account of transfer pricing adjustments falls outside the scope of Mutual Agreement Procedure.

3.0 Conclusion:

Perhaps this is the first time the position or interpretation of Indian tax administration has come to fore in respect of tax treaties. The views expressed by the tax authorities can be equated with that of CBDT Circulars, which are binding on the Income-tax Department and not the assessee. Courts mayor may not be guided by them, especially where the treaty provisions are at variance from India’s reservations/positions in respect of OECD Model Commentaries. However, at the same time the reservations/positions expressed in the OECD Model Commentaries would have a lot of persuasive value and guide the taxpayers.

On the one hand India favours ‘tax sparing’ and on the other hand it has taken aggressive stand on many issues which may result in taxation of certain activities of captive BPOs or other infrastructure companies. Can or should India take such an aggressive stand especially when it is facing a stiff competition from other BRIC economies?

In fact a detailed ‘Technical Interpretation on Indian Tax Treaties’ on the line of US Technical interpretation is the need of the hour, as there are very diverse and inconsistent judgments on international tax matters from Pan India.

Nirav Shah

Underlying tax credit — Concept and its significance

Nirav Shah

Taxation of Fees for Technical Services payable to a Non-Resident — Impact of Amendment in S. 9 of the Income-tax Act by the Finance Act, 2010

1. Background :

1.1 S. 9 of the Act provides for situations where income is deemed to accrue or arise in India. S. 9 was extensively amended vide the Finance Act, 1976, to provide that in case of payments of interest, royalty or fees for technical services (FTS) received from a resident payer, income would be deemed to accrue or arise in India, except where the interest or royalty or FTS is relatable to a business or profession carried on by the resident payer outside India or for making or earning any income from any source
outside India.

1.2 The Finance Act, 2007 inserted an Explanation in S. 9 with retrospective effect from 1-6-1976 and clarified that where income is deemed to accrue or arise in India u/s.9(1)(v), (vi) or (vii), such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India. The amendment was made to neutralise the judgment of the Supreme Court in Ishikawajima-Harima Heavy Industries Ltd. v. DIT, (2007) (288 ITR 408/158 Taxman 259).

1.3 The Karnataka High Court in Jindal Thermal Power Co. Ltd. v. Dy. CIT, (2009) 182 Taxman 252 (Kar.) has held that the explanation does not fully neutralise the Supreme Court decision. We shall deal with these two decisions in some detail in the following paragraphs.

1.4 The Finance Act, 2010 has substituted the Explanation, with retrospective effect from
1-6-1976, also to cover the situation left out earlier i.e., rendition of services in India, and provides that the income shall be deemed to accrue or arise in India whether the non-resident has rendered services in India or not.

2. Provisions of S. 4 of the Finance Act, 2010 :

Let us now examine the amendment made by the Finance Act, 2010 in some detail.

2.1 S. 4 of the Finance Act, 2010 has substituted the existing Explanation after S. 9(2) with a new Explanation as under :

“4. In S. 9 of the Income-tax Act, for the Explanation occurring after Ss.(2), the following Explanation shall be substituted and shall be deemed to have been substituted with effect from the 1st day of June, 1976, namely :

“Explanation — For the removal of doubts, it is hereby declared that for the purposes of this Section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of Ss.(1) and shall be included in the total income of the non-resident, whether or not

(i) the non-resident has a residence or place of business or business connection in India; or

(ii) the non-resident has rendered services in India.”

2.2 Notes on the Finance Bill, 2010 :

The Note 4 of Notes on clauses of the Finance Bill, 2010 reads as under :

“Clause 4 of the Bill seeks to amend S. 9 of the Income-tax Act relating to income deemed to accrue or arise in India. The existing provisions contained in the Explanation occurring after Ss.(2) of the aforesaid Section provide that, for the removal of doubts, for the purposes of the said Section, where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of Ss.(1), such income shall be included in the total income of the non-resident, whether or not, the non-resident has a residence or place of business or business connection in India. It is proposed to substitute the said Explanation so as to provide that the income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of subsection (1) and shall be included in the total income of the non-resident, whether or not

(i) the non-resident has a residence or place of business or business connection in India; or

(ii) the non-resident has rendered services in India.

This amendment will take effect, retrospectively, from 1st June, 1976 and will, accordingly, apply in relation to the A.Y. 1977-1978 and subsequent years.”

2.3 The Memorandum to the Finance Bill, 2010 explains the background of the proposed amendment as under :

“Income deemed to accrue or arise in India to a non-resident :

S. 9 provides for situations where income is deemed to accrue or arise in India.

Vide the Finance Act, 1976, a source rule was provided in S. 9 through insertion of clauses (v), (vi) and (vii) in Ss.(1) for income by way of interest, royalty or fees for technical services, respectively. It was provided, inter alia, that in case of payments as mentioned under these clauses, income would be deemed to accrue or arise in India to the non-resident under the circumstances specified therein.

The intention of introducing the source rule was to bring to tax interest, royalty and fees for technical services, by creating a legal fiction in S. 9, even in cases where services are provided outside India as long as they are utilised in India. The source rule, therefore, means that the situs of the rendering of services is not relevant. It is the situs of the payer and the situs of the utilisation of services which will determine the taxability of such services in India.

This was the settled position of law till 2007. However, the Supreme Court, in the case of Ishikawajima-Harima Heavy Industries Ltd., v. DIT (2007) (288 ITR 408), held that despite the deeming fiction in S. 9, for any such income to be taxable in India, there must be sufficient territorial nexus between such income and the territory of India. It further held that for establishing such territorial nexus, the ser-vices have to be rendered in India as well as utilised in India. This interpretation was not in accordance with the legislative intent that the situs of rendering service in India is not relevant as long as the services are utilised in India. Therefore, to remove doubts regarding the source rule, an Explanation was inserted below Ss.(2) of S. 9 with retrospective effect from 1st June, 1976 vide the Finance Act, 2007. The Explanation sought to clarify that where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of Ss.(1) of S. 9, such income shall be included in the total income of the non-resident, regardless of whether the non-resident has a residence or place of business or business connection in India. However, the Karnataka High Court, in a recent judgment in the case of Jindal Thermal Power Company Ltd. v. DCIT (TDS), has held that the Explanation, in its present form, does not do away with the requirement of rendering of services in India for any income to be deemed to accrue or arise to a non-resident u/s.9. It has been held that on a plain reading of the Explanation, the criteria of rendering services in India and the utilisation of the service in India laid down by the Supreme Court in its judgment in the case of Ishikawajima-Harima Heavy Industries Ltd. (supra) remains untouched and unaffected by the Explanation.

In order to remove any doubt about the legislative intent of the aforesaid source rule, it is proposed to substitute the existing Explanation with a new Explanation to specifically state that the income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of Ss.(1) of S. 9 and shall be included in his total income, whether or not,

a) the non-resident has a residence or place of business or business connection in India; or

b) the non-resident has rendered services in India.

This amendment is proposed to take effect retrospectively from 1st June, 1976 and will, accordingly, apply in relation to the A.Y. 1977-78 and subsequent years.”

3. Supreme Court’s decision in Ishikawajima-Harima Heavy Industries Ltd. v. Director of Income-tax, (2007) 288 ITR 408 (SC) :

Since the Memorandum refers to this case, let us examine in some detail, as to what was held by the Supreme Court. Regarding the necessity of the sufficient territorial nexus, the Supreme Court held as under :

“Territorial nexus doctrine, thus, plays an important part in assessment of tax. Tax is levied on one transaction where the operations which may give rise to income may take place partly in one territory and partly in another. The question which would fall for consideration is as to whether the income that arises out of the said transaction would be required to be proportioned to each of the territories or not. [Para 26]

Income arising out of operation in more than one jurisdiction would have territorial nexus with each of the jurisdictions on actual basis. If that be so, it may not be correct to contend that the entire income ‘accrues or arises’ in each of the jurisdictions. The Authority has proceeded on the basis that supplies in ques-tion had taken place offshore. It, however, has rendered its opinion on the premise that offshore supplies or offshore services were intimately connected with the turnkey project. [Para 27]

For attracting the taxing statute there has to be some activities through permanent establishment. If income arises without any activity of the permanent establishment, even under the DTAA the taxation liability in respect of overseas services would not arise in India. S. 9 spells out the extent to which the income of non-resident would be liable to tax in India. S. 9 has a direct territorial nexus. Relief under a double taxation treaty having regard to the provisions contained in S. 90(2) would arise only in the event a taxable income of the assessee arises in one Contracting State on the basis of accrual of income in another Contracting State on the basis of residence. Thus, if the appellant has income that accrued in India and is liable to tax because in its State all residents are entitled to relief from such double taxation payable in terms of Double Taxation Treaty. However, so far as accrual of income in India is concerned, taxability must be read in terms of S. 4(2) read with S. 9, whereupon the ques-tion of seeking assessment of such income in India on the basis of Double Taxation Treaty would arise. [Para 67]

Reading the provision of S. 9(1)(vii) (c) in its plain sense, it can be seen that it requires two conditions which have to be satisfied.
The services which are the source of the income, that is sought to be taxed, have to be rendered in India, as well as utilised in India, to be taxable in India. In the instant case, both these conditions are not satisfied simultaneously, excluding that income from the ambit of taxation in India. Thus, for a non-resident to be taxed on income for services, such services need to be rendered within India, and have to be a part of a business or profession carried on by such person in India. The appellant in the instant case have provided services to persons resident in India, and though the same have been used in India, the same have not been rendered in India. [Para 71]

S. 9(1)(vii) whereupon reliance has been placed by the Revenue, must be read with S. 5, which takes within its purview the territorial nexus on the basis whereof tax is required to be levied, namely, (a) resi-dent, and (b) receipt or accrual of income. [Para 72]

Global income of a resident although is sub-jected to tax, global income of a non-resident may not be. The answer to the question would depend upon the nature of the contract and the provisions of the DTAA. [Para 73]

What is relevant is receipt or accrual of income, as would be evident from a plain reading of S. 5(2). The legal fiction created although in a given case may be held to be of wide import, yet it is trite that the terms of a contract are required to be construed having regard to the international covenants and conventions. In a case of the instant nature, interpretation with reference to the nexus to tax territories would also assume significance. Territorial nexus for the purpose of determining the tax liability is an internationally accepted principle. An endeavour should, thus, be made to construe the taxability of a non-resident in respect of income derived by it. Having regard to the internationally accepted principle and the DTAA, it may not be possible to give an ex-tended meaning to the words ‘income deemed to accrue or arise in India’ as expressed in S.

S. 9 incorporates various heads of income on which tax is sought to be levied by the Republic of India. Whatever is payable by a resident to a non-resident by way of fees for technical services, thus, would not always come within the purview of S. 9(1)(vii). It must have sufficient territorial nexus with India so as to furnish a basis for imposition of tax.

Whereas a resident would come within the purview of S. 9(1)(vii), a non-resident would not, as services of a non-resident to a resident which are utilised in India may not have much relevance in determining whether the income of the non-resident accrues or arises in India. It must have a direct live link with the services rendered in India. When such a link is established, the same may again be subjected to any relief under the DTAA. A dis-tinction may also be made between rendition of services and utilisation thereof.” [Para 74] [Emphasis supplied]

In this connection, attention is invited to Shri N. A. Palkhivala’s comments on the amendments made in S. 9(1) vide the Finance Act, 1976 in para 18 on pages 384 and 385 of ‘The Law & Practice of Income-tax’ Vol-I, 9th edition, 2004.

4. Karnataka High Court’s decision in Jindal Thermal Power Co. Ltd. v. Deputy Commissioner of Income-tax (TDS), Bangalore

Let us now also examine in some detail the decision of the Karnataka High Court in the case of Jindal Thermal Power Co. Ltd., referred to in the Memorandum explaining Provisions of Clause 4 of the Finance Bill, 2010.

The Karnataka High Court considered the aforesaid Supreme Court’s decision while considering the import of Explanation inserted after S. 9(2) and held as under :

“In this case, the counsel for the assessee relied upon the decision of the Bombay High Court in Clifford Chance v. Dy. CIT, (2009) 176 Taxman 458 to contend that the ratio of the Supreme Court in Ishikawajima-Harima Heavy Industries Ltd.’s case (supra) regarding twin criteria of rendering of service in India and its utilisation in India has not been done away with by the incorporation of Explanation to S. 9(2). The Explanation makes it clear that the tax liability is subject to the provisions of S. 9(1)(vii)(c). Thus the twin requisites laid down by the Supreme Court in Ishikawajima-Harima Heavy Industries Ltd.’s case (supra) still holds the field. The memorandum explaining the provisions although declares that the Explanation is incorporated to overcome the decision of the Supreme Court, however, the counsel submitted that the objects and reasons stated are only external aids to be used only when the text of the law is ambiguous. In the instant case it is argued that the Explanation incorporated does not offer any ambiguity to seek the assistance of external aids. Plain reading of the provision makes it unequivocal that the position of tax liability clarified in the Explanation is subject to the provisions of S. 9(1)(vii)(c).”

“The Explanation incorporated in S. 9(2) declares that ‘where the income is deemed to accrue or arise in India under clauses (v), (vi), of Ss.(1), such income shall be included in the total income of the non-resident, whether or not the resident has a residence or place of business or business connection in India.’ The plain reading of the said provision suggests that criterion of residence, place of business or business connection of a non -resident in India has been done away with for fasten-ing the tax liability. However, the criteria of rendering service in India and the utilisation of the service in India laid down by the Su-preme Court in Ishikawajima- Harima Heavy Industries Ltd.’s case (supra) to attract tax liability u/s.9(1)(vii) remains untouched and unaffected by the Explanation to S. 9(2).

When the purport of the Explanation to S. 9(2) is plain in its meaning, it is unnecessary and impermissible to refer to the Memorandum explaining the Finance Bill, 2007. Therefore, it is explicit from the reading of S. 9(1)(vii)(c) and Explanation to S. 9(2) that the ratio laid down by the Supreme Court in Ishikawajima-Harima Heavy Industries Ltd.’s case (supra) still holds the field.” (Emphasis supplied.)

5. Does the amendment adversely impact all payments for Fees for Technical Services rendered by Non-Residents ?

In the following five types of cases, payment of Fees for Technical Services rendered by Non-Residents may still not be taxable in India, subject to fulfilment of other applicable conditions :

i) Payment for FTS covered by concept of ‘Make Available’.

ii) Payment for FTS where relevant treaty does not contain FTS clause.

iii) Payments covered by exclusions provided under provisions of S. 9(1)(vii)(b) of the Income-tax Act.

iv) Payments covered by exclusions provided in the definition of FTS provided in Explanation 2 to S. 9(1)(vii) in respect of “consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head
‘salaries’.”

Fees for Independent Personal Services covered by applicable Article 14 of a tax treaty.

These five items are explained in some detail below.

5.1 Concept of ‘Make Available’ :

Many Indian tax treaties limit the scope of fees for technical services which are taxable in India by application of the concept of ‘Make Available’ discussed below :

The expression ‘make available’ used in the Article in the tax treaties relating to ‘Fees for Technical Services’ (FTS) has far-reaching significance since it limits the scope of technical and consultancy services in the context of FTS.

India has negotiated and entered into tax treaties with various countries where the concept of ‘make available’ under the FTS clause is used. India’s tax treaties with Australia, Canada, Cyprus, Finland1, Malta, Netherlands, Portuguese Republic, Singapore, UK and USA contain the concept of ‘make available’ under the FTS clause. Further, the concept is also applicable indirectly due to existence of Most Favoured Nation (MFN) clause in the protocol to the tax treaties with Belgium, France, Israel, Hungary, Kazakstan, Spain, Switzerland and Sweden.

It is interesting to note that India-Australia Tax Treaty does not have separate FTS clause, but the definition of Royalty, which includes FTS, has provided for make available concept. An analysis of the countries having the concept of make available directly or indirectly in their tax treaties with India reveals that almost all of these countries are developed nations and they have successfully negotiated with India the restricted scope of the definition of FTS as almost all of them are technology exporting countries.

In view of the above, while deciding about taxability of any payment for FTS, the reader would be well advised to examine the relevant article and the protocol of the tax treaty to decide whether the concept of ‘make available’ is applicable to payment of FTS in question and accordingly whether such a payment would be not liable to tax in the source country. He would also be well advised to closely examine the relevant judicial decisions to determine the applicability of the concept of ‘make available’ to payment of FTS in question.

The concept of ‘make available’ is still continuously subject to judicial scrutiny under different circumstances and in respect of various kinds of services. In some cases there are conflicting/differing views and in some cases the concept has not been considered/applied while examining the taxability of the payment of FIS/FTS. As the law is not yet settled, continuous and ongoing monitoring and study of various judicial pronouncements would be necessary for proper understanding and practical application of the concept in practice. It may be noted that this concept does not exist in the OECD Model.

We may draw the attention of the readers to the series of 5 articles on this topic in the Bombay Chartered Accountant Journal (November, 2009 to March, 2010). The reader would be well advised to peruse the same.

5.2 Impact of absence of FTS Clause in Indian tax treaties :

In the following Indian tax treaties, there is no Article dealing with taxation of Fees for Technical Services :

Greece, Bangladesh, Brazil, Indonesia, Libya, Mauritius, Myanmar, Nepal, Philippines, Saudi Arabia, Sri Lanka, Syria, Tajikistan, Thailand, United Arab Republic, United Arab Emirates

Wherever, the Article on Fees for Technical Services is absent in a tax treaty, such a payment is classifiable as ‘Business Profit’ under Article 7 of the relevant tax treaty and if the payee does not have a Permanent Establishment in India in terms of Article 5 of the tax treaty, the same will not be liable to tax in India. The view is supported by many judicial decisions; amongst others :

        i) Tekniskil (Sendirian) Berhard v. CIT, (1996) 222 ITR 551 (AAR);
        ii) Siemens Aktiengesellschaft v. ITO, (1987) 22 ITD 87 (Mum.);
        iii) GUJ Jaeger GmbH v. ITO, (1991) 37 ITD 64 (Mum.);
        iv) Christiani & Nielsen Copenhagan v. First ITO, (1991) 39 ITD 355 (Mum.).

In Tekniskil (Sendirian) Berhard v. CIT, a Malaysian company had entered into an agreement with a Korean company under which the Malaysian company was to supply skilled labour to work on Korean company’s barges in India. As the agreement with Malaysia did not have any Article dealing with ‘Fees for Technical Services’ and the business of providing skilled personnel was a part of the Malaysian company’s business and since taxability of the fees received by the Malaysian company was governed by Article 7 of the DTAA dealing with ‘business profits’ with the Malaysian company not having a place of business in India, the AAR held that the fees received by the Malaysian company were not taxable in India. This advance ruling has been universally followed by various Benches of the Tribunal for deciding the issue in favour of the assessee in several cases.

The reader would be well advised to study Article 5(2) of the applicable DTAA and examine whether the activities of the foreign service provider in India would constitute a Service PE, Construction PE or Installation PE. If such a PE is constituted, then the income attributable to the PE would be taxable in India, as business income in accordance with the provisions of Article 7 of the applicable DTAA.

5.3 Exclusions provided under provisions of S. 9(1) (vii)(b) of the Income-tax Act :

One also has to keep in mind the exclusion provided in S. 9(1)(vii)(b) as under :

    “(vii) income by way of fees for Technical Services payable by
        a) …………..
        b) a person who is a resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India; or
        c) ………….. (Emphasis supplied)

Thus, the assessee also needs to examine whether such Technical Services have been utilised (a) in a business or profession carried out by the assessee outside India, or (b) for the purposes of making or earning any income from any source outside India. If the answer is in the affirmative, then also such Fees for Technical Services payable to a Non-Resident would not be taxable in India.

In this connection, attention is invited to the decision of the Bangalore Bench of the ITAT in the case of Titan Industries Ltd. v. Income-tax Officer, International Taxation, Ward-19(1), Bangalore (2007) 11 SOT 206 (Bang.)

5.4 Exclusions provided in the definition of FTS provided in Explanation 2 to S. 9(1)(vii) :

Explanation 2 to S. 9(1)(vii) defines the term ‘Fees for Technical Services’ as under :

“Explanation 2 — For the purposes of this clause, ‘Fees for Technical Services’ means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient for consideration which would be income of the recipient chargeable under the head ‘Salaries’.” [Emphasis supplied]

With regard to interpretation of the words ‘construction, assembly, . . . . . . . . or like project’, the readers’ attention is invited to the Andhra Pradesh High Court’s decision in Commissioner of Income-tax v. Sundwiger EMPG and Co., (2003) 262 ITR 110 (AP).

Further as regard to interpretation of the words ‘mining and like project’, the reader may refer to the following decisions :

a. Geofizyka Torun SP. ZO.O. (2009 TIOL 31 ARA-IT)

b. ACIT v. Paradigm Geophysical Pvt. Ltd., [2008 TIOL 362 ITAT Del]

c. Many other decisions rendered in the context of S. 44BB read with S. 9(1)(vii)

Due to space constraints we are not dealing with the above case laws in detail here. The reader also needs to examine whether such services have been excluded from the definition of FTS as defined in Explanation 2 to S. 9(1)(vii).

5.5 Fees for Independent Personal Services :

5.5.1 Article 14 is concerned with professional services and other services of an independent character. It excludes :

Industrial or commercial activities;

Services performed by an employee who is covered by Article 15 (dependent Personal Services);

Independent activities which are covered by more specific provisions of Articles 16 and 17 (e.g., Non-employee director, artistes and sportsmen, etc.);

Payments to an enterprise in respect of furnishing of the services of employees or other personnel [which are subject to Article 5(3)(b)].

5.5.2 The definition in Article 14(2) illustrates the meaning of ‘professional services’ and is not exhaustive. The expression ‘professional services’ involves any vocation requiring predominantly intellectual skills, dependent on individual characteristics of the person (pursuing that vocation) and requires specialised and advanced education or expertise in related fields.

5.5.3 Illustrations of ‘Professional’ activities :

(a) Technical and marketing consultation for :

Location of manufacturers of specialised raw materials for use in the manufacture;

Application of machines for various purposes;

Changes in design construction;

Improvement and advancement required in manufacturing

Identification of customers;

Promotion of products.

        b) Erection, assembly and commissioning
        c) Legal consultancy
        d) Tax consulting
        e) Solicitor
        f)Keeping the client abreast of matters concerning technology upgradation and development of new products, and sharing fruits of research and development.
        g) Painting
        h) Sculpture
        i) Surgery
        j) Payment to statutory auditors for carrying out audit
        k) Scientist
        l) Teacher
        m) Artist who is paid for product endorsement
        n) Consultation for :

Upgradation of quality

Increase in productivity

Developing customers in international markets

Conducting furnace trial

5.5.4 Professional Fees v. FTS :

There are overlapping areas in ‘professional services’ and in ‘technical, managerial or consultancy services’ inasmuch as a professional service can be rendered in a technical, managerial or consultancy field. In light of the possible overlap between these Articles, certain treaties exclude income covered under Article 14 from the purview of Article 12. In such cases, if at all the amount is chargeable to tax in the State of Source, it can only be under Article 14 and hence to that extent provisions of Article 12 (FTS) and Article 14 are non-competing and mutually exclusive. On the other hand, there are Indian treaties, wherein Article 12 does not expressly exclude from its purview income covered under Article 14. In such cases, it has been held in Dieter Eberhard Gustav Von Der Mark v. CIT, (1999) 235 ITR 698 (AAR) that Article 14 overrides Article 12 by applying the principle that if a case fell under more beneficial provisions of a treaty (Article 14), then it would be futile to stretch the interpretation to bring it under some other provisions of the treaty (Article 12).

Thus, payment of fees falling within the scope of Article 14 cannot be taxed as ‘Fees for Technical Services’ under Article 12.

5.5.5 While deciding about taxability of any Fees for Independent Personal Services under Article 14, the reader would be well advised to examine the relevant Article of the applicable tax treaty and the Article 4 and the definition of ‘Person’ given in the tax treaty to decide whether Article 14 would be rightly applicable to payment of the fees in question and whether the conditions of Article 14 are satisfied on the facts of the case; and accordingly determine whether such a payment would be not liable to tax in the source country. He would also be well advised to closely examine the relevant judicial decisions to determine the applicability of Article 14 to the payment in question.

6. Conclusion :

In light of the SC’s observations on the necessity of ‘territorial nexus’ in the case of Ishikawajima-Harima (supra) extracted above in para 3 above, it would be interesting to see how the Courts will interpret the law even after the amendment to S. 9, as regards the taxability of payment for fees for technical services, irrespective of territorial nexus of such fees to the Union of India.

Another incidental issue for discussion and consideration is : What is the impact of the retrospective amendment on the payer who has already remitted payment of such FTS without TDS, following the law laid down by the Courts in the aforesaid decisions. In our view, the payer should not be considered as ‘an assessee in default’ on account of any retrospective amendment carried out subsequently. Expecting the taxpayer to act on foresight of a retrospective amendment should be hit by the doctrine of impossibility of performance. Therefore, the Tax Department should not initiate any penal action or recovery proceedings against such payer.

It should be noted that India is emerging as a major service provider. If other countries also amend their tax laws on similar lines, various services provided by Indians to non-residents from India may also become exposed to taxation in foreign countries.

(Acknowledgment : We acknowledge that we have relied upon ‘The Law and Practice of Tax Treaties : An Indian Perspective’ by authors CA Rajesh Kadakia and CA Nilesh Modi — 1st Edition, 2008, for writing parts of the article. We express our sincere thanks and gratitude to the authors.)

Nirav Shah

Interpretation of Tax Treaties

Interpretation of Tax Treaties has been a very vexed issue, full of controversies and complexities. Basically tax treaties have dual nature in that they are international tax treaties between two sovereign States and at the same time they are a part of the domestic tax law of each country applying such treaties. This adds to the complexities in their interpretation. Tax Treaties fall under public international laws. There are certain commonly accepted principles of interpretation as enshrined in Vienna Convention. Interpretation also depends upon the approach adopted for the purpose. Besides this, preparatory work, rulings from Tribunals and Courts provide useful aid in interpretation of tax treaties. In this Article, an attempt is made to cull out some important principles in interpretation of tax treaties, commonly accepted as well as emanating from Indian rulings. Various sources or aids in interpretation of tax treaties are also highlighted at relevant places.

1.0 Introduction : Monist v. Dualist Views :

Tax treaties are signed between two sovereign nations by competent authorities under the delegated powers from the respective Governments. Thus, an international agreement has to be respected and interpreted in accordance with the rules of international law as laid down in the Vienna Convention on Law of Treaties, 1969. These rules of interpretation are not restricted to tax treaties but also apply to any treaty between two countries. So any dispute between two nations in respect of Article 25 relating to Mutual Agreement Procedure of the OECD/UN Model Conventions has to be solved in the light of the Vienna Convention.

However, when it comes to application of a tax treaty in the domestic forum, the appellate authorities and the courts are primarily governed by the laws of the respective countries for interpretation. Fortunately, in India, even before insertion of S. 90(2) 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 Double Taxation Avoidance Agreements (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. This position has been upheld in many of judicial decisions in India. The prominent amongst them are CIT v. Visakhapatnam Port Trust, (1983) 144 ITR 146 (AP); Union of India v. Azadi Bachao Andolan, (2003) 263 ITR 706; CIT v. Kulandagan Chettiar (P.V.A.L.), (2004) 267 ITR 654 (SC).

Thus, in India, treaty override over domestic tax law has a legal sanction. Internationally this situation falls under Monist View, wherein International and National laws are part of the same system of law and where DTAA overrides domestic law. Some other countries which follow such a system are: Argentina, Italy, the Netherlands, Belgium and Brazil.

The other prevalent view is known as Dualistic View wherein International Law and National Law are separate systems and DTAA becomes part of the national legal system by specific incorporation/legislation. In case of Dualistic View, DTAAs may be made subject to provisions of the National Law. Some of the countries that follow Dualistic View are Australia, Austria, Norway, Germany, Sri Lanka, UK.

Interpretation of any statute, more so international tax treaties, require that we follow some rules of interpretation. In subsequent paragraphs we shall deal with rules of statutory construction.

2.0 Basic principles of interpretation of a Treaty :

Principles or rules of interpretation of a tax treaty would be relevant only where terms or words used in treaties are ambiguous, vague or are such that different meanings are possible. If words are clear or unambiguous then there is no need to resort to different rules for interpretation.

Prior to the Vienna Convention, treaties were interpreted according to the customary international law. Just as each country’s legal system has its own canons of statutory construction and interpretation, likewise, several principles exist for the interpretation of treaties in the customary international law. Some of the important principles of Customary International law in interpretation of tax treaties are as follows :

(i) Golden Rule — Objective interpretation :

Ideally any term or word should be interpreted keeping its objective or ordinary or literal meaning in mind. The term has to be interpreted contextually.

Words and phrases are in the first instance to be construed according to their plain and natural meaning. However, if the grammatical interpretation would result in an absurdity, or in marked inconsistency with other portions of the treaty, or would clearly go beyond the intention of the parties, it should not be adopted1.

(ii) Subjective interpretation :

Under this approach, the terms of a treaty are to be interpreted according to the common intention of the contracting parties at the time the treaty was concluded. The intention has to be found from the words used in the treaty and the context thereof.

In Abdul Razak A. Meman’s case’, the Authority for Advanced Rulings (the AAR) relied on the speeches delivered by Shri Manmohan Singh, Minister of Finance (as he then was) and His Highness Sheik Harridan- Bin Rashid Al-Maktoum, Minister of Finance and Industry in the presence of His Highness Sheik Zayed Bin Sultan Al-Nahyan, the President of the UAE to arrive at the intention of parties in signing the India-UAE Tax Treaty.

iii) Teleological or purposive interpretation:

In this approach the treaty is to be interpreted so as to facilitate the attainment of the aims and objectives of the treaty. This approach is also known as the ‘objects and purpose’ method.

In case of Union of India v. Azadi Bachao Andolani, the Supreme Court of India observed that “the principles adopted for interpretation of treaties are not the same as those in interpretation of statutory legislation. The interpretation of provisions of an international treaty, including one for double taxation relief, is that the treaties are entered into at a political level and have several considerations as their bases.” The Apex Court also agreed to the argument put forth by the Appellant that “the preamble to the Indo-Mauritius DTAC recites that it is for the ‘encouragement of mutual trade and investment’ and this aspect of the matter cannot be lost sight of while interpreting the treaty”.

iv) The principle of effectiveness:

According to this principle, a treaty should be interpreted in a manner to have effect rather than to be void.

This principle, particularly stressed by the Permanent Court of International Justice, requires that the treaty should be given an interpretation which ‘on the whole’ will render the treaty ‘most effective and useful’, in other words, enabling the provisions of the treaty to work and to have their appropriate effects”.

In Cyril Eugene Pereira”, the AAR held that “a tax treaty has to be given a liberal interpretation to make it workable but that would only mean ironing out of the creases, as it is called, which would be within the realm of interpretation.”

v) Principle of contemporaneity:

A treaty’s terms are normally to be interpreted ‘on the basis of their meaning at the time the treaty was concluded. However, this is not a universal principle.

In Abdul Razak A. Memans case”, the AAR observed that “there can be little doubt that while interpreting treaties, regard should be had to material contemporanea expositio. This proposition is embodied in Article 32 of the Vienna Convention, referred to above, and is also referred to in the decision of the Supreme Court in K. P. Varghese v. ITO, (1981) 131 ITR 597.”

vi) Liberal construction:

If is a general principle of construction with respect td treaties that they shall be liberally construed so as to carry out the apparent intention of the parties.

In John N. Gladden v, Her Majesty the Queen”, the principle of liberal interpretation of tax treaties was reiterated by the Federal Court, which observed: “Contrary to an ordinary taxing statute a tax treaty or convention must be given a liberal interpretation with a view to implementing the true intentions of tne parties. A literal or legalistic interpretation must be avoided when the basic object of the treaty might be defeated or frustrated in so far as the particular item under consideration is concerned.”

The Court further recognised that “we cannot expect to find the same nicety or strict definition as in modern documents, such as deeds, or Acts of F Parliament; it has never been the habit of those engaged in diplomacy to use legal accuracy but rather to adopt more liberal terms.”

(vii) Treaty as a whole – Integrated approach:

A treaty should be construed as a whole and effect should be given to each word which would be construed in the same manner wherever it occurs. Any provision should not be interpreted in isolation; rather the entire treaty should be read as a whole to arrive at its object and purpose.

To quote Prof. Roy Rohatgi”:

a) tax treaties tend to be less precise and require a broad purposive interpretation;

b) the purpose is not the same as the subjective intention of Contracting States. It refers to the goals of the treaty as reflected objectively by the treaty as a whole.

viii) Reasonableness and consistency” :

Treaties should be given an interpretation in which the reasonable meaning of words and phrases is preferred, and in which a consistent meaning is given to different portions of the instrument. In accordance with the principles of consistency treaties should be interpreted in the light of existing international law.

One thing may be noted regarding the rules of interpretation, that they are not rules of law and are not to be applied like the rules enacted by the legislature in an Interpretation Act. In Maunsel v. Olins Lord Reid observed that U They are not rules in the ordinary sense of having some binding force. They are our servants not our masters. They are aids to construction, presumptions or pointers. Not infrequently one ‘rule’ points in one direction, another in a different direction. In each case, we must look at all relevant circumstances and decide as a matter of judgement what weight to attach to any particular ‘rule”‘.

3.0 Principles of interpretation as per the Vienna Convention:

The Vienna Convention of 1969 codified the then existing public international law. Worldwide treaties are entered and interpreted taking into account provisions of the Vienna Convention. Even though India is not a signatory to this Convention, it has a great persuasive value as it is the authentic, codified customary public international law. Courts in India have recognised and referred to principles enshrined in this Convention. Some of the important Articles of this Convention which provide great help in interpretation of a tax treaty are as follows:

3.1 Article 26: Pacta stint servanda :

Every treaty in force is binding upon the parties to it and must be performed by them in good faith.

3.2 Article 27 : Internal Law and observance of Treaties:

A party to a treaty cannot invoke the provisions of internal law as justification for its failure to perform a treaty.

In India the concept of ‘Treaty Override’ is well accepted. Moreover S. 90 (2) provides that provisions of domestic tax laws vis-a-vis treaty would be applied to the extent the same are more beneficial to the assessee.

3.3 Article 30: Application of successive treaties relating to the same subject matter:

Sometimes parties to the treaty subject themselves to provisions of other tax treaties that may be entered at a later date; in such cases the provisions of that later treaty shall prevail. For example, MFN Clause in the protocol on DTA with France provided that in respect of Dividends, Interest, Royalties and FTS if India signed a treaty after 1st September 1989 with any OECD country wherein these incomes are taxed at a lower rate or the scope is narrower, then provisions of India-France Treaty would stand modified to. that extent.

3.4 Article 31 : General rules of interpretation:

Treaties should be interpreted in Good Faith in accordance with the ordinary meaning in the light of its Object and Purpose and Context.

As per this Article primacy is given to the ‘ordinary meaning’ and ‘textual approach’ while preserving the role of ‘objects and purpose’. The context for the purpose of the interpretation of a treaty shall comprise in addition to the text, including its preamble and annexes.

In Abdul Razak A. Meman’s case”, the AAR observed that “these recitals’? indicate that the purpose of entering into the treaty is to promote mutual economic relations by concluding an agreement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and on capital”. (emphasis supplied)

Article 31(3) further provides that there shall be taken into account, together with the context:

a) any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions;

b) any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation; and

c) any relevant rules of international law applicable in the relations between the parties.

Further, Article 31(4) provides that a special meaning shall be given to a term if it is established that the parties so intended.

3.5 Article 33 : Interpretation of Treaties authenticated in two or more languages:

Both texts are equally authoritative, unless treaty provides or parties agree that in case of divergence, a particular text shall prevail.

Indian tax treaties invariably provide that both Hindi and English are authentic texts, however in case of divergence, the text in English shall prevail.

4.0 Extrinsic aids to interpretation of a tax treaty:

A wide range of extrinsic material is permitted to be used in interpretation of tax treaties. According to Article 32 of the Vienna Convention the supplementary means of interpretation include the preparatory work of the treaty and the circumstances of its conclusion.

4.1 According to Prof. Starke one may resort to following extrinsic aids to interpret a tax treaty-‘ provided that clear words are not thereby contradicted:

i) Interpretative Protocols, Resolutions and Committee Reports, setting out agreed interpretations;

ii) A subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions [Article 31(3) of the Vienna Convention];

iii) Subsequent conduct of the state parties, as evidence of the intention of the parties and their conception of the treaty;

iv) Other treaties, in pari materia,in case of doubt;

Provisions in parallel tax treaties:

If the language used in two tax treaties (say treaties: X and Y) are same and one treaty is more elaborative or clear in its meaning (say treaty X) can one rely on the interpretation/explanations provided in a treaty X while applying provisions of a treaty Y?

In case of Raymond Ltd.13the Tribunal relied on the examples given in the Memorandum of Understanding concerning Fees for Included Services in respect of Article 12 of the India-US Tax Treaty while interpreting the concept of ‘make available’ under the India-UK Treaty as the language used in both the treaties is similar.

However, the views of the Indian Judiciary are not consistent in this respect. There is contradictory judgments by Indian Courts/Tribunals in this regard as mentioned below:

For:

UOI v. Azadi Bachao Andolan, (2003) 263 ITR 706 (SC)
AEG Telefunkenv. CIT, (1998) 233 ITR 129 (Kar.)
P. No. 28 of 1999, In re (2000) 242 ITR 208 (AAR)
P. No. 16 of 1998, In re (1999) 236 ITR 103 (AAR)
DCIT v. Boston ConsultingGroup Pte. Ltd., (2005) 93 TTJ 293 (Mum.)

Against:

Mashreq Bank PSC v. DOlT, (2007) 108 TIJ 554 (Mum.)
CIT v. PV AL Kulandagan Chettiar, (2004) 267 ITR 654 (SC)
CIT v. Vijay Ship Breaking Corpn., (2003)261 ITR 113 (Guj.)
Essar Oil Ltd. v. JCIT, (2006) 102 TTJ 270 (Mum.)

4.2 Technical explanation on US MC:

US has published Technical Explanation accompanying the United States Model Income Tax Convention on Nov. IS, 1996. This explanation though refers extensively to the OECD Commentary, it highlights differences and provides basic explanation of US treaty policy for all interested parties.

Similarly, there ‘is a technical explanation for the India-US tax treaty as well.

4.3 International Articles/Essays/Reports:

In DCIT v. ITC Ltd., (2003) 85 ITD 162 (Kol.) the Tribunal referred to an essay to support its observations. Similarly, in case of CIT v. Vishakhapatanam Port Trust, (1983) 144 ITR 146 (AP), the High Court obtained ‘useful material’ through international articles.

4.4 Cahiers published by IFA, Netherlands:

Cahiers were relied upon in case of Azadi Bachao Andolan’s (supra) case by the sc.

4.5 Protocol:

A protocol is an integral part of a tax treaty and has the same binding force as the main clauses therein.
[Sumitomo Corpn. v. DCIT, (2007) 110 TTJ 302 (Del.)]

Protocol to India-US tax treaty provides many ex-amples to elucidate the meaning of the term ‘make available’. Protocol to India France treaty contains the Most Favoured Nation Clause. Thus, one must refer to protocol before reaching to any final conclusion in respect of any tax treaty provision.

4.6 Preamble:

Preamble to a tax treaty could guide in interpretation of a tax treaty. In case of Azadi Bachao Andolan, the Apex Court observed that ‘the preamble to the Indo-Mauritius Double Tax Avoidance Convention (DTAC) recites that it is for the ‘encouragement of mutual trade and investment’ and this aspects of the matter cannot be lost sight of while interpreting the treaty’. These observations are very significant whereby the Apex Court has upheld ‘economic considerations’ as one ofthe objectives of a Tax Treaty.

4.7 Mutual Agreement Procedure (MAP) :

MAP helps to interpret any ambiguous term/provision through bilateral negotiations. MAP is more authentic than other aids as officials of both countries are in possession of materials/ documents exchanged at the time of signing the tax treaty which would clearly indicate the object or purpose of a particular provision. Successful MAPs also serve as precedence in case of subsequent applications.

5.0 Commentaries on DECD/UN Models:
OECD Model Commentary has been widely used in interpretation of tax treaties. Paragraph 29.3 of the July 2008 version of the Commentary on the OECD Model Convention states that: “the Commentaries have been cited in the published decisions of the courts of the great majority of Member countries. In many decisions, the Commentaries have been extensively quoted and analysed, and have fre-quently played a key role in the judge’S delibera-tions.” Phillip Baker regards the OECD Commen-taries as an aid to tax treaty interpretation in sev-eral countries. In US v. Al Burbank & Co. Ltd.,14 the US Second Circuit Court of Appeal referred to the Commentaries as an ‘aid to interpretation’.

In CIT v. Vishakhapatanam Port Trust’s case,”, the Andhra Pradesh High Court observed that “the OECD provided its own commentaries on the technical expressions and the clauses in the Model Convention. Lord Radcliffe in Ostime v. Australian Mutual Provident Society, (1960) AC 459, 480; 39 ITR 210,219 (HL), has described the language employed in these agreements as the ‘international tax language.’

Both UN and OECD Model Commentaries are great help in interpretation of tax treaties. Their importance in interpretation of tax treaties can hardly be over emphasised. [Credit Lyonnais v. DCIT, (2005)94 ITD 401 (Mum)]

Model Commentaries give the authoritative interpretation of the provisions of DTAAs. [Sonata Information Technology Ltd. v. ACIT, (2006) 103 ITD 324 (Bang.)]

UN Commentary reproduces significant part of the OECD Model Commentary and thus, OECD plays a greater role in providing standardised or systematised approach in interpretation of tax treaties.

6.0 Foreign Courts’ decisions:

In CIT v. Vishakhapatanam Port Trust’s case,”; the Andhra Pradesh High Court observed that, “in view of the standard OECD Models which are being used in various countries, a new era of genuine ‘international tax law’ is now in the process of developing. Any person interpreting a tax treaty must now consider decisions and rulings worldwide relating to similar treaties. The maintenance of uniformity in the interpretation of a rule after its international adoption is just as important as the initial removal of divergences. Therefore, the judgments rendered by courts in other countries or rulings given by other tax authorities would be relevant.”

In undernoted cases, foreign court cases have extensively been quoted for interpretation of treaty provisions:

i) Union of India v. Azadi Bachao Andolan”
(ii) CIT v. Vishakhapatanam Port Trust”
iii) Abdul Razak A. Meman’s case’?

7.0 Ambulatory v. Static Approach:

Whenever a reference is made in a treaty to the provisions of domestic tax laws for assigning meaning to a particular term, a question often arises as to what meaning is to be assigned to the said term the one which prevailed on the date of signing a tax treaty or the one prevailing on the date of application of a tax treaty. There are two views on,the subject, namely, Static and Ambulatory.

Static:

Static approach looks at the meaning at the time when the treaty was signed.

Ambulatory:

Ambulatory approach provides that one looks, to the meaning of the term at the time of application of treaty provisions. All Model Commentaries ” including the Technical Explanation on US Model Tax Convention favors ambulatory approach, however with one caution and that is ambulatory approach cannot be applied when there is a radical amendment in the domestic law thereby changing the sum and substance of the term.’

India-Australia Treaty, in para 3(2) adds the expression ‘from time to time in force’ to provide for an ‘ambulatory’ interp retation.

8.0 Ambulatory approach subject to contextual interpretation: –

Paragraph 3 of the OECD Model Convention provides that meaning of the term not defined in the treaty shall be interpreted in accordance with the provisions of the lax laws of the Contracting State that may be applying the Convention. However, this provision is subject to one caveat and that is if the context requires interpreting the term ‘otherwise’, then the meaning should be assigned accordingly. For example, India-US treaty provides that assignment of meaning under the domestic law t9 any term not defined in the treaty shall be according to the common meaning agreed by the Competent Authorities pursuant to the provisions of Article 27 (Mutual Agreement Procedure). And if it is not so agreed then only meaning would be assigned from the domestic tax law that too provided the context does not require otherwise.

In case of Union of India v. Elphinstone Spinning and Weaving Co. Lid.,”, the Supreme Court observed that “when the question arises as to the meaning of certain provisions in a Statue it is not only legitimate but proper to read that provision in its context. The Context means the statute as a whole, the previous state of law, other statutes in pari materia, the general scope of statute and the mischief that it was intended to remedy.”

In Pandit Ram Narain v. State of Uttar Pradesh”, the Supreme Court observed that the meaning of words and expressions used in an Act must take their colour from the context in which they appear.

9.0 Objectives of Tax Treaties:

Objectives for signing a tax treaty also playa significant role in its interpretation as they determine the context in which a particular treaty is signed. For example, OECD and UN Model Conventions have different objectives to achieve. The same are as follows:

9.1 OECD Model Convention:

Principal objectives of the OECD Model Convention are as follows:

The principal purpose of double taxation conventions is to promote, by eliminating international double taxation, exchange of goods and services and the movement of capital and persons. It is also a purpose of tax conventions to prevent tax avoidance and evasion”.

9.2 UN Model Convention:

Principal objectives of the UN Model Convention are as follows: .

To protect taxpayers against double taxation (whether direct or indirect)
To encourage free flow of international trade and investment
To encourage transfer of technology
To prevent discrimination between taxpayers
To provide a reasonable element of legal and fiscal certainty to the investors and traders
To arrive at an acceptable basis to share tax revenues between two States
To improve the co-operation between taxing authorities in carrying out their duties.

9.3 Indian Tax Treaties:

S. 90 of the Income-tax Act, 1961 contains the objectives of signing tax treaties in general. The same areas follows :

a) for the granting of relief in respect of :

i) income on which taxes have been paid, both income-tax under this Act and income-tax in that country; or

ii) income-tax chargeable under this Act and under the corresponding law in force in that country to promote mutual economic relations, trade and investment”, or

b) for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country, or

c) for exchange of information for the prevention of evasion or avoidance of income-tax chargeable under this Act or under the corresponding law in force in that country, or investigation of cases of such evasion or avoidance, or

d) for recovery of income-tax under this Act and under the corresponding law in force in that country.

Thus, it can be observed that there are several objectives for entering into tax treaties by the Government of India besides the primary objective of avoidance of double taxation as enumerated in clause (b) above. Besides avoidance of double taxa-tion, Indian treaties are aimed at achieving two more important objectives, namely, ‘prevention of fiscal evasion and recovery of taxes’.

The amendment made by the Finance Act,”2003, to the Indian Income-tax Act, 1961, clarifies that the Government may enter into tax treaty for the purposes of ‘promotion of mutual economic relations, trade and investment’. This amendment is more in the nature of clarification because there are several existing treaties whose preambles suggest that they were entered into for the purposes of encouragement of mutual trade and investments and/ or pro-motion of mutual economic relations. For example, treaties with Mauritius, Turkmenistan, UAE, Germany, Ukraine”, and Switzerland’? are entered into for various economic reasons, besides the main objectives of avoidance of double taxation and prevention of fiscal evasion.

10.0 Conclusion:

There is a famous saying by one judge in his order. He wrote “Language at best is an imperfect instrument for the expression of human thoughts and emotions”. It is the inadequacy of language which creates lot of communication gaps in application of a tax treaty. Determination of intent of parties, prevalent at the time of entering into agreement, after considerable lapse of time is a herculean task in absence of “Travaux Preparatories’ i.e. Prepara tory work.

Tax Treaties are result of prolonged negotiations between two Contracting States. Ideally, therefore the same should be interpreted keeping in mind the objectives with which they are entered into. Minutes of negotiations, exchange of notes, letters etc. are important material in determining the object of a particular treaty provision. However, absence of any such document in public domain makes the task of interpretation very difficult.

Interpretation of tax treaties is an evergreen subject of controversy considering the complexities involved. Application of international rules of interpretation while giving effect of provisions under the domestic law creates further confusion. Even courts are not unanimous in their rulings. A general technical explanation on the lines of India-USA tax treaty may be published by the Indian Government to reduce the disputes in interpretation of tax treaties.

Nirav Shah

Concept of ‘Beneficial Owner’ in Tax Treaties — Canadian Tax Court’s decision in case of Prévost Car Inc, — (Part I)

International Taxation

Overview :

Tax
treaties use the terms ‘beneficial owner’, ‘beneficially owned’ and ‘beneficial
ownership’ in various Articles dealing with taxation of interest, dividends,
capital gains and royalties and fees for technical services. These terms are not
defined anywhere in any of the Model Conventions or any of the Indian tax
treaties or in the Income-tax Act. The situation is no different in foreign tax
jurisdictions and foreign tax treaties.

In the absence of definition of the said terms in the tax
laws or in the tax treaties, interpretation thereof poses great challenge when
granting/claiming benefit of lower rate of tax in the hands of the ‘beneficial
owner’ in terms of applicable Article of a tax treaty.

Not much guidance is available from Indian judicial
decisions, particularly in the context of interpretations of the terms as used
in various Indian tax treaties.

Recently, the Canadian Tax Court examined the issue in depth
in the case of Prévost Car Inc (Citation 2008 TCC 231) vide judgment dated 30th
April, 2008, in the context of payment of dividends to a Netherlands holding
company.

This Article analyses the said Canadian decision.

1. Facts of the case :

(i) Prévost is a resident Canadian corporation which
declared and paid dividends to its shareholder Prévost Holding B.V. (‘PHB.V.’),
a corporation resident in the Netherlands.

(ii) The Revenue assessed on the basis that the beneficial
owners of the dividends were the corporate shareholders of PHB.V., a resident
of the United Kingdom and a resident of Sweden, and not PHB.V. itself. When
Prévost paid the dividends, it withheld tax by virtue of Ss.212(1) and
Ss.215(1) of the Act. According to Article 10 of the Tax Treaty, the rate of
withholding tax was 5%.

(iii) The Revenue contended that the assessee was required
to withhold and remit to the Crown 25% of the dividends paid to PHB.V.

(iv) The appellant was incorporated under the laws of
Quebec and is resident of Canada. It manufactures buses and related products
in Quebec and has parts and services facilities throughout North America.

(v) In 1995, the assessee’s erstwhile shareholders agreed
to sell their shares of the appellant to Volvo Bus Corporation, a resident of
Sweden and Henlys Group PLC (‘Henlys’), a resident of the United Kingdom.
Volvo and Henlys were parties to a Shareholders’ and Subscription Agreement
(“Shareholders’ Agreement”) under which Volvo undertook to incorporate a
Netherlands resident company and subsequently transfer to the Dutch company
all of the shares Volvo acquired in Prévost; the shares of the Netherlands
company would be owned as to 51% by Volvo and 49% by Henlys.

(vi) Volvo and Henlys were both engaged in the manufacture
of buses, Volvo manufacturing the chassis and Henlys, the bus body. Prévost
was in the same business, building coaches for different types of buses and
bus body shells.

(vii) PHB.V. was established as a vehicle for Henlys and
Volvo to pursue multiple North American projects. The first of these projects
was Prévost. The second was to be a Mexican company, Masa.

(viii) The Shareholders’ Agreement also provided, among
other things, that not less than 80% of the profits of the appellant and PHB.V.
and their subsidiaries, if any, (together called the ‘Corporate Group’) were
to be distributed to the shareholders.

(ix) The amounts of dividends in question were paid by the
appellant to PHB.V. and then distributed by PHB.V. to Volvo and Henlys in
accordance with the Shareholders’ Agreement.

(x) The Canada Revenue Agency acknowledged that it did not
dispute that the dividends in question were properly declared by the appellant
and paid to PHB.V.

(xi) At the relevant time PHB.V.’s registered office was in
the offices of Trent International Management PHB.V. (‘TIM’), originally in
Rotterdam and later in Amsterdam. TIM was affiliated with PHB.V.’s banker,
Citco Bank.

(xii) In 1996, the directors of PHB.V. executed a Power of
Attorney in favour of TIM to allow it to transact business on a limited scale
on behalf of PHB.V. PHB.V. executed another Power of Attorney in favour of TIM
to allow it to arrange for the execution of payment orders in respect of
interim dividend payments to be made to PHB.V.’s shareholders.

(xiii) PHB.V. had no employees in the Netherlands, nor does
it appear that it had any investments other than the shares in Prévost.

(xiv) According to KYC documentation, PHB.V. represented
that the beneficial owners of the shares of Prévost were Volvo and Henlys, not
PHB.V. itself.

2. Treaty & OECD Model Conventions :

(i) The assessee company withheld tax of (six and) five
percent on the payment of the dividends to PHB.V., relying on paragraphs 1 and 2
of Article 10 of the Tax Treaty, which read as under :

1. Dividends paid by a company which is a resident of a
Contracting State to a resident of the other Contracting State may be taxed in
that other State.

2. However, such dividends may also be taxed in the State
of which the company paying the dividends is a resident, and according to the
laws of that State, but if the recipient is the beneficial owner of the
dividends, the tax so charged shall not exceed :

(a) 5% of the gross amount of the dividends if the
beneficial owner is a company (other than a partnership), that holds
directly or indirectly at least 25% of the capital or at least 10% of the
voting power of the company paying the dividends;

Sub-paragraph (a) of paragraph 2 of Article 10 of the Tax Treaty was replaced effective January 15, 1999 as follows:

(a) 5% of the gross amount of the dividends if the beneficial owner is a company (other than a partnership) that owns at least 25% of the capital of, or that controls directly or indirectly at least 10% of the voting power in, the company paying the dividends;

(ii) The Tax Treaty is based on the Organisation for Economic Cooperation and Development (‘OECD’) Model Tax Convention on Income and on Capital 1977 (‘Model Convention’).

(iii) Paragraphs 2 of Article 10 of the Model Convention and the Tax Treaty require that the recipient of dividends be the ‘beneficial owner’ or, in French, ‘le beneficiaire effectif’ of the dividends. The words used for ‘beneficial owner’ and ‘Ie beneficiaire effectif’ in the Dutch version of the Treaty is uiteindelijk gerechtigde. These words are defined neither in the Model Convention, nor in the Tax Treaty. The French version of the Act generally uses the words ‘proprietaire effectif or ‘personne ayant la proprieie effective’ for ‘beneficial owner ‘.

(iv) The Commentary on Article 10 of the 1977 _ OECD Model Convention states that:

12. Under paragraph 2, the limitation of tax in the State of Source is not available when an intermediary, such as an agent or nominee, is interposed between the beneficiary and the payer, unless the beneficial owner is a resident of the other Contracting State. States which wish to make this more explicit are free to do so during bilateral negotiations.

Canada has not undertaken any negotiations with the Netherlands to make paragraph 2 of Article 10 of the Tax Treaty any more explicit.

(v) In 2003 the OECD Commentaries to Article 10 of the OECD Model Convention were modified. Paragraphs 12, 12.1 and 12.2 of the Commentaries explain that the term ‘beneficial owner in Article 10(2) of the Model Convention’ is not used in a narrow technical sense, rather, it would be understood in its context and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance. With respect to conduit companies, a report from the Committee on Fiscal Affairs concluded “that a conduit company cannot normally be regarded as the beneficial owner if, though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties”.

(vi) In 1995, Article 10, paragraph 2 of the Model Convention, 1977 was amended by replacing the words ‘if the recipient is the beneficial owner of the dividends’ with ‘if the beneficial owner of the dividends is a resident ofthe other Contracting State’. (There was no change to this wording in the Tax Treaty.) The Commentary was also amended to explain that the Model Convention was amended to clarify the first sentence of the original commentary above, ‘which 7 See paras. 62-64 infra. has been the consistent position of all member countries’. The second sentence of the Commentary was not altered. The key words, as far as these appeals are concerned, in both the 1977 and 1995 versions of the GECD Model Convention and the Tax Treaty, are ‘beneficial owner’ and the equivalent words in the French and Dutch languages.

(vii) Article 3(2) of the Tax Treaty provides an ap-proach to understanding undefined terms :

2. As regards the application of the Convention by a State, any term not defined therein shall, unless the context otherwise requires, have the meaning which it has under the law of that State concerning the taxes to which the Convention applies.

In other words, when Canada wishes to impose our income tax, a term not defined in the Tax Treaty will have the meaning it has under the Act, assuming it has a meaning under the Act.

(viii) The Income Tax Conventions Interpretation Act, at S. 3, directs how the meaning of undefined terms in a tax treaty are to be understood:

3. Notwithstanding the provisions of a convention or the Act giving the convention the force of law in Canada, it is hereby declared that the law of Canada is that, to the extent that a term in the convention is

(a) not defined in the convention,

(b) not fully defined in the convention, or

(c) to be defined by reference to the laws of Canada, that term has, except to the extent that the context otherwise requires, the meaning for the purposes of the Income Tax Act has changed.

(ix) The Vienna Convention on The Law of Treaties (‘VCLT’), at Article 31(1), states that:

A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and are the light of its object and purpose.

(x) Tax treaties are to be given a liberal interpretation with a view of complementing the true intentions of the contracting states. The paramount goal is to find the meaning of the words in question.

(xi) Article 3(2) of the GECD Model Convention 1977 is similar to Article 3(2) of the Tax Treaty:

… [A]s regards the application of the Convention by a Contracting State any term not defined therein shall, unless the context otherwise requires, have the meaning which it has under the law of that State concerning the taxes to which the Convention applies.

(xii) In 1999 Article 3(2) of the Model Convention, was amended as follows :

2. As regards the application of the Convention at any time by a Contracting State, any term not defined therein shall, unless the context other-wise requires, have the meaning that it has at that time under the law of that State for the purposes of the taxes to which the Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State.

(xiii) The concept of ‘beneficial ownership’ or ‘beneficial owner’ is not recognised in the civil law of Quebec or other civil law countries who are members of GECD.

3. Expert evidence:

The assessee-company produced several expert witnesses to explain Dutch law and the development of the GECD Model Conventions and the Commentaries on the Model Conventions.

3.1 Professor Dr. S. van Weeghel:

He is a Professor of Law and practises taxation law in the Netherlands. He is an expert in Dutch tax treaties, Dutch tax law and abuse of tax treaties.

3.1.1 Professor van Weeghel concluded that under the Dutch law, PHB.V. is the beneficial owner of Prevost’s shares. He relied, in particular, on an interpretation by the Hoge Raad (Dutch Supreme Court) 6 April 1994, BNB 1994/217, sometimes called the ‘Royal Dutch’ Case. Based on the Hoge Raad’s interpretation, Professor van Weeghel concluded that:

. . . a clear and simple rule emerges. A person is the beneficial owner of a dividend if (i) he is the owner of the dividend coupon, (ii) he can freely avail of the coupon, and (iii) he can freely avail of the monies distributed. One could read the formulation of this rule by the Court so as to leave open the question whether the freedom to avail of the coupon or of the distribution must exist in law or in fact, or both. The reference to the wording pertaining to the ‘zaakwaarnemer’ and the ‘lasthebber’, however, seems to require a narrow reading of the ruling, i.e., one in which the freedom must exist in law. The addition of these terms cannot be read as a further condition, because a zaarkwaarnemer and a lasthebber by definition cannot freely avail of the dividend. Thus the addition must be seen as a clarification of the conditions of free avail and the zaakwaarnemer and the lasthebber both lack that freedom in law.

3.1.2 The assessee’s counselled evidence that the Canada Revenue Agency, or its predecessor, and the Dutch tax authorities disagreed who was the ‘beneficial owner’ of the dividends received from Prevost. The Dutch are of the view PHB.V. was the ‘beneficial owner’. The appellant requested competent authority assistance relating to the term ‘beneficial owner’ in Article 10(2) of the Tax Treaty. There was some communication between the tax authorities of Canada and the Netherlands, but when the Dutch and Canadian views differed as to whether the beneficial ownership requirement in Article 2 of the 1986 Convention affected situations similar to those in the appeals at bar, the Canadian authorities terminated the competent authority review.

3.1.3 Professor van Weeghel stated that under Dutch law, PHB.V. would be considered as the beneficial owner of the dividends. However, if PHB.V. were legally obligated to pass on the dividends to its shareholders, Dutch law would consider PHB.V. not to be the beneficial owner of the dividends.

3.2 Professor Rogier Raas

Professor Rogier Raas is a professor in European banking and securities law at the University of Luden in the Netherlands. Since 2000 he has practised law; he also acts as counsel to corporations and financial institutions on finance-related and regulating matters .

3.2.1 Professor Raas opined that the dividends received by PHB.V. were within the taxing authority of the Dutch government and that, but for the participation exemption granted by the Dutch government to PHB.V., PHB.V. would have been subject to Dutch tax in respect of the dividends. Despite the existence of a Shareholders’ Agreement between Volvo and Henlys and the Powers of Attorney granted to TIM, PHB.V. itself was not contractually or otherwise required to pass on the dividends it received from the appellant. In all cases, dividend payments had to be authorised by PHB.V.’s directors in accordance with Dutch law and practice. The Shareholders’ Agreement and Powers of Attorney did not have any effect on the ownership of the dividends by PHB.V., he stated.

3.2.2 In respect of the impact of the dividend policy in the Shareholders’ Agreement on the powers of PHB.V., Professor Raas concluded that:

(a) the dividend policy in the Shareholders’ Agreement does not provide for a limitation of the powers of the Board of Directors of PHB.V. that is uncommon in a Netherlands law context. A considerable influence of share-holders on the dividend policy of a Dutch B.V. is very common; and

(b) unlike the default scenario or where annual profits are at the disposal of the general meeting of PHB.V.’s shareholders, the Board of Directors had the discretion under PHB.V.’s Articles of Association and the dividend policy to decide the adequacy of the working capital requirements, before dividends were paid.

3.2.3 The revenue responded that Professor Raas assumed incorrectly that PHB.V. had a dividend policy independent of that of the Corporate Group set out in the Shareholders’ Agreement and referred to in PHB.V.’s Articles of Association. Instead, the respondent’s counsel argued, the discretion of the directors of PHB.V. to determine the adequacy of working capital of PHB.V.was inextricably tied to the same determination being made by the directors of Prevost. The proviso in the Shareholders’ Agreement on the payment of not less than 80%of the after-tax profits of the Corporate Group was limited only by a determination of the Board of Directors of both PHB.V. and Prevost ‘as to the adequacy of normal and foreseeable working capi-tal requirement of the Corporate Group at the time of each dividend payment. The dividend policy of PHB.V.,as described in the Raas report, was in fact a resolution of purported shareholders of Prevost, represented as Volvo and Henlys, and adopted by the Board of Directors of Prevost, both occurring on March 23, 1996.

3.2.4In short, the Revenue submitted that the dividend policy in the Shareholders’ Agreement, the shareholder and director resolutions of March 23, 1996, coupled with the authorisation in PHB.V.’s Articles of Association to pay interim dividends defined the scope of the discretion of the directors of the PHB.V.to determine its working capital requirement. This discretion was purely academic.

3.3 Mr. Daniel Luthi:

3.3.1 Mr. Daniel Luthi, a graduate in law, worked in the Swiss Ministry of Finance and negotiated about 30 tax treaties on behalf of Switzerland. He was also a member of the Swiss delegation to the – – “DECO Fiscal Committee, member of OECD Committee on Fiscal Affairs (‘CFA’), a member and chairman of the Swiss delegation to the OECD Working Party 1 on ‘Double Taxation, as well as a member of the OECD Informal Advisory Group in international tax matters.

3.3.2 Mr. Luthi’s report was essentially a fact-driven recollection of events that transpired during OECD Model Convention discussions and negotiations. Mr. Luthi testified on matters relating to the term ‘beneficial owner’ and to the issues facing drafts-men of the OECD Convention more for background than for anything else.

3.3.3 The term ‘beneficial owner’ was introduced into Article 10(1)of the 1977OECD Convention, Mr. Luthi stated, so as to explicitly exclude intermediaries in third States, such as agents and nominees, from treaty benefits. Article 10(1)still caused concern as to whether the shareholder was entitled to treaty benefits in a case where the dividend was received by an agent or nominee, but not the shareholder directly. Hence Article 10(1) was further amended in 1995.

3.3.4 Mr. Luthi could find ‘no traces’ why the term ‘beneficial owner’ had been chosen in the 1977 OECD Convention. Other terms were considered, for example, ‘final recipient’. The intention was that the ‘beneficialowner’ of the incomebeing a resident of the other Contracting State was to benefit from a treaty, not an agent or nominee who is not considered to be the beneficial owner of the income.

3.3.5 There was no expectation that a holding company was a mere agent or nominee for its share-holders, that is, that its shareholders were the beneficial owners of the holding company’s income. Indeed, a holding company is the beneficial owner of dividend paid to it, unless there is strong evidence of tax avoidance or treaty abuse.

3.3.6 Conduit Companies:
Mr. Luthi referred to the CFA Report of 1987, Double Taxation Conventions and the Use of Conduit Companies. An OECD working party’s report on conduit companies adopted by the OECD Council on 27 November 1986 distinguishes between two types of conduit companies, direct conduit companies and ‘stepping-stone’ conduits; the former is the conduit discussed here and is described as follows:

Direct conduits :

A company resident of State A receives dividends, interest or royalties from State B. Under the tax treaty between States A and B,the company claims that it is fully or partially exempted from the with-holding taxes of State B. The company is wholly owned by a resident of a third State not entitled to the benefit of the treaty between States A and B. It has been created with a view to taking advantage of this treaty’s benefits and for this purpose the assets and rights giving rise to the dividends, interest or royalties were transferred to it. The income is tax exempt in State A, e.g., in the case of dividends, by virtue of a parent-subsidiary regime provided for under the domestic laws of State A, or in the convention between States A and B.

He summarised the CFA’s report as follows:

… According to this Report, OECD does not deny every conduit company the ability to be the beneficial owner by stating “The fact that the conduit company’s main function is to hold assets or rights is not itself sufficient to categorise it as a mere agent or nominee, although this may indicate that further examination is necessary”. On the other hand, a conduit company cannot normally be considered to be the beneficial owner of the income received if it has very narrow powers, performs mere fiduciary or administrative functions and acts on account of the beneficiary (most likely the shareholder). In the view of OECD, such a company has only title to property, but no other economic, legal or practical attributes of ownership. In such a case, the company, based on a contract by way of obligations taken over, will have similar functions to those of an agent or a nominee.

According to Article 4 of the OECD Model Convention, a conduit company, in order to be entitled to claim treaty benefits, must be liable to tax in its residence country on the basis of its domicile, place of management, etc. In addition, the assets and rights giving rise to the income must have effectively been transferred to the conduit company. If this is the case, the conduit company cannot be considered to act as a mere agent or nominee with respect to the income received.

The analysis, observations and conclusions by the Tax Court will be discussed in Part II of the Article which will appear in the next issue of the Journal.

Nirav Shah

Taxation of Payments for Technical Plan or Technical Design Part II

International Taxation

Part II

In the first part of the article published in December 2010
issue of BCAJ, we discussed broadly the issues which arise while making payments
for designs and drawings acquired from foreign entities for diverse business
purposes, definitions of the terms Royalty and Fees for Technical Services (FTS)
under the Income-tax Act, 1961 (the ACT), under Model Conventions and under some
important Indian DTAAs. We also discussed meaning of the terms ‘design’,
technical and plan, as per various dictionaries.

In this part, we will discuss taxability of the payment for
technical plans and technical design with reference to various judicial
pronouncements with a view to understand how the case law has developed over the
years and to cull out guiding principles.

Taxation of Payment for Technical Plan or

Technical Design as explained in various judicial

pronouncements :

Taxation of Payments for Technical Plan or Technical Design
has been examined, explained and applied by various judicial authorities in
India

A gist of relevant cases is given below. It is important to
note that in the gist of cases given below, we have only considered and analysed
the aspect relating to taxation of payments for Technical Plan or Technical
Design. Other aspects relating to royalty, FTS, PE, etc. have not been discussed
or analysed here. For this, the reader should consider and refer the text of the
decisions.

1. CIT v. Davy Ashmore India Ltd. (Cal.)

(1991) 190 ITR 626 (India-UK DTAA) :

Nature of payment :

Import of concept designs and drawings for enabling the
assessee to prepare the detailed manufacturing drawings for purposes of
manufacture of the terminal equipments which were required to be supplied by the
assessee.

Issue :

Whether the payment made to the non-resident company were in
the nature of royalty within the meaning of Explanation 2 to S. 9(1)(vi) ?

Held :

That the non-resident did not retain the property in the
designs and drawings. The designs and drawings were imported under the import
policy with the approval of the RBI on the basis of the letter of intent. The
import of the designs and drawings postulated an out and out transfer or sale of
such designs and drawings. The consideration paid for the transfer was not
assessable as royalty.

2. CIT v. Klayman Porcelains Ltd. (AP)

(1998) 229 ITR 735 (India-Germany DTAA) :

Nature of payment :

Under the agreement, consideration was paid for
construction/installation of a kiln. The amount paid under that memorandum by
the Indian company to the non-resident company was payment for technical
drawings towards engineering for the kiln.

Issue :

Whether the lump sum payment made by the resident company to
the non-resident company for supply of designs and drawings (engineering for the
kiln) did not constitute ‘income’ by way of royalty of the non-resident company,
within the meaning of the provisions of S. 9(1)(vi) ?

Held :

The Tribunal on construing the relevant portion of the
agreement recorded the finding that this was a case of a foreign company
undertaking to supply, erect and commission a kiln in India, the only service
rendered in India being that of supervision by an expert deputed by the foreign
company. The amount was not paid for imparting any information concerning the
working of, or the use of, a patent, invention, model, design, secret formula or
process or trade mark or similar property falling under clause (ii) of
Explanation 2 to S. 9(1)(vi) or for imparting of any information concerning
technical, industrial, commercial or scientific knowledge, experience or skill
within the meaning of clause (iv) of Explanation 2. A close reading of the
second type of work as well as the other items of the memorandum showed that the
consideration was paid for construction/installation of the kiln. Therefore, the
payment made by the assessee to the non-resident company did not constitute
‘income’ by way of royalty of the non-resident company, within the meaning of
the provisions of S. 9(1)(vi) of the Act.

3. Leonhardt Andra Und Partner, GmbH v. CIT

(2001) 249 ITR 418 (Old India-Germany DTAA) :

Nature of payment :

Payment was made to the German company in connection with the
design of the bridge to be built.

Issues :

1. Whether the sums received by the assessee for design and
technical services for the construction work are chargeable to income-tax under
the Act ?

2. Whether the transfer of the drawings, designs and
technical services under the collaboration agreement constituted an out and out
transfer of such rights and as such the sums received therefor could be treated
as royalty for the purpose of the Indo-German DTAA and liable to Indian
Income-tax ?

3. Whether, the sum received by the assessee for the supply
of designs, drawings and technical services constituted ‘industrial and
commercial profits’ for the purpose of the Indo-German DTAA and, as such, the
same is assessable under the Act ?

Held:

Royalty was not defined in the old India-Germany DTAA and was
not included within the term ‘industrial and commercial profits’. The term
‘royalty’ not being defined in the DTAA, the definition in the Act would
prevail. Therefore, the sums received by the assessee for design and technical
services for the construction work were in the nature of royalty within the
meaning of the term in S. 9(1)(vi) of the Act, which was taxable and did not
constitute industrial and commercial profits. The fact that the assessee had no
permanent establishment in India was of little consequence.

Note :

CIT v. Davy Ashmore India Ltd., (1991) 190 ITR 626 (Cal.) was distinguished on the ground that as royalty was not defined in the Old India-Germany DTAA and as such the statutory provision will prevail.

4. Munjal Showa Ltd. v. ITO, (2001) 117

Taxman 185 (Delhi) (Mag.) (India-Japan DTAA)

Nature of payment:

The Japanese company undertook to provide to assessee technical know-how and services in connection with manufacture of shock absorbers. The assessee sought drawings and designs of equipments in order to fabricate plant and machinery in India and the Japanese company charged a sum towards cost of supplying the same.

Issue:

Whether such supply of drawings and designs was an outright sale in the Japanese company’s hands and purchase in the assessee’s hands, and, accordingly, consideration paid was commercial profit of Japanese company within meaning of Article III(1) of DTAA?

Held:

The ITAT held that:

As per the contract agreement, the assessee-company had received the licence to use the industrial property rights for manufacture of shock absorbers and also technical documents and know-how relating to the process for manufacturing shock absorbers.

In consideration, the assessee-company had agreed to pay royalty to the Japanese company at the rate of 3% of the ex-factory sale price of the shock absorbers manufactured. The royalty so agreed to be paid was clearly for allowing the assessee-company to manufacture the shock absorbers as per the technical know-how developed by the Japanese company and for supply of technical information, know-how, documentation, etc., relating to the production of shock absorbers and also information and assistance in setting up the manufacturing facilities for production of shock absorbers.

The agreement, however, did not provide for supply of requisite machinery for the plant. Rather the machinery required had to be procured by the assessee-company, though under the advice and specifications given by the Japanese company.

The assessee-company instead of importing the required machinery being costlier, decided to get the same fabricated indigenously and as per requirement of the fabricators, the drawings and designs of the machinery were agreed to be obtained from the Japanese company under an arrangement separate from the collaboration agreement for consideration.

The supply of drawings and designs of the machinery for setting up of the plant was an outright sale in the hands of the Japanese company and purchase in the hands of the assessee-company and, accordingly, the consideration paid was the commercial profit of the Japanese company within the meaning of para 1 of Article III of DTAA.

Apart from the approval accorded by the Government of India to the collaboration agreement, separate approval was sought and granted for the import of drawings and designs by the Government of India and the payment to be made to the Japanese company for import of drawings and designs had also been approved by the Reserve Bank of India.

Had there been a provision in the collaboration agreement for supply of such drawings and designs for manufacturing of machinery for the plant, there would have been no necessity of having a separate arrangement and approval of the Government of India.

There clearly was a distinction between the consideration to be paid for licence and right to use the technical know-how and documentation, etc., for manufacturing of shock absorbers. As per the collaboration agreement, the same was directly linked to the sale of the product and had rightly been termed as ‘payment of royalty’ within the meaning of clauses (e) and (f) of Article X of DTAA and there was no dispute as such about its taxability in India, whereas the payment of US $ 32729 was a consideration for outright purchase of drawings and designs of the machinery required for setting up of the plant and the amount paid was apparently commercial profit of the Japanese company within the meaning of para 1 of Article III of DTAA.

Admittedly, the Japanese company had no permanent establishment in India within the meaning of para 2 of Article III of DTAA and, accordingly, the payment made of US $ 32729 was not liable to be taxed in India as per Article III of DTAA.

Hence, the payment made represented business commercial profits of the Japanese company and the Japanese company having no permanent establishment in India, the said payment was not subject to tax in India as per provisions of Article III of DTAA.

5. Pro-Quip Corporation — AAR

(2002) 255 ITR 354 (India-USA DTAA):

Nature of payment:

Linde Process Technologies (India) Ltd. (LPT) received a purchase order from another Indian company for design, engineering technical know-how and erection and commissioning of hydrogen generation plant. As part of execution of the project, LPT was required to obtain and supply the engineering drawings and designs for the setting up of the plant.

The engineering drawings and designs were available with?Pro-Quip?Corporation, USA, the applicant. LPT placed a purchase order with the applicant for the purpose of specified engineering drawings and designs for the construction of hydrogen generation plant for the Indian company.

Issue:

Whether the applicant is liable to tax on the amount received from Linde Process Technologies (India) Ltd. towards consideration for the sale of engineering, drawings and designs received under purchase order of Linde Process Technologies (India) Ltd.?

Held:

The AAR held that:

This was a case of out and out sale of engineering drawings and designs by the applicant, a non-resident American company to LPT an Indian company to enable LPT to execute an order received by it from another Indian company.

The payment basically was not made for any service to be rendered by the American company. This was not a case of a licensing agreement or sale being coupled with a restrictive clause.

The purchaser was entitled to use the engineering designs and drawings as it liked. It was entitled to sell or transfer the properties purchased.

The agreed price of the sale CIF Mumbai airport was fixed and not subject to any escalation or variation until complete execution. All costs, taxes and duties were to be borne by the seller. The agreed price included cost of documentation.

The total price of the purchase order was to be the sole consideration for supply of goods as described in the purchase order. If any alienation of right or property was made for consideration and such consideration was payable contingent upon productivity, use or disposition, as the case may be, of that property, such payment might come within the expanded definition of royalty. This would not include an out and out sale as in the instant case.

There was no such contingent clause. Payment received by LPT or the sale of engineering, design or drawing was not contingent upon any of the things mentioned in clause (3) of paragraph (3). Therefore, this payment could not be treated as royalty at all.

Moreover, drawings and designs which constitute know-how and are fundamental to an assessee’s manufacturing business are treated as ‘plant’ u/s.32 of the Indian Income-tax Act. If the only source of income of the applicant was the consideration for sale of engineering drawings and designs under purchase order, then the applicant would not be liable to pay any tax in India under Article 12.

6. Gentex Merchants (P.) Ltd. v. DDIT(IT)

(2005) 94 ITD 211 (Kol.) (India-USA DTAA):

Nature of payment:

The assessee-company entered into an agreement with a US company for development of water features at premises owned by it. Under this agreement, the US company was not only to provide schematic ideas but also to provide technical designs, drawings and information, on basis of which the assessee was to execute and install water features. Moreover, the US company was to ensure that features executed by contractors at site conformed to drawings, designs specifications provided by it.

Issue:

Whether since the US company was required to deliver technical designs or plan for sole use by the assessee-company in India, payments effected under agreement squarely fell within definition of ‘fees for technical services’ mentioned in Article 12(4)(b) of India-USA DTAA?

Held:

The ITAT held that:

On reading of the agreement between the parties as a whole, it was noted that various phases contemplated in the agreement were composite and cumulative. Every phase was related to each other and the contract was a single composite contract and the non-resident company was to undertake the work on cumulative basis for which composite non-divisible fee was to be paid.

It was clear from the agreement that each phase was depended on the other and each phase was carried out in succession and only on completion of all phases the scope of work envisaged in the agreement stood fulfilled. It was, therefore, incorrect to say that the agreement merely provided for giving advice to the assessee and there was no transfer of any design or knowledge.

The reading of the agreement clearly indicated that the assessee-company was to execute the water features at its premises in accordance with the designs, drawings and technical specifications provided by the non-resident company and the non-resident company was to ensure that the features executed by the contractors at the site conformed to the drawings, designs specifications provided by it.

From the agreement between the assessee and the foreign company, it was also quite clear that the non-resident company was not only to provide the schematic ideas but also to provide technical designs, drawings and information on the basis of which alone the Indian company was to execute and install the water features. Article 12(4)(b) of DTAA provides that fees for included services shall include ‘services which makes available technical knowledge, experience, skill, know-how or consists of development and transfer of technical plan or technical design’.

For deciding the issue under Article 12(4) it is not material as to whether the assessee acquired on outright basis any technical knowledge, know-how, technical plan or design. Article 12(4) is attracted the moment a person resident of one state (country) makes available technical knowledge, experience or transfers a technical plan or technical design to the person of other contracting state (country).

From the agreement between the assessee and the non-resident company it was apparent that the later was to deliver the technical drawings and designs to the former for its own use and benefit in India. The term transfer as used in Article 12(4) does not refer to the absolute transfer of rights of ownership. It refers to the transfer of technical drawing or designs to be effected by the resident of one state to the resident of other state which is to be used by or for the benefit of resident of other state. The said Article 12(4)(b), does not contemplate transfer of all rights, title and interest in such technical design or plan.

Even where the technical design or plan is transferred for the purpose of mere use of such design or plan by the person of other contracting state and for which payment is to be made, Article 12(4)(b) will be attracted.

The facts on record clearly indicated that under the agreement the non-resident company was required to deliver such technical designs or plan for the sole use by the assessee-company in India. In fact, the assessee did use those technical plans and drawing for constructing and/or installing the water feature in the premises.

In the above circumstances, the payments effected under the agreement with the non-resident company squarely fell within the definition of ‘fees for included services’ and therefore, the assessee was liable to deduct tax at the rate of 15% of the amount payable, u/s.195.

7. Indian Hotels Company Ltd. v. CIT [IT Appeal No. 553 (Mum.) of 2000, dated 14-12-2005] India-Singapore DTAA:

[Decision not yet reported. However, the same has been cited with approval in the case of Abhisek Developers v. ITO, (2008) 24 SOT 45 (Bang.) (URO).] The relevant portion cited in the decision of Abhisek Developers is reproduced below. “The facts of the case on hand are identical with the facts of the case dealt by the Mumbai ‘B’ Bench of the Tribunal in IT Appeal No. 553 (Mum.) of 2000, order dated 14-12-2005 in the case of Indian Hotels Co. Ltd. v. ITO, wherein at para 7 it is held as follows: “A careful reading of the above clauses of the agreement between the assessee company and M/s. HBA clearly shows that the fees payable to M/s. HBA are neither fees paid for technical services nor are in the nature of royalty as defined in various articles of the DTAA between India and Singapore. As per the various clauses of the said agreement it is clear that?M/s. HBA has to hand over and transfer all layout plans and interior concepts in regard to the areas defined in the agreement and all the interior design, drawings and presentation material shall become the property of the assessee-company. All design work submitted by M/s. HBA is for the use solely on this project and cannot be used as part of any other design and the transfer of property in the interior design, drawing, presentation material shall take place in Singapore. It is specifically provided in clause 4.5 of the agreement that all interior design, drawing and specifications shall become the property of the client and the same shall be used for any other purpose other than that covered by this agreement by the interior designer. The services were only to create ‘design’ and title in the design, etc. has passed in this case to the assessee-company. In these facts of the case, we hold that the fee payable to M/s. HBA is not a fee for technical services and is not in the nature of royalty as per the articles of DTAA between India and Singapore and therefore, the assessee was not liable to deduct tax from remittances to M/s. HBA (P.) Ltd. The assessee-company has purchased and acquired interior design and drawing from M/s. HBA and the property therein has in fact passed to the assessee-company. In this view of the matter, the issue is decided in favour of the assessee and the grounds of appeal of the assessee are allowed.”

8. DCIT v. All Russia Scientific Research

Institute of Cable Industry, Moscow

(2006) 98 ITD 69 (Mum.)

(India-Russian Federation DTAA):

Nature of payment:

The assessee, a Russian company, possess-ing knowledge and experience in the field of manufacturing technique of a particular product, entered into an agreement with IPL, an Indian company under which the assessee-company was to provide to IPL a “non-exclusive right to use the ‘know-how’ for the purpose of realisation of the process and the technical process and the special process in the territory and sell the licensed product and the special product in the territory and zone of non-exclusive right”. Under this arrangement, the assessee was, upon a request from the IPL, to render ‘technical assistance’.

Issue:

Whether or not the payment in consideration of supply of technical documentation, on the facts of this case, is to be treated as ‘royalty’ or not?

Held:

The ITAT held that:

An outright sale of designs and drawings essentially implies unfettered right of the assessee to use the same. However, the agree-ment would establish that it was not so in the instant case. Under clause 2.1 of the agreement, the assessee had granted IPL non-exclusive right to use the ‘know-how’ for a specific purpose and that ‘know-how’ included the technical designs and drawings set out in clause 3 of the agreement.

Under clause 12.2 ‘IPL’ could not assign any rights under the said agreement, including, thus, the right to use the designs and drawings to anyone else. In any event, the right to use the ‘know-how’ was a clearly non-exclusive right and, therefore, the assessee retained property in the same even while the ‘know-how’ was made available to IPL.

Under clause 7 of the agreement, IPL was under an obligation to maintain the confidentiality, about the designs and drawings. The IPL had an obligation not only to maintain confidentiality, but also to make every effort that it was not divulged to third parties without the assessee’s specific permission.

Clause 7.2 further provided that in case the drawings and designs were so known to the third parties, IPL would make good the resultant losses incurred to the assessee.

In the light of that factual position, it could not be said that IPL had outrightly purchased the designs and drawings and that consequent to supply of those drawings and designs, the non-resident assessee did not have any interest in the same.

The very fact that IPL could be hauled up to pay damages under Article 7.2 of the agreement would clearly show that the non-resident assessee had valuable property and interest in the drawings and designs which were supplied to IPL and in consideration of which were received by the assessee.

In CIT v. Davy Ashmore India Ltd., (1991) 190 ITR 626 (Cal.), the High Court had categorically observed that where the transferor retains the property right in the designs, secret formulae, etc., and allows the use of such rights, consideration received for such use is royalty.

It was only in the case of outright sale that the consideration for such sale was not to be treated as ‘royalty’.

The instant case was not a case of an out-right sale, nor was it a case of importation of drawings under the import policy. It was a case of collaboration of drawings under the import policy. It was a case of collaboration agreement and a case of limited non-exclusive use of certain drawings and designs for that purpose and therefore, consideration in question was taxable as royalty in hands of the assessee.

In the next part of the Article, we shall discuss some more judicial decisions on the subject.

Nirav Shah

Taxability of profits from purchase of goods from India

International Taxation

Attribution of profits to a Permanent Establishment/Business
Connection is an evergreen controversial subject. Article on ‘Business Profits’
in a tax treaty and S. 9 of the Income-tax Act, 1961 deal with this subject.
However, many a time activities of an enterprise in the source State are
restricted to purchase of goods. In such a scenario, whether the same results in
any tax liability or not, is discussed in this Article.

1.0 Introduction :

Many a time, activities of a foreign enterprise are
restricted to purchase of goods from India. As per the provisions of the Foreign
Exchange Management Act, 1999 (FEMA), a branch or a liaison office in India of a
foreign enterprise is permitted to carry out limited activities only. In
Rahim v. CIT, (1949) 17 ITR 256 (Orissa) and CIT v. Rodriguez, (1951)
20 ITR 247 (Mad.), it was held that a part of profits may be attributed to the
buying activities. However, the Supreme Court, in case of Anglo-French Textile
Co. Ltd., (1954) 25 ITR 27 (SC), held that if the act of buying is negligible,
it may not justify the allocation of any portion of the profits to that
activity. In CIT v. Ahmedbhai Umarbhai, (1950) 18 ITR 472 (SC), the Apex
Court held that “when considering the place of accrual of profits u/s.5, in
cases where the assessee carries on both manufacturing and selling operations,
the whole of the profits should not be considered as accruing from the sale or
at the place of sale, but a part of the profits should be held to accrue at the
place where the goods are manufactured.” Thus, it can be interpreted here that
profits accrue not only on final sale of the product but at every stage, right
from buying, manufacturing, processing and final selling. The complexities arise
where the above activities take place in two or more countries. How the
resultant profits are to be attributed to various activities, is a major area of
concern and controversy worldwide. Let us understand the position from the
perspective of the Indian tax law.

2.0 Domestic Tax Law
Provisions :

2.1 Provisions under the Income-tax Act, 1961 :

The relevant provisions under the Income-tax Act, 1961 are S.
5 and S. 9. S. 5 provides that income of a non-resident is taxed in India if it
is received or is deemed to be received or if it accrues or arises or is deemed
to accrue or arise to him in India. Relevant extracts from S. 9 which deals with
income deemed to accrue or arise in India in respect of a non-resident assessee
are as follows :

“S. 9 : Income deemed to accrue or arise in India

(1) The following income shall be deemed to accrue or
arise in India :

(i) 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, or through the transfer of a capital asset situate in
India.

Explanation 1 : For the purposes of this Clause :

(a) in the case of a business of which all the operations
are not carried out in India, the income of the business deemed under this
clause to accrue or arise in India shall be only such part of the income as
is reasonably attributable to the operations carried out in India;

(b) in the case of a non-resident, no income shall be
deemed to accrue or arise in India to him through or from operations which
are confined to the purchase of goods in India for the purpose of export;

From Clause (a) mentioned above, it is clear that even in
case where the business connection in India is established, only the profits
which are attributable to such business connection would be taxable in India.
Clause (b) clearly provides that if the non-resident’s activities in India are
confined to purchase of goods for the purpose of exports, then no income shall
be deemed to accrue or arise in India.

2.2 CBDT Circulars :

CBDT Circular No. 23, dated 23-7-1969 provides that
maintaining a branch office in India for the purchase of goods or appointing an
agent in India for the systematic and regular purchase of raw materials or other
commodities would tantamount to business connection in India.

However, Paragraph 3(5) of the said Circular further
clarifies that a non-resident will not be liable to tax in India on any income
attributable to operations confined to purchase of goods in India for export,
even though the non-resident has an office or an agency in India for this
purpose. Where a resident person acts in the ordinary course of his business in
making purchases for a non-resident party, he would not normally be regarded as
an agent of the non-resident u/s.163. But where the resident person is closely
connected with the non-resident purchaser and the course of business between
them is so arranged that the resident person gets no profits or less than the
ordinary profits which might be expected to arise in that business, the
Income-tax Officer is empowered to determine the amount of profits which may
reasonably be deemed to have been derived by the resident person from that
business and include such amount in the total income of the resident person.

The Circular further provides that the taxability of the
apportionment of any income under Explanation (a) to S. 9(1)(i) to an agent of a
non-resident in India will be subject to the exemption provided in Clause (b) of
the said Explanation.

CBDT Circular No. 163, dated 29-5-1975 further clarifies that lithe correct legal position is that in the case of a non-resident, no income shall be deemed to accrue or arise in India through or from operations which are confined to purchase of goods in India for the purpose of export. Accordingly, the mere existence of an agency established by a non-resident in India will not be sufficient to make the non-resident liable to tax, if the sole function of the agency is to purchase goods for export”.

In view of these CBDT Circulars and provisions of law, it is clear that even though the activities of purchase of goods in India for the purpose of exports in case of non-residents are effectively connected to a business connection, no income is attributable to it.

In spite of these clear legal provisions, the matter has come up for judicial interpretation in some cases. In the following paragraphs the same are discussed.

3.0 Judicial Rulings:

3.1 In CIT v. N. K. lain, (1994) 206 ITR 692 (Del.), it was held that no income could be deemed to have accrued to the non-resident assessee in India where, on his instructions, his agent purchased dress material, got it stitched into garments and exported such garments to him abroad.

3.2 The AAR in the case of Angel Garments Ltd., (2006) 287 ITR 341 (AAR) had occasion to decide a similar issue, the facts of which are given below.

Angel Garments Ltd., which was incorporated in Hong Kong, proposed to set up liaison office in India. The proposed activities of the liaison office were as follows:

a) Collecting information and samples of various garments and textiles from various manufacturers, traders and exporters;

b) Passing on information with regard to various garments and textiles products available in India to the applicant’s head office at Hong Kong;

c) Co-ordinate and act as the channel of communication between the applicant and the Indian exporters; and

d) Follow up with the Indian exporters for timely export of goods ordered by the applicant.

Angel Garments applied for an advance ruling seeking determination of taxability or otherwise of the above transactions in India.

Usually, Article 5 of a tax treaty provides that the maintenance of a fixed place of business solely for the purpose of purchase of goods or merchandise or of collecting information for the enterprise does not constitute a permanent establishment. However, since M/ s. Angel Garments Ltd. was incorporated ~ in Hong Kong with which India does not have a tax treaty, the Advance Ruling Authority examined the issue under the provisions of the Income-tax Act, 1961. The Authority concluded that u/s.9 of the Act, lino income shall be deemed to accrue or arise in India to him through or from operations which are confined to the purchase of goods in India for the purpose of exports”. The Authority further held that Explanation to S. 9(1)(i) does not specify that the export should be made to the country of which the applicant is the tax resident (in the instant case it was Hong Kong). Exports can be made to any country.

3.3 Ikea Trading (Hong Kong) Ltd. (2009) 308 ITR 422 (AAR):

In this case also the AAR reached identical conclusions. Brief facts of the case were as follows:

The applicant set up a liaison office in India to carry out the following activities:

i) Enquiry into and consideration of potential suppliers for the IKEA product range.

ii) Collecting information and samples of various home-furnishing items from manufacturers and passing on information with regard to various textiles, rugs & carpets and other material (such as plastics, metals and lighting products) available in India.

iii) Doing quality check of the various products at labs to see whether they adhere to the costing and quality parameters as prescribed by IKEA group.

iv) Coordinating and acting as the channel of communication between the applicant and the Indian exporters.

v) Follow up with the Indian exporters for timely export of goods ordered by the applicant and supervising the inland logistics.

vi) Doing social audit of the suppliers to ensure that they adhere to various environmental and other regulations.

The applicant shared the office with Ikea Trading (India) Pvt. Ltd., a Group company. The items purchased by the applicant were to be invoiced by the Indian suppliers directly to the applicant who in turn would sell the same to the wholesale companies outside India and the sale price would be received by the applicant outside India and no revenue-generating activities would take place in India. In this case, the consignee was different from the buyer as with a view to save freight, travel and other expenses, the Indian suppliers had been requested to deliver the goods directly to Ikea Group distribu-tion outlets at Belgium and other countries. Further, the export remittances were made to Indian suppli-ers by Ikea Switzerland (and not by the Ikea Hong Kong on whose names invoices were raised) as the said company in Switzerland carried out the function of ‘Central treasury’.

The AAR in this case held that “no income can be attributed to the purchase operations in India by resorting to the deeming fiction u/s.9(1)(i) because the Explanation clearly excludes such attribution. In the case of Mushtaq Ahmed (2008) 307 ITR 401 (AAR), this Authority had noted that Clause (b) of Explanation 1 acts as an embargo against attributing any income to the purchase operations carried out in India, if such purchases are for the purpose of export”.

3.4 Nike Inc. v. ACIT, (2008 TIOL 255 ITATBang.) :

3.4.1 Recently, the Bangalore Tribunal had occasion to consider similar facts in the above case.

3.4.2 Facts of the case:

i) Nike Inc (the assessee) set up a liaison office in India with the approval of the Reserve Bank of India (RBI) to act as a communication channel between manufacturers in India, the assessee and affiliates of the assessee.

ii) The activities of the Indian liaison office, amongst others, included:

Liaisoning between the manufacturers and the assessee;
Giving opinion on reasonability of prices;
Ensuring the quality of goods exported;
Tracking delivery dates;
Shipment tracking

iii) The assessee as a buying agent for its affiliates, directly entered into an agreement with manu-facturers in India for procurement of goods from India. The goods would be directly shipped to the affiliate’s location by the manufacturers. The assessee earned a commission for performing the buying agency services.

3.4.3 The Tax Authorities contended that:

i) The assessee is not purchasing goods from the manufacturer and does not take title to the goods which are directly exported to the affiliates.

ii) The exclusion to business connection in respect of purchase of goods by a non-resident for the purpose of export would not apply to the assessee.

iii) The activities of liaison office are beyond its activities as approved by RBI as the staff of the liaison office trained factories, evaluated samples, certified auditors, etc.

iv) Nike Inc has a business connection/Permanent Establishment in India and is chargeable to tax to the extent of income which is attributable to the activities carried out in India or accruing or arising in India.

v) 5% of the FOB value of exports could be reasonably considered as income attributable to Ind!a operation.

The Commissioner of Income-tax (Appeals) upheld the view of the Assessing Officer as regards the taxability of sourcing operations carried on by the liaison office in India.

3.4.4 The assessee contended that:

i) The Revenue authorities cannot travel beyond the Income-tax Act. Violation if any from RBI approval could only be examined by RBI authorities.

ii) The assessee is a one-window procurement agency for distribution and sale by its affiliates.

iii) The assessee is performing the role of an agent for its various affiliates in respect of procurement of goods.

iv) Assessee acting as an agent and assessee acting on its own are more or less parallel to one another, since both end up only in purchase.

v) All the activities performed by the liaison office are within the ambit of purchase function.

vi) Exclusion to business connection under Explanation (l)(b) to S. 9(1)(i) of the Act is clearly attracted because it is export in the course of purchase. Hence no income accrues or arises in India.

3.4.5 The Tribunal held in favour of the assessee as follows:

The assessee is a purchasing agent of the various affiliates. The liaison office was clearly not floating tenders, placing purchase orders and taking physical delivery of the goods, since it was only an agency office of the assessee. It merely ensured that various affiliates receive the goods they require and the quality they expect.

There are three ways to purchase:

1) Purchase of goods and receipt of goods at the same time at one place where the office of the assessee is located.

2) Purchase information sent by the assessee, but goods despatched to its various sales outlets.

3) The assessee as an agent of the buyers indicates to the manufacturers the rate at which the goods will be supplied, the names and addresses of the buyers where the goods have to be sent.

The Tribunal observed that situations 2 and 3 are more or less similar. In the present case which is similar to 3, the affiliates have purchased the goods with the help of the agent. Irrespective of whether the purchase is by the principal directly or through an agent, so long as the purchase is for the purpose of export, the activity would be excluded from the gamut of business connection.

The Tribunal also observed that the assessee is not in anyway representing the manufacturer and is not an agent of the manufacturer but of the affiliates. The liaison office only ensures and supervises the manufacturing activity as an agent of the affiliates. The manufacturer does not receive any services from the liaison office or the assessee. The activities of the liaison office are well within the limits pre-scribed by RBI.

4.0 Provisions under a Tax Treaty :

Normally Paragraph 4 of Article 5 of a tax treaty contains specific exclusions from the definition of the term ‘Permanent Establishment’. Paragraph 4 of Article 5 of the United Nation’s Model Convention reads as follows:

“4. Notwithstanding the preceding provisions of this Article, the term ‘permanent establishment’ shall be deemed not to include:

a) the use of facilities solely for the purposes of storage or display of goods or merchandise belonging to the enterprise;

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

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

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

e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character.”

Clause (d) of Paragraph 4 of Article (5) relevant to our discussions, of the OECD Model is similarly worded.

From the above provisions, it is clear that maintenance of a fixed place of business solely for the purpose of purchase of goods or merchandise or of collecting information for the enterprise does not constitute a permanent establishment in the source country.

5.0 Conclusion:

From the above discussion, the following principles emerge in respect of exclusion provided under clause (b) of the Explanation to S. 9(1)(i) of the Act:

i) Goods may be exported to any country and not necessarily to the country of the concerned non-resident entity whose activities in India are under question;

ii) Goods may be exported directly by Indian suppliers / exporters;

iii) Delivery of goods may be made to a country different from the country of the concerned non-resident entity i.e., consignee may be different from the buyer;

iv) Payment may be made from a group company from a third country.

Nirav Shah

Recent decision in the case of E*Trade Mauritius Limited — issues arising therefrom

International Taxation

1. Background

1.1 After the Supreme Court’s [SC] decision in Azadi Bachao Andolan’s case [2003] 263 ITR 706 and the CBDT’s Circular No. 789 dated 13th April 2000, taxpayers and tax planners were clear that the matter was settled and closed and that Mauritius entities holding Tax Residency Certificates [TRCs] issued by Mauritius Tax Authorities could claim exemption from Capital gains tax on sale of shares in Indian Companies under Article 13(4) of Indo-Mauritius Tax Treaty [DTAA] without any hassles. The recent Bombay High Court’s orders dated 26th September, 2008 and dated 23rd March, 2009 in Writ Petition No. 2134 of 2008 have caused consternation in the minds of overseas investors and their tax and investment advisors. This decision seems to have rekindled the controversy in the matter.

1.2 E*Trade Mauritius Limited [ETM] is a wholly owned subsidiary of Converging Arrows Inc. USA [CAI], which in turn is a wholly owned subsidiary of E*Trade Financial Corporation, USA [ETFC], listed on NASDAQ. ETM acquired a substantial stake [43.85%] in M/s. IL&FS Investsmart Ltd., [IIL] a listed company in India. ETM sold its holding in IIL to HSBC Violet Investments (Mauritius) Limited [HSBC Violet]. As a result, substantial capital gains accrued to ETM.

1.3 ETM applied to ADIT (IT), Mumbai [AO] for issue of a Certificate under section 197 of the Income-tax Act, 1961 [the Act] for authorising HSBC Violet not to deduct any tax at source from amounts payable to ETM in view of Article 13(4) of the DTAA. However, the AO directed HSBC Violet to withhold tax @ 21.11% on the gross amount of the sale consideration rather than on the net amount of capital gains.

1.4 ETM challenged the AO’s order u/s. 197 of the Act before the Bombay High Court in the aforesaid writ petition. The Bombay High Court, with the consent of both the parties, directed ETM to file a revision petition before the Director of Income-tax (International Taxation) [DIT(IT)] within a week and the DIT(IT) was directed to decide upon the revision petition within a period of three months from the date of filing of the revision petition. The High Court further directed that HSBC Violet should deduct a sum of Rs.24.50 Crores from the sale consideration and deposit the same with the Court and directed the DIT(IT) to pass appropriate order about the disposal of the amount.

1.5 Being Orders relating to summary proceedings u/s. 197, the High Court’s Orders do not discuss the facts of the case in detail and the legal issues arising therein, which have been discussed in detail in the AO’s Certificate u/s. 197 and the DIT(IT)’s Order u/s. 264. As the said Certificate and Order are now in public domain, having been placed in writ proceedings before the Bombay High Court, we intend to summarise and analyse the facts and legal issues mentioned therein.

2. Summary of AO’s Certificate u/s. 197

2.1 The AO, based upon the Public Announce-ment [PA] made by HSBC Securities and Capital Markets (India) Private Limited [HSCI] and HSBC Violet alongwith persons acting in concert [PACs] [the Acquirers] under the provisions of the SEBI Takeover Code and the Share Purchase Agreement between Infrastructure Leasing & Financial Services Limited [IL&FS] and HSCI dated 16th May, 2008 [IL&FS Share Purchase Agreement] drew attention to the fact that one of the conditions precedent to the IL&FS Share Purchase Agreement was completion of the E*Trade Share Purchase Agreement between ETM & HSBC Violet dated 16th May, 2008.

The AO also drew attention to the statement in the PA under the Reasons for the Offer and Future Plans that pursuant to the substantial acquisition, the acquirers will be in control of the management of the target company. The acquirers propose to reconstitute the Board of Directors of the target company upon completion of the offer formalities.

It is worth noting that upon the acquisition of shares by the Acquirers from IL&FS and ETM under both the abovementioned agreements, the acquirers’ shareholding in IIL would amount to 73.21%, besides the acquisition of shares from other minority shareholders.

2.2 The AO rejected the contentions of the ETM based upon Article 13(4) of the DTAA and drew the following inferences and held as follows :

a. “It is inferred that the transaction is prima facie, liable to Income Tax in India. E*TRADE, by reason of this transaction has earned income liable for Capital Gains Tax in India as the income was earned towards sale consideration of transfer of its business/economic interests, in favour of the acquirers.”

b. “Like most other taxing jurisdictions, the Indian Income Tax Act follows the twin basis for taxation, (i) based on residence or domicile and (ii) based on source of income. While Indian residents are taxed on global income under Section 5(1), non residents are taxed only on the income, which has its source in India under Section 5(2). The non-residents should have either received or deemed to have received the income in India or the income should have arisen or accrued in India or should be deemed to have accrued or arisen in India. The deeming provision is enumerated in section 9 of the Income Tax Act. It is the submission of the Revenue that the income or capital gains of E*TRADE is deemed to have accrued or arisen in India and therefore, it squarely falls within the ambit of Section 9 and is hence chargeable to Income Tax.”

c. “The question that arises for considera-tion in the present case is

(i) what was the subject matter of the transaction;

(ii) whether the subject matter can be said to be a capital asset;

(iii) whether the transaction involved transfer of a capital asset situate in India.

(i) The subject matter of the present transaction between the acquirer and E*TRADE is nothing but transfer of interests, tangible and intangible, in Indian company in favour of the acquirer and not an innocuous acquisition of shares of some Mauritian Company.

ii) From the facts and material available as of now, it is demonstrable that a strong prima facie case is made out to show that the transaction entered into by the Acquirer amounts to transfer of capital asset situated in India. The above transfer is a transfer of a capital asset and not merely a transfer simpliciter of controlling interest ipso facto in a corporate entity. It is :

a) A transfer of a bundle of interests;

b) Substitution of the Acquirer as a successor in interest;

c) Transfer of Controlling Interest in an Indian Company; and

d) Transfer of Management Rights

iii) Mode of transfer of an asset is not determinative of the nature of the asset.

Shares in themselves may be an asset but in some case like the present one, shares may be merely a mode or a vehicle to transfer some other asset(s). In the instant case, the subject matter of transfer as contracted between the parties is not actually the shares of a Mauritian Company, but the assets situated in India. The choice of the acquirer in selecting a particular mode of transfer of these right enumerated above will not alter or determine the nature or character of the asset.

It is seen that E*TRADE Mauritius Limited, a limited company formed under the laws of Mauritius is a subsidiary of E*TRADE’ Financial Corporation, a company incorporated under the laws of the State of Delaware, USA. The very purpose of entering into agreements between the two foreigners is to acquire the controlling interest which one foreign company held in the Indian company, by other foreign company. This being the dominant purpose of the transaction, the transaction would certainly be subject to laws of India, including the Indian Income Tax Act.

d. Prima facie on the basis of details available on record and submissions of the applicant, it is seen that the Capital Gains have accrued in India. The transaction is not a transaction merely of shares but is a transaction which is not covered under article 13(4) of the India-Mauritius DTAA. Also it may be mentioned here that this application is an application for tax deduction at source and not an assessment proceeding.”

Thus, the AO ignored ETM’s submissions based on Article 13(4) of the DTAA and decided to tax the capital gains u/s. 9(1) of the Act.

2.3 Accordingly, the AO directed HSBC Violet to deduct tax at source @ 21.11% on gross payments to be made to ETM. This was the Order u/s. 197 which was subject matter of the writ petition before the Bombay high court.

3. Findings and observations of the DIT(IT) in his order u/s. 264

3.1 Pursuant to the order of the High Court on 26.9.2008, ETM filed a revision petition u/ s. 264 with the DIT(lT) on 3.10.2008, urging the DIT(IT) to quash / set aside the Order of the AO u/s. 197. The ETM submitted as follows:

a) The applicant is a company incorpo-rated in Mauritius and holds a Tax Residency Certificate issued by the competent authority of that country.

b) Consequent to that, Circular No 789 issued by the Board is applicable to the facts of the case, and

c) As a corollary to the above two facts, capital gains earned from the sale of shares of the Indian Company IlL, would not be taxable in India in view of Article 13(4) of the Indo-Mauritius Tax Treaty.

3.2 The DIT(IT), in his order u/s. 264 dated 1st January, 2009 essentially upheld the Order of the AO but on different grounds. However, the DIT(IT) directed the AO to substitute the quantum of the capital gains by the net amount of capital gains instead of gross sales consideration adopted by the AO in his order u/s. 197. He further upheld the rate of tax @ 21.11% as against tax rate of 10% sought by ETM as per proviso to section 112. The findings and observations of the DIT(IT) are summarised in the following paragraphs.

3.3 On the basis of the enquiries made and information gathered by the DIT(IT) from the public domain, mainly through Internet, the DIT (IT) noted and observed as under:

(i) The CAI was incorporated in November 2000 in the State of Nevada, USA. It holds various investments in equity shares and manages corporate cash and investments on behalf of ETFC.

ii) Dilemma of the Managerial Spectrum : The DIT noted the composition of Board of Directors of CAI (about Two Directors), ETFC (10 Directors), ETM (5 Directors) and IlL, before sale of shares by ETM (17 Directors).

iii) The DIT (IT) further noted that certain key personnel from ETFC, USA and group companies were deputed to the Indian Company IlL, including the MD & CEO of Indian Company, who prior to joining IlL was employed with ETFC USA as its Vie-President Finance-Capital Markets and who was also on ETM’s Board for some period. He noted that these key personnel were neither shareholders in ETM nor its employees nor its Directors except one person. The DIT(IT) concluded from these facts that ETFC, the ultimate parent company of ETM, was exercising the rights available to a Shareholder in appointment of Directors in the Indian Company and the management of the Indian company through deputation of its senior managerial personnel. It may be noted that ETM declined to furnish the aforesaid information on the ground that they were not concerned as the matter relates to ETFC whom it did not represent and the DIT(IT) obtained the information from the public domain through Internet and the Indian Company.

iv) Intricacies of the Financial Conundrums: The DIT(IT) noted, observed and concluded as follows:

a) ETM was incorporated in October, 2004. In November, 2004 it entered into Share Purchase Agreements (with 3 Companies) for purchase of share in IlL i.e. from a Mauritian Company, a Japanese Company and IL&FS, aggregating to 48.80 Lakhs shares.

b) IIL, the investee company, was a party to a Share Purchase Agreement under which it undertook to furnish an Annual Certificate to the US parent ETFC under the US tax laws in relation to its status as Passive Foreign Investment Company as per section 1297 of the US Internal Revenue Code.

c) Thereafter, between December 2005 to November 2006, ETM acquired GDRs issued by IlL and thus increased its holding in IlL to 37.67%, which exceeded the holding of the Indian Promoter namely IL&FS of 29.36%. ETM further acquired shares by an open offer increasing its shareholding in IlL to 43.85% at a Total Cost of Rs. 494.38 Crores.

d) The DIT(IT) noted from the Bank Statements of ETM that these funds were contributed either by CAlor ETFC. He further noted that in some cases dividends due to ETM were remitted to E*Trade Securities (HK) Ltd., as an associate company of ETFC.

e) He further analysed the Bank Statements of ETM for the year ended 31.12.2005, 31.12.2006 & 31.12.2007 and based on his analysis he concluded that not only the funds for investments have been completely sourced from the parent companies but even their allocation in the accounts of ETM are not clear and dividends received from IlL have been remitted as reimbursement of excess funds.

f) Accordingly, the DIT (IT) came to a conclusion, that “The Financial element was routed through the Mauritian entities whereas the management of those routed funds invested in the Indian Company was ensured by” deputation of senior key personnel from ETFC and group companies.

g) The DIT(IT) has extracted relevant information from Annual Report of IlL for FY 2004-05, Prospectus dated 13th July, 2005 issued by IlL and Public Announcement of offer to the equity shareholders of IlL by ETFC dated 7th October, 2006 to arrive at an inference that “This ingeniously planned affair appears to have been conceptualised by and between both the Groups i.e. IL&FS, the Indian Promoter Group and E Trade Group, USA in the year 2004 itself when E* Trade made its first investment in the Indian company. The Mauritius subsidiary was set up in October, 2004. Some of the disclosures made in the Annual Report of IlL for the Year 2004-05, in the Prospectus and in the appointments of MD & CEO as well as deputationists indicate and prove this inference.”

h) Based on the above discussions, the DIT(IT) concluded as follows:

“Three issues emerge from the entire discussion above, one which is certain that there existed a Permanent establishment of the parent company, ETFC in terms of Article 5 (2) (l) of the India-US Tax Treaty, and the second one, that whether a permanent establishment of the Mauritian company, ETM existed would depend on further enquiries. It is a fact that Mr. James Leslie Whiteford was director in ETM from October 2004 till May 2008 and was also MD & CEO in I1L from May 2007 to May 2008 when ETM thought to divest its 43.85% stake in IlL. The discussions in respect of the managerial and financial aspects throw light in that direction to some extent. Another situation may emerge where the comingling of assets and management of the Indian company by persons from US company and their activities in India may lead to their carrying on business of the US entity in India and the Mauritian entity is simply a facade. At this moment, the evidence captured indicates such a possibility but more evidence is surely needed to hold so. The fact of direct exercise of rights available to a shareholder and remittance of dividend received from IlL immediately after the receipt thereof coupled with deployment of ETFC’s senior personnel on deputation and with the Board of Directors in the Indian company IlL, is a clear indication for such a possibility.”

4. Taxpayer’s Response

4.1 The taxpayer challenged the inquiries made to ascertain the facts and circumstances by contending that this amounts to exercise of jurisdiction under Section 263 of the Act and not under Section 264. It was asserted that the DIT(IT) can make enquiry only concerning the record of the proceedings which were before the AO and grant relief to the taxpayer in light of the legal position on the subject matter of the revision petition.

4.2 The DIT(IT) repelled the said contention of the tax payer as follows:

a) The High Court had observed that all the contentions available to both the sides are kept open to be raised before the revision authorities;

b) The statutory provisions empower the Revision Authority to make such enquiry or cause such enquiry to be made and pass such order thereon, as he thinks fit. However, the order passed under Section 264 should not be prejudicial to the assessee. Explanation 1 to Section 264 defines what should not be considered as prejudicial to the assessee. There is no mandate in the section that whatever relief is sought for by the assessee must be allowed to him.

(c) The assessee has contended that under Section 264, the revision authority is required to rectify the order of the AO for just and equitable relief. Such a mandate is not discernible from a reading of Section 264 of the Act.

5. Applicability of Circular 789 and Supreme Courts decision in Azadi Bachao Andolan’s case

5.1 The taxpayer’s main argument was that in view of Tax Residency Certificate issued by the Mauritius Revenue Authority, it is a tax resident of Mauritius. Accordingly, it claimed to be entitled to the benefit available under Article 13(4) of the Treaty, as per Circular 789 issued by the CBDT and the judgement of Hon’ble Apex Court in the case of Azadi Bachao Andolan reported in (2003) 263 ITR 706.

5.2 The DIT (IT) repelled the taxpayer’s argument in the following words:

a) “The facts and circumstances discussed above leave the question wide open whether the said Treaty would at all apply here. Assuming for a moment – though not admitting that it is so, it is a fact that Circular 789 was issued to provide that where a Tax Residency Certificate is issued by the Mauritian Revenue Authority, the provision of India-Mauritius Tax Treaty should be given effect to. That situation does not exist in the present case and needs further examination.”

b) “The explanation of the applicant was also called for especially in the context of judgement dated 14th October 2008 of the Hon’ble Apex Court in the case of Commissioner of Central Excise vs. Ratan Melting & Wire Industries 2008 (231) ELT 22 (SC). The applicant, inter alia, replied vide letter dated 15th December 2008 that the above referred decision has no impact or effect on the validity, applicability, and maintainability of the CBDT Circular No 789.”

c) “The moot question is whether India-Mauritius Tax Treaty would apply on the given facts or India-US Tax Treaty would be applicable in the light of overwhelming facts indicative of the ownership of shares resting with the US Company. These complex issues which do not admit solution through doctrinaire or straight jacket formula cannot be decided in these summary proceedings. Since ETM is regularly assessed to tax by the ADIT (IT) -3 (2), Mumbai, these issues can be examined in greater detail in the course of regular assessment and be decided therein.”

6. Decision of the DIT(IT)

6.1 The DIT(IT) citing the following High Court Decisions held that provision of the section 195 of the Act is only for the tentative deduction of income-tax subject to regular assessment and the rights of the parties are, not adversely affected in any manner and that the orders u/s. 195(2)/ 197 are not conclusive and they do not pre-empt the tax department from passing appropriate assessment orders:

a) CIT vs. Tata Engineering and Locomotive Company Limited [2000] 245 ITR 823 (Bom)

b) CIT vs. Elbee Services Private Limited [2001] 247 ITR 109 (Born).

6.2 Based on the above discussions, the DIT(IT) crystallised the following three issues for decision:

1. Whether tax should be deducted from the gross sale consideration received on the sale of shares of the Indian company, IlL by the Mauritian company ETM ?

2. Whether such capital gains are exempt from tax in view of the benefit available under Article 13(4) of the India- Mauritius Tax Treaty in view of Circular 789 issued by CBDT and ratio of the Hon’ble Apex Court in the case of Azadi Bachao Andolan reported in 263 ITR 706?

3. What would be the rate of tax, if the gains are to be taxed ?

6.3 The DIT(IT) decided the above issues as follows:

a) Tax should be deducted from the net amount of capital gains instead of gross sale consideration as adopted by the AO. He thus reversed the direction of the AO on this point and granted partial relief to the taxpayer.

b) It can not be said at this stage that capital gains have arisen to the Mauritian entity, ETM and not to the US entity and much is left to be looked into as apparent does not appear to be real. There are enough flaws, defects and discrepancies in the claim of the applicant which need to be explained by it before the claim of the applicant can be accepted. In view of the same, in so far as this finding of the AO is concerned that capital gains are made by ETFC, at this stage, no interference is called for.

c) Following the Mumbai Tribunal’s decision in the case of BASF Aktiengesellschaft vs. Deputy Director of Income tax (International Taxation) [2007] 12 SOT 451/110 TTJ (MUM.) 741, the DIT (IT) held that proviso to Section 112would not apply in the case of long term capital gains arising on account of sale of shares of a listed company and consequently, the rate of tax on long term capital gains computed under the first proviso to section 48 would be 20 per cent.

d) In view of the above, the DIT(IT) ordered that an amount of Rs. 18.94 lakhs be returned to the taxpayer and a sum of Rs. 24.31 crores be deposited with the AO.

7. Analysis

7.1 It appears that the DIT(IT) has virtually lifted the corporate veil of ETM to ascertain the beneficial ownership of such capital gains and in order to bypass the application of the Indo-Mauritius DTAA. It may be pointed out here that the concept of beneficial ownership is applicable to Article 10 (Dividends) and Article 11 (Interest) and not to Article 13 of the Treaty in respect of Capital Gains.

7.2 The matter will be finally decided by the AO in the regular assessment proceedings wherein the taxpayer would have opportuni ty to furnish all such facts, documents, explanations and legal submissions as may be appropriate in its case and the tax department would also be able to make such further inquiries and collect such further evidence as it may deem necessary. However, the AO is unlikely to adopt a line different from that of his superior. Hence, the matter may be tested in successive appeal proceedings.

7.3 In the meantime, the tax officers, in appropriate cases, are likely to use this precedent, depending upon the facts and circumstances of each case, to deny the benefit of Article 13(4) of the DTAA to Mauritius entities resulting in protracted litigation and it may impact flow of investments through Mauritius.

7.4 In view of this precedent, such investors and their investment and tax advisors would be well advised to take proper precautions to ensure that there is substance in the operations of the Mauritius entities and that financial transactions are routed through Mauritian entities and not directly with other group entities Iaccounts. The recording of the transactions in the books of accounts and their documentation should be done very meticulously and various financial disclosures to various regulatory authorities are well thought out and vetted by the tax advisors.

7.5 It is important to note that from the orders of the High Court it appears that the Taxpayer did not vehemently urge its case based on the CBDT’s Circular No. 789 and the decision of the Supreme Court in Azadi Bachao Andolan’s case (Supra). Had it been so, perhaps the decision of the High Court could have been different, even in a case involving summary proceedings u/s. 1971 195(2).

7.6 The DIT(IT) has relied upon the SC’s decision in the case of Ratan Melting and Wire Industries (Supra) to rebut the tax payer’s reliance upon the aforesaid CBDT Circular No. 789. In Ratan Melting’s case, the SC held that Circulars and instructions issued by the Central Board of Excise and Customs are no doubt binding in law on the authorities under the respective statutes, but when the Supreme Court or the High Court declares the law on the question arising for consideration, it would not be appropriate for the Court to direct that the circular should be given effect to and not the view expressed in a decision of this Court or the High Court. So far as the clarifica tions I circulars issued by the Central Government and State Govern-ments are concerned, they represent merely their understanding of the statutory provisions. They are not binding upon Courts. It is for the Court, and not for the Executive, to declare what the particular provision of a statute says. Further, a circular which is contrary to the statutory provisions has really no existence in law.

The DIT(IT) ought to have appreciated that the legal validity of the said CBDT Circular No. 789 has been upheld by the SC in unequivocal terms in Azadi Bachao Andolan’s case (Supra) and it is not a case where the court has held that the said circular is contrary to the statutory provisions. Thus, in our view, Ratan Melting’s case has no application in respect of the validity and the binding nature of the said Circular No. 789.

7.7 Media reports appearing at the point in time when the said Circular No. 789 was issued, suggest that the same was issued keeping in mind the then prevailing economic conditions, fiscal situation, position of the forex reserves and the need to attract foreign investments into the country, both FDI as well as FII investments. In addition, in view of notices being issued/inquiries being made by the revenue authorities to/with Mauritius-based FIls and investors, a huge hue & cry was made by such investors severely impacting the stock markets adversely as well as the fear of negatively impacting the inflow of the foreign investments into the country leading to issuance of the said circular by the CBDT, probably under political pressure. The veracity of this statement cannot be verified and it is in the realm of speculation.

To ensure that the decision of E*Trade Mauritius’s case does not create uncertainty in the minds of the FIls’ and the Investors coming through Mauritius and such other jurisdictions, it would be perhaps in the fitness of things that Political leadership, Revenue authorities in both the countries, Investors and Tax Advisors put their heads together to find a viable and acceptable solution to the issue. This would help in removing the uncertainties from the minds of the investors and also in avoiding protracted litigation.

7.8 The moot point is whether in respect of a matter which has been concluded and settled by the SC and which under Article 141 of the Constitution becomes the law of the land, is it open to the revenue authorities to reagitate the matter for some reason or the other?

7.9 There is no doubt that the provisions of India Mauritius DTAA have been used for Treaty shopping and may cause loss of revenue. Treaty Shopping has been clearly upheld by the Supreme Court in Azadi Bachao Andolan’s case. A more appropriate course of action would be for the political leadership to take a firm stand in the matter to renegotiate the treaty about which we have been hearing for a long time but there is no real action on the ground.

7.10 In view of the experience in Vodafone’s case and E*Trade Mauritius’s case, the tax payer would be well advised to submit to the tax authorities requisite facts, documents and information during such summary proceedings as well as regular assessment proceedings in order to avoid antagonism and protracted litigation because the tax authorities are now becoming more tech savvy and are able to gather lot of relevant information available in the public domain through Internet or from the filings with the regulatory authorities in domestic/foreign jurisdictions.

Nirav Shah

FEMA — A case study

This case study seeks to explore the complicated FDI regulations applicable when an existing foreign joint venture company in India seeks to establish a new joint venture company jointly with a third foreign venture partner in India. As there can be differing views and more than one solution to an issue, the author seeks comments and feedback from the readers.

1. Facts :

(i) XYZ is an Italy-based manufacturer and seller of premium quality luxury bathroom fittings and accessories.

(ii) ABC, Spain and an Indian business family have established a joint venture company, namely, ABC (India) Pvt. Ltd. in which ABC, Spain holds 75% equity shares and the balance 25% is held by the Indian promoters. The company has obtained due permission of FIPB in 2003 for import and distribution in India of ceramic tiles and sanitaryware products of ABC, Spain on wholesale cash and carry basis and act as their indenting agents in India.

(iii) It is desired to establish a new JV company in India jointly with XYZ, Italy, ABC Spain and the Indian promoters. The business of the new JV company shall be to import and distribute in India, on wholesale cash and carry basis, various products of XYZ, Italy, whether manufactured in Italy or by XYZ’s subsidiaries, joint ventures and associates worldwide and also to act as XYZ’s indenting agents in India. The new JV company shall also procure and sell, on wholesale cash and carry basis, such other ancillary products from Indian manufacturers/dealers or from other overseas parties as may be permissible in law. The shareholding pattern is subject to negotiations between the parties.

(iv) Alternatively, ABC (India) Pvt. Ltd. may invest in the equity capital of the proposed new JV company. Thus, the existing JV company, namely, ABC (India) Pvt. Ltd. may be a partner in the new JV company along with XYZ, Italy.

2. Issues :

In this connection, the following issues arise for consideration :

(i) Whether FIPB’s permission is required for setting up such a new joint venture company ?

(ii) What are the implications in terms of Press Note No. 1 (2005 series), dated 12-1-2005 ?

(iii) Which is the preferable mode of investment — Whether ABC (India) Pvt. Ltd. should have a stake in the proposed new JV company or ABC, Spain and the Indian promoters should hold direct equity stake in the proposed new JV company ?

(iv) What are the tax implications ?

3. Analysis of legal provisions :

On analysis and consideration of Press Note 1 of 2005, dated 12-1-2005, Press Note 3 of 2005, dated 15-3-2005, Press Note 7 of 2008, dated 16-6-2008, and Press Note 2 (2009 series), dated 13-2-2009 and Press Note 4 (2009 series), dated 25-2-2009, the following conclusions emerge :

3.1 Whether FIPB’s permission required :

(a) Item No. 29 (a) of Press Note 7 of 2008, dated 16-6-2008 clearly states that wholesale trading on cash and carry basis is allowed under automatic route up to 100% foreign equity. In view of the same, the proposed new JV company can engage in wholesale trading on cash and carry basis without FIPB permission.

(b) However, trading of items sourced from ‘Small Scale Sectors’ would require FIPB’s approval. Thus, the proposed JV company cannot procure and sell such items sourced from SSI Units without FIPB’s approval. It appears that this condition is applicable only to those items which are reserved for manufacture by small scale sectors. Therefore, this point needs to be looked into with reference to Industrial Policy for small scale sector. If the product does not fall in the reserved product list of small scale sector, the same can be procured locally without FIPB approval and can be further traded on wholesale cash and carry basis in India.

3.2 Implications in terms of Press Note No. 1 of 2005 :

The next issue arises whether FIPB’s permission is required by the proposed new JV company in view of the fact that ABC, Spain, already has an existing JV company in India, as noted above. The matter has to be examined in light of Press Note # 1 of 2005, dtd. 12-1-2005 r/w Press Note # 3, dtd. 15-3-2005.

3.2.1 The operative part of Press Note 1 issued by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India is reproduced below :

“Guidelines pertaining to approval of foreign/technical collaborations under the automatic route with previous ventures/tie-ups in India.

Press Note No. 1 (2005 Series), dated 12-1-2005

The Government has reviewed the guidelines notified vide Press Note 18 (1998 series) which stipulated approval of the Government for new proposals for foreign investment/technical collaboration where the foreign investor has or had any previous joint venture or technology transfer/trademark agreement in the same or allied field in India.

2. New proposals for foreign investment/technical collaboration would henceforth be allowed under the automatic route, subject to sectoral policies, as per the following guidelines :

(i) Prior approval of the Government would be required only in cases where the foreign investor has an existing joint venture or technology transfer/trademark agreement in the ‘same’ field. The onus to provide requisite justification as also proof to the satisfaction of the Government that the new proposal would or would not in any way jeopardise the interests of the existing joint venture or technology/trademark partner or other stakeholders would lie equally on the foreign investor/technology supplier and the Indian partner.

(ii) Even in cases where the foreign investor has a joint venture or technology transfer/trademark agreement in the ‘same’ field, prior approval of the Government will not be required in the following cases :

(a) Investments to be made by Venture Capital Funds registered with the Securities and Exchange Board of India (SEBI); or

b) Where in the existing joint venture investment by either party is less than 3%; or

c) Where the existing venture/collaboration is defunct or sick.

iii) Insofar as joint ventures to be entered into after the date of this Press Note are concerned, the joint venture agreement may embody a ‘conflict of interest’ clause to safe-guard the interests of joint venture partners in the event of one of the partners desiring to set up another joint venture or a wholly-owned subsidiary in the ‘same’ field of economic activity.”

3.2.2 The term ‘same field’ has been clarified by the Government of India in Press Note No. 3 of 2005 series as under :

“Subject: Clarification regarding guidelines pertaining to approval of foreign/technical collaborations under the automatic route with previous ventures/tie-ups in India.

1. The Government, vide Press Note 1 (2005 Series), dated 12-1-2005, notified fresh guidelines for approval of new proposals for foreign/technical collaboration under the automatic route with previous venture/tie up in India. According to these guidelines, prior approval of the Government would be required for new proposals for foreign investment/ technical collaboration, in cases where the foreign investor has an existing joint venture or technology transfer / trademark agreement in the same field in India.

2. The Government had, earlier vide Press Note (1999 Series) notified the definition of ‘same field’ as the 4-digit National Industriai Classification (NIC) 1987 Code. It is hereby reiterated that for the purposes of Press Note 1 (2005 Series), the definition of ‘same’ field would continue to be 4-digit NIC 1987 Code.

3. It is also clarified that proposals in the information technology sector, investments by multi-national financial institutions and in the mining sector for same area/mineral were exempted from the application of Press Note 18 (1998 series) vide Press Note 8 (2000), Press Note 1 (2001) and Press Note 2 (2000), respectively. Investment proposals in these sectors would continue to be exempt from Press Note 1 (2005 series).

4. From Para 2(i) of guidelines notified vide Press Note 1 (2005 series), it is clear that prior Government approval for new proposals would be required only in cases where foreign investor has an existing joint venture, technology transfer / trademark agreement in ‘same’ field, subject to provisions of Para 2(ii) of Press Note 1 (2005 series).

5. For the purpose of avoiding any ambiguity, it is reiterated that joint ventures, technology transfer / trademark agreements existing on the date of issue of the said Press Note i.e., 12-1-2005 would be treated as existing joint venture, technology transfer / trademark agreement for the purposes of Press Note 1 (2005 Series).”

3.2.3 On reference to National Industrial Classification (NIC), 1987 Code it is found that the products of proposed new JV company have different NIC Code. In other words, the NIC Code allotted to tiles and sanitarywares is completely different from the NIC Code allotted to bathroom and toilet fittings and accessories. In view of the same, the proposed new JV company would not be required to obtain prior approval of FIPB in terms of the said Press Note 1 r /w Press Note 3 of 2005.

3.3 Preferable mode of investment:

To determine the preferable mode of investment we have to understand the applicability of Press Notes – 2 and 4 of 2009.

The opening Para of Press Note # 4 (2009 series), dated 25-2-2009 reads as under:

“The Policy for downstream investment by Indian companies seeks to lay down and clarify about compliance with the foreign investment norms on entry route, conditionalities and sectoral caps. The ‘guiding principle’ is that downstream investment by companies ‘owned’ or ‘controlled’ by non-resident entities would require to follow the same norms as a direct foreign investment i.e., only as much can be done by way of indirect foreign investment through downstream investment in terms of Press Note 2 (2009 series) as can be done through direct foreign investment and what can be done directly can be done indirectly under the same norms.”

3.3.1 While issuing Press Note 2 and Press Note 4 of 2009 series as aforesaid, the Government was aware of Press Note 1 of 2005, dated 12-1-2005 r / w Press Note 3 of 2005, dated 15-3-2005. In spite of that, Press Note 4 allows an operating Indian Company to invest in another downstream Indian Company by way of Indirect Foreign Investment without any reference or requirement to comply with Press Note 1 of 2005. Probably, the understanding is that the existing Indian JV partner also becomes an interested party in the downstream investment and his interest is in no way jeopardised which is the purpose and rationale of aforesaid Press Note 1 of 2005 r /w Press Note 3 of 2005.

3.3.2 Therefore, it appears that it would be in order for ABC (India) Pvt. Ltd. to acquire an Equity Holding in proposed new JV company with XYZ, Italy without attracting aforesaid Press Note 1 of 2005 and thus it would not require FIPB’s prior approval.

3.3.3 In this connection, attention is invited to Para-graphs 4, 5 and 6 of Press Note 4 of 2009 series, dated 25-2-2009 reproduced below:

“4.0 Guidelines for downstream investment by investing Indian companies’ owned or controlled by non-resident entities’ as per Press Note 2 of 2009 : Recognising the need to bring in clarity into the Policy for downstream investment by investing Indian companies, the Govt. of India now proposes to clarify the policy in this regard.

4.1 The Policy on downstream investment comprises policy for (a) only operating companies (b) operating-cum-investing companies (c) only investing companies.

4.2 The Policy in this regard will be as below:

4.2.1 Only operating companies: Foreign investment in such companies would have to comply with the relevant sectoral conditions on entry route, conditionalities and caps with regard to the sectors in which such companies are operating.

4.2.2 Operating-cum-investing companies: Foreign in-vestment into such companies would have to comply with the relevant sectoral conditions on entry route, conditionalities and caps with regard to the sectors in which such companies are operating. Further, the subject Indian companies into which downstream investments are made by such companies would have to comply with the relevant sectoral conditions on entry route, conditionalities and caps in regard of the sector in which the subject Indian companies are operating.

4.2.3 Investing companies: Foreign investment in investing companies will require prior Government/FIPB approval, regardless of the amount or extent of foreign investment. The Indian companies into which downstream investments are made by such investing companies would have to comply with the relevant sectoral conditions on entry route, conditionalities and caps in regard of the sector in which the subject Indian companies are operating.

5.0 For companies which do not have any operations and also do not have any downstream investments, for infusion of foreign investment into such companies, Government/FIPB approval would be required, regardless of the amount or extent of foreign investment. Further, as and when such company commences business(s) or makes downstream investment it will have to comply with the relevant sectoral conditions on entry route, conditionalities and caps.

6.0 For operating-cum-investing companies and investing companies (Para 4.2.2, 4.2.3) and for companies as per Para 5.0 above, downstream investments can be made subject to the following conditions:

a) Such company is to notify SIA, DIPP and FIPB of its downstream investment within 30 days of such investment even if equity shares/CCPS/ CCD have not been allotted along with the modality of investment in new /existing ventures (with/without expansion programme);

b) downstream investment by way of induction of foreign equity in an existing Indian company to be duly supported by a resolution of the Board of Directors supporting the said induction as also a shareholders agreement if any;

c) issue/transfer/pricing/valuation of shares shall be in accordance with applicable SEBI/RBI guidelines;

d) Investing companies would have to bring in requisite funds from abroad and not leverage funds from domestic market for such investments. This would, however, not preclude downstream operating companies to raise debt in the domestic market.”

3.3.4 Thus, ABC (India) Pvt. Ltd. will have to notify SIA, DIPP and FIPB of its downstream investment within 30 days of such investment in terms of Para 6(a) of the aforesaid Press Note-4.

The issue arises whether ABC (India) Pvt. Ltd. should have an equity stake in the proposed JV company or ABC, Spain and the Indian promoters should hold direct equity stake in the proposed new JV company. As discussed above, in terms of FDI Policy, both options are equally open. In other words, FIPB permission is not required in terms of Press Note 1 and 3 of 2005, whatever may be the mode of investment. However, on tax consideration as discussed below, investment by ABC (India) Pvt. Ltd. would not be advisable.

3.4 Tax considerations:

3.4.1 Under Indian Tax Laws all companies registered in India, whatever be the nature of activities and extent of public participation or foreign share-holding, are liable to tax at the same rate of taxation. Only foreign companies operating in India through a branch are liable to tax in India at a higher rate since they are not liable to pay Dividend Distribution Tax.

3.4.2 When structuring the shareholding pattern, one has to keep in mind the Dividend Distribution Tax levied u/s.115-0. All Indian companies have to pay Dividend Distribution Tax @ 15% +Surcharge thereon + Education Cess (amounting to 16.995%) on the amount of dividend paid in addition to the normal Income-tax liability. If the equity shares in the proposed JV company are held by ABC (India) Pvt. Ltd., it would involve double payment of Dividend Distribution Tax – once when the proposed new JV company declares dividend in future and second time when ABC (India) Pvt. Ltd. declares dividend out of such dividend income.

3.4.3 As ABC (India) Pvt. Ltd. is a subsidiary of ABC, Spain, it would be liable to pay such Dividend Distribution Tax in terms of S. 115-0(lA) reproduced below, which is self explanatory.

“Special provisions relating to tax on distributed profits of domestic companies

Tax on distributed profits of domestic companies.

115-0. (1) Notwithstanding anything contained in any other provision of this Act and subject to the provisions of this Section, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount declared, distributed or paid by such company by way of dividends (whether interim or otherwise) on or after the 1st day of April, 2003, whether out of current or accumulated profits shall be charged to additional income-tax (hereafter referred to as tax on distributed profits) at the rate of fifteen per cent.

(1A) The amount referred to in Ss.(l) shall be reduced by the amount of dividend, if any, received by the domestic company during the financial year, if:

a) such dividend is received from its subsidiary;

b) the subsidiary has paid tax under this section on such dividend; and

c) the domestic company is not a subsidiary of any other company:

Provided that the same amount of dividend shall not be taken into account for reduction more than once.

Explanation – For the purposes of this sub-section, a company shall be a subsidiary of another company, if such other company holds more than half in nominal value of the equity share capital of the company.”

3.7 Ancillary issues:

3.7.1 The proposed new JV company will have to comply with Transfer Pricing Regulations in respect of business dealings with XYZ, Italy and ABC, Spain.

3.7.2 The proposed new JV company will have to comply with all the formalities with RBI through the authorised dealer within 30 days of the receipt of remittance and within 30 days of allotment of shares, as the case may be. It may be noted that RBI is levying heavy Compounding Fees for any delay in filing the relevant forms and intimations.

3.7.3 The JV company should ensure to obtain ‘In-ward Remittance Certificate’ from the bankers in respect of such foreign remittances received with correct and clear mention of the sender and purpose of the remittance.

4. Summation:

The above discussion and reply to queries may be summarised as follows:

4.1 The new joint venture company with XYZItaly can engage in import and distribution of XYZ’s products in India on wholesale cash and carry basis without requiring prior permission of FIPB as such activities are permitted under automatic route on wholesale cash and carry basis.

4.2 Press Note 1 of 2005 r /w Press Note 3 of 2005 are not attracted as NIC Code of both the products dealt by ABC (India) Pvt. Ltd. and proposed new JV company are different.

4.3 Both the modes of investment in JV company are permissible in Law. In other words, ABC (India) Pvt. Ltd. can have an equity stake in the JV company or ABC, Spain and the Indian promoters can hold direct equity stake in the proposed JV company. However, direct holding by ABC, Spain and the Indian promoters would be preferable in view of tax considerations.

4.4 In view of possible double taxation of dividends by way of Dividend Distribution Tax, shareholding by ABC (India) Pvt. Ltd. in the proposed new JV company would not be advisable.

5. Concluding remarks:

The FDI regulations in India have been amended from time to time by various Notifications and Circulars issued by RBI and various Press Notes issued by concerned Ministries in New Delhi. As a result, the FDI regulations have become such a maze that a foreign investor or his local business partner cannot find his way through the maze without the help of experts. Recent Press Notes 2, 3 and 4 of 2009 have further complicated the web of regulations. The matter is further complicated for an investor by the differing and contrary interpretations adopted by the RBI and the concerned ministry on some issues. If FDI in India is to be encouraged, it is high time that a single policy document be issued in lieu of all previous Notifications, Circulars and Press Notes.

Nirav Shah

Taxability of Professional Fees Payable to a Head-Hunting Company in USA — A case study

In a series of articles published in this Journal (November, 2009 to March, 2010) the concept of ‘Make Available’ used in the article in the Tax Treaties relating to ‘Fees for Technical Services (FTS)’ or ‘Fees for Included Services (FIS)’ has been discussed and analysed. We have also analysed in brief, Indian judicial decisions dealing with the subject and provided relevant information regarding all Indian DTAAs and related aspects and issues dealing with the subject. In this case study, we have sought to illustrate application of this concept.

1. Facts of the case :

1.1 An educational foundation established by a leading Indian industrialist is in the process of setting up a world-class educational complex/university to provide cutting-edge higher education in all streams of physical sciences, technology, medicine and management services.

1.2 The foundation has engaged a consultant in the USA to conduct a search for the Vice-Chancellor for the University and to locate, screen, interview and present qualified candidates for this position in the foundation.

1.3 The main financial terms and conditions of the contract are as follow :

Professional fees :

The consultant works on a retainer arrangement. The minimum retainer fee for this assignment will be $ 1,50,000. The fee will be invoiced in four instalments.

Engagement expenses :

The consultant will also be reimbursed for direct and indirect expenses (‘Reimbursable Expenses’), which are invoiced on a monthly basis.

Direct expenses are costs associated with the candidate development, interview and overall selection process.

Examples include candidate’s travel, consultants’ travel to meet with the client and to interview candidates, project-specific advertising and mailing costs. Indirect expenses are costs that are attributable to client projects as incremental costs, but are not possible to be attributed to each individual project. Examples include com unications, courier and external database research costs.

1.3 The consultant is a company incorporated in the USA and is a Tax Resident of USA and that it does not have a Permanent Establishment in India.

2. Issues for consideration :

In the context of deducting tax at source from payment of Professional Fees to the consultant and reimbursement of expenses, the major issues for our consideration are as follows :

(a) Whether the Professional Fees payable under the contract constitute ‘Fees for Included Services’ (FIS) as defined in Article 12(4) & (5) of the Double Taxation Avoidance Agreement (DTAA) with the USA ?

(b) Whether the said Professional Fees payable are taxable as ‘Business Profits’ under Article 7 read with Article 5 of the DTAA with the USA ? In other words, whether service activities of the consultant constitute a Service PE in term of Article 5(2)(l) of the India-USA DTAA ?

3. Analysis and observations :

3.1 Fees for Included Services — Meaning thereof :

The DTAA with the USA uses the term ‘Fees for Included Services’ (FIS), whereas other tax treaties use the term ‘Fees for Technical Services’ (FTS); both terms essentially relate to rendering of technical services. However, the term FIS has been defined differently in the India-USA DTAA when compared with the definition of the term FTS as used/defined in other tax treaties.

3.2 Definition of FIS in Tax Treaty with USA :

The term FIS has been defined in Article 12(4). Paragraphs (4), (5) and (6) of Article 12 of the India-USA DTAA are reproduced below :

Article 12 — Royalties and fees for included services

3. The term ‘royalties’ as used in this article means :

(a) …………………

(b) …………………

4. For purposes of this article, ‘fees for included services’ means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services?:

b. are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3 is received; or

a. make available technical knowledge, experience, skill, know-how or processes, or consist of the development and transfer of a technical plan or technical design.

5. Notwithstanding paragraph 4, ‘fees for included services’ does not include amounts paid:
a. for services that are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property other than a sale described in paragraph 3(a);

        b. for services that are ancillary and subsidiary to the rental of ships, aircraft, containers or other equipment used in connection with the operation of ships or aircraft in international traffic;
    c. for teaching in or by educational institutions;
        d. for services for the personal use of the individual or individuals making the payment; or
        e. to an employee of the person making the payments or to any individual or firm of individuals (other than a company) for professional services as defined in Article 15 (Independent Personal Services).

6. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties or fees for included services, being a resident of a Contracting State, carries on business in the other Contracting State, in which the royalties or fees for included services arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the royal-ties or fees for included services are attributable to such permanent establishment or fixed base. In such case the provisions of Article 7 (business profits) or Article 15 (Independent Personal Ser-vices), as the case may be, shall apply.

     7.   (a)
        (b)

8. …………………

3.3 Extract from the Memorandum of Understanding dated 15th May, 1989:

The Governments of India and the USA have signed a Memorandum of Understanding intended to give guidance in interpreting various aspects of Article 12 relating to the scope of ‘included services’ i.e., paragraph 4 of Article 12. We reproduce below the relevant extracts from the said MOU. Various examples given in the MOU have not been reproduced here as the same are different from the facts of the case and therefore, not relevant.

Memorandum of understanding concerning fees for included services in Article 12

Paragraph 4 (in general):

This memorandum describes in some detail the category of services defined in paragraph 4 of Article 12 (Royalties and Fees for Included Services). It also provides examples of services intended to be covered within the definition of included services and those intended to be excluded, either because they do not satisfy the tests of paragraph 4, or because, notwithstanding the fact that they meet the tests of paragraph 4, they are dealt with under paragraph 5. The examples in either case are not intended as an exhaustive list but rather as illustrating a few typical cases. For ease of understanding, the examples in this memorandum describe U.S. persons providing services to Indian persons, but the rules of Article 12 are reciprocal in application.

Article 12 includes only certain technical and con-sultancy services. By technical services, we mean in this context services requiring expertise in a technology. By consultancy services, we mean in this context advisory services. The categories of technical and consultancy services are to some extent overlapping because a consultancy service could also be a technical service. However, the category of consultancy services also includes an advisory service, whether or not expertise in a technology is required to perform it.

Under paragraph 4, technical and consultancy services are considered included services only to the following extent?: (1) as described in paragraph 4(a), if they are ancillary and subsidiary to the application or enjoyment of a right, property or information for which a royalty payment is made; or (2) as described in paragraph 4(b), if they make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design. Thus, under paragraph 4(b), consultancy services which are not of a technical nature cannot be included services.

Paragraph 4(a):

Paragraph 4(a) of Article 12 refers to technical or consultancy services that are ancillary and subsidiary to the application or enjoyment of any right, property, or information for which a payment described in paragraph 3(a) or is received. Thus, paragraph 4(a) includes technical and consultancy services that are ancillary and subsidiary to the application or enjoyment of an intangible for which a royalty is received under a licence or sale as described in paragraph 3(a), as well as those ancillary and subsidiary to the application or enjoyment of industrial, commercial, or scientific equipment for which a royalty is received under a lease as described in paragraph 3(b).

It is understood that in order for a service fee to be considered ‘ancillary and subsidiary’ to the application or enjoyment of some right, property, or information for which a payment described in paragraph 3(a) or (b) is received, the service must be related to the application or enjoyment of the right, property or information. In addition, the clearly predominant purpose of the arrangement under which the payment of the service fee and such other payment are made must be the application or enjoyment of the right, property, or information described in paragraph 3. The question of whether the service is related to the application or enjoyment of the right, property, or information described in paragraph 3 and whether the clearly predominant purpose of the arrangement is such application or enjoyment must be determined by reference to the facts and circumstances of each case. Factors which may be relevant to such determination (although not necessarily controlling) include:

1. the extent to which the services in question facilitate the effective application or enjoyment of the right, property, or information described in paragraph 3;

2. the extent to which such services are customarily provided in the ordinary course of business arrangements involving royalties described in paragraph 3;

3. whether the amount paid for the services (or which would be paid by parties operating at arm’s length) is an insubstantial portion of the combined payments for the services and the right, property, or information described in paragraph 3;

4. whether the payment made for the services and the royalty described in paragraph 3 are made under a single contract (or a set of related contracts); and

5. whether the person performing the services is the same person as, or a related person to, the person receiving the royalties described in paragraph 3 (for this purpose, persons are considered related if their relationship is described in Article 9 (Associated Enterprises) or if the person providing the service is doing so in connection with an overall arrangement which includes the payer and recipient of the royalties).

To the extent that services are not considered ancillary and subsidiary to the application or enjoyment of some right, property, or information for which a royalty payment under paragraph 3 is made, such services shall be considered ‘included services’ only to the extent that they are described in paragraph 4(b).

Paragraph 4(b):

Paragraph 4(b) of Article 12 refers to technical or consultancy services that make available to the person acquiring the service technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design to such person. (For this purpose, the person acquiring the service shall be deemed to include an agent nominee, or transferee of such person.) This category is narrower than the category described in paragraph 4(a), because it excludes any service that does not make technology available to the person acquiring the service. Generally speaking, technology will be considered ‘made available’ when the person acquiring the service is enabled to apply the technology. The fact that the provision of the service may require technical input by the person providing the service does not per se mean that technical knowledge, skills, etc., are made available to the person purchasing the service, within the meaning of paragraph 4(b). Similarly, the use of a product which embodies technology shall not per se be considered to make the technology available”.

(Emphasis supplied)

3.4 In view of the above, in our opinion, the Professional Fees payable to the consultant do not satisfy the requirements of either clause or clause (b) of Article 12(4) as above and therefore the Professional Fees payable by the foundation to the consultant do not constitute FIS under Article 12(4) of the India-USA DTAA.

3.5 Thus, we are of the opinion that professional fees payable by the foundation to the consultant do not constitute FIS as defined in Article 12(4) of the India-USA DTAA. We may, however, add that the same would constitute Fees for Technical Services (FTS) u/s.9(1)(vii) of the Income-tax Act, but in view of S. 90(2) of the Act, the Foundation has the option to be governed by the provisions of the Tax Treaty, if the same are more beneficial.

However, though the payment would not constitute FIS, one has to consider whether the payment would be taxable as Business Profits. We shall discuss the issue in the following paragraphs.

3.6 Whether the consultant’s activities in India would constitute a Service PE :

    Article 5 of the DTAA defines the term ‘Permanent Establishment’ as under :
    “Article 5 — Permanent Establishment
    1.   For the purposes of this Convention, the term ‘permanent establishment’ means a fixed place of business through which the business of an enterprise is wholly or partly carried on.
    2.   The term ‘permanent establishment’ includes especially :
    (a) a place of management;
    (b) a branch;
    (c) an office;
    (d) a factory;
    (e) a workshop;
    (f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources;
    (g) a warehouse, in relation to a person providing storage facilities for others;
    (h) a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on;
    (i) a store or premises used as a sales outlet;
    (j) an installation or structure used for the exploration or exploitation of natural resources, but only if so used for a period of more than 120 days in any twelve-month period;
    (k) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities (together with other such sites, projects or activities, if any) continue for a period of more than 120 days in any twelve-month period;
    (l) the furnishing of services, other than included services as defined in Article 12 (royalties and fees for included services), within a Contracting State by an enterprise through employees or other personnel, but only if :
    (i) activities of that nature continue within that State for a period or periods aggregating to more than 90 days within any twelve-month period; or
    (ii) the services are performed within that State for a related enterprise [within the meaning of paragraph 1 of Article 9 (associated enterprises)].
    3.   Notwithstanding the preceding provisions of this article, the term ‘permanent establishment’ shall be deemed not to include any one or more of the following :
      (a) the use of facilities solely for the purpose of storage, display, or occasional delivery of goods or merchandise belonging to the enterprise;
      (b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or occasional delivery;
      (c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
         (d)     the    maintenance    of    a    fixed    place    of    business
    solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise;
         (e)     the    maintenance    of    a    fixed    place    of    business
    solely for the purpose of advertising, for the supply    of    information,    for    scientific    research    or    for other activities which have a preparatory or    auxiliary    character,     for     the    enterprise.

4. Not relevant

5. Not relevant

      6. Not relevant”
    What is relevant for our purposes is Clause (l) of paragraph 2 of Article 5. All the Professional Services will be rendered in/from the USA, and, the con-sultant’s visits to India in this connection are not likely to exceed 90 days in a year. In other words, the professional activities of the consultant to the foundation would be for less than 90 days within 12-month period. The payee company does not appear to be covered under any other paragraph of Article 5 of the treaty. Therefore, the service activities of the consultant would not constitute a PE in India within the meaning of Article 5, and therefore, the professional fees receivable by the consultant, would not be taxable as Business Profits under Article 7 of the Tax Treaty.

    3.7    In view of the above, the foundation need not deduct any TDS from payment of Professional Fees to the consultant.

4. Reimbursement of expenses:

Reimbursement of expenses will stand on the same footing as payment of Professional Fees. In view of discussion in paragraphs 3.1 to 3.8, the foundation need not deduct any TDS from reimbursement of various expenses under the said Contract.

5. Precautions:

The foundation should obtain a Tax Residency Certificate from the consultant to the effect that it is a tax resident of the USA in terms of Article 4 of India-USA DTAA to ensure that it is eligible to access the India-USA DTAA and that it does not have and is not likely to have a Permanent Establishment in India under Article 5 of the Treaty.

6. Summation:

We wish to reiterate that the concept of ‘make available’ is still continuously subject to judicial scrutiny under different circumstances and in respect of various kinds of services. In some cases, there are conflicting/differing views and in some cases the concept has not been considered/applied while examining the taxability of the payment of FIS/FTS. As the law is not yet settled, continuous and ongoing monitoring and study of various judicial pronouncements would be necessary for the proper understanding and practical application of the concept in practice.

Nirav Shah

Limitation of Benefits Articles – Concept and its Application in Indian Tax Treaties

1. Introduction :

1.1 While making cross-border investments, a tax-payer usually looks forward to, among others, the following objectives :

(a) protection against double taxation;

(b) achieving certainty in respect of quantum of tax liability, including withholding taxes;

(d) hassle-free tax regulatory environment.

1.2 For achieving the above objectives, many a time appropriate tax treaties are used. Taking advantage of the Double Taxation Avoidance Agreement (DTAA) between two countries by a resident of third country is known as treaty shopping.

Of late, the tax authorities have expressed apprehensions on misuse of tax treaties, whether by way of treaty shopping or otherwise. As a result of the problems created by treaty shopping, strong views are expressed that a tax treaty should not facilitate tax avoidance and therefore, the common practice of treaty shopping should be restrained by incorporating various safeguards.

1.3 There has been a conscious attempt on the part of various countries to incorporate the concept of ‘Limitation of Benefits’ (LOB) in tax treaties, to ensure that their tax base is not eroded by foreign companies taking advantage of tax treaty network by way of treaty shopping, etc. Thus, the concept of LOB assumes lot of significance while studying and interpreting the international tax treaties.

1.4 The Supreme Court (SC) in Union of India v. Azadi Bachao Andolan, (263 ITR 706), observed as under :

“. . . . if it was intended that the national of a third state should be precluded from the benefits of Double Taxation Avoidance Convention, then a suitable term of limitation to that effect should have been incorporated therein . . . . The appellants rightly contend that in the absence of a limitation clause, such as the one contained in Article 24 of the Indo-U.S. Treaty, there are no disabling or disentitling conditions under the Indo-Mauritius Treaty prohibiting the resident of third nation from deriving benefits thereunder . . . . .”

Thus, the SC decision in Azadi Bachao appears to be a catalyst for India to take note and insist on the LOB clause in its tax treaties.

2. Meaning and Concept of Limitation of Benefits :

2.1 The terms ‘Limitation on Benefits’ or ‘Limitation of Benefits’ or ‘Limitation of Relief’ as are used in tax treaties, are generally not defined under the international tax treaties. At times, the relevant Articles/Clauses may not also be titled as such. The LOB provisions are intended to prevent treaty shopping, whereby an entity can be established without any economic connection, so that access can be had and thereby the benefits of treaty obtained. The LOB prevents treaty shopping and thus tax avoidance by denying treaty benefits to unintended beneficiaries who channel their investments through entities formed in a treaty country without being the resident thereof. The concept underlying such a provision is that a contracting state should accord treaty benefits only if the recipient of income has sufficient nexus with the other contracting state.

2.2 The IBFD International Tax Glossary defines the term ‘Limitation on Benefits Provision’ as under :

“Provision which may be included in a tax treaty to prevent treaty shopping e.g., through the use of a conduit company. Such provisions may limit benefits to companies which have a certain minimum level of local ownership (‘look-through approach’), deny benefits to companies which benefit from a privileged tax regime (‘exclusion approach’) or which are not subject to tax in respect of the income in question (‘subject-to-tax approach’), or which pay on more than a certain proportion of the income in tax-deductible form (‘channel approach’ or ‘base erosion rule’) . . . .”

2.3 From the above definition, it is apparent that LOB provisions are included in the tax treaties mainly to put restriction on availment of treaty benefits by a conduit company or an entity formed for the purposes of treaty shopping. However, the concept of LOB could also include the following :

(a) Look-through approach : Such provisions may limit benefits to companies which have certain minimum level of local ownership. Treaty benefit may be denied to a company not owned, directly or indirectly by residents of a state of which the company is resident.

(b) Subject-to-tax approach : Such provision may deny benefits to companies which are not subject to tax in respect of the income in question in the state of residence. Treaty benefits in the state of source are granted if the income in question is subject to tax.

(c) Channel approach : The provisions may deny benefits to companies which pay more than a certain percentage of the income in tax-deductible form to non-qualified entities. The treaty benefits could be denied if substantial interest in the company is owned by the residents of a third country and more than 50% of the income is used to satisfy claims by such persons.

(d) Exclusion approach : Such provisions may include denying treaty benefits (such as dividends, interest or capital gains) to specific type of companies enjoying tax privileges in the state of residence.

(e) Specific condition to be fulfilled with respect to exemption from particular category of income e.g., the Protocol to the India–Singapore DTAA provides for specific condition to be fulfilled by an entity for claiming exemption from capital gains tax in the source country.

(f) Specific LOB Articles dealing in general with conduit entities or treaty shopping or entities attempting to claim double non-taxation e.g., Indian DTAAs with countries such as UAE, Namibia, Kuwait, Saudi Arabia contain specific LOB Articles dealing in general with the treaty shopping or double non-taxation.

(g)OECD Model Convention in Article 10(2)(a) relating to concessional rate of tax on dividends in case of companies, provides for beneficial ownership of the minimum threshold percentage of the capital of the company paying the dividends. Many DTAAs entered into by India contain such clauses with varying threshold limits. Similarly, the interest and royalties and fees for Technical Services Articles restrict the benefit of lower rate of tax provided in those articles to only ‘beneficial owner’ of the respective incomes.

3. LOB Articles in the Model Conventions:

3.1 The OECD and UN Model Conventions do not contain separate Article in respect of LOB clause.

However, Commentary on OECD Model Tax Convention, July, 2008 update in para 20 on page 54, under Commentary on Article 1 provides as under:

“20. Whilst the preceding paragraphs identify different approaches to deal with conduit situations, each of them deals with a particular aspect of the problem commonly referred to as ‘treaty shopping’. States wishing to address the issue in a comprehensive way may want to consider the following example of detailed limitation-of-benefits provisions aimed at preventing persons who are not resident of either contracting states from accessing the benefits of a Convention through the use of an entity that would otherwise qualify as a resident of one of these states, keeping in mind that adaptations may be necessary and that many states prefer other approaches to deal with treaty shopping:………..”

Thus, in para 20 of Commentary on Article I, the OECD has given example of detailed limitation of benefits provisions, which the states may adopt.

3.2 Article 22 of the United States Model Income-tax Convention of November 15,2006 contains separate article in respect of limitation on benefits. United States Model Technical Explanation accompanying the United States Model Income-tax Convention of November IS, 2006 gives detailed explanation and examples in respect of LOB Article. The reader would greatly benefit by going through the said explanation and examples in this regard. Article 24 of the India-US DTAA contains the provisions relating to limitation on benefits.

4. LOB Clauses in Indian Tax Treaties:

4.1 At present 8 DTAAs entered into by India with Armenia, Iceland, Namibia, Kuwait, Saudi Arabia, Singapore, USA and UAE contain separate articles in respect of LOB.

In addition, India’s recent treaties with Mexico (signed on September, 10, 2007) and Luxemburg (signed on June 2, 2008) contain LOB Articles, although both the treaties are yet to be notified by the Government of India.

4.2 The text of the relevant LOB Articles in the above-mentioned 8 DTAAs, is given below for ready reference .

Conclusion:

Nirav Shah

Concept of ‘Beneficial Owner’ in Tax Treaties — Analysis of Canadian Tax Courts’ decision in case of Prévost Car Inc. v. Her Majesty the Queen, 2008 TCC 231 (Part II)

International Taxation

In Part I of the article published in July, 2008 issue of the
Journal, we discussed the facts of the case, the position in law as per the Tax
Treaty and OECD Model Convention and the evidence of 3 International Tax
Experts. In this part, we shall discuss the analysis, observations and
conclusions of the Canadian Tax Court.

4. Analysis and observations by the Court :

(i) The term ‘beneficial owner’ is not unique to the Tax
Treaty; it is found in 85 of Canada’s 86 tax treaties. Only Canada’s treaty with
Australia uses the term ‘beneficially entitled’.

(ii) The evidence of Professor van Weeghel is that the
Netherlands recognises PHB.V. as beneficial owner of Prévost’s dividends.
Professor Raas suggests the same. The Revenue contends that Volvo and Henlys,
the shareholders, are the beneficial owners of the dividends.

(iii) The terms ‘beneficial owner’, ‘beneficially owned’ and
‘beneficial ownership’ are found in the English version of the Canadian
Income-tax Act. As the judge mentioned earlier, these terms are not defined in
the Canadian Income-tax Act.

The Revenue maintains that there is no meaning of the terms
‘beneficial ownership’ and ‘bénéficiaire effectif’ for the purposes of the Act
which can be invoked for the purpose of Article 3(2) of the Tax Treaty. First of
all, according to the respondent, the words used in the Act have multiple and
often irreconciliable meanings. The appellant’s counsel referred to a study by
Professor Catherine Brown who concluded that the term ‘beneficial owner’ has
different meanings under the Act depending on the provision. [Symposium :
Beneficial ownership and the Income-tax Act (2003) 51 Canadian Tax Journal, No.
1, pp. 424-427.] For example, she identified at least four categories of meaning
for the expression ‘beneficial ownership’, ‘beneficial owner’ and ‘beneficially
owned’ when used in a trust context :

(a) the owner is the beneficial owner;

(b) the beneficiary is considered to be the beneficial
owner as a result of tax decisions and the operation of the Act;

(d) the trust is the owner of trust property, for example,
the Act deems the trust to be the owner of the trust property. Also, the term
‘beneficial owner’ is not used in any provision of the Act concerned with
withholding tax on Canadian sourced dividends, interest or royalties.

(iv) The Revenue’s counsel, citing an article by Mr. Mark D.
Brender, submits that there is no settled definition of ‘beneficial ownership’
even under common law, let alone for the purposes of the Act. [Symposium :
Beneficial ownership and the Income-tax Act, supra, at pp. 315-318].
Indeed, Mr. Brender suggests that words or concepts neutral as between the civil
and common laws be used in place of ‘beneficial owner’ or ‘beneficial
ownership’.

(v) The counsel for the Revenue referred to the VCLT, the Tax
Treaty, Model Conventions as well as the Act to suggest how the terms
‘beneficial owner’ and ‘bénéficiaire effectif’ should be interpreted, bearing in
mind that these terms are not defined in the Tax Treaty, Model Conventions and
the Act and have no legal meaning in Quebec civil law jurisdiction. The
respondent’s submission was that these words should not have a technical or
legal meaning, but an interpretation recognised internationally.

(vi) The terms ‘beneficial owner’ and ‘bénéficiaire effectif’,
together with the Dutch term uiteindelijk gerechtigde, appear in the Tax
Treaty and must be given meaning. The words ‘bénéficiaire effectif’ appear
nowhere in the French version of the Act. This may, it is suggested, limit the
scope of Article 3(2) of the Tax Treaty. The term ‘bénéficiaire effectif’ also
does not appear in the Quebec Civil Code. The Revenue’s counsel submits that the
use of the words ‘bénéficiaire effectif’ in the Tax Treaty rather than
‘propriétaire effectif’, which are used in the Act, suggests that Parliament
intended to use the private law of the provinces to complement the Act and the
words are not to be determined by reference to the common law.

(vii) The Revenue also states that while the Tax Treaty
refers to the ‘beneficial owner of the dividends’, the Act never uses such a
phrase. The Act refers to a taxpayer who has income from property, for example,
a dividend received by a taxpayer, and this income is included in the taxpayer’s
income for the year. The phrase is never used in conjunction with the income
which is derived from the property. The Revenue’s counsel submits that the term
‘beneficial owner’ or a similar expression is never used in the Act in the same
context as it is used in the Tax Treaty and Model Convention.

(viii) The Revenue’s counsel declared that when determining
the meaning of an undefined treaty term, Canadian courts have relied on the
meaning relevant to the specific tax provision in respect of which the treaty
applies. Thus, in A.G. of Canada v. Kubicek Estate, the word ‘gain’,
which was not defined in the Canada U.S. Tax Treaty, was given the meaning found
in Ss.40(1) of the Act. The Hoge Raad could not find the meaning of the word
‘present’ in the domestic laws of the Netherlands and therefore held that the
word appearing in tax treaties between the Netherlands and Brazil and the
Netherlands and Nigeria be interpreted in accordance with Articles 31 and 32 of
the VCLT and not the equivalent provisions of Article 3(2) of the Model
Convention.

(ix) The Revenue’s counsel therefore concluded that the terms
‘beneficial owner’ and similar terms in the Act are based on legalistic trust
meanings originating under the laws of equity and ought not to apply to the Tax
Treaty. The words ‘beneficial owner’ and ‘bénéficiaire effectif’ have no meaning
in the Act.

x) The Revenue’s counsel submitted that the phrase ‘beneficial owner’ does not appear in English dictionaries. The words do appear separately, of course. The word ‘beneficial’ in the Canadian Diciionary of the English Language is defined primarily as ‘producing or promoting a favourable result’ or ‘receiving or having the right to receive proceeds or other advantages’. The word ‘beneficial’, counsel states, connotes both a factual (‘receiving’) and legal (‘right to’) meaning. The Shorter Oxford Dictionary (1973) defines ‘beneficial’ as ‘of or pertaining to the usufruct of property; enjoying the usufruct’, usufruct being a civil law concept. In The New Shorter Oxford Dictionary ‘beneficial’ is defined as ‘Of, pertaining to, or having the use of benefit of property, etc.

xi) The Canadian Dictionary defines ‘owner’ as ‘of or belonging to oneself’, ‘to have or possess as. property’, and ‘to have control over’. The word ‘owner’ it states also connotes both a factual (possess, control) and legal (‘belonging’) meaning. The Shorter Oxford defines ‘own’ as one’s own . . . to have or hold as own’s own”. The word ‘owner’ is ‘one who owns or holds something; one who has a rightful claim or title to a thing’.

xii) In the Jodrey Estate, the Supreme Court approved of the meaning given by Hart J., in MacKeen Nova Scotia, who wrote:

It seems to me that the plain ordinary meaning of the expression ‘beneficial owner’ is the real or true owner of the property. The property may be registered in another name or held in trust for the real owner, but the ‘beneficial owner’ is the one who can ultimately exercise the rights of owner-ship in the property. [Covert v. Nova Scotia (Minister of Finance), [1980] S.c.J. No. 101 (Q.L.), [1980] 2 S.c.R. 774, at p. 784, citing MacKeen Estate v. Nova Scotia, [1977] C.T.C. 230 (NSSC), para. 46].

xiii) The Revenue’s counsel submitted that from a textual reading of the term ‘beneficial owner’, its meaning can be distilled as applying to the person who can exercise the normal incidents of ownership (possession, use, risk, control) and as such ultimately benefits from the income. The ordinary meaning of ‘beneficiaire effectif’ in the French text and uiteindelijk gerechtigde in Dutch share common features with the ordinary meaning of ‘beneficial owner’, but have a significant difference.

xiv) ‘Beneficiaire’ is defined, the counsel submits, consistently as the person who enjoys or takes ad-vantage of a benefit of any kind, including a right or a privilege. Therefore, he submits that ‘beneficiaire’ is clearly not a technical term and does not per se connote a legal right, such as that of ownership.

xv) Therefore, the Revenue’s counsel concluded, the term ‘beneficiaire effectif’ means the person or group that actually and truly enjoys or benefits from an advantage of any kind. Authors have translated the words ‘beneficiaire effectif’ to ‘real beneficiary’, which is a fairly accurate translation as long as the word beneficiary is not understood in a legal sense.

xvi) The Dutch version of the Convention uses the term uiteindelijk gerechtigde for ‘beneficial owner’. This term, translated back to English, means ‘he who is ultimately entitled’. Professor van Weeghel, notes in his text The Improper Use of Tax Treaties that:

It is unclear why this translation (uiteindelijk gerechtigde) was chosen. The term ‘beneficial owner’ (One who does not have title to property but has rights in the property which are the normal incidents of owning the property’, Black’s Law Dictionary, Fifth Edition) has a closer equivalent in Dutch language and this would be ‘economiscn eigenaar’ a term which has a well understood meaning also in Dutch law.

xvii) However, as the Revenue’s counsel contends, the government of the Kingdom of the Netherlands opted in the Tax Treaty to use a term for ‘beneficial owner’, whose English translation of ‘ultimately entitled’ connotes a factual inquiry, meaning ‘final’ or ‘in the end’. Just as in the French text, there is no reference to ownership in the Dutch text. Uiteindelijk gerechtigde is also consistent with the ordinary meaning given to the term by the Royal Dutch case, supra, in which the uiteindelijk gerechtigde of a dividend is one who can ‘freely avail of the distribution’; being the person ultimately entitled to the benefit of the income.

xviii) The Revenue’s counsel submitted that the plain and ordinary meaning of the terms ‘beneficial owner’, ‘beneficiaire effectif’ and uiteindelijk gerechtigde in the three languages of the text of the Tax Treaty does not suggest that an exclusively legal meaning should be given to the terms. The counsel is of the view that the term ‘beneficiaire effectif’ points strongly to a determination of the true relationship and is inconsistent with a narrow legalistic meaning. The respondent insists that the meaning of each term used in all three versions accommodates only a non-legal meaning. It is this commonality between the three versions which must form the basis for defining the term, he suggests.

(xix) The respondent’s view is that a reconciliation of the three language versions of the Tax Treaty results in a meaning that requires a search behind the legal relationships in order to identify the person who, as a matter of fact, can ultimately benefit from the dividends. The respondent seeks support from a non-tax case before the England and Wales Court of Appeal that was called upon to interpret the term ‘beneficial ownership’ within the context of the civil law of Indonesia: Indofood International Ltd. v. JP Morgan Chase Bank N.A. London Branch. [2006] E.W.C.A. Civ. 158, S.T.L. 1195. The judge also noted that the Court of Appeal had regard to substance over form, as required by the law of Indonesia (paras. 18 and 24).

xx) The decision in Indofood conflicts somewhat with the opinion the Dutch government and the Hoge Raad in the Royal Dutch case, supra, that a recipient is not the beneficial owner of income only if it is contractually obligated to pay the largest part of the income to a third party. In Indofood, the Court of Appeal did not base its reasoning on contractual obligation to forward the interest, but rather whether the recipient enjoyed the ‘full privilege’ of the interest or if it was simply an ‘administrator of income’.

xxi) The parties agree that PHB.V. was not an agent, trustee or nominee for Volvo and Henlys. Rather, it is the Revenue’s view that PHB.V. was acting as a mere conduit or funnel in favour of Volvo and Henlys upon receiving dividends from Prevost.

xxii) One has to determine what the words ‘beneficial owner’ and ‘beneficiate effectif’ (and the Dutch equivalent) mean in Article 10(2) of the Tax Treaty. Article 3(2) of the Tax Treaty requires one to look to a domestic solution in interpreting ‘beneficial owner’. The OECD Commentaries on the 1977 Model Convention with respect to Article 10(2) are also relevant.

xxiii) The Commentary for Article 10(2) of the Model Convention explains that one should look behind ‘agents and nominees’ to determine who is the beneficial owner. Also, a ‘conduit’ company is not a beneficial owner. In these three examples, the person ‘the agent, nominee and conduit company’ never has any attribute of ownership of the dividend. The ‘beneficial owner’ is another person.

xxiv) In common law, a trustee, for example, holds property for the benefit of someone else. The trustee is the legal owner, but does not personally enjoy the attributes of ownership, possession, use, risk and control. The trustee is holding the property for someone else and that, ultimately, it is that someone else who has the use, risk and control of the property. Also, in common law, one person may have a life interest in property and another may have a remainder interest in the same property. The owner of the life interest receives income from the property and owns the income; the owner of the remainder interest owns the capital of the property. There is no division of property in common law as there is in civil law. The word ‘beneficial’ distinguishes the real or economic owner of the property from the owner who is merely a legal owner, owning the property for someone else’s benefit, i.e., the beneficial owner.

xxv) In both the common law and the civil law, the persons who ultimately receive the income are the owners of the income property. It may well be, as the respondent’s counsel argues, that when the terms ‘beneficial owner’, ‘beneficially owned’ or ‘beneficial ownership’ are used in the Act, it is either used in conjunction with property, such as shares or some other property, but is never used in conjunction with the income which is derived from the property. i.e., dividends from shares. However, dividends, whether coin or something else, are in and by themselves also property and are owned by someone. S. 12 of the Act includes in computing income of a taxpayer for a taxation year income from property, including amounts of dividends received in the year. The taxpayer required to.include the amount of dividends in income is usually the person who is the owner ‘the beneficial owner’ of the dividends, except, for example, when the Act deems another person to have received the dividend or requires a trust to include the dividend in its income. The words ‘beneficial owner’ in plain ordinary language used in conjunction with dividends is not something alien.

5. Court’s decision:

i) The ‘beneficial owner’ of dividends is the person who receives the dividends for his or her own use and enjoyment and assumes the risk and control of the dividend he or she received. The person who is beneficial owner of the dividend is the person who enjoys and assumes all the attributes of ownership In short, the dividend is for the owner’s own benefit and this person is not accountable to anyone for how he or she deals with the dividend income. When the Supreme Court in Jodrey stated that the ‘beneficial owner’ is one who can ‘ultimately’ exer-cise the rights of ownership in the property, the Court did not mean, in using the word ‘ultimately’, to strip away the corporate veil so that the shareholders of a corporation are the beneficial owners of its assets, including income earned by the corporation [Radwell Securities Ltd. v. Inland Revenue Commissions, (1968) 1 All E.R. 257]. The word ‘ultimately’ refers to the recipient of the dividend who is the true owner of the dividend, a person who could do with the dividend what he or she desires. It is the tru owner of property who is the beneficial owner of Hie property. Where an agency or mandate exists or the property is in the name of a nominee, one looks to find on whose behalf the agent or mandatary is acting or for whom the nominee has lent his or her name. When corporate entities are concerned, one does not pierce the corporate veil unless the corporation is a conduit for another person and has absolutely no discretion as to the use or application of funds put through it as conduit, or has agreed to ad on someone else’s behalf pursuant to that person’s instructions without any right to do other than what that person instructs it, for example, a stockbroker who is the registered owner of the shares it hold’s for clients. This is not the relationship between PHB.V. and its shareholders.

ii) There is no evidence that PHB.V.was a conduit for Volvo and Henlys. It is true that PHB.V. had no physical office or employees in the Netherland or elsewhere. It also mandated to TIM the transaction of its business as well for TIM to pay interim dividends on its behalf to Volvo and Henlys. However there is no evidence that the dividends from Prevost were ab initio destined for Volvo and Henlys with PHB.Y. as a funnel of flowing dividends from Prevost. For Volvo and Henlys to obtain dividends, the directors of PHB.V. had to declare interim dividends and subsequently shareholders had to approve the dividend. There was no predetermined or automatic flow of funds to Volvo and Henlys even though Henlys’ representatives were trying to expedite the process.

iii) PHB.Y. was a statutory entity carrying on business operations and corporate activity in accordance with the Dutch law under which it was constituted. PHB.V. was not party to the Shareholders’ Agreement; neither Henlys nor Volvo could take action against PHB.V. for failure to follow the dividend policy described in the Shareholders’ Agreement. Henlys may have a cause of action against Volvo and Volvo a cause of action against Henlys under the Shareholders’ Agreement if the dividend policy was not carried out. But neither would have a bona fide action in law under the Shareholders’ Agreement against a person not a party to that agreement, that is, PHB.V. Volvo and Henlys, of course, may have action against PHB.V. if PHB.V. did not repay “monies advanced as loans by them, but such action would be taken as creditors of PHB.Y., not shareholders.

iv) Article 24 of PHB.Y.’s Deed of Incorporation does not obligate it to pay any dividend to its shareholders. The directors of PHB.V. are to duly observe what has been agreed to in the Shareholders’ Agreement concerning reserving part of its accrued profits. Article 24, paragraph 2 of the Deed provides that any profits remaining after the reservation of part of the accrued profits shall be at the disposal of the general meeting. The judge could not find any obligation in law requiring PHB.Y. to pay dividends to its shareholders on a basis determined by the Shareholders’ Agreement. When PHB.Y. decides to pay dividends it must pay the dividends in accordance with Dutch law.

v) PHB.V. was the registered owner of Prevost shares. It paid for the shares. It owned the shares for itself. When dividends are received by PHB.V. in respect of shares it owns, the dividends are the property of PHB.Y. Until such time as the management board declares an interim dividend and the dividend is approved by the shareholders, the monies represented by the dividend continue to be property of, and is owned solely by, PHB.V. The dividends are an asset of PHB.V. and are available to its creditors, if any. No person other than PHB.V. has an interest in the dividends received from Prevost. PHB.V. can use the dividends as it wishes and is not accountable to its shareholders except by virtue of the laws of the Netherlands. Volvo and Henlys only obtain a right to dividends that are properly declared and paid by PHB.V. itself, not-withstanding that the payment of the dividend has been mandated to TIM. Any amount paid by PHB.V. to Henlys and Volvo before a dividend was properly declared and paid, as I see it, was a loan from PHB.V. to its shareholders. This, too, is not uncommon. There is a practice in Canada of corporations advancing funds to its shareholders without a declaration of dividend. At the end of the fiscal year, the corporation’s directors determine whether the funds are to remain a loan or be ‘adjusted’ to a dividend, with the proper directors’ resolutions.

vi) Accordingly, the Canadian Tax Court held that Volvo and Henlys were not the beneficial owners of the dividends paid by Prevost. There is no evidence satisfying that PHB.Y. was a conduit for Volvo and Henlys. The appeals were allowed, with costs.

Author’s Note:

In the aforesaid Canadian Tax Court decision, the court has discussed in detail the concept of the ‘beneficial owner’ in the context of interpretation of tax treaties. In arriving at its conclusion, the Court has referred to and considered various foreign Court cases, academic articles and the testimony of experts, on the subject.

In our view, this decision should serve as an important guide in cases of disputes relating to ‘beneficial owner’ issues. Though the ratio of the decision is not binding on the Indian Courts, it should serve as a good guide and have strong persuasive value in related cases.

Nirav Shah

Concept of ‘Beneficial Ownership’ under tax treaties — Decision of Canadian Federal Court of Appeal in case of Prévost Car Inc.

International Taxation

1. Background :

1.1 On February 26, 2009 the Canadian Federal Court of Appeal (‘the Federal Court’) unanimously dismissed the Revenue’s appeal in Prévost Car Inc.

v. The Queen, (2009 FCA 57). The Court held that a Dutch holding company was the ‘beneficial owner’ of dividends received from its Canadian subsidiary for purposes of the Canada-Netherlands Tax Treaty, despite having distributed substantially all of the dividends to its shareholders resident in other countries. The Court thus affirmed that the Dutch company was not a mere conduit for its shareholders as had been alleged by the Revenue. This is the first appellate decision in Canada to interpret the term ‘beneficial owner’ in the tax treaty context.

1.2 This decision of the Federal Court of Appeal upholds the principle that in determining the applicable withholding rate on dividends, interest, royalties and other payments to treaty countries and other intermediary jurisdictions with low withholding tax rates, the Revenue cannot ignore the intermediary jurisdiction and apply a higher rate that may be applicable had the payment been made directly. This is a watershed decision which will have implications for existing structures and may create opportunities for new planning.

1.3 We have discussed the facts of the case, contentions of parties and the Tax Court’s decision in detail in July & August, 2008 issues of BCAJ. Therefore, the facts of the case and the decision of the Tax Court are not repeated here in detail. In this Article, we shall discuss the decision of the Federal Court in some detail.

2. Context and issue before the Federal Court :

2.1 The issue before the Court was the interpretation of the term ‘beneficial owner’ in Article 10(2) of the DTAA between Canada and the Netherlands (the ‘Tax Treaty’). The Tax Treaty came into force on November 27, 1986 and was based on the OECD Model.

2.2 The context in which the issue was raised was that of a payment of dividends by a resident Canadian corporation, Prévost Car Inc. (‘Prevost’) to its shareholder Prevost Holding B.V. (‘Prevost Holding’), a corporation resident in the Netherlands, which in turn paid dividends in substantially the same amount to its corporate shareholders Volvo Bussar Corporation (Volvo), a resident of Sweden
and Henlys Group plc (Henlys), a resident of the United Kingdom.

2.3 If Prevost Holding was found to be the beneficial owner, the rate of withholding tax by virtue of the Canadian Income Tax Act (the Act) and in accordance with Article 10 of the Tax Treaty would be 5%. However, if Volvo and Henlys be found to be the beneficial owners, Ss.215(c) of the Act would have required Prevost to withhold 25% (reduced to 15% in the case of the dividend paid to Volvo because of the Canada-Sweden Tax Treaty and 10% in the case of the dividend paid to Henlys because of the Canada-U.K. Tax Treaty).

2.4
The Tax Court (2008 TCC 231) found that the beneficial owner was Prevost Holding.

3. Revenue case :

The Revenue argued that the Tax Court used an incorrect approach in its interpretation of the term ‘beneficial owner’ and in the end committed a palpable and overriding error in finding that Prevost Holding was, in the circumstances of this case, the beneficial owner.

The main thrust of the Revenue’s argument was that the Tax Court gave to the term ‘beneficial owner’ the meaning they have in common law, thereby ignoring the meaning they have in civil law and in inter-national law.

4. Observations and decision of the Federal Court of Appeal :

4.1 It is common ground that there is no settled definition of ‘beneficial ownership’ (or in French, ‘beneficiaire effectif’) in the Model Convention, in the Tax Treaty or in the Canadian Income Tax Act. In its search for the meaning of these terms, the Tax Court closely examined their ordinary meaning, their technical meaning and the meaning they might have in common law, in Quebec’s civil law, in Dutch law and in international law. The Tax Court relied, inter alia, on the OECD Commentary for Article 10(2) of the Model Convention and on OECD documents issued subsequently to the 1977 Commentary, i.e., the OECD Conduit Companies Report adopted by the OECD Council on November 27, 1986 and the amendments made in 2003 by the OECD to its 1977 Commentary. The Tax Court also had the benefit of expert evidence.

4.2 The counsel for both sides agreed that the Tax Court was entitled to rely on subsequent documents issued by the OECD in order to interpret the Model Convention. The Federal Court shared their view.

4.3 Relevance and importance of OECD Model Commentary :

The worldwide recognition of the provisions of the Model Convention and their incorporation into a majority of bilateral conventions have made the Commentaries on the provisions of the OECD Model a widely-accepted guide to interpretation and application of the provisions of existing bilateral conventions [see Crown Forest Industries Ltd. v. Canada, (1995) 2 S.c.R. 802; Klaus Vogel, ‘Klaus Vogel on Double Taxation Conventions’ 3rd ed. (The Hague: Kluwer Law International, 1997) at 43]. In the case before the Court, Article 10(2) of the Tax Treaty was mirrored on Article 10(2) of the Model Convention. The same may be said with respect to later commentaries when they represent a fair inter-pretation of the words of the Model Convention and do not conflict with Commentaries in existence at the time a specific treaty was entered into and when, of course, neither treaty partner has registered aft objection to the new Commentaries. For example, in the introduction to the Income and Capital Model Convention and Commentary (2003), the OECD invites its members to interpret their bilateral treaties in accordance with the Commentaries ‘as modified from time to time’ (paragraph 3) and ‘in the spirit of the revised Commentaries’ (paragraph 33). The introduction goes on, at paragraph 35, to note that changes to the Commentaries are not relevant ‘where the provisions …. are different in substance from the amended Articles’ and, at para 36, that many amendments are intended to simply clarify, not change, the meaning of the Articles or the Commentaries”.

4.4 The Federal Court, therefore, reached the conclusion that for the purposes of interpreting the Tax Treaty, the OECD Conduit Companies Report (in 1986) as well as the OECD 2003 Amendments to the 1977 Commentary are a helpful complement to the earlier Commentaries, insofar as they are eliciting, rather than contradicting, views previously expressed. Needless to say, the Commentaries apply to both the English text of the Model Convention (‘beneficial owner ‘) and to the French text (‘beneficiaire effectif’).

4.5 In the end the Tax Court held that the ‘beneficial owner’ of dividends is the person who receives the dividends for his or her own use and enjoyment and assumes the risk and control of the dividend he or she received. To illustrate this point of view, the Tax Court observed as follows :

“Where an agency or mandate exists or the property is in the name of a nominee, one looks to find ?n whose behalf the agent or mandatary is acting or for whom the nominee has lent his or her name. When corporate entities are concerned, one does not pierce the corporate veil unless the corporation is a conduit for another person and has absolutely no discretion as to the use or application of funds put through it as conduit, or has agreed to act on someone else’s behalf pursuant to that person’s instructions without any right to do other than what that person instructs it, for example, a stockbroker who is the registered owner of the shares it holds for clients.”

4.6 The Tax Court’s formulation captures the essence of the concept of ‘beneficial owner’ as it emerges from the review of the general, technical and legal meanings of the terms. Most importantly, perhaps, the formulation accords with what is stated in the OECD Commentaries and in the Conduit Companies Report.

4.7 The counsel for the Revenue invited the Court to determine that ‘beneficial owner’, ‘beneficiaire effectif’, ‘mean the person who can, in fact, ultimately benefit from the dividend’. That proposed definition does not appear anywhere in the OECD documents and the very use of the word’ can’ opens up a myriad of possibilities which would jeopardize the relative degree of certainty and stability that a tax treaty seeks to achieve. The Revenue is asking the Court to adopt a pejorative view of holding companies which neither the Canadian domestic J law, the international community, nor the Canadian government through the process of objection, have adopted.

4.8 Finding of the Tax Court:

As per the Federal Court, the findings of the Tax Court can be summarised as follows :

(a) the relationship between Prevost Holding and its shareholders is not one of agency, or mandate nor one where the property is in the name of a nominee;

(b) the corporate veil should not be pierced because Prevost Holding is not ‘a conduit for another person’. It cannot be said to have ‘absolutely no discretion as to the use or application of funds put through it as a conduit’ and has not ‘agreed to act on someone else’s behalf pursuant to that person’s instructions without any right to do other than what that person instructs it; for example a stockbroker who is the registered owner of the shares it holds for clients;

(c) there is no evidence that Prevost Holding was a conduit for Volvo and Henlys and there was no predetermined or automatic flow of funds to Volvo and Henlys;

(d) Prevost Holding was a statutory entity carrying on business operations and corporate activity in accordance with the Dutch law under which it was constituted;

(e) Prevost Holding was not party to the Shareholders’ Agreement;

(f) neither Henlys nor Volvo could take action against Prevost Holding for failure to follow the dividend policy described in the Shareholders’ Agreement;

(g) Prevost Holding’s Deed of Incorporation did not obligate it to pay any dividend to its shareholders;

(h) when Prevost Holding decides to pay dividends, it must pay the dividends in accordance with the Dutch law;

(i) Prevost Holding was the registered owner of Prevost shares, paid for the shares and owned the shares for itself; when dividends are received by Prevost Holding in respect of shares it owns, the dividends are the property of Prevost Holding and are available to its creditors, if any, until such time as the management board declares a dividend and the dividend is approved by the shareholders.

The Federal Court held that these findings, to the extent that they are findings of fact, are supported by the evidence. No palpable or overriding error has been shown.

5. The Federal Court held that as these findings are based on the interpretation of the contractual relationships between Prevost, Prevost Holding, Volvo and Henlys, no error of law has been shown. Accordingly, the Federal Court dismissed the Revenue’s appeal with costs.

6. Comments:

6.1 Although the taxpayer won this case, the facts of the case were favourable to the taxpayer, and it is certain that the Revenue will not give up its efforts to attack such structures. The case may be appealed further to the Supreme Court of Canada, and even if not overturned, it is certain that the Revenue will seek to apply Prevost Car as narrowly as possible, seek out every opportunity to make distinctions on the facts, and assess accordingly. Canada has no anti-treaty shopping provisions in its treaties with low-withholding intermediary jurisdictions, but the Revenue has sought to achieve the same result by applying domestic principles such as agency and General Anti-Avoidance Regulations. Prevost Car does not signal an end to this, and taxpayers need therefore to plan accordingly.

6.2 To better ensure a structure which can with-stand the Revenue’s attack, the following steps should be considered:

A real commercial purpose for the intermediary jurisdiction holding company;

As much substance as is feasible in the intermediary jurisdiction, including if possible, employees, and especially if possible, other investments and particularly in the intermediary jurisdiction;

A board of directors that consists of a majority of local directors, and proper directors’ meetings, preferably with local directors present; and

Avoid back-to-back financing arrangements, and if necessary, ensure that

there is a spread in interest rates or royalty rates;
there is minimal, if any, contractual tie-in to automatically flow through amounts – this will be a difficult fact to overcome; and
the holding company takes some risk.

6.3 Care must be exercised up front to ensure a good fact pattern, and regular ‘risk management’ review is warranted to ensure that those responsible for implementing the plan ‘respect’ the proper legal steps that are required to make such planning work.

Nirav Shah

On facts, transaction was for supply of technology and therefore, the p

1. Bajaj Holdings & Investments Ltd vs. ADIT
(2013)141 ITD 62 (Mumbai -Trib)
Article 13 of India-UK DTAA; Section 9 of I-T Act
Asst Year: 2008-09
Decided on: 16th January 2013
Before Rajendra (AM) and D K Agarwal (JM)

On facts, transaction was for supply of technology and therefore, the payment was FTS under Article 13(4) of India-UK DTAA.

Facts

The taxpayer was an Indian company manufacturing automotive two-wheelers. The taxpayer entered into an agreement with a UK company (“UKCo”) for developing inkjet printing solution comprising printers and special inks for decoration of two-wheelers. The printing solution was to be developed as per the specifications of the taxpayer and was to be installed and commissioned at the plant of the taxpayer in India. The taxpayer was required to pay certain startup fees for printing solution, and, also the manufacturing cost of printer. In terms of the agreement, the taxpayer was to exclusively own intellectual property for its own field (namely, inkjet decoration for two-wheelers) and even had the right to obtain a patent on the same. The supplier was restrained from supplying the same printing solution in India but there was no restraint for such supply outside India. The issue before the Tribunal was whether the payment made to UKCo was for supply of machinery or for supply of technology (which would constitute FTS).

Held

The Tribunal observed and held as follows. As per the agreement, UKCo had supplied technology to the taxpayer who even had right to obtain patent. Hence the transaction was not for supply of printer but for supply of technology, which was exclusively made available to the taxpayer. Accordingly, the consideration paid was in the nature of FTS under Article 13(4) of India-UK DTAA.

levitra

Nirav Shah

Recent Global Developments in International Taxation – Part I

In this Article, we discuss the recent global
developments in the sphere of international taxation which would be of
relevance and use in day to day practice. We intend to keep the readers
informed about such developments from time to time in the future.

1. OECD

(i) OECD issues report Aggressive Tax Planning based on After-Tax Hedging

On
13th March 2013, the OECD issued the report Aggressive Tax Planning
based on After-Tax Hedging, describing the features of aggressive tax
planning (ATP) schemes based on after-tax hedging as well as the
strategies used to detect and respond to those schemes. This report
follows after the 2011 OECD report Corporate Loss Utilisation through
Aggressive Tax Planning, which recommends countries to analyse the
policy and compliance implications of after-tax hedges in order to
evaluate the appropriate options available to address them.

Risk
management and hedging are key issues in corporate management. In
certain cases, taxpayers may see an opportunity or a need to factor
taxation into their hedging transactions to be fully hedged on an
after-tax basis. However, after-tax hedging, while not of itself
aggressive, may be used as a feature of schemes which are designed to
allow taxpayers to achieve higher returns, without actually bearing the
associated risk which is in effect passed on to the government through
the tax charge.

In general terms, after-tax hedging consists of taking
opposite positions for an amount which takes into account the tax
treatment of the results from those positions (gains or losses) so that,
on an after-tax basis, the risk associated with one position is
neutralised by the results from the opposite position.

ATP schemes based
on after-tax hedging pose a threat to countries’ revenue base:
empirical evidence suggests that hundreds of millions of US dollars are
at stake, with a number of multi-billion US-dollar transactions
identified by certain countries. ATP schemes based on after-tax hedging
exploit the disparate tax treatment between the results (gain or loss)
from the hedged transaction/risk on the one hand, and the results (gain
or loss) from the hedging instrument on the other. In some of these
schemes, the tax treatment of gains and losses arising from each
transaction is symmetrical, while in others the tax treatment is
asymmetrical. Other schemes rely on similar building blocks and are
often structured around asymmetric swaps or other derivatives. ATP
schemes based on after-tax hedging can exploit differences in tax
treatment within one tax system and are in that sense mostly a domestic
law issue. Any country that taxes the results of a hedging instrument
differently from the results of the hedged transaction/risk is
potentially exposed. The issue of after-tax hedging also arises in a
cross-border context with groups of companies operating across different
tax systems, which gives rise to additional challenges for tax
administrations.

The report describes the following main challenges
raised by after-tax hedging from a compliance and policy perspective,
and takes the following positions:

• The difficulty in drawing a line
between acceptable and non-acceptable after-tax hedging. The report
concludes that, in practice, the decision of where to draw the line will
depend on a number of elements, including the facts and circumstances
of each case, the commercial reasons underlying the transactions, and
the intent of the applicable domestic law.

• The difficulties in
detecting ATP schemes based on after-tax hedging, especially crossborder
schemes. These difficulties arise because often there is no explicit
link between the hedged item and the hedging instrument or because there
is no trace of them in the taxpayers’ financial statements.

• Here, the
report underlines that, in order for tax administrations to be able to
face the above challenges, it is important for them to ensure they have
sufficient resources and expertise to understand schemes of this nature
which are often very complex. A fair and transparent dialogue with the
taxpayer, as part of discussions which take place under cooperative
compliance programmes, has also proven to help tax administrations gain a
better understanding.

• Deciding how to respond to ATP schemes based on
after-tax hedging. The report shows that different response strategies
have been used, including strategies seeking to deter taxpayers from
entering into such schemes and/or promoters/advisors from promoting the
use of such schemes.

Finally, the report recommends countries concerned
with ATP schemes based on aftertax hedging to:

• Focus on detecting
these schemes and ensure that their tax administrations have access to
sufficient resources (in particular expertise in financial instruments
and hedge accounting) to detect and examine in detail after-tax hedging
schemes.

• Introduce rules to avoid or mitigate the disparate tax
treatment of hedged items and hedging instruments.

• Verify whether
their existing general or specific anti-avoidance rules are suitable to
counter ATP schemes based on after-tax hedging and, if not, to consider
amending those rules or introducing new rules.

• Adopt a balanced
approach in their response to after-tax hedging, recognising that not
all arrangements are aggressive, that hedging in and of itself is not an
issue and that ATP schemes based on after-tax hedging may necessitate a
combination of response strategies.

• Continue to exchange information
spontaneously and share relevant intelligence on ATP schemes based on
after-tax hedging, including deterrence, detection and response
strategies used, and monitor their effectiveness.

(ii) OECD releases
study on electronic sales suppression

On 19th February 2013, the OECD
released the study Electronic Sales Suppression: A Threat to Tax
Revenues, to help all countries understand and address this risk.
“Electronic sales suppression” techniques facilitate tax evasion and
result in massive tax loss globally. Point of sales systems (POS) in the
retail sector are a key component in comprehensive sales and accounting
systems and are relied on as effective business accounting tools for
managing the enterprise. Consequently, they are expected to contain the
original data which tax auditors can inspect. In reality such systems
not only permit “skimming” of cash receipts just as much as manual
systems like a cash box, but once equipped with electronic sales
suppression software, they facilitate far more elaborate frauds because
of their ability to reconstitute records to match the skimming activity.

Tax administrations are losing billions of dollars/ euros through
unreported sales and income hidden by the use of these techniques. A
Canadian restaurant association estimates sales suppression in Canadian
restaurants at some CAD 2.4 billion in one year. Since the OECD’s Task
Force on Tax Crimes and Other Crimes (TFTC) began to work on and to
spread awareness of this phenomenon a number of countries (including
France, Ireland, Norway and the United Kingdom) have tested their retail
sector and found significant problems.

The report describes the
functions of POS systems and the specific risk areas. It sets out in
detail the electronic sales suppression techniques that have been
uncovered by experts, in particular “Phantomware” and “Zappers”, and
shows how such methods can be detected by tax auditors and
investigators.

Phantomware is a software program already installed or embedded in the accounting application software of the electronic cash registers (ECR) or computerised POS system. It is concealed from the unsuspecting user and may be accessed by clicking on an invisible button on the screen or a specific command sequence or key combination. This brings up a menu of options for selectively deleting sales transactions and/or for printing sales reports with missing lines.

Zappers are external software programs for carrying out sales suppression. They are carried on some form of electronic media such as USB keys, removable CDs, or they can be accessed online through an internet link. Zappers are designed, sold, and maintained by the same people who develop industry-specific POS systems, but some independent contractors have also developed these techniques.

The report compiles and analyses the range of government responses that are being used to tackle the abuse created by electronic sales suppression and identifies some best practices. These include strengthening compliance with a focus on voluntary compliance through industry bodies, raising awareness with all stakeholders including the public, improving audit and investigation skills, developing and sharing intelligence and the use of technical solutions such as certified POS systems.

The report makes the following recommendations:

• Tax administrations should develop a strategy for tackling electronic sales suppression within their overall approach to tax compliance to ensure that it deals with the risks posed by electronic sales suppression systems and promotes voluntary compliance as well as improving detection and counter measures.

• A communications programme should be developed aimed at raising awareness among all the stakeholders of the criminal nature of the use of such techniques and the serious consequences of investigation and prosecution.

• Tax administrations should review whether their legal powers are adequate for the audit and forensic examination of POS systems.

• Tax administrations should invest in acquiring the skills and tools to audit and investigate POS systems including developing the role of specialist e-auditors and recruiting digital forensic specialists where appropriate.

• Tax administrations should consider recommending legislation criminalising the supply, possession and use of electronic sales suppression software.

2. Singapore

(i) Taxation of property developers

The Inland Revenue Authority of Singapore (IRAS) issued an e-Tax Guide on the taxation of property developers on 6th March 2013. The main details of the Guide are as follows:

• the date of commencement of a property development business is the date of ac-quisition of any land/property acquired for development for sale;

• for tax purposes, the profits of a property development project are recognised when the Temporary Occupation Permit (TOP) is issued;

• taxable profit is generally computed as sale proceeds of the property units in accordance with the sales and purchase agreement payment schedule less development costs incurred up to that date;

• income from the lands/properties accruing before and during development is, depending on the nature of the income, either taxed upfront or set-off against development costs;

• expenses that are directly attributable to the acquisition of land and property development activities are to be capitalised and accumulated in the Development Cost Account up to the TOP year of assessment;

• provisions (e.g. for diminution in value, warranty liability etc.) are generally non-deductible;

• expenditure related to development projects that are held partly for sale and partly for investment, or for mixed uses should be apportioned based on actual costs incurred;

• all gains from the sale of land or uncompleted development projects and rental income earned from the letting out of unsold properties are taxable; and

• discounts on sale of properties to employees are taxable as benefits-in-kind.

(ii) Rights-based approach for software payments – e-Tax Guide issued

Further to the Inland Revenue of Singapore’s (IRAS) Consultation on Software Payments, an e-Tax Guide (the Guide) on the same was issued on 8th February 2013. The Guide reiterates the rights-based approach proposed in the consultation paper, which draws a distinction between the transfer of a “copyright right” and the transfer of a “copyrighted article” from the owner to the payer, with effect from 28th February 2013. With this, the withholding tax exemptions u/s. 13(4) of the Income-tax Act for certain payments for soft-ware and rights to use information are abolished.

The Guide clarifies the following:

• A transaction involves a copyright right if the payer is allowed to commercially exploit (as defined in the Guide) the copyright.

• A copyrighted article is transferred if the rights are limited to those necessary to enable the payer to operate the software or use the information or digitised goods for personal consumption or for use within his business operations. Such payments are not treated as royalty and hence are not subject to withholding tax when made to non-residents. However, where the payments constitute income derived from a trade or profession of the non-resident in Singapore, or is effectively connected with a permanent establishment of that person in Singapore,

he will be required to file an income tax return to declare the income which is subject to tax in Singapore.

• Where a payer obtains multiple rights, the primary purpose of the payment will be examined in determining whether a payment is for the right to use a copyrighted article or a copyright right.

• Payment for the transfer of partial rights in a copyright is treated as a royalty, which is subject to withholding tax if made to a non-resident.

• Payment for the complete alienation of the transferor’s copyright right in the software, information or digitised goods is treated as business income or capital gains, which is not subject to withholding tax.

3. Japan: Earnings stripping provisions to take effect from 1st April 2013

As part of the 2012 Tax Reform, Japan adopted earnings stripping provisions under which a corporation’s deduction for net interest expense paid to a related party will be limited to 50% of adjusted income effective for tax years beginning on or after 1st April 2013.

Related party
A related party is defined to be any:

(i) person with whom the corporation has a 50% of more equity relationship;

(ii) person with whom the corporation has a de facto controlling or controlled relation-ship; or

(iii) third party lender which is financially guar-anteed by a person in (i) or (ii) above.

Net interest
Net interest is the difference between the interest paid to related parties and any interest income which corresponds to such interest paid. Interest paid to related parties includes interest and inter-est in the form of lease payments or guarantee payments, but excludes back-to-back repo interest and interest paid to a related party lender which is subject to Japan corporation tax.

Corresponding interest income includes a pro rata portion of interest income and interest in the form of lease payments received based on the ratio of interest from related parties to total gross interest income, but excludes interest income from resident related parties, domestic corporations, and non-residents and foreign corporations with a permanent establishment in Japan.

Adjusted income
Adjusted income is taxable income to which is added back (or subtracted) net interest expense, depreciation expense, excluded dividend income, and extraordinary loss (or income).

Net interest expense which exceeds 50% of adjusted income is not deductible, but may be carried forward for up to seven years and deducted in such future tax year up to the 50% threshold computed for that tax year. In addition, the unused carry-forward amount of a disappearing corporation in a tax qualified merger, or 100% subsidiary in liquidation, is transferred to the surviving, or parent corporation.

The limitation does not apply if net interest expense for the tax year is JPY 10 million or less, or if interest paid to related parties (after deducting back-to-back repo interest, but before deducting corresponding interest income from third parties or non-residents) is 50% or less of the total interest expense (excluding interest paid to related parties which is subject to corporation tax).

In the case of a corporation which is part of a consolidated group tax filing, the excess of the corporation’s net interest (excluding interest of other consolidated group members) over 50% of the adjusted consolidated income, is not deductible.

Where the thin capitalisation interest limitations apply (i.e. when the debt-to-equity ratio exceeds 3:1), the deductible interest expense is the lower of the limit under either the thin capitalisation or these earnings stripping rules.

If the corporation is subject to the anti-tax haven (controlled foreign corporation) rule, the non-deductible interest paid to the tax haven company (the corporation’s foreign subsidiary) is reduced to the extent that the corporation is subject to current tax on the interest income of the tax haven company.

4. South Korea: Arm’s length calculation for inter-company guaranty transactions clarified

In response to a growing number of disputes involving companies receiving guarantee fees from their foreign subsidiaries, the Ministry of Strategy and Finance (MOSF) has amended the Law for the Coordination of International Tax Affairs (LCITA) to provide new standards for Korean companies to calculate the arm’s length price for intercompany guaranty transactions.

Under the new standards, there are four methods that may be used in calculating the arm’s length price of guaranty fees for intercompany guaranty transactions. The new standards, which will be effective from January 2013, are summarised as follows:

• Benefit approach: This method is based on the benefit that a company is expected to receive from a guarantor’s guaranty. The arm’s length price is to be calculated as the difference in the company’s financing cost, with and without the intercompany guaranty.

• Cost approach: This method is based on the guarantor’s expected risks and costs. The arm’s length price is calculated as a sum of the guarantor’s expected risks from the guaranty provided and the related costs incurred.

• Cost-benefit approach: This method is based on both the guarantor’s expected risks and costs, and the company’s expected benefits. The arm’s length price is reasonably ad-justed from the arm’s length range derived from using the benefit approach and the cost approach taking into consideration the guarantor’s expected risks and costs and the company’s expected returns.

• Price deemed arm’s length: If a guaranty fee was calculated based on the difference between borrowing rates, quoted by a lending financial institution, with and without a guarantee, or calculated with a method specified by a commissioner of the National Tax Service (NTS), then it is deemed to be an arm’s length price.

5. Poland : Introduction of general anti-avoidance rules announced

The Minister of Finance (MF) announced to introduce comprehensive modifications to the Tax Code, which regulates the administration of taxes. The most significant changes that are proposed are as follows:

• General anti-avoidance rules (GAAR) are to be introduced aiming at counteracting avoidance of tax, with a particular focus on transactions and arrangements of artificial and abusive character, the only purpose of which is the obtaining of a tax advantage.

• Bank secrecy: The fiscal authorities are to be granted a larger access to the taxpayer’s personal and account information available to banks.

• GAAR Ombudsman: MF proposes to set up a council of GAAR Ombudsman, the role of which will be limited to non-binding opinions in the appealing proceedings, concerning tax abusive transactions. The GAAR Ombudsman will consist of the representatives of the Supreme Administrative Court and Supreme Court, Ombudsman, National Chamber of Tax Advisors, Attorney-General, universities and the Minister of Finance.

Note: Currently the concept of a general Tax Ombuds-man does not exist in Poland.

• Tax rulings: Taxpayers will be entitled to apply for a tax ruling exclusively by way of using electronic means. The very application for the ruling will already be subject to a fee, whereas currently, the fee is paid only upon the receipt of the tax ruling. MF proposes that the issue of a tax ruling may be denied if the facts imply the taxpayer’s intention to avoid taxation.

• Statute of limitations: MF intends to expand the catalogue of events, which lead to the suspension of the limitation period (e.g. consulting the tax institutions of other countries about the taxpayer’s “hidden” income will be included in the catalogue). Additionally, adjudication of bankruptcy or starting of the enforcement proceedings will entail the restarting of the limitations period, instead of its suspension. In practice, upon the completion of the enforcement proceedings, the new period of limitation will commence.

6. Australia : Non-residents will be ineligible for capital gains tax concession

The Assistant Treasurer released Exposure Draft Legislation that will make non-resident individuals ineligible for the Capital Gains Tax (CGT) discount in respect of gains from disposal of taxable Australian property with effect from 8th May 2012, when this measure was initially announced.

At present, individuals may be entitled to a 50% reduction, or discount, of their net capital gains in respect of assets held more than a year. Capital gains of non-residents are subject to tax only to the extent the gains are from Australian taxable property, such as Australian real estate.

The proposed changes will retain the discount for the gains to the extent the increase in value that contributed to the gain occurred before 9th May 2012, but any increase in value after that date that contributed to a capital gain made by non-resident individuals will be ineligible for the concessional treatment.

Temporary residents and relevant individual beneficiaries of trust estates will also be ineligible for the capital gain discount.

The Draft Exposure legislation was released on 8th March 2013.

7. Switzerland : Revised lump-sum taxation regime enters into force in 2016

On 20th February 2013, the Swiss Federal Council decided that the revised lump-sum taxation regime will enter into force as per 1st January 2016. The Swiss cantons are given two 2 years’ time to adapt their cantonal tax legislation.

The lump-sum taxation regime is granted to individual taxpayers at the federal level and (with the exception of the cantons of Basel-Landschaft, Basel-Stadt, Zurich, Schaffhausen and Appenzell-Ausserrhoden) in all cantons of Switzerland. The privilege is granted only to a resident individual with foreign nationality who does not derive in-come from employment in Switzerland.

The worldwide annual living expenses form the lump-sum tax base, but with a minimum pre-determined threshold:

• for federal and cantonal tax purposes, the lump-sum tax base will be at least:

seven times the rental value of the individual’s own property; or

seven times the rent paid to the landlord in Switzerland; or

three times the costs for board and lodging;

• for federal tax purposes, the minimum tax base will be CHF 400,000;

• for cantonal tax purposes, the minimum tax base will be freely determined by the canton concerned; and

• the cantons will levy a wealth tax.

Individuals who at the time of the entry into force of the revised tax legislation benefit from a lump-sum taxation agreement with the tax authorities which is more relaxed compared to the new tax legislation benefit from a transition period of five years.

8. United Kingdom

(i) Non-standard treaty tie-breaker rules for company residence – guidelines published

On 14th January 2013, HM Revenue & Customs (HMRC) published new section INTM120085 of the International Manual on company residence, providing clarification on non-standard treaty tie-breaker rules.

According to certain double taxation agreements, e.g. Canada – United Kingdom Income Tax Treaty (1978), Netherlands – United Kingdom Income Tax Treaty (2008) and United Kingdom – United States Income Tax Treaty (2001), when a person, other than an individual, is a resident of both States, the competent authorities of the two States determine by mutual agreement the State of which the person shall be deemed to be a resident (see also section INTM120080). The person is not able to attend or directly take part in the discussions, but can make representations regarding the State in which it considers itself to be actually resident.

Different criteria may be used by the competent authorities when discussing the question of residence and, according to HMRC, the relevant fac-tors that are likely to be considered are as follows:

• place of incorporation;

• place of central management and control;

• place of effective management;

• where company’s business activities are;

• economic linkages to each State;

• if there is actually double taxation; and

• the simplest administrative route for the company.

In addition, the section provides for several example scenarios.

(ii) Settlement opportunity for participant in tax avoidance schemes

On 8th January 2013, HM Revenue & Customs (HMRC) announced that it will offer to individuals, companies and partnerships that have entered into specific tax avoidance schemes, the opportunity to finalise their tax position and settle their tax liabilities by agreement without recourse to litigation.

The schemes covered include UK Generally Accepted Accounting Practice (GAAP) Partnership and schemes seeking to access the film relief leg-islation for production expenditure or create losses in partnerships through specific reliefs.

However, the settlement opportunity will not be available to participants in film partnership sale and lease-back schemes, interest relief schemes and schemes falling within HMRC’s criminal investigation policy or civil investigation of fraud procedures.

HM Revenue and Customs published the terms of the settlement opportunity open to individuals taking part in UK GAAP Partnerships and will publish the details of the opportunity available for other eligible schemes as they become available.

9. New Zealand

(i) Issues paper on review of the thin capitalisation rules

An officials’ issues paper, “Review of the thin capitalisation rules”, released on 14th January 2013, invites public submissions on proposed changes to the thin capitalisation rules as part of a continuing improvement to the international tax rules.

The proposed changes include:

• extension of the thin capitalisation rules to apply not only to investments controlled by single non-residents, but also to groups of non-residents, provided that those investors are acting together either specifically by agreement or by co-ordination by a party, e.g. a private equity manager;

• extension of the current rules applying to a resident trustee where more than 50% of settlements on the trust are made by a non-resident, to include settlements made by a group of non-residents acting together, or another entity which is subject to the rules;

• exclusion of related-party debt from the debt-to-asset ratio of a multinational’s worldwide group for the purposes of the thin capitalisation calculations. Debt from third parties would not be affected;

• exclusion of capitalised interest from assets when a tax deduction has been taken in New Zealand for the interest;

• exclusion of increased asset values as a result of internal sales of assets, with the exception of internal sales that are part of the sale of an entire worldwide group; and

• consolidation of individual owners’ interests with those of an outbound group.

(ii) Officials’ report on taxation of large multi-national companies

On 19th December 2012, the Minister of Revenue released an officials’ report on issues relating to the taxation of large multi-national companies.

The report considers the global issue of large multi-national companies paying little or no taxation in any country. The broad options put forward to tackle the problem are:

• to identify and amend the deficiencies in New Zealand’s base protection rules that apply to non-resident investment in New Zealand;

• promote best practice for residence taxation by all countries under their domestic law;

• participate in work to update and improve the international tax framework, in particular in the OECD tax base erosion and profit shifting (BEPS) project; and

• work closely with Australia at an official level to develop measures to address the problem.

Officials will report back to government on the issues in March 2013.

[Acknowledgment: We have compiled the above information from the Tax News Service of the IBFD for the period 18-12-2012 to 18-03-2013.]

Nirav Shah

S/s. 92A, 92B – ‘Deemed international transaction’ fiction is not applicable to transactions between Indian entities. Indian JV’s transaction with ‘Indian JV partner’ is not hit by transfer pricing provisions.

Facts:

S Pvt Ltd (taxpayer) is a joint venture company (JV Co), with Andhra Pradesh Housing Board (APHB) and an Indian company (ICo) as JV partners. ICo is a subsidiary of a foreign group (FCo Group). APHB and ICo are the shareholders of the taxpayer in the ratio of 49:51. The taxpayer JV Co was responsible for the construction and implementation of the housing projects as contemplated by APHB and was bound by the policy framework of the Government of Andhra Pradesh (GAP).

During the year, the JV Co entered into transactions with ICo. The Transfer Pricing Officer (TPO) treated these transactions as ‘deemed international transactions’ u/s. 92B(2) and held that though the transactions were entered into by the taxpayer with IJMII, the terms of such transactions were determined in substance between the taxpayer and FCo Group (Associated Enterprise). On appeal, Dispute Resolution Panel (DRP) upheld TPO’s view. Aggrieved, the taxpayer appealed before the Tribunal.

Held:

In order to determine deemed associated enterprise relationship u/s. 92B(2), the international transaction should be between enterprises wherein at least one of enterprise is a non-resident. In the facts of the case, both the parties are residents and hence the same should not constitute international transaction.

Further on scope of s/s. 92A and 92B(2) the tribunal held as below:

One of the essential limbs/constituents of an international transaction is “associated enterprise”. Section 92B(2) outlines the circumstances under which a transaction between two persons would be deemed to be between associated enterprises. Such deeming fiction is in addition to the one created u/s. 92A(2) i.e., parameters of management, control or capital. Section 92B(2) should be read as an extension of definition of AE u/s. 92A.

U/s. 92A two or more enterprises once determined to be AEs remain so for the entire financial year. However, the fiction embodied in section 92B(2) is transaction specific and does not apply to all transactions between the enterprise.

The legal fiction created u/s. 92B(2) in respect of the specified transaction can be used only for the purpose of examining whether such transaction constitutes an ‘international transaction’ u/s. 92B(1). In case section 92B(1) is not attracted, the fiction u/s. 92B(2) ceases to operate.

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Nirav Shah

S/s. 195A and 206AA – The grossing up of the payment in case of net of tax contracts is to be made at “rates in force” and should not be made at the higher rate of 20% specified u/s. 206AA.

Facts:

Taxpayer, an Indian company, entered into repairs contracts with its foreign supplier, a resident in Germany. Further, as per the contracts, taxpayer was required to pay on net-of-tax-basis. The Tax Authority contended that
(a) the payments were in the nature of technical services and constituted FTS, both under the Act and the India-Germany DTAA.
(b) Also, section 206AA overrides all other provisions of the IT Act and, hence, nonresidents are also required to furnish their PAN to the payer of income
(c). Accordingly, in the absence of PAN, higher rate of 20% should be applied and consider net of tax payments grossing up also should be done at 20%. CIT(A) upheld tax authority’s observations. Aggrieved, the taxpayer filed an appeal before the Tribunal.

Held:

Section 206AA overrides all the other provisions of the ITL and applies to all recipients of income, irrespective of the recipients’ residential status. Therefore, a nonresident whose income is chargeable to tax in India has to obtain a PAN and provide the same to the payer of income/taxpayer. In the absence of PAN, section 206AA is applicable and tax is required to be withheld at 20%.

A literal reading of the grossing up provisions u/s. 195A implies that the income should be increased by the “rates in force” for the relevant tax year and not the rate at which the “tax is to be withheld” by the taxpayer. Meaning and effect has to be given to the expression used in a section, as held by the SC in the case of GE India Technology [(2010) 327 ITR 456 (SC)]. Thus, the grossing up of the amount is to be done at the “rates in force” and not at the rate of 20% specified u/s. 206AA.

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Nirav Shah

(i) Commission paid to UK agent for engaging artists from outside India was not taxable in India as the services were performed outside India and agent had no PE in India. (ii) Reimbursement of expenses to UK agent was not chargeable to tax in India.

New Page 2

14. ACIT v. Wizcraft International

Entertainment Pvt. Ltd. (unreported)

ITA No. 3208/Mum./2003

Articles 5, 7, 18, India-UK DTAA

Dated : 19-11-2010

(i) Commission paid to UK agent for engaging artists from
outside India was not taxable in India as the services were performed outside
India and agent had no PE in India.

(ii)
Reimbursement of expenses
to UK agent was not chargeable to tax in India.

Facts :

ICo was engaged in the business of entertainment event
management and marketing. It had organised events/performances of renowned
foreign artists/groups in India. For various events/performances of
international artists in India, ICo had entered into agreement with a UK
agent. The UK agent was also acting as an agent for various event management
companies.

Under the agreement, ICo granted limited authority to the
UK agent to act on its behalf; enter into contract with artists; and other
ancillary acts required to be performed outside India. Apart from payment of
fees to artists, ICo agreed to pay certain commission to the UK agent and also
to reimburse expenses incurred by it in connection with visits and
performances of artists in India.

ICo deducted tax from the fee paid to the artist as it was
taxable in India in terms of Article 18 of India-UK DTAA. However, it did not
deduct any tax either from the commission paid, or reimbursement of expenses,
to the UK agent, on the ground that the UK agent had rendered the services
outside India and it did not have PE in India. ICo also did not deduct tax
from reimbursement of artists’ travel and related expenses which ICo had
undertaken to bear in terms of its contract with artists.

Held :

The Tribunal held as follows :

(i) Commission paid to the UK agent was not for services of
entertainers/artists. The UK agent had also 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.

(ii) The UK agent did not have any PE in India. Relying on
the Supreme Court’s decision in Carborandum Co. v. CIT, (1977) 108 ITR 335
(SC) and CBDT Circular Nos. 17 (XXXVII) of 1953 at 17th July and 786, dated
February 7, 2001, commission paid to the UK agent was not taxable in India.
Consequently, there was no obligation on ICo to deduct tax as source.

(iii) From the details furnished by ICo, it was clear that
the payments were reimbursement of expenses. The law is well settled that
reimbursement of expense is not chargeable to tax and therefore, there was no
obligation to deduct tax at source.

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Nirav Shah

Foreign tax paid by an assessee cannot be claimed as a deductible expense but is an appropriation of income, eligible for double taxation relief.

New Page 2

13. DCIT v. Tata Sons Ltd. (unreported)

ITA No. 4776/Mum./2004

S. 2(43), S. 37(1), S. 40(a)(ii), S. 90,

Income-tax Act

A.Y. : 2000-01. Dated : 24-11-2010

Foreign tax paid by an assessee cannot be claimed as a
deductible expense but is an appropriation of income, eligible for double
taxation relief.

Facts :

ICo was an investment company and a resident of India. ICo
was also engaged in the business of export of software and provision of
engineering consultancy. ICo paid taxes in the USA on income earned from the
USA. ICo had claimed tax credit in respect of foreign taxes paid by it. In terms
of S. 80HHC, ICo claimed exemption in respect of the income earned in the USA
and thus attracted no tax liability in India.

While computing its taxable income, apart from tax credit,
ICo also claimed deduction of foreign taxes as normal business expenditure. In
this respect, ICo relied on favourable ITAT decision in its own case for earlier
years against which the High Court had rejected the appeal.

As per the Tax Authority, income tax paid, whether in India
or overseas, was an application of income and not a charge on income which
qualified as deductible business expenditure. Also, ICo was entitled to tax
credit in respect of foreign taxes paid by it and foreign taxes were
specifically not allowable as a deduction, either u/s.37(1) or u/s. 40(a)(ii).

Held :

The Tribunal held as follows :

(i) By claiming overseas taxes as deduction in computing
taxable profits, ICo had treated foreign taxes as a ‘charge’ on income. By
claiming tax credit in respect thereof, it had also treated them as an
‘application’ of income. There cannot be any justification for making such
contradictory claims and obtaining overall tax relief larger than actual taxes
paid overseas.

(ii) In Lubrizol India Ltd. v. CIT, (1991) 187 ITR 25
(Bom.), the High Court has held that tax as defined is not restricted to tax
as levied under the Income-tax Act, but also includes taxes as levied by the
foreign country. In view of such direct precedent of the jurisdictional High
Court, it would not be correct to accept that foreign taxes on profit are not
tax covered by the restriction provision.

(iii) Referring to the said decision, the Tribunal observed
that “there is a categorical observation to the effect that the tax deducted
is a local tax and not a tax on profits, whereas in the present case it is an
undisputed position that the tax levied abroad, being income tax, is a tax on
profits of the assessee — whether on presumptive basis or on the basis of
actual profits earned by the assessee.

(iv) The foreign taxes paid by ICo are covered by S. 37(1)
or S. 40(a)(ii) and deduction of the same from taxable profits is not allowed
under the Income-tax Act.

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Nirav Shah

(i) In absence of allegation that the agreement approved by regulatory authority is a sham, the tax authority cannot disregard the same.(ii) For transfer pricing analysis internal compar-ables are preferable over external compar-ables.(iii) While applyi

New Page 2

12. Abhishek Auto Industries Ltd. v. DCIT

(2010) TII 54 ITAT-Del.-TP

S. 92, Income-tax Act

A.Y. : 2004-05. Dated : 12-11-2010

(i) In absence of allegation that the agreement approved by
regulatory authority is a sham, the tax authority cannot disregard the same.

(ii) For transfer pricing analysis internal compar-ables
are preferable over external compar-ables.

(iii) While applying TNMM, only profits related to the
transaction with AEs should be compared and not profits of the company as a
whole.

Facts :

ICo was engaged in manufacture of car seat belts for Indian
markets. For certain types of seat belts, ICo imported raw materials and
obtained technical know-how from its Associated Enterprise (‘AE’) for assembling
seat belts which were supplied to domestic car manufacturers. In its transfer
pricing documentation, ICo had mentioned that (i) raw materials imported from
its AE were not available from any other supplier, (ii) In the circumstances it
was difficult to ascertain its arm’s-length price.

As regards to payment of royalty and technical know-how fees,
ICo had mentioned that as the payment was in accordance with agreements approved
by appropriate regulatory authority (viz. Central Government), question of
complying with arm’s-length price did not arise. Further, in hearing before
Transfer Pricing Officer (‘TPO’), ICo presented comparison of gross
profitability between AE and non-AE transactions.

In TP proceedings TPO concluded that :

l No
transfer of technology had taken place as the payments were included in the
price of raw materials supplied by AE.

l TNMM
was the most appropriate method for applying on totality basis.

Accordingly, adjustments were made on the basis of difference
between profit of selected
comparables and overall profit from both AE and non-AE transactions.

Held :

The Tribunal held as follows :

(i) It was erroneous on the part of Tax Authority to
disregard the agreement which was approved by regulatory authority. Commercial
expediency is the domain of the assessee and in the absence of allegation that
the agreement is a sham, it cannot be rejected arbitrarily without assigning
cogent reasons.

(ii) Internal comparables are preferable over external
comparables. As profit margin from AE transaction was higher than that from
non-AE transaction, international transactions complied with arm’s-length
requirement.

(iii) While applying TNMM, only profits related to the
transactions with AEs should be compared and not profits of the company as a
whole.

levitra

Nirav Shah

S/s. 5(2), 9(1)(v) – Interest on FCCBs issued outside India neither accrues or arises in India nor is deemed to accrue or arise in India; Where an interest income falls within the ambit of the source rule exclusion specifically dealing with deemed accrual of interest, it cannot be taxed by evaluation within the ambit of “income accrued and arisen in India.

24. TS-18-ITAT-2013(Ahd)
ADIT (IT) vs. Adani Enterprises Ltd.
A.Y.: 2009-10, Dated: 18-1-2013

S/s. 5(2), 9(1)(v) – Interest on FCCBs issued outside India neither accrues or arises in India nor is deemed to accrue or arise in India; Where an interest income falls within the ambit of the source rule exclusion specifically dealing with deemed accrual of interest, it cannot be taxed by evaluation within the ambit of “income accrued and arisen in India”.

Facts

An Indian Company (Taxpayer) made interest payments to a US Bank on Foreign Currency Convertible Bonds (FCCBs), issued by the Taxpayer. The funds were deployed by the Taxpayer outside India, primarily invested in the foreign subsidiary, which in turn is involved in financing further business abroad. Taxes were not withheld on interest payments made by the Taxpayer. The tax authority held that the interest on FCCBs accrued in India in the hands of non resident investors, as FCCBs were issued by an Indian company and the interest was paid by an Indian company from India and the obligation to pay the interest rested with the Taxpayer. However, CIT(A) ruled otherwise and held that the interest income was not taxable in India. Aggrieved, tax authority appealed before the Tribunal.

Held

Tribunal referred to the Madras HC’s ruling in case of C.G. Krishnaswami Naidu [(1966) 62 ITR 686 (Mad)], and held that the decisive factor in order to determine the place of accrual would be the place where the money is actually lent, irrespective of where it came from. In the present case, the money was actually lent by the non-resident investors in the foreign country and it was not lent in India and therefore, it cannot be said that the interest income has accrued or arisen to the non-resident investors in India. Further payment of interest by an Indian Company is not a decisive factor to determine whether income accrues in India.

Section 9(1)(v) of the Act is applicable for the purpose of determining whether interest income is deemed to accrue or arise in India. As per clause (b) of section 9(1)(v) of the Act interest payment to non-resident investors by an Indian resident, if such interest payment is in respect of amount borrowed outside India and used outside India for investment or for business carried out outside India is excluded from the ambit of taxation in India. In the facts of the case, the above exclusion would squarely apply as the money has been utilised for the business outside India. The Tribunal also pointed out that if an income is said to accrue or arise in India whether the same can be excluded specifically from scope of income deemed to accrue or arise in India, which according to the Tribunal was not correct. Deeming of income accruing or arising in India are those situations where income has not actually accrued or arisen in India, but still it will be deemed to accrue or arise in India. Hence, both the situations are mutually exclusive. If one case is falling within the ambit of income accrued and arisen in India, it cannot fall within the ambit of income deemed to accrue or arise in India and vice versa.

Tribunal ruling in favour of the Taxpayer concluded that, as the interest income in the present case is falling within the ambit of the exclusion clause of “income deemed to accrue or arise in India”, it cannot fall within the ambit of “income accrued and arisen in India” and hence the same was not taxable in India.

levitra

Nirav Shah

S/s. 9(1)(vii), 195 – Transfer of fabric designs by a UK Company to an Indian Company is in the nature of FTS in terms of treaty and hence liable to withholding tax in India.

23. TS-18-ITAT-2013(Ahd)
Sintex Industries Ltd. vs. ADIT
A.Ys.: 2009-10 and 2010-11, Dated: 18-1-2013

S/s. 9(1)(vii), 195 – Transfer of fabric designs by a UK Company to an Indian Company is in the nature of FTS in terms of treaty and hence liable to withholding tax in India.

Facts

An Indian Company (Taxpayer) made payments to a UK Company (FCo) for providing fabric designs. As per the agreement, FCo was required to; deliver fabric designs for cotton shirting; show and/make available all documents/reports in relation to fabric designs; provide detailed quantity report in writing along with specific/new design developed, to the Taxpayer. It was also contemplated in the agreement that on expiry or termination, FCo would be required to return all the documents and other internal documents of the Taxpayer. The tax authority held that the payments made were in the nature of FTS under the India-UK DTAA, which was also upheld by the CIT(A). Aggrieved, the Taxpayer appealed to the Tribunal.

Held

The Tribunal did also note that there was no clause in the agreement obliging the Taxpayer to return the design supplied by FCo on expiry or termination of the agreement. It accordingly held that the designs supplied by FCo to the Taxpayer became the property of the Taxpayer, which could be either used by the Taxpayer for its own business or be sold to any outsider for consideration. Accordingly, the Tribunal ruled that FCo was required to transfer the design to the Taxpayer and consequently FCo made available the designs which could be used in the business of the Taxpayer or sold to an outsider and hence, the above services were in the nature of FTS under the India-UK DTAA as it involved transfer of a technical plan or design. Further, the Tribunal also referred to the MOU to India- US DTAA to arrive at the conclusion that the payments made to FCo were for making available technical services. Consequently, the payments made were subject to withholding tax in India.

levitra

Nirav Shah

S/s. 9(1)(vii), 195(2) – Payments to non-resident for availing automated machine oriented and standard laboratory testing services are not taxable as FTS under the Act as it lacked human intervention.

22. TS-51-ITAT-2013(Mum)
Siemens Limited vs. CIT Dated: 12-2-2013

S/s. 9(1)(vii), 195(2) – Payments to non-resident for availing automated machine oriented and standard laboratory testing services are not taxable as FTS under the Act as it lacked human intervention.

Facts

An Indian Company (Taxpayer) made payments to a German Laboratory (GL) for carrying out certain laboratory tests on circuit breakers so as to establish that the design and the product meets the international standards. The tests were done automatically by machines without any human intervention and on completion of these tests a certificate was issued by the authorities of GL for the quality of the product tested. The tax authority contented that the amount paid to GL was taxable in India as the payment was for technical services covered u/s. 9(1)(vii) of the Act. The CIT (A) upheld the view of tax authority. Aggrieved, the Taxpayer appealed to the Tribunal.

Held

Relying on Delhi High Court’s (HC) decision in the case of CIT v. Bharati Cellular Ltd [(2009) (319 ITR 139) (Del)] and Madras HC’s decision in the case of Skycell Communications Ltd vs. DCIT [(2001) 251 ITR 53 (Mad.)], Tribunal observed as below:

• The word “technical” as appearing in FTS definition is preceded by the word “managerial” and succeeded by the word “consultancy” and therefore, it takes colour from these words and cannot be read in isolation. Based on the principle of “noscitur a sociis”1 the word technical should be understood in the same sense as the words surrounding it.

• Managerial and consultancy services can be provided by humans only and cannot be provided by means or any equipment. Therefore, the word “technical” has to be construed in the same sense involving direct human involvement, without which technical services cannot be held to be made available.

• Where simply an equipment or sophisticated machine or standard facility is provided (though that facility may itself have been developed or manufactured with the usage of technology), such a user cannot be characterised as providing technical services.

• As against that if a person delivers his technical skills or services or makes available any such services through aid of any machine, equipment or any kind of technology, then such a rendering of services may be regarded as “technical services”. In such a situation, there is a constant human endeavour and the involvement of the human interface.

• If any technology or machine is developed by human and the same is put to operation automatically, wherein it operates without any amount of human interface or intervention, then the usage of such technology cannot per se be held as rendering of technical services by human skills. In such a situation, some human involvement could be there but it is not a “constant endeavour of the human” in the process.

Applying the above principles, the Tribunal ruled that the services rendered by GL were not technical in nature, as there was not much human involvement for carrying out the tests in the laboratory which were mostly done by machines, though under observations of technical experts. Further, the services were more of a standard facility through the usage of machines and human activities were limited to providing test certificate and test reports. Therefore, merely because the test was observed and the certificates were provided by the humans, it cannot be said that the services have been provided through human skills.

levitra

Nirav Shah

Taxpayer expected to charge separate royalty from the person who uses know-how for manufacture & supply of goods to the taxpayer itself. • Taxpayer has a right to legally arrange its affairs so as to reduce its incidence of tax.

New Page 1

Part C : Tribunal & AAR International Tax Decisions

17 Robert Bosch GmbH v. ACIT

(2010) TII 149 ITAT-Bang.-Intl.

Article 5, 12 of India Germany DTAA,

S. 9(1)(vi) of ITA

A.Y. : 2004-05. Dated : 23-7-2010

Taxpayer is not expected to charge separate royalty from the person who uses
know-how for manufacture and supply of goods to the taxpayer itself.

Taxpayer has a right to legally arrange its affairs so as to reduce its
incidence of tax.

Facts :

Taxpayer, a German company (GCO), entered into a
collaboration agreement with MICO, an Indian company (MICO), for supply of the
right to use technology, patent, design, etc. The supply of technology enabled
MICO to manufacture products which were exported to taxpayer as well as to other
third parties.

Terms of the agreement, as existed up to 31-12-2000, provided
for payment of products supplied (by GCO to MICO) as well as separate payment
for know-how (by MICO to GCO). Payment for know-how was 5% of value of all sales
made by MICO. On this basis, till 31-12-2010, the taxpayer was of-fering royalty
income (including in respect of goods supplied to the taxpayer itself) to tax.

The terms of the agreement, were revised, w.e.f. 1-1-2001,
such that no royalty was payable by MICO to the taxpayer for goods supplied to
the taxpayer.

The comparative position of contract terms concerning supply
and know-how fees which persisted between GCO and MICO before and after 1st
January 2001 was as under :

Tax authority rejected the claim of the taxpayer, and imputed royalty of 5% on the basis that the revised terms of agreement resulted in evasion of taxes by the taxpayer as royalty was no longer offered for tax.

Held :

ITAT rejected the contentions of the Tax Authority and held as under :

Effect of terms of the agreement, prior to 1-1-2001, was that the royalty income was taxable in the hands of taxpayer in India and simultaneously it would be allowable expenditure in the country to where the taxpayer belonged. In order to avoid this situation the taxpayer had arranged its affairs in such a way that the receipt of royalty was eliminated and to that extent payment for purchases from MICO was reduced.

The taxpayer is not expected to make royalty income with reference to the sale effected to taxpayer itself by MICO, when know-how for manufacture of the same is supplied by the taxpayer. When the know-how belongs to the taxpayer, it is its prerogative to charge royalty for use of its know-how for manufacture of goods to be supplied to the taxpayer.

Taxpayer has every right to arrange its affairs such that it is in a position to reduce its tax incidence.

The Tax Authority’s finding was based only on presumption that royalty is deemed to have been paid to the taxpayer by MICO without deduction of tax.

The Tax Authority who concluded the assessment in the case of MICO had neither disputed the amount payable to the taxpayer by MICO, nor raised the issue on TDS implication.

Nirav Shah

Consideration simplicitor for supervising erection, assembling and commissioning of machinery does not fall within the exclusion clause provided for ‘construction/assembly project’ u/s.9(1)(vii). •Payments for technical services though covered under Artic

New Page 2

Part C : Tribunal & AAR International Tax Decisions

16 Aditya Birla Nuvo Limited v. ADIT

ITA 7527/Mum./2007

Articles 5, 13 of India-Italy DTAA;

S. 9(1)(vii) & S. 195 of ITA

Dated : 30-11-2010

Consideration simplicitor for supervising erection, assembling and
commissioning of machinery does not fall within the exclusion clause provided
for ‘construction/assembly project’ u/s.9(1)(vii) of ITA.

Payments for technical services though covered under Article 13 of DTAA (FTS),
would be excluded from Article 13 if payments are for services that are
effectively connected with a PE or fixed base in India.

Non-fulfilment of threshold period of stay would not trigger supervisory PE in
terms of Article 5(2) of the DTAA. In the absence of PE, payment for
supervisory services would not be taxable in India.

Facts :

Taxpayer, an Indian company (ICo), was engaged in the
business of yarn, filament, garments, fertilisers, textiles and insulators. It
entered into an agreement with an Italian company (GTA) for supervising the
reassembling and re-commissioning of machinery at the taxpayer’s factory
premises in India.

Key features of obligations of GTA were as under :

Supervising job of uninstalling textile plant, located at South Africa and
reinstalling at ICo’s premises in India.

Deputing skilled engineers for supervision of re-installation/re-commissioning
of plant in India.

Deputing two engineers to India, who worked for 30 days and 22 days
concurrently.

All equipments/facilities were provided by ICo. Further actual erection of
machines was to be done by local workers, provided by ICo.

The taxpayer made an application u/s.195(2) of the ITA for
remitting funds, to GTA, without deduction of tax on the basis that payments
would fall under exclusion clause (‘for any construction, assembly, mining or
like project’) of definition of ‘fees for technical services’ u/s.9(1)(vii) of
ITA. In any case, in terms of DTAA, amount would not be taxable in India, as the
services were connected to PE/fixed base of GTA in India.

Though the activities of GTA were mainly supervisory in
nature, its duration did not exceed the time threshold, of six months,
prescribed for constituting a supervisory PE under Article 5 of the DTAA. Hence
payments in relation to such activities would not be taxable in India.

Held :

Under ITA

The technicians of GTA were in India only for supervising the erection of
machines and giving advice on reassembling, erecting and commissioning of
machinery. Actual erection of machines was done by local workers, supplied by
the taxpayer.

The payments in question thus could not fall under the exclusion clause of FTS
under ITA as the project of construction/assembly was not of ICo.

Under the DTAA

The nature of service rendered by GTA was technical, being supervisory in
nature. However Article 13 of the DTAA excludes payments for services
connected to PE or a fixed base in India under Article 5 of DTAA.

AAR in the case of Horizontal Drilling Inter-national (94 Taxman 142) held
that PE rule and FTS definition of the DTAA must be read harmoniously. Hence,
payments made in consideration for supervision or construction or installation
project should be excluded from purview of FTS taxation.

Though GTA, by virtue of technicians’ presence in India, would be covered
within supervisory PE in India, since their stay did not exceed time threshold
of 6 months, the same would therefore not constitute PE in India under the
DTAA.

Once proposed remittance was held as non-taxable, question of considering
taxability of reimbursement of expenditure was not required.

levitra

Nirav Shah

Credit for taxes withheld cannot be denied to the taxpayer on the basis of subsequent refund to deductor when all obligations complied with.Lawful implications of validly issued TDS certificates cannot be declined on the ground that payer has been refund

New Page 2

Part C : Tribunal & AAR International Tax Decisions

15 Lucent Technologies GRL LLC v. DCIT

ITA No. 6353/Mum./2009

Article 12 of India-US DTAA, S. 195, S. 200 of Income-tax Act
(ITA)

A.Y. : 2006-07. Dated : 31-12-2010

Credit for taxes
withheld cannot be denied to the taxpayer on the basis of subsequent grant of
refund to tax deductor (against indemnity bond), when all obligations under
provisions of ITA relating to tax deduction and issue of TDS certificate, etc.
have been duly complied with.

Lawful
implications of validly issued TDS certificates cannot be declined on the
ground that payer has been refunded taxes that were deposited with Government.

Facts :

The taxpayer, resident of USA, was in the business of supply
of copyrighted software for a telecommunication project. The taxpayer received
consideration from R Info (payer) for supply of software. The consideration
received was after deduction of tax. To illustrate, from supply consideration of
Rs.100, taxpayer received Rs.85 after deduction of tax @15%. The tax deduction
was pursuant to the AO’s order which directed that the remittance should be made
after deduction of tax.

The payer deposited TDS with the Government and also issued
TDS certificate to the taxpayer.

However, being aggrieved with AO order directing TDS, the
payer filed an appeal before the CIT(A). The payer was refunded the amount that
it had deducted and deposited while making remittance to the taxpayer. The CIT(A)
decided the issue in favour of the payer. It appears, refund to the payer was
granted against indemnity bond to the effect that taxes refunded would be
re-deposited with the Government.

The taxpayer claimed credit for the taxes withheld on the
basis of TDS certificates issued by the payer. On inquiry from the AO of the
taxpayer, the payer stated that it has executed an indemnity bond to the effect
that the taxes refunded to it will be re-deposited with the Government.

The AO of the taxpayer, however, held that since tax has been
refunded to the payer, the TDS certificates were not valid and hence no credit
for TDS could be granted to the taxpayer.

The AO also observed that since no confirmation of TDS being
re-deposited was made, credit of taxes would not be available to the taxpayer.
The CIT(A) also confirmed the stand taken by the AO, but directed him to verify
whether the TDS refunded to payer has been re-deposited by it with the
Government.

Aggrieved by the CIT(A) order, the taxpayer went in appeal
before the ITAT.

Held :

The ITAT rejected contention of the tax authority and held
that :

Since the taxes have been deducted from the payment made to the taxpayer
and the taxpayer is also in receipt of the appropriate TDS certificates,
credit for TDS cannot be declined on the basis of an administrative action
of refund, which is neither envisaged by the provisions of the Act, nor in
the control of the taxpayer.

Refund of taxes to the payer is a matter that has to be dealt with by Tax
Authorities who must have protected their interests effectively while
granting refund; and by now the payer may even have re-deposited the monies.
But the taxpayer (recipient of income from which tax is deducted and to whom
valid TDS certificate is issued) is generally not expected to get into these
aspects of the matter.

All the requirements for grant of TDS credit such as deduction of tax
u/s.195, fulfilment of obligations by tax deductor u/s.200 and issue of TDS
certificate were duly complied with. Fairness of these procedures had also
not been questioned by the Tax Authority.

Refund of tax to a tax deductor is not prescribed under the scheme of the
ITA and is an administrative exercise. Such exercise cannot take away,
curtail or otherwise dilute the rights of the person from whose income taxes
are so deducted and to whom such certificate is issued.

The Tax Authority is bound to grant credit of taxes to the taxpayer on the
basis of original TDS certificates produced by the taxpayer and in
accordance with the provisions of the ITA.

This ruling shall, in no way dilute the remedies that the Tax Authority
may pursue qua the tax deductor, for recovery of taxes that were
inappropriately refunded to them.

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Nirav Shah

Information supplied was in nature of data. It was not exploitation of know how. Hence, the payment received was business receipt and not Royalty.

4. P T McKinsey Indonesia vs. DDIT [2013] 29
taxmann.com 100 (Mumbai-trib)
Article 7 and 12 of India-Indonesia DTAA
Asst Year: 2007-2008
Decided on: 16th January 2013
Before Rajendra (AM) and D K Agarwal (JM)

Information supplied was in nature of data. It was not exploitation of know how. Hence, the payment received was business receipt and not Royalty.

Facts

The taxpayer was an Indonesian company engaged in the business of providing strategic consultancy services. During the year, it had provided information to its group company in India and had received certain amount as consideration therefor. The taxpayer had claimed that the consideration received by it was in the nature of business receipt and since it did not have a PE in India, it was not chargeable into tax in India. According to the AO, the information provided by the taxpayer constituted technical and consultancy services so as to make available technical knowledge, skill, know-how, experience or process and thus, was in the nature of ‘fees for included services’ as covered by Article 12 of the DTAA between India and Indonesia2. The AO held that the fees received by the taxpayer were for consultancy/advisory services without any technology and they constituted Royalty in term of Article 12. The taxpayer approached DRP, which held that provisions of Article 22(3) – ‘other income’ – apply.

Held

The Tribunal observed and held as follows. The AO had nowhere established that the information supplied was arising out of exploitation of the knowhow generated by the skills or innovation of person who possesses such talent. In taxation terminology, the term ‘royalty’ has a distinct meaning. The information received by the Indian group company was in the nature of data and the consideration for the same cannot constitute ‘Royalty’. Article 22 is a residuary head analogous to sections 56 and 57 of I-T Act. Hence, It will not apply if the sum can be taxed under any other Article. With regard to earlier decisions of the Tribunal in respect of similar payments by the Indian group company, the payment should be treated as business profits in terms of Article 7.

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Nirav Shah

Referral fees received by non-resident for referring international clients does not constitute FTS u/s. 9(i)(vii) of I T Act.

3. CLSA Ltd vs. ITO [2013] 31 taxmann.com 5 (Mumbai-Trib)
Section 9 r.w. S. 5 of I T Act
Asst Year: 2004-05
Decided on: 18th January 2013
Before P M Jagtap (AM) and D K Agarwal (JM)

Referral fees received by non-resident for referring international clients does not constitute FTS u/s. 9(i)(vii) of I T Act.

Facts

The taxpayer was a company incorporated in Hong Kong. It was a member of a group of companies having global presence. During the year, the Indian group company (“IndCo”) of the taxpayer had made certain payments to the taxpayer which were recorded by IndCo as recovery of overhead expenditure. IndCo had also withheld tax from the payments. The taxpayer contended that the payments were referral fees for referring overseas institutional clients to IndCo and hence, were not FTS in terms of section 9(1)(vii) of I-T Act. Consequently, they were not chargeable to tax. The issue before the Tribunal was: whether the referral fees constitute FTS in terms of section 9(1)(vii)?

Held

The Tribunal observed and held as follows. The Tribunal referred to Advance Ruling in Cushman and Wakefield (S) Pte Ltd., In re [2008] 305 ITR 208 (AAR) wherein, on similar facts, the AAR had held that the referral fees was not FTS1. Following the AAR ruling, the Tribunal held that the referral fees received by the taxpayer were not FTS u/s. 9(1)(vii) of I T Act.

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Nirav Shah

Test reports provided by the Singapore company did not ‘make available’ technical knowledge, etc., and therefore, the payment did not constitute FTS under Article 12(4) of the India-Singapore DTAA.

2. Romer Labs Singapore Pte Ltd vs. ADIT [2013]
30 taxmann.com 362 (Delhi-Trib)
Article 12 of India-Singapore DTAA; Section
9 of I-T Act
Asst Year: 2005-06
Decided on: 24th January 2013
Before B C Meena (AM) and I C Sudhir (JM)

Test reports provided by the Singapore company did not ‘make available’ technical knowledge, etc., and therefore, the payment did not constitute FTS under Article 12(4) of the India-Singapore DTAA.

Facts

The taxpayer was a tax resident of Singapore (“SingCo”). The taxpayer provided services for testing of toxicity level in animal feeds to Indian companies. The Indian companies were forwarding products’ samples to the laboratory of the taxpayer in Singapore. After testing, the taxpayer forwarded the reports to the Indian company. In consideration, the Indian company paid service fee to the taxpayer. Admittedly, the taxpayer did not have PE in India. The issue before the Tribunal was whether the services provided by the taxpayer ‘made available’ any technical knowledge, experience, skill, knowhow or process in terms of Article 12(4)(b) of the India-Singapore DTAA?

Held

The Tribunal observed and held as follows: The expression ‘make available’ has been examined by various judicial authorities. There is a difference between section 9 of I-T Act and Article 12(4)(b). While Article 12(4)(b) requires the services to be ‘made available’, section 9 has no such requirement. In terms of Article 12, the payment would constitute FTS only if the service provider provides the services in a manner which equips the recipient to independently perform his functions in future without any help from the service provider. Since the test reports provided by SingCo did not ‘make available’ technical knowledge, etc. to the Indian company, the payments made for such reports were not FTS.

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Nirav Shah

S/s. 4, 163 – Where necessary RBI approval was not obtained for remitting amounts in foreign exchange and such amount was still payable during the relevant year, such amount cannot be taxed in the hands of recipients, despite the claim for deduction by the payer.

Facts 1:

Taxpayer is a foreign partnership firm established in Germany, having a branch office in India through which it renders management and technical consultancy services. During the relevant year, taxpayer obtained services from overseas group entities and the consideration for services was shown as ‘payable’ in the books of accounts. However, the actual payments were not made, as Reserve Bank of India (RBI) approval for the same was not obtained.

The taxpayer was incurring losses and did not have sufficient funds and therefore did not even make an application to RBI seeking its approval to remit the amount. These amounts were debited to Profit & Loss Account of PE of taxpayer in India and deduction on the same was claimed.

The tax authority treated the taxpayer to be the representative assessee of the recipient group entities and considered the amounts payable by the taxpayer as income in the hands of recipients. CIT(A) upheld tax authority’s order. Aggrieved, the taxpayer appealed to the Tribunal.

Held 1:

Income on account of amounts payable by the taxpayer to the overseas group entities could be said to have accrued to the said entities only on receipt of the required approval from RBI and there being no such approval received during the year under consideration, the same could not be taxed as income in that year. Reliance was placed on the Bombay High Court decision in the case of Kirloskar Tractors Ltd. [(1998) 231 ITR 849) (Bom)] and in the case of Dorr-Oliver (India) Ltd. [(1998) 234 ITR 723 (Bom)], wherein it was held that accrual of income takes place only on obtaining of necessary approval required from RBI.

S/s. 9, 90 – In respect of recipient from treaty country, income in the nature of FTS should be ‘paid’ during the relevant previous year to be taxed in the hands of recipients.

Facts 2:

In addition to the above, taxpayer had received certain technical services from other overseas entities, amounts for which were also ‘payable’ during the year. However, the same was not offered to tax on the premise that as per the relevant tax treaties the same was taxable only on actual receipt. The tax authority brought these amounts to tax as FTS in the hands of these overseas entities.

Held 2:

Following the decision of Bombay High Court in the case DIT (IT) v. Siemens Aktiengesellschaft [TS-795-HC- 2012(BOM)] as well as the decisions of the Tribunal in the case of DCIT vs. UDHE GmbH [(1996) 54 TTJ 355 (Bom)] and in the case of CSC Technology Singapore Pte. Ltd. vs. ADIT [(2012) 50 SOT 399 (Del)], Tribunal held that the amounts payable by taxpayer to the overseas group entities could not be brought to tax in India during the year under consideration as FTS as per the relevant provisions of the tax treaties, since the same had not been ‘paid’ to the said entities.

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Nirav Shah

Nimbus Sport International Pte. Ltd. v. DDIT (2011) TII 178 ITAT-Del.-Intl. Articles 5, 7 & 12 of India-Singapore DTAA A.Ys.: 2002-03, 2003-04, 2004-05 Dated: 30-9-2011 Before K. D. Ranjan (AM) and R. P. Tolani (JM) Counsel for assessee/revenue: S. R. Wadhwa/A. K. Mahajan, A. D. Mehrotra

(i) On facts, the taxpayer had no fixed place PE or service PE in India.

(ii) Receipts of the taxpayer were in the nature of FTS and not business income.

(iii) FTS received by the taxpayer were taxable @10% in terms of Article 12(2) of India-Singapore DTAA.

(iv) As the taxpayer did not have PE in India, the advertisement revenue received in respect of matches played outside India which were telecast outside India was not taxable in India. The force of attraction also cannot apply merely because some viewers may be in India or advertisement may have some incremental value in India.

Facts:
The taxpayer was Singapore company (‘SingCo’) engaged in the business of sports coverage, production, distribution, event management, sponsorship, etc. SingCo was formed as a joint venture between two independent and unrelated companies, one was a Mauritius company and another was a BVI company. SingCo was a tax resident of Singapore and was wholly managed and controlled from Singapore. It had claimed that it did not have a fixed place PE, a service PE, an agency PE or any other type of PE in India. Pursuant to an International Bidding, SingCo entered into agreement with Prasar Bharti (‘PB’), a broadcaster owned by the Government of India for production of TV signals of international cricket events from February 2002 to October 2004 for which it received remuneration from PB. SingCo also received advertisement revenue outside India from certain advertisers in India.

The AO held: (i) that SingCo had a PE in India; (ii) its income was in the nature of FTS; and (iii) accordingly, in terms of section 44D read with section 115A, its gross receipts were taxable @20%. The AO further held that the advertisement revenue of SingCo was changeable to tax in India.

The issues before the Tribunal were as follows:

(i) Whether SingCo had a PE in India?

(ii) Whether receipts of SingCo from PB were business income of a taxpayer having no PE in India?

(iii) Whether gross receipts of SingCo from PB should be treated as FTS and taxed @10% as claimed by SingCo or @20% as held by AO?

(iv) Whether advertisement revenue received by SingCo in Singapore from Indian companies was taxable in India?

Held:
The Tribunal observed and held as follows.

(i) PE in India:

Contract was signed in Singapore and all activities relating to it were carried out from Singapore.

There was no evidence that the management and control of SingCo were not situated in India. Holding of mere one board meeting in India cannot lead to the conclusion that the control and management of SingCo was situated only in India.

On facts, affairs and management of SingCo were not carried out in India and SingCo was rightly held to be non-resident.

Further, SingCo had provided sufficient evidence to establish that while furnishing the services, the stay of its personnel in India was less than 90 days. Consequently, SingCo did not have a fixed place PE or service PE in India during the relevant years.

(ii) Nature of receipts:

The receipts of SingCo from PB were FTS as service of production and generation of live television signal rendered by SingCo was in the nature of technical service and SingCo had made available services which were based on technical knowledge, skill and know-how.

(iii) Applicable rate of tax:
In terms of Article 12(2) of the DTAA, taxability of FTS would be chargeable to tax @10% of the gross receipts.

(iv) Taxability of advertisement revenue:

The key fact is that SingCo did not have a PE in India, the advertisement revenue was in respect of the matches that were not played in India and the telecast of those matches was also not in India.

Hence, force of attraction cannot apply merely because some viewers may be in India and advertisement may have some incremental value in India.

As the dominant object of the Indian advertisers was advertising outside India, advertisement revenue cannot be attributed to India and in absence of PE, it was not taxable in India.

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Nirav Shah

[2013] 37 taxmann.com 343 (Mumbai-Trib.) United Helicharters Pvt. Ltd. vs. ACIT A.Ys.: 2006-07 & 2007-08 Dated: 14th August 2013

Article 12, Indo U.S. DTAA, section 9-Training to pilots does not make available technical knowledge – Payment for training not taxable in India.

Facts:

The taxpayer was engaged in the business of charter hire of helicopters. During the year under consideration, a US company provided training to pilots and other staff of the taxpayer in consideration of which the taxpayer made payments to a US company.

The taxpayer contended that the receipt of the US Company were business profits, which, in absence of PE of US company in India, were not chargeable to tax in India. However, the AO treated the payments as FTS in terms of Explanation 2 to section 9(1)(vii) of the Act and hence, chargeable to tax.

The issue before the Tribunal was, whether expenditure on training of pilots was in the nature of FTS under Article 12(4) of India-USA DTAA?

Held:

In terms of Article 12(4)(b) of India-USA DTAA, to constitute FTS the services should have ‘made available’ technical knowledge, experience, skill, know-how or processes or consist of the development and transfer of a technical plan or technical design.

The training given to the pilots and other staff was as per the requirement of the regulator and was necessary for eligibility of the pilots and other staff working in aviation industry. Such training does not fall under the term ‘make available’ under India-USA DTAA. Since the training expenses were not taxable in India in hands of non-resident company, the taxpayer was not required to deduct tax at source while making payment.

The ITAT ruled that such training does not make available technical skills etc. without considering education institution exclusion.

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Nirav Shah

[2013] 37 taxmann.com 296 (Mumbai-Trib.) ITO vs. Satish Beharilal Raheja A.Y.2004-05, Dated: 12th August 2013

Article 13, India-Switzerland DTAA. Units of MF not deemed to be shares of companies even though MF may invest in shares – Gain on units not chargeable to tax in India.

Facts:

The taxpayer was a citizen of Switzerland. He had also submitted tax residence certificate issued by Swiss authorities. During the relevant assessment year, the taxpayer was a non-resident in terms of the Act and had received long-term and short-term capital gain from sale of mutual fund units.

The AO noted that the taxpayer had basically invested in Indian capital market and in Indian shares through selective investment routes known as mutual funds; the capital gain was basically attributable to gain in shares of companies in which mutual funds had made investments; therefore, effectively the gain was from alienation of shares of companies resident in India; and accordingly, treated the capital gain from sale of mutual fund units as that arising from sale of shares and held it to be taxable in India in terms of Article 13(5)(b) of India-Switzerland DTAA.

The taxpayer contended that the capital gain had arisen from sale of mutual fund units and that the Act has made clear distinction between shares issued by Indian companies and units issued by mutual funds and has also treated them differently. Accordingly, Article 13(6), and not Article 13(5), was applicable.

Held:

In the absence of any specific provision under the Act to deem the unit of MF as shares, it could not be considered as shares of companies and, therefore, the provisions of Article 13(5)(b) cannot be applied in case of units. As such, provisions of Article 13(6) are applicable as per which the capital gain on sale of units cannot be taxed in India.

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Nirav Shah

[2013] 37 taxmann.com 337 (AAR) Eruditus Education (P.) Ltd., In re Dated:20th September 2013

Section 9, Article 12, 5 of India Singapore DTAA. Provision of high quality education FTS – However exemption under Article 12 available to Singapore educational institution – on facts no PE and sum not chargeable to tax in India.

Facts:

The applicant was an Indian company in the business of providing high quality executive education programs. The applicant entered into agreement with a Singapore company (“SingCo”), which was in the business of providing management education programmes globally. As per the Agreement, SingCo was to conduct teaching intervention at SingCo’s global campuses in Singapore/France/ India and through telepresence in Singapore,while the applicant was to assist in marketing, organising, managing and facilitating. The programme was to be for 11 months and teaching intervention by SingCo was to be for 30 days comprising in-class teaching at Singapore and at French campuses of SingCo (16 days), in-class teaching by SingCo faculty in India (6 days) and teaching through tele-presence in Singapore (8 days). The applicant was to compensate SingCo for the cost and other incidental expenses.

Held:

(i) The services to be rendered by SingCo involved expertise in, or possession of, special technical skill or knowledge. Hence, the payment will be FTS, both under the Act and under India- Singapore DTAA. However, since there is no dispute that SingCo is an educational institution, the payment will be covered by the exclusion in Article 12(5)(c) of India-Singapore DTAA.

(ii) On facts, SingCo will not have PE in India under Article 5(1) or 5(8) of India-Singapore DTAA.

(iii) Accordingly the amount is not chargeable to tax in India.

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Nirav Shah

Merieux Alliance & Groupe Industrial Marcel Dassault, In re (Unreported) AAR Nos. 846 & 847 of 2009 Article 14(5) of India-French DTAA Dated: 28-11-2011 Counsel for assessee/revenue: Porus Kaka, Manish Kanth, B. M. Singh, Dominique Tazikawa, Rohan Shah, Rohit Jain, Parth Contractor, Kumar Visalaksh/Girish Dave, Gangadhar Panda

French residents transferred shares of a French company to another French resident. The only business/asset of the French company were shares comprising 80% equity shares in an Indian company. Since the transfer resulted in transfer of underlying assets and control of Indian company, on purposive interpretation, gains arising from the transfer were liable to tax in India.

Facts:
Merieux Alliance (‘MA’) & Groupe Industrial Marcel Dassault (‘GIMD’) (jointly referred to as the applicants) were French companies. MA incorporated wholly-owned subsidiary (‘ShanH’) in France. MA acquired 80% equity shares of an Indian company (‘Shantha’) from shareholders of Shantha in the name of ShanH. Due diligence, funding and payment of stamp duty for the purchase was done by MA. Subsequently, GIMD and a foreign individual acquired 20% of the shares in ShanH from MA. In 2009, MA and GIMD sold their holding in ShanH to Sanofi, another French company.

On the basis of the information available with it, the tax authority initiated proceedings against Sanofi for failure to withhold tax from payment made to MA and GIMD. In view of the proceedings, the applicant approached AAR for its ruling on the following issues:

(i) Whether capital gains arising from transfer of shares of ShanH, a French company, were changeable to tax in India, either under the Act or under the DTAA?

(ii) Without prejudice to (i), whether transfer of controlling interest (assuming, while denying that it is a separate asset) is liable to be taxed in France under Article 14(6) of the DTAA?

The applicant contended as follows :

The shares transferred were of a French company and therefore, such transfer cannot be taxed either under the Act or under the DTAA.

Acquiring shares of Shantha through a subsidiary was a legitimate business route.

As per the Supreme Court in Azadi Bachao Andolan, the Revenue cannot go behind the transaction since it was not permissible to ignore the corporate structure, the tax residency certificate and the fact that the transaction was recognised by the Government of India.

As the capital gains from transfer of shares of a French company were taxable in France, there was no question of tax evasion or treaty shopping.

A taxing statute should be construed strictly and nothing is to be added and subtracted. The concepts of ‘underlying assets’ and ‘controlling interest’ cannot be reckoned while interpreting a taxing statute and transactions not directly hit by the taxing statute cannot be roped in based on presumed intention or purpose.

The tax authority contended as follows :

As the withholding tax proceeding against Sanofi were pending and the transaction was, prima facie, a tax avoidance scheme, in terms of section 245(4) of the Act, no ruling could be given by AAR.

ShanH had no substance, it was a front, a paper company, having no office, no employees, no business and no asset except the share in Shantha and was created only for dealing with the share of Shantha.

Alienation is a word of wide import. Alienation of shares coupled with a participation of at least 10% in a company implies that under Article 14(5) of the DTAA, such participation would attract tax in India if the participation interest is in an Indian company. ‘Participation’ would mean right to vote, to nominate directors, control and management, day-to-day decision making and right to get profits distributed. All these rights in Shantha were with MA and GIMD, which were transferred pursuant to the transfer of shares of ShanH.

The transfer of shares of ShanH involved alienation of assets and controlling interest of an Indian company, gains from which was taxable in India.

Held:
AAR observed and held as follows :

(i) Maintainability of application:

Initiation of proceedings u/s.195/197 of the Act or even final order passed were preliminary and were not conclusive and it was no bar on considering an application. ? Merely because there was no tax avoidance as the transaction was taxable in France, AAR can yet examine whether the scheme was designed, prima facie, for Indian tax avoidance.

(ii) Tax avoidance:

While the Supreme Court decision in Azadi Bachao Andolan is binding on AAR, it may not be the final word in a given situation. In considering the question of prima facie tax avoidance, AAR is not piercing the corporate veil, but examining whether the steps taken had any business purpose.

Usually adopted scheme can be treated as an attempt at avoidance of tax depending on the effect of the scheme in entirety on liability of the entity to be taxed.

The series of transactions commencing from formation of ShanH appears to be a preordained scheme to produce a given result, viz., to deal with assets and control of Shantha, without actually dealing with the shares of Shantha. A gain is generated by this transaction. If the transaction is accepted at face value, by repeating the process, control over Indian assets and business can pass from hand to hand without incurring any tax liability in India.

(iii) Corporate veil and controlling interest:

Since ShanH had no business or assets other than shares in Shantha, the transaction resulted in transfer of underlying assets, business and control of Shantha.

Based on literal construction of Article 14(5) of the DTAA, the transfer of shares in ShanH can be taxed only in France. However, since the transaction involved alienation of assets and controlling interest of an Indian company, on purposive construction of Article 14(5), capital gains arising from the transaction would be taxable in India. The question as to whether controlling interest is an asset taxable in France under Article 14(6) of the DTAA is not required to be answered.

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Nirav Shah

Poonawalla Aviation Private Limited, in re (Unreported) AAR No. 953 of 2010 Article 12(3)(b) of India-France DTAA; Section 195 of Income-tax Act Dated: 5-12-2011 Counsel for assessee/revenue: Rajan Vora, Rahul Kashikar, Siddharth Kaul, Arijit Charkravarty/Mukundraj M. Chate

(i) Although ‘insuring’ of the loan is not equivalent to ‘endorsing’, having regard to the MFN clause and corresponding provision in other DTAAs, exemption under Article 12(3)(b) would apply.

(ii) Exemption under Article 12(3)(b) would apply even if the interest was paid into a bank account outside France since the interest was beneficially owned by a French resident.

Facts:
The applicant was an Indian company. It entered into an agreement with a French company (‘FrenchCo’) for purchase of aircraft for which price was deferred and was to be paid over 6 years’ time. Subsequently, COFACE (an agency of France Government) agreed to insure credit facility to be extended by FrenchCo. The applicant executed promissory notes covering principal and interest in favour of FrenchCo. FrenchCo irrevocably and unconditionally assigned the promissory notes to a French bank. Thereafter, the applicant made payments into the account of the PE of the French bank in the USA. The issues before AAR were as follows:

(i) Whether interest payable to FrenchCo was taxable in view of Article 12(3)(b) of the DTAA?

(ii) Whether interest payable to the French bank (after assignment of promissory note by FrenchCo to French bank) would be taxable in view of Article 12(3)(b) of the DTAA?

(iii) Whether the applicant was required to withhold tax u/s.195 of the Income-tax Act in respect of the interest paid to FrenchCo or French bank?

The applicant contended that Article 12(3)(b) of the DTAA provides for exemption in respect of interest beneficially owned by a French resident in connection with a loan or credit extended or endorsed by COFACE. Hence, the applicant contended that the interest paid, was exempt since the loan was insured by COFACE. The word ‘endorse’ was of wide amplitude and also covered providing of insurance cover on loan. The applicant also claimed benefit of MFN clause in the Protocol to the DTAA.

The tax authority contended that the interest was not derived in connection with a loan or credit intended by or endorsed by COFACE, but COFACE had only provided export credit insurance and further, as the instalments were payable in the USA and not in France, the DTAA was not applicable.

Held:
AAR observed and ruled as follows:

(i) Mere fact of COFACE having ‘insured’ the credit extended to the applicant does not mean ‘endorsement’ of credit. The DTAA between France and other countries mentioned ‘guaranteed or assured’ or ‘guaranteed or insured’ by COFACE. However, the DTAA with India has not used such expression. Accordingly, mere extending of insurance cover by COFACE does not amount to ‘extending or endorsing’ the loan or credit by COFACE as required in Article 12(3)(b) to quality for exemption.

(ii) India’s DTAA as with Canada, Hungary, Ireland (which were entered into after the DTAA) include loans or credits ‘insured’ for the purpose of exemption. Therefore, based on MFN clause, the protection is understood as extended to loan or credit ‘insured’ by COFACE and hence, it would come within the purview in exemption of Article 12(3)(b). Accordingly, payment of interest to FrenchCo is exempt under Article 12(3)(b).

(iii) The beneficial ownership of the French bank is not endorsed or assigned to its branch in the USA. Accordingly, interest payable to French bank pursuant to the endorsement of the promissory note by FrenchCo is exempt under Article 12(3)(b) as interest beneficially belongs to French resident.

(iv) In view of the exemption of interest, withholding obligation u/s.195 will not arise.

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Nirav Shah

Fes for Technical Services — Exclusions provided in Section 9(1)(vii)(b)

Taxation of Fees for Technical Services (FTS) has assumed great significance in the Indian context. In this Article, we wish to highlight and discuss the issues concerning the exclusions provided in section 9(1)(vii) (b), which are of very practical utility and relevance.

It is important to note that in this article we have not dealt with the exclusions contained in the definition of the term ‘Fees for Technical Services’ given in Explanation 2 to section 9(1)(vii), relating to noninclusion of consideration for any construction, assembly, mining or like project undertaken by the recipient of such consideration.

We invite the readers to provide their useful comments and feedback in respect of the same.

1. Introduction

1.1 Section 5 of the Act dealing with scope of total income provides that both in the case of a resident as well as non-resident, total income would include all income from whatever source derived which accrues or arises or is deemed to accrue or arise to him in India during such year.

1.2 Section 9 of the Act contains the provisions relating to income deemed to accrue or arise in India.

Section 9(1)(vii)(b) of the Act reads as under:

“(1) The following income shall be deemed to accrue or arise in India:

(vii) income by way of fees for technical services payable by —

(b) a person who is resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India; or”

Thus the exclusionary part of clause (b) makes it clear that in order to be eligible for the benefit provided, the following conditions needs to be fulfilled:

(a) amount is paid as fees for technical services.
(b) such services are utilised:

(i) in a business or profession carried on by such person outside India, or

(ii) for the purpose of making or earning any income from any source outside India.

1.3 The language of the second limb of the exclusionary part of section 9(1)(vi)(b) of the Act providing source rule for royalties, is almost identical and accordingly, the discussion in respect of second limb of the exclusionary part of section 9(1)(vii)(b) relating to FTS would equally apply to royalties also.

1.4 From the plain reading of the provisions of section 9(1)(vii)(b), it is evident that if any payment of fees falls within the exclusionary portion of the clause (b), then the payment of such fees made by a person who is resident, would not be deemed to accrue or arise in India and accordingly would not be taxable in India.

1.5 The exclusionary portion of the clause (b) contains two important limbs which are as follows:

(a) where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India, or

(b) for the purposes of making or earning any income from any source outside India.

1.6 In the first limb of exclusionary part of clause (b) mentioned above would apply in a case where the FTS are payable by a resident in respect of services utilised in a business or profession carried on by such person outside India.

Thus, for example, A Ltd., an Indian company, has a branch in Dubai and makes payment of FTS to a third party in London for the services which are utilised in the business carried by the Dubai branch of the Indian company. Such payment would be covered by the first limb of exclusionary clause (b) mentioned above and the same would not be deemed to accrue or arise in India.

It is important to note that the services have to be utilised in a business or profession carried on by such a person outside India. In this connection, two important questions arise which are as follows:

(a) The first question in this context would be as to when can a resident be said to be ‘carrying on a business or profession outside India’?

In the view of the authors, if the business is carried on outside India by a branch, liaison office, project office or Permanent Establishment (PE) in any form of the person resident in India, then it could be assumed that the resident is ‘carrying on a business or profession outside India’. It is difficult to think of a situation where without a branch, liaison office, project office or PE, a resident could be said to be ‘carrying on a business or profession outside India’.

It is an open question whether business carried on by a person resident in India through the means of e-commerce can be considered to be carried on outside India for the purposes of the first limb of the exclusionary part of clause (b)?

(b) The second question arises which is very relevant is: What is the meaning of the words ‘such person’ appearing in the first limb of exclusionary clause (b)? Does the same refer to the payer of the fees or the recipient of the fees?

On a plain reading of the opening part of the clause (b) along with the first limb of the of exclusionary clause (b), it would be apparent that the words ‘such person’ should refer to the payer of the fees.

However, the Bombay High Court in the case of Grasim Industries Ltd. v. S. M. Mishra, CIT (Bombay High Court), (2011) 332 ITR 276, while disposing of the writ petition, has held that the words ‘such person’ would mean the recipient of the fees and not the payer of the fees. The aforesaid case is discussed below.

1.7 The second limb of exclusionary part of clause (b) mentioned above would apply in a case where the FTS is payable by a resident in respect of services utilised for the purposes of making or earning any income from any source outside India. In this connection also, two important questions arise as follows:

(a) Firstly, for the purposes of second limb of exclusionary clause (b), it is extremely important to determine the true meaning of the words ‘source outside India’. For this purposes it is very important to determine: What is meant by the word ‘source’ and when can a ‘source’ be said to be ‘outside India’? Can the ‘export of goods and services’ to customers out side India be said to be ‘source outside India’?

(b) The second question which arises for consideration is: Whether the ‘source’ has to be an ‘existing source’ or it could be even for a ‘future source’ of income?

2. Judicial pronouncements

A. Judicial pronouncements relating to first limb of exclusionary part of clause (b)

2.1 332 ITR 276 — Grasim Industries Ltd. v. S. M. Mishra, CIT (Bombay High Court)

(a) Nature of payment

Receipt of Fees for Technical services rendered by a non-resident outside India

(b) Brief facts

The assessee company was a company incorporated in India in which public was substantially interested and had its principal place of business at Mumbai. The petitioner No. 2 was a company incorporated under the laws of Delaware and had its principal place of business in Pennsylvania, USA. The U.S. company did not have any office or place of business in India and was not resident in India.

The Indian company being desirous of setting up a sponge-iron plant approached the U.S. company for technical assistance. By a basic engineering and training agreement the U.S. company agreed to render to the Indian company outside India certain engineering and other related services in relation to the sponge-iron plant.

By another agreement (the supervisory agreement), the U.S. company agreed to provide certain supervisory services to the Indian company in India. By the basic engineering and training agreement, the U.S. company was to prepare basic engineering drawings specifications, calculations and other documents and design and also prepare monthly schedule of non-Indian activities outside India.

The U.S. company was to deliver to the authorised representative of the Indian company the designs, drawings and data outside India. The U.S. company also agreed to train outside India a certain number of employees of the Indian company in order to make available to such employees scientific knowledge, technical information, expertise and technology necessary for commissioning, operation and maintenance of the sponge-iron plant.

As a consideration, the Indian company agreed to pay to the U.S. company a sum of US $ 16,231,000, net of Indian income-tax, if any, leviable. In accordance with the basic engineering and training agreement, the U.S. company delivered the total basic engineering package to the representative of the Indian company in Pennsylvania (USA) between November 1989 and August 1990. The U.S. company also imparted training to 22 key personnel of the Indian company at the plant in Mexico as provided in the basic engineering and training agreement.

The Assessing Officer charged the consideration received by the U.S. company to tax. The U.S. company did not dispute that the services under supervisory services were rendered in India and as such the income received therefrom was liable to income-tax. The dispute related only to the amount paid by the Indian company to the U.S. company under the basic engineering and training agreement dated October 22, 1989.

c) Key issue in relation to section 9(1)(vii)(b)

Does the expression ‘by such person’ appearing in section 9(1)(vii)(b) refers to the recipient of income and not to the person making the payment?

d) Decision

The Bombay High Court held in the assessee’s favour as follows:

“Section 9(1)(vii) of the Act says that the income by way of fees for technical services payable by three classes of persons shall be deemed to have accrued or arisen to the recipient in India. The three classes of payees are described in three sub-clauses, viz. (a), (b) and (c) of clause (vii). Sub-clause (a) is in respect of an income received by way of fees payable by the Government. Sub-clause (b) is regarding the income by way of fees payable by a person who is a resident in India and sub-clause (c) is in respect of an income by way of fees payable by a person who is a non-resident.

So far as sub-clause (a) is concerned, it admits of no exception and every rupee received as an income by way of fees for technical services paid by the Government to him is deemed to have accrued or arisen to the recipient in India.

So far as sub-clause (b) is concerned, income by way of fees for technical services payable by a person who is a non-resident (should be read as ‘Resident’) is deemed to have accrued or arisen to the recipient in India ‘except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purpose of making or earning any income from any source outside India.’

The expression ‘by such person’ appearing in section 9(1)(vii)(b), in our opinion, refer to the recipient of the income and not to the person making the payment. This would be clear if one looks to the opening words of s.s (1) of section 9 which reads ‘the following income shall be deemed to accrue or arise in India’. Section 9(1) refers to the income which is deemed to have accrued or arisen in India by the recipient of the income. The expression ‘such person’ appearing in sub-clause of section 9(1)(vii) therefore refer to the recipient, because one has to consider whether the income received by him (the recipient) is deemed to have accrued or arisen in India. Section 9 does not contemplate taxing the payer but contemplates taxing the recipient for the income received by him. In our considered view, the expression ‘such person’ appearing in sub-clause of section 9(1)(vii) refers to the recipient of the income and not to the payer. If we were to construe the expression ‘such person’ appearing in section 9(1)(vii)(b) as to the person who makes the payment for technical services it would give rise to a startling results.

We would demonstrate this by means of an illustration. Take a case where a resident Indian goes abroad, falls sick, and avails services of a pathological laboratory for testing his blood and pays the fees to the laboratory for the technical services of blood analysis performed by it. Obviously, the payment made by the Indian resident for the technical services payable to the owner of the laboratory who is a non-resident would fall in the first part of sub-clause (b) of section 9(1)(vii) of the Act and the fee received by the owner of the laboratory would be subject to the Indian income-tax unless it falls within the exception provided under sub-clause (b) itself. If we were to read the expression ‘such person’ in sub-clause (b) to refer the person making the payment i.e., the resident Indian, then obviously the case would not fall within the exception, because the fees were not payable in respect of any business or profession carried on by ‘such resident Indian’ outside India. Consequently, the income received by the owner of the pathology laboratory would be subject to Indian income-tax. By no stretch of imagination, the owner of the pathology laboratory who is a non-resident Indian can be subjected to income-tax because Parliament obviously would have no legislative competence to tax him in respect of services rendered by him (who is a non-resident and non-citizen) outside Indian territory. However, if the expression ‘such person’ appearing in sub-clause (b) of section 9(1)(vii) is construed to refer to the recipient of the fees, then he would be covered by the exception and not liable to pay Indian income-tax.

If we apply sub-clause (b) of section 9(1)(vii) of the Act so construed to the facts of the case at hand, the fees received by petitioner No. 2 for technical services from petitioner No. 1 would fall within the exception carried out by sub-clause (b) of section 9(1)(vii) of the Act and not taxable in India.”

Thus, the Bombay High Court has provided a completely new perspective to the interpretation of the words ‘such person’ appearing in section 9(1) (vii)(b). In the authors’ humble opinion, on a holistic view of the purpose and intention of insertion of section 9 and also of the exclusionary provisions contained in section 9(1)(vii)(b), the view taken by the Bombay High Court appears to be erroneous and the same may have to be tested in the Supreme Court.

Further, it is important to note that while disposing of the writ petition, the Bombay High Court did not consider the implications of the Explanation inserted by the Finance Act, 2010 at the end of section 9.

B. Judicial pronouncements relating to second limb of exclusionary part of clause (b)

2.2 (2002) 125 Taxman 928 (Mad.) — CIT v. Aktiengesellschaft Kuhnle Kopp and Kausch W. Germany by BHEL

a) Nature of payment

Royalty paid to a non-resident in respect of export sales.

b) Brief facts

Pursuant to a collaboration agreement with an Indian company the assessee, a non-resident company, received payment on account of royalty. The Tribunal held that the royalty payable on export sales could not be regarded as deemed to have accrued in India within the meaning of section 9(1) (vi).

c) Key issue in relation to section 9(1)(vii)(b)

Whether royalty could not be said to be deemed to have accrued or arisen in India u/s.9(1)(vi) as the same was paid out of ‘exports sales’ and hence the source for royalty was the sales outside India?

d) Decision

The Madras High Court held that as far as royalty on export sales is concerned, that amount is also exempt u/s.9(1)(vi). Though the royalty was paid by a resident in India, it cannot be said that it was deemed to have accrued or arisen in India as the royalty was paid out of the export sales and hence, the source for royalty is the sales outside India. Since the source for royalty is from the source situated outside India, the royalty paid on export sales is not taxable. The Appellate Tribunal was therefore correct in holding that the royalty on export sales is not taxable within the meaning of section 9(1)(vi).

2.3 Lufthansa Cargo India (P.) Ltd. v. DCIT, (2004) 91 ITD 133 (Delhi)

a) Nature of payment

Payments to a non-resident for aircrafts overhauling and repairs

b) Brief facts

The assessee, a domestic company, had acquired four boeing cargo aircrafts from a foreign company and obtained licence from licensing authority to operate those aircrafts on international routes only. It also engaged crew, technical personnel, engineers and other ground staff and wet-leased aircrafts to a foreign cargo company. Under wet-lease agreement, responsibility for maintaining crew and aircrafts in airworthy condition was that of the assessee and the lessee was to pay rental on basis of number of flying hours during period subject to minimum guarantee. The assessee periodically made payments to a non-resident company on account of overhaul, repairs of its aircrafts, engines sub-assemblies and rotables (components) in workshops abroad. The assessee did not deduct tax at source on such payments.

c) Key issue in relation to section 9(1)(vii)(b)

Whether the payments for repairs and maintenance charges would not be chargeable to tax in India as they were made for earning income outside India and therefore the would fall within the purview of exclusionary part of section 9(1)(vii)(b)?

d) Decision

The ITAT held that the sources from which the assessee has earned income are outside India as the income-earning activity is situated outside India. It is towards this income-earning activity that the payments for repairs have been made outside India. The payments therefore fall within the purview of the exclusionary clause of section 9(1)(vii)(b).

Thus, even assuming that the payments for such maintenance repairs were in the nature of fees for technical services, it would not be chargeable to tax.

These payments are not taxable for the reason that they have been made for earning income from sources outside India and therefore fall within exclusionary clause of section 9(1)(vii)(b).

2.4 Titan Industries Ltd. v. ITO, (2007) 11 SOT 206 (Bang.)

a) Nature of payment

Payment of Professional Fees in Hongkong for patent registration

b) Brief facts

The assessee-company was engaged in the manufacture of watches and was selling the same under its patent name ‘Titan’. An associate company of the assessee, incorporated in Singapore, was engaged in promoting the sales of ‘Titan’ watches in the Asia Pacific region. The assessee from the business point of view got its patent name registered in Hongkong through ‘C’ , a firm of professionals of Hongkong and paid to ‘C’ certain fees for technical services rendered by it. The assessee claimed that since the services had been utilised in its business abroad, the payment made to ‘C’ was covered in exception provided in section 9(1)(vii)(b) and, hence, it was not required to deduct tax at source in respect of the payment made to ‘C’.

c) Key issue in relation to section 9(1)(vii)(b)

Can the payment made for registration of a patent outside India for the purposes of exports, be considered as for the purposes of making or earning income from a ‘Source outside India’?

d) Decision

The Tribunal held that carrying on business means having an interest in a business at that place, a voice in what is done, a share in the gain or loss and some control, if not over the actual method of working, at any ratio, upon the existence of business.

The carrying on of a business is a bundle of activities and marketing is one of such activity. If the products are marketed outside India, then it cannot be said that there is no business activity.

Patent was registered outside the country for making an income from a source outside the country. The amounts paid are covered in exception provided in section 9(1)(vii)(b).

2.5 Income-tax Officer (IT) TDS-3 v. Bajaj Hindustan Ltd., (2011) 13 taxmann.com 13 (Mum.)

a) Nature of payment

Payment of Advisory Fees to a non-resident for acquisition of sugar mills/distilleries in Brazil

b) Brief facts

The assessee-company is engaged in the business of manufacturing of sugar. It engaged the services of KPMG, Brazil to advice and assist it in acquisition of sugar mills/distilleries in Brazil. In connection with the services rendered by KPMG for the said purpose, the assessee had made payment to KPMG. The Assessing Officer was of the view that the assessee ought to have deducted tax at source on the payment made to KPMG. According to him the amount received from the assessee by KPMG was in the nature of fees for technical services rendered. He was also of the view that in terms of section 9(1) income by way of Fees for Technical Services (FTS) payable by a person who is a resident shall be income deemed to accrue or arise in India.

c) Key issue in relation to section 9(1)(vii)(b)

Whether application of section 9(1)(vii)(b) is restricted only to an ‘existing source’ of income outside India or whether the same could be applied even in relation to a ‘future source’ of income?

d) Decision

The ITAT held that the payment in question made by the assessee to KPMG is in respect of services which otherwise fell within the definition of FTS as given in the Act. The dispute is whether the exceptions mentioned in clause (b) to section 9(1)(vii) would apply so that it can be said that the fees in the nature of FTS has not accrued or arisen to KPMG in India. As far as the first exception in section 9(1)(vii) clause is concerned viz., ‘where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India’, it is found that the assessee carried on business in India and has utilised the services of KPMG in connection with such business. Therefore, the case of the assessee would not fall within the first exception, notwithstanding the fact that services were rendered only in Brazil. As far as the second exception mentioned in section 9(1)(vii) clause (b) is concerned viz., ‘for the purposes of earning any income from any source outside India’, the undisputed facts are that the assessee wanted to acquire sugar mills/distillery plants in Brazil and for that purpose also wanted to set up a subsidiary company. In fact, the assessee had set up a subsidiary company on 8-8-2006 in Brazil. Thus the assessee was contemplating to create a source for earning income outside India. It is no doubt true that the source of income had not come into existence. But there is nothing in section 9(1)(vii) clause (b) to show that the source of income should have come into existence so as to except the payment of fees for technical services. The expression used is ‘for the purpose of earning any income from any source outside India’. There is nothing in the language of section 9(1)(vii) clause (b), which would go to show that the same is restricted only to an existing source of income. It was held that the payment by the assessee of fees for technical services rendered by KPMG was outside the scope of section 9(1)(vii). Hence, it cannot be considered as income deemed to have accrued in India and not chargeable to tax in India and hence the assessee was not liable to deduct tax u/s.195.

2.6 Havells India Ltd. v. ADCIT, (2011) 13 taxmann. com 64 (Delhi)

a) Nature of payment

Payment to a non-resident for Testing & Certification Services used in relation to Export Sales

b) Brief facts

The assessee-company paid certain amount to a foreign company incorporated in the USA, namely, ‘C’, for getting testing and certification services and claimed deduction of the same as business expenditure. It had not deducted tax at source from payment made to ‘C’. The Assessing Officer referring to provisions of section 9(1)(vii)(b) and
further taking view that testing and certification services provided by ‘C’ were utilised in manufacture and sale of products by the assessee in India, held that section 195 was applicable to payment made to ‘C’. He, therefore, disallowed impugned payment invoking provisions of section 40(a)(i). The assessee contended before the Tribunal that in order to invoke provisions of section 40(a)(i) amount paid should be chargeable to tax under the Income-tax Act, and that fee for technical services paid by it to ‘C’ was not chargeable to tax in India, due to exception contained in section 9(1)(vii)(b).

c) Key issue in relation to section 9(1)(vii)(b)

Whether payments made for the testing and certification services provided by a non-resident and utilised by the assessee only for its ‘exports’ activities were not chargeable to tax in India in view of section 9(1)(vii)(b)?

d) Decision

The Tribunal held in the assessee’s favour as follows: “In order to fall within exception of section 9(1)(vii) (b), the technical services, for which, the fees have been paid, ought to have been utilised by a resident in a business outside India or for the purposes of making or earning any income from any source outside India.

The KEMA certification obtained by the assessee from ‘C’ for enabling exports of its products was unassailed. The sole stand of the Department was that this service of testing and certification had been applied by the assessee for its manufacturing activity within India.

The initial onus u/s.9(1)(vii)(b) lay squarely on the assessee to prove that the exemption available thereunder was in fact available to it. The assessee had maintained throughout that the testing and certification services provided by ‘C’ were utilised only for its export activity and that the same were not utilised for its business activities of production in India. Thus, the assessee had discharged the onus, which lay on it u/s.9(1)(vii)(b). Therefore, the impugned payment made by the assessee to ‘C’ was not chargeable to tax in India.”

2.7 (2008) 305 ITR 37 — Dell International Services (India) P. Ltd., in re v. (AAR)

a) Nature of payment

Bandwidth charges paid to non-resident telecom service provider for use in relation to data processing and information technology support services provided to group companies abroad.

b) Brief facts

The applicant, a private company registered in India, was a part of the Dell group of companies. It was mainly engaged in the business of providing call centre, data processing and information technology support services to the Dell group companies. The applicant’s parent company had entered into an agreement with BT, a non-resident company formed and registered in the USA, under which BT, the non-resident company, provided the applicant with two-way transmission of voice and data through telecom bandwidth. While BT was to provide the international half-circuit from the USA/Ireland, the Indian half-circuit was provided by VSNL, an Indian telecom company. Apart from installation charges payable initially, fixed monthly recurring charges for the circuit between the USA and Ireland and for the circuit between Ireland and India were payable by the applicant to BT, and this was net of Indian taxes. BT raised its invoice directly on the applicant and the applicant made the payment directly to BT. The applicant was paying tax in India in relation to the recurring charges in accordance with section 195 of the Income-tax Act, 1961. There was no equipment of BT in the applicant’s premises and the applicant had no right over any equipment held by BT for providing the bandwidth. Fibre link cables and other equipment were used for all customers including the applicant. The bandwidth was provided through a huge network of optical fibre cables laid under seas across several countries of which BT used only a small fraction. There was no dedicated machinery or equipment identified or allowed to be used in the hands of the applicant; a common infrastructure was being utilised by various operators to provide service to various service recipients and the applicant was one among them receiving the service. The landing site was at Mumbai, and the Indian leg thereof to Bangalore, including the last mile connectivity to the premises of the applicant, was catered to by Bharti Telecom. On these facts the applicant sought the ruling of the Authority on questions relating to the tax liability of BT and the applicant’s duty to deduct tax at source.

c) Key issue in relation to section 9(1)(vii)(b)

What is the true meaning and ambit of the phrase ‘for the purposes of making or earning any income from any source outside India’ occurring in section 9(1)(vi)(b)/9(1)(vii)(b) of the Act?

d) Decision

The AAR observed and held as follows: “Sub-clause (b) of clause (vi) of section 9 carves out an ‘exception’ to the taxability of royalty paid by a resident. According to the ‘exception’, the royalty payable in respect of any right, property or information used or services utilised (a) for the purpose of business or profession carried out by such person outside India, or (b) for the purpose of making or earning any income from any source outside India is not an income that falls within the net of section 9. The applicant is relying on the second part of the exception i.e., ‘for the purposes of making or earning any income from any source outside India’. It is the case of the applicant that its business principally comprises of export revenue in the sense that it provides data processing and information technology support services to its group companies abroad and receives payment in foreign exchange against such exports. Therefore, although its business is carried out from India, the income it gets is from a source outside India and the payment it makes to BTA is for the purpose of earning income from a source outside India. Hence, according to the applicant, the benefit of exception envisaged by section 9(1)(vii)(b) will be available to it. In the context of this argument, it is pointed out by the learned counsel for the applicant that the two limbs of clauses (a) and (b) supra are distinct and the mere fact that the business is carried on in India and not outside India does not come in the way of invoking the exception provided by the latter limb, i.e., for the purpose of earning income from a source outside India.

We find it difficult to accept the applicant’s contention. No doubt, the factum of the applicant carrying on business in India does not come in the way of getting the benefit of the exception. It is possible to visualise the situations in which the business is carried on principally in India, whereas a particular source of income is wholly outside India, but, that is not the situation here. The income which the applicant earns by data processing and other software export activities cannot be said to be from a source outside India. The ‘source’ of such income is very much within India and the entire business activities and operations triggering the exports take place within India. The source which generates income must necessarily be traced to India. Having regard to the fact that the entire operations are carried on by the applicant in India and the income is earned from such operations taking place in India, it would be futile to contend that the source of earning income is outside India i.e., in the country of the customer. Source is referable to the starting point or the origin or the spot where something springs into existence. The fact that the customer and the payer is a non-resident and the end product is made available to that foreign customer does not mean that the income is earned from a source outside India. As aptly said by Lord Atkin in Rhodesia Metals Ltd. v. Commissioner of Taxes, (1941) 9 ITR (Suppl.) 45 “‘source’ means not a legal concept, but something which a practical man would regard as a real source of income”.”

The applicant’s counsel placed reliance on the decision of the Income-tax Appellate Tribunal in Synopsis India (P.) Ltd. v. ITO, [IT Appeal No. 919 (Bang.) of 2002] and that of the Madras High Court in CIT v. Aktiengesellschaff Kuhnle Kopp & Kausch W. Germany by BHEL, (2002) 125 Taxman 928.

The AAR distinguished these decisions as follows:

“In the case of Synopsis India (P.) Ltd. (supra), the assessee made payments to a foreign company which provided down-linking service to the assessee in connection with the transmission of data through satellite communications. The Tribunal found that the entire turnover of the company was export of software devices/products for which international connectivity was provided by a US company Datacom-Inc. The Tribunal held that the assessee, though carried on business in India, earned income from the sources outside India and the payments made to Datacom-Inc. were to earn income from a source outside India. The Tribunal apparently relied on two factors (i) the entire turnover of the assessee-company is derived from export of software, and (ii) such export activity was undertaken after ‘obtaining the data from international connectivity’. There is no reasoned discussion on the point whether the source of income was located outside India. The Tribunal proceeded on the premise that in the given set of facts the income was derived from sources outside India. In the second case, the Madras High Court found that the royalty was paid out of export sales and therefore the source for royalty was the sales outside India. It was on such finding of facts that the conclusion was drawn. The ratio of this decision also cannot be applied to the present case.”

3. Conclusion
3.1 From the above discussion, it is evident that there is a divergence of judicial opinion on interpretation of the second limb of the exclusionary part of clause (b) of section 9(1)(vii).

3.2 In the opinion of the authors, technically, the interpretation of the AAR in Dell International’s case (supra) of the words ‘source outside India’ occurring in the said second limb of section 9(1)(vii)(b) in respect of export of goods and services, appears to represent a better view as compared to the view taken by the Madras high Court in the case of (2002) 125 Taxman 928 (Mad.) — CIT v. Aktiengesellschaft Kuhnle Kopp and Kausch, W. Germany by BHEL (supra) in the context of royalties in respect of exports sales.

3.3 In view of above, the moot question then arises is: What is the true scope and ambit of the words ‘source outside India’? Does it mean that it will apply only to sources of income outside India other than relating to business income, such as income from house property, capital gains and income from other sources?

3.4 The true intention of the Legislature in providing the exclusionary limbs of section 9(1)(vii)(b) is not clear form the Memorandum explaining the provisions of the Finance Bill, 1976 or the Notes on Clauses relating to the Finance Bill, 1976. Even the Circular No. 202, dated 5-7-1976 explaining the amendments made by the Finance Act, 1976 does not explain the true nature and purpose of the exclusionary limbs of section 9(1)(vii)(b).

3.5 In the interest of clarity, certainty and to avoid litigation and to effectively reduce cost of export of goods and services, it would be prudent for the Government/CBDT to make necessary amendments and/or clarify that the payment of FTS/royalties for the purposes of exports of goods and services is covered by the exclusionary limbs of section 9(1)(vi)(b)/9(1)(vii)(b).

Nirav Shah

TS-527-ITAT-2013(Coch) English Indian Clays Ltd vs. ACIT (IT) A.Ys: 2004-2007, Dated: 18-10-2013

Section 9(1)(vii) – Providing report on market survey and identifying potential customers are consultancy services taxable as FTS under the Act.

Facts:
The Taxpayer, an Indian company, had entered into an agreement with a Foreign Company (FCo) to study the market situation in South East Asia for the product manufactured by the Taxpayer. The agreement referred to these services as ‘consultancy services’.

The Tax Authority observed that the services are in the nature of consultancy charges under the Act and liable for withholding taxes as FCo did not carry out marketing services but was required to conduct market survey and identify potential customers.

However, the Taxpayer argued that FCo was engaged only for the purpose of marketing the Taxpayer’s product in South East Asian countries.The nature of the transaction is required to be determined on the basis of the substance and not by the nomenclature. Hence the payments cannot be considered as consultancy charges. .

Held:
The work of FCo is to identify the potential customers and file a report regarding the market strategy and developmental studies. The Agreement does not enable FCo to market the products of Taxpayer in South East Asian countries. FCo had to provide a market survey report based on which the Taxpayer could market its product. Hence the payments were in the nature of consultancy charges taxable under the provisions of the Act.

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Nirav Shah

TS-511-ITAT-2013(Coch) US Technology Resources Pvt Ltd vs. ACIT A.Ys: 2007-2008, Dated: 27-09-2013

Article 12(4), India-USA DTAA – Provision of advisory services in relation to assisting in management and decision making are technical in nature and satisfies the test of ‘make available’ as stipulated under the India-US DTAA. Accordingly it is taxable as fees for included services (FIS).

Facts:
The Taxpayer is an Indian company (ICo) engaged in providing software development services to the customers based in India.

ICo had engaged an American company (FCo) to provide assistance, advice and support to ICo in management, decision making, sales and business development, financial decision making, legal matters and public relations activities, treasury service, risk management service and any other management support as may be mutually agreed between the parties.

For the above services, ICo made certain payments to FCo without deducting taxes and claimed the deduction for the same. I Co contended that the services rendered by FCo are mainly in the form of assistance in decision making; therefore, such services are clearly in the nature of management services, which is outside the ambit of definition of “FIS” under India USA DTAA. Further, it was argued that these services do not ‘make available’ any technical knowledge or expertise such that the person acquiring the service is enabled to apply the technology.

However the Tax Authority disallowed the payments on the grounds that such payments to non-residents were in the nature of consultancy fees on which tax was required to be withheld u/s. 195 of the Act. Also as soon as the advice or support is received, the same is available to ICo for using them in the decision making process of the management. Therefore, it may not be correct to say that the technical services were not ‘made available’ to ICo.

In terms of Article 12(4) of India-USA DTAA, FIS means payments of any kind to any person in consideration for rendering of any technical or consultancy services (including through the provision of services of technical or other personnel), if such services made available technical knowledge, etc.

Held:
Memorandum of Understanding between India and USA makes it clear that only services which are technical in nature can be considered for included services. Even consultancy services should be technical in nature.

The services rendered by FCo were used by ICo for making various management decisions. Tribunal also referred to the definitions of terms “management” and “decision making” from various management authors and observed that “Decision making is an act of selecting the suitable solution to the problems from various available alternative solutions to guide actions towards achievement of desired objectives”.

The knowledge accumulated by FCo through study, experience and experimentation with regard to management, finance, risk, etc. of a particular business is nothing but technical knowledge. In the era of technology transformation, the information/ experience gathered by FCo relating to financial risk management of business is technical knowledge. The knowledge and expertise of FCo would be used to support ICo in selecting suitable solution after considering all the alternatives available. Further FCo was giving training to the employees of ICo in making use of the inputs, experience, experimentation, etc. for taking better decision in order to achieve the desired objectives/goals.

The information and expertise made available to ICo was very much available with them and it could be used in future whenever the occasion arises.

Thus the management services provided by FCo were in the nature of FIS as per India-USA DTAA and subject to withholding tax in India.

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Nirav Shah

TS-555-ITAT-2013(Mum) M/s. A.P. Moller vs. DDIT (IT) A.Ys: 1997-2004, Dated: 08-11-2013

Article 9, India-Denmark DTAA – Fiscally transparent Danish partnership qualifies for benefits under India-Denmark DTAA; management of a business by a representative cannot lead to an inference that the income of the entity whose business is managed belongs to the representative.

Facts:
The Taxpayer is a partnership firm established under the laws of Denmark. The Taxpayer is “managing owner” of two shipping companies (FCos) incorporated under Danish law. The shipping business and the vessels belong to FCos, which are engaged in the shipping business in international traffic at the global level.

FCos were tax resident of Denmark and also had their place of effective management (POEM) in Denmark.

The Taxpayer managed the shipping business of FCos throughout the world, including India, and also filed corporate tax return on behalf of FCos in India (which had been merged), showing the gross receipts from the shipping income in India and claiming benefits under Article 9 of India-Denmark DTAA wherein profits derived from operation of ships in international traffic are taxable only in the country in which the POEM of the enterprise is situated.

The Tax Authority contended that income from shipping business is taxable in the hands of the Taxpayer as there is no difference between FCos and the Taxpayer, which was acting as the former’s beneficial owner. A person who is a resident of contracting State is entitled to treaty benefit of a DTAA if income of such a person is subjected to tax in the resident country. As per the tax laws of Denmark, the partnership firm is regarded as a fiscally transparent entity. It is not taxed at the entity level but its partners are taxed on the income earned by the partnership firm. Since the Taxpayer is a fiscally transparent entity, the India-Denmark DTAA benefits are not available to it.

Held:
On applicability of benefits of India-Denmark DTAA to a fiscally transparent entity:
• A person who is resident of a contracting state is entitled to treaty benefits if it is liable to tax in that state. As per Danish laws, the partnership firm, as such, is not taxable.
• However, the entire income of the partnership firm is taxed in the hands of its partners and, therefore, the entire income earned by the partnership firm can be said to be fully taxable in the resident state.
• As long as income of the partnership is taxed, albeit in the hands of the partners in the resident state, the India-Denmark DTAA benefits cannot be denied. The basic purpose is whether or not the entire income is taxable in the resident state. The mode of taxability, whether in the hands of partnership or the partners, cannot be given much credence so long as the income is fully taxed in the resident state.
• Reliance was placed on the Tribunal’s ruling in the case of Linklaters LLP, [2012] 132 TTJ (Mum.) 20, to conclude that, even though the partnership firm is a transparent entity, once its income and profit is taxed in the hands of the partners, the treaty benefits should be extended to the partnership firm.

On taxability of shipping income:

• As per the Articles of Association of FCos, the Taxpayer acts as a representative of FCo and, in that capacity, it acts and carries out obligations on behalf of FCo and also files corporate tax return in India on its behalf.
• The Taxpayer can be compared to a CEO of a company who is managing the affairs of the company and this does not lead to any inference that the income of the company belongs to the CEO.
• Thus, the shipping income belongs to FCo only and not to the Taxpayer. Accordingly, the exemption under Article 9 was available to FCo, being resident of Denmark.

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Nirav Shah

Income arising upon buy-back of shares by a whollyowned Indian subsidiary of a foreign company is taxable in accordance with section 46A and not section 47(iv).

RST in re
(2012) 19 taxmann.com 215 (AAR) Section 46A, 47(iv) of Income-tax Act Dated: 27-2-2012
Before P. K. Balasubramanyan (Chairman)
and V. K. Shridhar (Member)
Present for the appellant: Rajan Vora, Vinesh Kirplani, Srirupa Tandon
Present for the Department: V. S. Sreelekha

Income arising upon buy-back of shares by a wholly-owned Indian subsidiary of a foreign company is taxable in accordance with section 46A and not section 47(iv).

Facts:

The applicant, a German company (FCO), was a part of group of companies. FCO had a wholly-owned public limited subsidiary company in India (ICO). To comply with requirements of the Companies Act as regards the minimum number of members, one share each in ICO was held by six other companies as nominees of FCO. Also, FCO held shares in ICO as investment and not stock-in-trade. Subsequently, FCO received intimation from ICO for buy-back of shares at a price determinable in accordance with the RBI guidelines. FCO approached AAR on the issue whether transfer of shares in the course of the proposed buy-back by ICO was exempt u/s.47(iv) of the Income-tax Act. The Tax Department contended that upon buy-back, shares are extinguished and hence section 47(iv) has no application. Further, section 47 does not override section 46A. Also, section 46A was specifically introduced to deal with buy-back. Hence, the gain was taxable in India u/s.46A of the Income-tax Act or Article 13(4) of India-Germany DTAA. FCO contended that the charging section was section 45 and not section 46A. Section 46A was only clarificatory. Section 47(iv) and (v) apply generally to capital assets and to attract section 47(iv), it is enough if the share is a capital asset.

Ruling:

The AAR rejected FCO’s contention and held that income arising upon buy-back of shares by ICO would be taxable u/s.46A for the following reasons: Even if six other members of ICO are nominees of FCO, it cannot be postulated that FCO was holding all the shares in ICO. Section 45 is a general provision whereas section 46A is a specific provision dealing with purchase of its own shares by a company and hence, it should prevail over section 45.
Speech of Finance Minister while introducing section 46A has made it clear that section 46A was enacted to deem that the amount received on buy-back was taxable as capital gain and not as dividend.
Since income is chargeable to tax under section 46A, the payment made by ICO would be subject to withholding tax.

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Nirav Shah

Where the sale price of CCDs issued by subsidiary company was linked to the holding period; CCDs were guaranteed by parent company; directors of subsidiary company had no powers of management; difference between the sale price and purchase price of CCDs held by Mauritian company was ‘interest’ and not ‘capital gains’ in terms of DTAA.

‘Z Mauritius’, in re (2012) 20 taxmann.com 91 (AAR) Article 11, 13(4) of India-Mauritius DTAA; Section 2(28A) Income-tax Act Dated: 21-3-2012 Before P. K. Balasubramanyan (Chairman) and V. K. Shridhar (Member)
Counsel for applicant: Vinay Mangla, Gaurav Kanwin, Percy Pardiwala & Preeti Goel Counsel for Department: Poonam Khera Sidhu, R. K. Kakar

Where the sale price of CCDs issued by subsidiary company was linked to the holding period; CCDs were guaranteed by parent company; directors of subsidiary company had no powers of management; difference between the sale price and purchase price of CCDs held by Mauritian company was ‘interest’ and not ‘capital gains’ in terms of DTAA.

Facts:

The applicant (‘Z’) is a company incorporated in and tax resident of Mauritius. V Ltd. (‘V’) and S Ltd. (‘S’) are two Indian companies.

‘V’ is parent company of ‘S’ and company ‘S’ was engaged in developing a real estate project in India.
The applicant, ‘V’ and ‘S’ jointly executed a Share Holders Agreement (‘SHA’) and Securities Subscription Agreement (‘SSA’).
Pursuant to SHA and SSA, the applicant and ‘V’ invested in ‘S’. The applicant subscribed to equity shares and CCDs.
As per SHA, CCDs were to be fully and mandatorily converted into equity shares after 72 months. The applicant had put option to sell certain shares and CCDs on specified dates to ‘V’ and ‘V’ had call option to purchase the said shares and CCDs from the applicant.
The respective options were to be exercised prior to the mandatory conversion date. ‘V’ exercised its call option to purchase shares and CCDs from the applicant.
The applicant contended that the capital gains arising from transfer was exempt from tax in India in terms of Article 13(4) of India-Mauritius DTAA. The contention of applicant was rejected by the Tax Department which held that:
The concept of optional conversion rate was incorporated in SHA to compensate for normal interest from debentures. Only small portion of investment comprised equity shares and balance was CCDs. To characterise the gain to have arisen from transfer of capital assets was improper. ? For interpreting agreements, its essence as a whole should be considered and not merely their form. Relying on LMN India Ltd., in re (2008)5, CCDs recognised the existence of debt till repaid or discharged. The two agreements were entered into to camouflage the true character of income from interest on loan to capital gains.
The applicant submitted that it was engaged in real estate business, but its only transactions in India were investment in ‘S’. Hence, alternatively, nature of income arising from the transaction should be business income.
As per current FDI Policy, optionally and partly convertible debentures and preference shares are to be treated as ECB. Debentures recognise the existence of a debt. It does not cease to be so simply because they are redeemed by conversion to equity shares and not payment. Thus, ECB is contrived to look like CCDs convertible into equity. A transaction where the parties have a common intention not to create the legal rights and obligations which they give appearance of creating, is sham6. Since the rate of return was predetermined 6 years before the exercise of option, there was no commercial purpose. Accordingly, the transaction was designed to avoid tax by taking advantage of Article 13(4) of India-Mauritius DTAA. It was the applicant’s contention that:
Investment through CCDs is not loan or advance and there is no lender-borrower relationship with ‘S’. Even if ‘S’ is assumed to be borrower, the consideration is received from ‘V’ for sale of assets. Any amount received over and above purchase price cannot be treated as interest7.
Gains on sale of CCDs have arisen because of the value of the underlying assets, namely, equity shares.
Applicant and ‘V’ are totally unrelated parties and hence, purchase of CCDs by ‘V’ cannot be regarded as redemption of CCDs.
Since the tax benefit would result to only one, there is no reason for parties involved to share a common intention to create legal facade.

Ruling The AAR observed and ruled as follows:

(i) Reliance placed on CWT v. Spencer & Co. Ltd. and Eastern Investments Ltd. v. CIT8, to contend that a CCD creates or recognises the existence of a debt, which remains to be so till it is repaid or discharged.

(ii) Article 11(5) of India-Mauritius DTAA, includes any type/form of ‘income from bonds and debentures’ within the ambit of ‘interest’. Purchase price under call option was linked to the holding period. While CCDs were not to carry any interest, they gave option of conversion into shares at a different price. Conversion of debentures into equity shares at the end of the specified period amounts to constructive repayment of debt. While calculating the purchase price the conversion rates vary, depending upon the period of holding of CCDs. This is nothing else but ‘interest’ within the meaning of section 2(28A) of the Income-tax Act and Article 11 of India- Mauritius DTAA.

(iii) To ascertain true legal nature of the transaction, and to appreciate true nature of the consideration received, ‘look at’ test needs to be applied by examining substance of the transaction, inter se relationship of the parties and the transaction as a whole. While ‘S’ and ‘V’ were two independent juridical persons, ‘S’ did not exercise any power in managing its affairs. The management powers of the directors of ‘S’ were taken away through various clauses of SHA. ‘V’ was developing and running real estate business of ‘S’. ‘V’ was the guarantor of investment made by ‘Z’. ‘V’ acknowledged CCDs as debt. Thus, ‘V’ and ‘S’ were different only on paper, but otherwise they were one and the same entity. ‘V’ had de facto control and management over ‘S’. Therefore the argument that the sale of CCDs is not to the debtor but to a third party and hence, what is realised cannot be said to include interest, cannot be accepted.

(iv) Article 11 is a specific provision dealing with treatment of income from debt claims of every kind, whereas Article 13 deals with capital gains. ‘V’ and ‘S’ are one and the same. ‘V’ has paid fixed pre-determined return to the applicant. Hence, the amount paid by ‘V’ is towards the debt taken by ‘S’ from the applicant and therefore, appreciation in value of CCDs is ‘interest’ under Article 11.

levitra

Nirav Shah

Usance interest which is directly related to the period for which purchase price was due, is ‘interest’ in terms of section 2(28A) and consequently, it is deemed to accrue or arise in India u/s.9(1)(v) of ITA.

Uniflex Cables Ltd. v. DCIT
(2012) 19 Taxmann 315 (Mumbai-ITAT) Section 2(28A), 40(a)(i) of Income-tax Act A.Ys.: 1999-2000 & 2002-03. Dated: 28-3-2012
Before R. S. Syal (AM) and N. V. Vasudevan (JM)
Present for the appellant: Rajan Vora
Present for the Department: Jitendra Yadav

Usance interest which is directly related to the period for which purchase price was due, is ‘interest’ in terms of section 2(28A) and consequently, it is deemed to accrue or arise in India u/s.9(1)(v) of ITA.

Facts:

The taxpayer, an Indian company (ICO), purchased raw material from several non-resident suppliers under irrevocable LCs payable within 180 days from the date of bill of loading. ICO was required to pay usance interest for the period of credit and the supplier raised a separate invoice in respect of such usance interest. During the years under consideration, on the ground that the usance interest was in the nature of interest and it had accrued and arisen in India, the Tax Department held it to be chargeable to tax in India. Further, as ICO had not deducted tax on such usance interest, the claim for deduction of such interest was disallowed u/s.40(a)(i) of the Income-tax Act. The disallowance was upheld by the CIT(A). Before ITAT, ICO contended that:

Interest within meaning of section 2(28A) of the Income-tax Act means interest payable in respect of moneys borrowed or debt incurred. Payment of interest for the time granted by non-resident supplier of raw material cannot be considered as payment in respect of money borrowed or debt incurred. Hence, such payment would not partake the character of interest as per section 2(28A) of the Income-tax Act.
The finance charges were for delayed payment of raw material purchases and hence would partake the character of money paid for purchase price of raw material. Therefore, no tax is required to be deducted. In support, ICO relied on various decisions3.
Reliance placed by the Tax Department on the Gujarat HC in the case of CIT v. Vijay Ship Breaking Corporation, (2003)4, where it was held that usance interest was not part of the purchase price, but was interest and the payer was required to deduct tax.

Held:

The ITAT rejected ICO’s contentions and held: Unlike certain cases cited by ICO, in ICO’s case, usance interest had no relation with the price of raw material purchased, but had direct relationship with the time when the payment became due. Hence, on facts, usance interest was in the nature of interest within the meaning of section 2(28A) of the Incometax Act. Consequently such interest would be deemed to have accrued or arisen in India u/s.9(1) (v)(b) of the Income-tax Act.

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Nirav Shah

Payment for development of Balanced Score Card (BSC) management tool is Fees for Technical Services under Article 12 of the India-Singapore DTAA.

Organisation Development Pte. Ltd. v. DDIT TS 86 ITAT 2012 (CHNY)
Article 5, 7, 12 of India-Singapore DTAA; Section 9(1)(vi)/(vii)of Income-tax Act A.Y.: 2007-08. Dated: 9-2-2012
Abraham P. George (AM) and George Mathan (JM) Present for the appellant: Vikram Vijayaraghavan Present for the Department: K.E.B. Rangarajan

Payment for development of Balanced Score Card (BSC) management tool is Fees for Technical Services under Article 12 of the India-Singapore DTAA.

Facts:

Taxpayer, a company incorporated in Singapore (FCO), provided services to various clients around the world for development of BSC project. BSC is a strategic performance management tool which can indicate deviations from expected levels of performance. During the year under consideration, FCO rendered services to various companies located in India.

FCO contended that the receipts towards services were business profits under Article 7 of DTAA and in the absence of Permanent Establishment (PE) the same would not be taxable in India.

The Tax Department divided services for development of BSC into two segments viz. professional fees rendered to the clients and lump sum received for sale of software. The Tax Department held that the amount received towards the sale of software was taxable as ‘royalty’ for use of equipment, while the professional fees were taxable as ‘fees for technical services’ (FTS).

FCO contended that there was no ‘equipment royalty’ as the users had no domain or control over such software. Also the software downloaded by clients was not customised to suit any particular client. Furthermore, as FCO had not made available any technical knowledge, experience, skill, knowhow, etc. amount would not be taxable as FTS. The matter was referred before the Dispute Resolution Panel (DRP) which upheld the order of the Tax Department.

ITAT Ruling:

The ITAT held that the payments received by FCO would be taxable as FTS u/s.9(1)(vii) for following reasons: FCO had sent its team to help its clients in implementing licensed software which was required to develop BSC. The clients were required to make lump-sum payments for downloading such software from the designated sites and such software was to be used in various phases of developing the BSC system.
In a BSC system each client has its own goals and different strategies to reach such goals. A team, which is evolving a BSC system necessarily, has to identify the measures that are relatable to the entity under study. This is not a type of service which can be used by any organisation by application of an off-the-shelf software.
Software is only a part of the total process for development of BSC. Fees received by FCO are linked to the downloading of software, but that is not sufficient to come to a conclusion that software is equipment from which FCO earned royalty. The Tax Department was not right in dividing the whole process into two parts one for the royalty and the other for FTS.
The provisions of DTAA with regard to the definition of the term ‘FTS’ are different from the definition provided u/s.9(1)(vii) of the Incometax Act. This is supported by AAR in the case of Bharti AXA General Insurance1. FCO is thus justified in availing benefit of treaty provisions and this is well supported by SC ruling in UOI v. Azadi Bachao Andolan2.
FCO made available technical knowledge and skill which enabled its clients to acquire the knowledge for using BSC system for their business and for meeting long-term targets.
Software was only a part of the management consultancy tool and was never considered as independent of the total system. The technical knowledge and skill provided by FCO remained with its clients. Thus, fees received for designing of BSC management tool falls within definition of FTS under Article 12(4) of the India–Singapore DTAA.

levitra

Nirav Shah

[2013] 32 taxmann.com 132 (Mumbai – Trib.) IHI Corporation vs. ADIT A.Y.: 2009-10, Dated: 13-03-2013

Article 7 of India-Japan DTAA; Section 9(1)(vii) – While pursuant to the retrospective amendment to section 9(1)(vii) of the Act, income from offshore services will be taxable in India, it will not be taxable in terms of Article 7 of India-Japan DTAA.

Facts:
The taxpayer was a company incorporated in, and tax resident of Japan. The taxpayer had executed contracts with an Indian company for engineering, procurement, construction and commissioning of certain equipment. The consideration under the contract was segregated into offshore portion and onshore portion. As regards the offshore portion, the taxpayer contended that no income had accrued in India as all activities were undertaken outside India and that the project office in India had no role to play in respect of the offshore services. Further, since the transfer of property in goods and the payments had taken place outside India, no income was taxable in India.

Held:
(i) Position under the Act

a) In an earlier case of the taxpayer, the Supreme Court [Ishikawajima-Harima Heavy Industries Ltd vs. DIT (2007) 288 ITR 408 (SC)] had held that section 9(1)(vii) of the Act envisages fulfillment of two conditions, namely, the services must be utilised in India and they must be rendered in India.

b) Pursuant to the retrospective amendment to section 9, even if the services are rendered outside India, the consideration will be taxable in India if services are utilised in India. As there was no dispute that the payment received by the taxpayer was in the nature of fees for technical services and further that though the services were rendered outside India, they were utilised in India, the rendition of such services outside India could not now take the income out of the ambit of section 9(1)(vii). Therefore, income from offshore services rendered outside India will be taxable in India u/s. 9(1)(vii) of the Act.

(ii) Position under India-Japan DTAA

a) In an earlier case of the taxpayer, the Supreme Court [Ishikawajima-Harima Heavy Industries Ltd vs. DIT (2007) 288 ITR 408 (SC)] had held that Article 7 of India-Japan DTAA is applicable and it limits the taxability to profits arising from the operation of the PE. Since the services were rendered outside India and since they had nothing to do with the PE in India, no income can be attributable to PE in India.

b) As there was no change in this position, income arising from offshore services was not taxable in India.

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Nirav Shah

[2013] 33 taxmann.com 200 (Mumbai – Trib.) (SB) Assistant Director of Income-tax (IT) -1(2) vs. Clifford Chance A.Ys.: 1998-99 TO 2001-02 & 2003-04, Dated: 13-05-2013

Article 7, 15 of India-UK DTAA; section 9(1) – Since professional services are not covered under section 9(1)(vii) of the Act, retrospective amendment impacting special source taxation applicable to FTS etc has no effect; Since Article 7(3) of India- UK DTAA unambiguously explains “indirectly attributable” profits to PE, reference to Article 7(1) of UN Model convention is not warranted.

Facts:
The taxpayer was a partnership firm of Solicitors in UK, engaged in providing international legal services operating through its principal office in UK and branch offices in certain other countries. During the years under consideration, it had provided legal consultancy services in connection with different projects in India. While it did not have an office in India, some part of the work relating to the projects in India was performed in India by its partners and employees during their visits to India. Relying on Article 15 of the India-UK DTAA, the taxpayer claimed exemption from tax on the ground that short duration test in Article 15 was satisfied as its presence in India was of less than 90 days . However, according to AO the said test was not satisfied and hence, taxpayer had constituted a PE in India as per Article 5 and as the services had been rendered in India, the entire income in respect of Indian projects was chargeable to tax in India under Article 7.

Having regard to the retrospective amendment to section 9 of the Act, issues before the special bench were as follows.

(i) Whether insertion of Explanation to section 9 by way of retrospective amendment changes the position in law?

(ii) Whether on interpretation of the term “directly or indirectly attributable to Permanent Establishment” in Article 7(1) of the India-UK DTAA, it is correct in law to hold that the consideration attributable to the services rendered in UK is taxable in India?

Held
(i) Position under the Act

a) In an earlier case of the taxpayer, Bombay High Court [(2009) 318 ITR 237] had held that Article 15 and section 9(1)(i) of the Act was applicable for determination of its taxable income in India.

b) In DIT vs. Ericsson [2012] 343 ITR 470, Delhi High Court has held that the retrospective amendment in section 9 impacts only special source rule provision applicable to interest, royalty and FTS as contemplated in clauses (v), (vi) and (vii) of section 9(1).

c) Accordingly, as the tax department has not been able to substantiate applicability of section 9(1)(vii) and the earlier proceedings have proceeded on the basis that income derived by the taxpayer from professional services in respect of projects in India was covered u/s. 9(1)(i) of the Act, taxation is to be restricted to income in India to the extent attributable to the services performed in India. Retrospective amendment to special source rule has no applicability to taxation u/s 9(1)(i) and the earlier ruling in case of taxpayer holds good despite the amendment

(ii) Position under India-UK DTAA

a) In terms of Article 7(1), profits “directly or indirectly” attributable to the PE in India are chargeable to tax in India. Article 7(2) explains what constitutes “directly attributable” profits and Article 7(3) explains what constitutes “indirectly attributable” profits. In terms of the treaty only that proportion of the profits of the contract in which PE actively participates in negotiating, concluding or fulfilling contracts is to be treated as “indirectly” attributable.

b) In terms of Article 7(3) in India-UK DTAA “indirectly attributable” profits are to be apportioned in proportion to the contribution of PE to that of the enterprise as a whole and hence, profits apportioned to the contribution of other parts of the enterprise cannot be brought to tax in India.

c) Provisions of Article 7(1)(b) and (c) of UN Model convention are materially different from Article 7(3) of India-UK DTAA, which are unambiguous. Hence, reference to Article 7(1) of UN Model convention in Linklaters LLP vs. ITO [2010] 40 SOT 51 (Mum) was misplaced.

levitra

Nirav Shah

S/s.- 5, 9, 40(a)(i), 195 – Payments made for online advertisement on search engines of Google/Yahoo are neither royalty nor FTS. On facts, no business connection; accordingly, not taxable in India and hence no tax withholding applies; websites do not constitute permanent establishment in India.

8. TS-137-ITAT-2013(KOL)
ITO vs. right Florists Pvt. Ltd.
A.Ys.: 2005-06, Dated: 12-04-2013

S/s.- 5, 9, 40(a)(i), 195 – Payments made for online advertisement on search engines of Google/Yahoo are neither royalty nor FTS. On facts, no business connection; accordingly, not taxable in India and hence no tax withholding applies; websites do not constitute permanent establishment in India.

Facts
The Taxpayer, an Indian company, used search engines of Google/Yahoo for advertising its business. Payments were made to Google Limited (a company resident of Ireland) and Yahoo (a US based company) for displaying the Taxpayer’s advertisement when certain key terms were used on such search engines. No taxes were withheld as the Taxpayer was of the view that the payment was not taxable in India in the hands of the recipient non-residents.

The Tax Authority disallowed the advertisement expenses u/s. 40(a)(i) on the ground that taxes ought to have been withheld by the Taxpayer. CIT(A) ruled in favour of the Taxpayer as the non-resident recipients did not have any permanent establishment (PE) in India, no portion of the payments can be considered as taxable in India.

Held
The Tribunal based on the following ruled that the payment for online advertisement is not taxable in India and hence no withholding on the same was warranted.

Whether income accrues or arises in India:

The Tribunal drew reference to SC decision in the case of Hyundai Heavy Industries (291 ITR 482) wherein SC observed that in order to attract taxability in India u/s. 5(2)(b), income must relate to such portion of income of the non-resident, as is attributable to business carried out in India, and the business so carried out in India could be through its branches or through some other form of presence such as office, project site, factory, sales outlet etc which was collectively referred to as “PE of the foreign enterprise”

Whether Google/ Yahoo have a PE in India

• Traditional commerce required physical presence to carry out business in a country and the concept of PE had developed at a time when e-commerce was non-existent. • The ITAT concluded that a website per se could not constitute a PE in India under the Act for the search engine companies which was also the view taken by the High Powered Committee (HPC) .

• In a tax treaty context, reliance was placed on the OECD MC Commentary to conclude that a search engine, which has a presence through its website, cannot therefore, constitute a PE under the treaty unless its web servers are located in the same jurisdiction which is in line with the physical presence test.

• India’s reservations on the OECD MC Commentary merely state that the website may constitute a PE in certain circumstances, but it does not specify what those “circumstances” are in which, according to tax administration, a website could constitute a PE. Hence, the reservations do not really constitute “actionable statements” and there is difficulty in understanding somewhat vague and ambiguous stand of the tax administration on this issue.

Thus, conditions of income accrual u/s. 5(2)(b) as laid by the SC in Hyundai Heavy Industries are not satisfied to the extent no profits can be said to accrue or arise in India.

Whether income deemed to accrue or arise in India,

• On business connection, the ITAT held that there was nothing on record to demonstrate or suggest that the receipts were on account of business connection in India.

• Payment in connection with online advertising services is not in the nature of royalty – Reliance placed on earlier rulings in Yahoo India Pvt Ltd (140 TTJ 195) and Pinstorm Technologies Pvt Ltd [TS- 536-ITAT-2012(Mum)].

• Based on SC ruling in Bharti Cellular (330 ITR 239), it was concluded that payment is not fees for technical services (FTS) as “human intervention,” is essential for the service being characterised as FTS. As the whole process of online advertising is automated in which there is no human element, the same cannot constitute FTS.

levitra

Nirav Shah

DDIT vs. Marriott International Licensing Company BV [2013] 35 taxmann.com 400 (Mumbai-Trib) A.Ys.: 2003-04 Dated: 17-07-2013 Article 12(4) of India-Netherlands DTAA

Payment can be characterised as “royalties” only if it is consideration for use or right to use any defined property in existence at the time of use—since the payment made was not for pre-existing defined property, it could not be characterised as “royalties”. Contribution linked to percentage of turnover is unlikely to be regarded as reimbursement of expenses.

Facts:
The taxpayer was a company incorporated in, and tax resident of, the Netherlands. The taxpayer had entered into a Franchise Agreement with a hotel in India for providing sales, marketing publicity and promotion services outside India. The Indian hotel was also to participate in the hotel system of the taxpayer. Clause 3.2 of the agreement provided that the hotel was to pay certain proportion of its gross revenue for international marketing activities which were in the nature of advertising and printed media, marketing, promotional, public relations and sales campaigns etc. The issue before the Tribunal was, whether the payment made under clause 3.2 of the agreement was purely reimbursement of expenses on sales promotion and marketing and hence was not “royalties”?

Held:
To cover any amount within the purview of Article 12(4) of India-Netherlands DTAA, the payment should be received as consideration ‘for the use of or right to use’ any defined property (i.e. copyright, patent, trademark, etc). Thus, a payment would be “royalties” if it is made for defined property existing at the time of use and not for creation of defined property. Even if the payment contributed towards brand building, it would not be for use of the brand and hence cannot be characterised as “royalties”.

The contribution, being a percentage of gross revenue, was not reimbursement of actual expenses on itemised basis and no material was placed on record to demonstrate that actual expenses were equal to the reimbursed amount. Therefore, the AO should decide on the taxability of the amounts under Article 7 of India-Netherlands DTAA.

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Nirav Shah

S/s. 195, 40(a)(i) – Reimbursement of expenses to holding company is not an income under the Act and hence not chargeable to tax; Expenses routed through holding company for payment to third party not in the nature of reimbursement of expenses and liable to withholding by evaluating tax implications in the hands of the third party.

7. TS-132-ITAT-2013(Mum)
C. U. Inspections (I) Pvt. Ltd. vs. DCIT
A.Y. 2006-07, Dated: 06-03-2013

S/s. 195, 40(a)(i) – reimbursement of expenses to holding company is not an income under the Act and hence not chargeable to tax; expenses routed through holding company for payment to third party not in the nature of reimbursement of expenses and liable to withholding by evaluating tax implications in the hands of the third party.

Facts

The Taxpayer, an Indian company, was a subsidiary of a company incorporated in Netherlands (Parent Company). During the relevant AY, the Taxpayer made two types of payments to the Parent Company on which taxes were not withheld on the ground that the same amounted to reimbursement of expenses, viz :

(i) Payment in respect of common expenses borne by the Parent Company for various group companies in respect of accounting services, legal and professional services, communication, R&D etc.

These expenses were incurred by the Parent Company for and on behalf of the Taxpayer and other group companies and the same were recovered/allocated on the basis of arm’s length principle based on agreed parameters. As per the Auditor’s Certificate, allocation of such expenses was done without any income element. (Common expenses)

(ii) Payments in respect of expenses for training services availed by the Taxpayer from independent third party and for which the payment was routed through the Parent Company.

Such training services were arranged by the Parent Company which paid to the third party trainers and later on recovered the amount from the Taxpayer on actual basis. (Training expenses)

The tax authority was of the view that taxes were required to be withheld on the above payments and in the absence of tax withholding, such payments/ expenses were not allowed as deduction while computing taxable income of the Taxpayer under the Act.

The CIT(A) upheld the action of the tax Authority.

Held
• The payments towards common expenses incurred by the Parent company for and on behalf of the Taxpayer and group entities, amounted to reimbursement of expenses. Such reimbursement of expenses was not chargeable to tax in the hands of parent company and, hence, was not subject to withholding of taxes u/s. 195 of the Act.

• In connection with training expenses, it held that the payments were not reimbursement of expenses but remission of amount by the Taxpayer to the Parent company for finally making the payment to third party service provider and, hence, was a payment to third party through the hands of the parent company. Accordingly, provisions of withholding of taxes under Act will apply as if the Taxpayer has made the payment to such independent third party service provider.

levitra

Nirav Shah

ITO vs. Veeda Clinical Research Pvt Ltd [2013] 35 taxman.com 577 (Ahmedabad-Trib) A.Y. 2008-09, Dated: 28-06-2013 Article 13(4) (c), India-UK DTAA

Fees paid by Indian company to UK company for general training does not involve transfer of technology and hence, is not covered under ‘make available’ clause.

Facts:
The taxpayer was an Indian company. It had made certain payments to a UK service provider for providing ‘market awareness and development training’ to its employees.

The issue before the Tribunal was whether the training fees paid to the service provider were covered under Article 13(4)(c) of India-UK DTAA and accordingly, were taxable in India?

Held:
The law on the connotation of ‘make available’ clause in definition of FTS is settled and the condition precedent for invoking this clause is that the services should enable the person acquiring the services to apply the technology contained in such services.

Unless the technical services provided by the UK Company resulted in transfer of technology, the ‘make available’ condition was not satisfied. To invoke ‘make available’ clause, the onus is on the tax authority to demonstrate that the training services involved transfer of technology. This onus was not discharged.

The training services provided were general in nature and did not involve transfer of technology. Therefore, the fees paid for the same could not be covered under Article 13(4) of India-UK DTAA.

levitra

Nirav Shah

Article 7, 11 of India-UAE DTAA – Interest received by an UAE resident from an Indian partnership firm in which he is a partner is not taxable as business income, but as Interest income, owing to specific “Interest” article in the India-UAE DTAA; DTAA rate is not to be further enhanced by surcharge and education cess.

6. TS-117-ITAT-2013(Mum)
Sunil V. Motiani vs. ITO
A.Ys.: 2008-09, Dated: 27-02-2013

Article 7, 11 of India-UAE DTAA – Interest received by an UAE resident from an Indian partnership firm in which he is a partner is not taxable as business income, but as Interest income, owing to specific “Interest” article in the India-UAE DTAA; DTAA rate is not to be further enhanced by surcharge and education cess.

Facts

The Taxpayer, resident of UAE, received interest income from partnership firms in India in which he was a partner. The Taxpayer offered such interest income to tax in India as per provisions of India-UAE DTAA (UAE DTAA). The tax authority, in addition to taxing the interest income at the rate prescribed in Article 11 of DTAA, also levied education cess and surcharge.

The CIT(A) ruled that as the interest income was in the nature of business income the same was taxable as per normal rates and the concessional rate as provided in the Article 11 was not applicable.

Held
• The specific Articles in DTAA dealing with taxation of income under different heads would govern the taxability of a specific income.

• Income from business is governed by Article 7 whereas interest income is governed by Article 11.

• Article 7(7) of the DTAA provides that in case specific provision deals with a particular type of income, the same has to be dealt with by those provisions.

• Thus, though interest income may be assessed as business income under the Act, in view of specific interest Article i.e. Article 11, interest income should be governed by the said Article 11.

• The term ‘Income Tax’ has been defined in Article 2 of the UAE DTAA to include surcharge. Therefore, tax rate provided in Article 11(2) dealing with interest income also includes surcharge.

• Based on Kolkata Tribunal decision in the case of DIC Asia Pacific Pte Ltd. v. ADIT(IT) [ITA No.1458/ Kol/2011], it can be held that education cess is in the nature of surcharge. Accordingly, both education cess and surcharge can be regarded as included in the treaty rate of 12.5%.

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Nirav Shah

Varian India (P.) Ltd. vs. ADIT [2013] 33 taxmann.com 249 (Mumbai-Trib) A.Ys.: 2002-03 to 2006-07, Dated: 27-02-2013

Article 5 and 7 of India-USA DTAA, India-Australia DTAA and India-Italy DTAA

Since no condition under Article 5(4) dealing with dependent agent was fulfilled, the PE was not constituted—in absence of PE, ‘force of attraction rule’ did not apply.

Facts:
The taxpayer was the Indian branch of an American company VIPL, which in turn was a wholly owned subsidiary of Varian USA. Varian USA was engaged in manufacturing and marketing of various kinds of instruments. Varian group had five group entities in USA, Australia, Italy, Switzerland and the Netherlands. The taxpayer had entered into Distribution and Representation agreements with Varian group companies in respect of India. The taxpayer carried out pre-sale activities such as liaisoning and post-sale support activities and received commission for the same. The taxpayer did not have any authority to negotiate or conclude contracts on behalf of the group companies. Further, all the risks like market risk, product liability risk, research and development risk, credit risk, price risk, inventory risk or foreign currency risk were born by the selling entity.

The issues before the Tribunal were as follows.

(i) Whether the Indian branch of the taxpayer constituted PE of the group companies?
(ii) If the taxpayer was considered to constitute the PE, whether ‘force of attraction rule’ could apply?

Held:
(i) Dependent agent PE

The taxpayer did not have any authority to negotiate or conclude contract on behalf of group companies. The group companies directly sold the products to the Indian customers and also undertook all the associated risks.

Under Article 5 (4) of India-USA DTAA, an agent constitutes a PE only if he fulfils one of the three conditions specified therein. On facts, the taxpayer did not fulfil any of the three conditions as it had no authority to conclude contract, nor did it act as delivery agent, nor as order-securing agent. Therefore, the test of dependent agent PE failed and the US affiliate triggered no taxation in India.

The corresponding conditions under India-Australia DTAA and India-Italy DTAA were also similar to Article 5(4) of India-USA DTAA and in those cases too, the PE did not kick in.

(ii) Applicability of ‘force of attraction rule’

For application of ‘force of attraction rule’: the foreign enterprise should have a PE in India for selling goods, and the goods sold by the foreign enterprise should be same or similar to those sold by the PE. As the foreign enterprise did not have a PE in India, question of applicability of ‘force of attraction rule’ did not arise.

levitra

Nirav Shah

Wellinx Inc vs., ADIT [2013] 35 taxmann.com 420 (Hyderabad-Trib) A.Ys.: 2006-07, Dated: 28-06-2013 Article 7(3), India-USA DTAA

Article 7(3) of India-USA DTAA distinguishes between commercial and non-commercial services. While the former are taxable, the latter are not taxable. Customer care and medical transcription services provided by BO to HO were commercial services and hence taxable in India.

Facts:
The taxpayer was a company incorporated in USA. It was engaged in the business of medical transcription and software development related to health care. The taxpayer established a Branch Office (“BO”) in India for providing certain services to Head Office (“HO”) in USA after obtaining approval of RBI. BO received payments from HO for these services.

According to taxpayer, as BO was providing services to HO, in terms of Article 7(3) of India-USA DTAA, the resultant income was not chargeable to incometax. However, the AO concluded that the BO was engaged in software development and estimated its income on cost plus basis.

Held:
The taxpayer had a PE in India.

Article 7(3) has two parts. The first part relates to commercial and business activities carried on by a PE whereas second part relates to certain specified non-commercial services performed by PE for its HO. While the commercial and business services are taxable, if HO assigns some non-commercial activities to its BO, income from such activities would not be taxable in terms of Article 7(3) of India-USA DTAA.

In the present case, BO provided customer care and medical transcription services to the HO. These were commercial services outsourced by the HO. Hence, consideration for such services was taxable in India.

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Nirav Shah

S/s. 9, 10(23G) – Sale of shares of an Indian company by a Netherlands company to a Singapore company not taxable under the Act or India-Netherlands DTAA; Shares in the Indian company engaged in infrastructure activity is not “immovable property” so as to be taxed under Article 13(1) of Netherlands DTAA; Interest received for delay in payment of sale consideration by the Netherlands company which was received outside India, did not accrue or arise in India and cannot be taxed u/s. 9 of the Act.<

5. TS-120-ITAT-2013(HYD)
Vanenburg Facilities B.V. vs. ADIT
A.Ys.: 2005-06, Dated: 15-03-2013

S/s. 9, 10(23G) – Sale of shares of an Indian company by a Netherlands company to a Singapore company not taxable under the Act or India-Netherlands DTAA; Shares in the Indian company engaged in infrastructure activity is not “immovable property” so as to be taxed under Article 13(1) of Netherlands DTAA; Interest received for delay in payment of sale consideration by the Netherlands company which was received outside India, did not accrue or arise in India and cannot be taxed u/s. 9 of the Act.

Facts
The Taxpayer, a Netherlands Company, made 100% equity investment in an Indian Company (ICo), which was engaged in the business of developing, operating and maintaining infrastructure facilities of an industrial park in India. Further, ICo was an approved infrastructure company u/s. 10(23G) of the Act, which exempts Long Term Capital Gains (LTCG) on investments made in infrastructure projects.

During the relevant AY, the Taxpayer sold its 100% shareholding in ICo to a Singapore Company (BuyCo). BuyCo also paid interest to the Taxpayer for delay in payment of sale consideration. Taxes were withheld by BuyCo both on LTCG and on interest paid. The Taxpayer claimed refund of the taxes withheld on the ground that, under the India-Netherlands Double Taxation Avoidance Agreement (Netherlands DTAA) LTCG was not taxable and the interest income did not accrue or arise in India. Alternatively, the Taxpayer also claimed shelter u/s. 10(23G) of the Act.

The tax authority rejected the claim made by the Taxpayer on the following grounds

• Article 13(1) of the Netherlands DTAA, which permitted taxation of gains arising on alienation of ‘immovable property’ and the same is applicable in the facts of the present case as transfer of 100% shares implied that the rights to enjoy the property of ICo vested with BuyCo.

• Exemption u/s. 10(23G) was not available as the approval to ICo was granted after the investment was made by the Taxpayer.

• Since interest is inextricably linked to base transaction, the same is taxable on the same lines as the base transaction.

The CIT(A) upheld tax authority’s order.

Held
The Tribunal based on the following, ruled that the LTCG and the interest received from FCo is not taxable in India in the hands of the Taxpayer.

On taxability under the Netherlands DTAA:

• Though the Act does not define ‘immovable property’ in section 2, it has been defined in a varied manner under different sections in the Act, which would be applicable specifically in a particular scenario. Therefore, it cannot be considered that ‘immovable property’ as defined for special purpose in sections like 269UA of the Act, 3(26) of General Clauses Act etc. has a general purpose meaning applicable to all provisions of the Act.

• A share held by a company cannot be considered as ‘immovable property’. In terms of Article 6 of the Netherlands DTAA immovable property shall have the meaning which it has under the law of the State in which the property in question is situated. Unless the conditions prescribed in Article 6 of Netherlands DTAA apply, the same cannot be considered as immovable property under Article 13(1) of the DTAA.

• Article 13(1) cannot be made applicable to the transfer of shares, as Taxpayer has not sold the immovable property or any rights directly attached to the immovable property.

• Article 13(5), which provides for taxability in case of alienation of shares (and consequential exclusive right of taxation to country of residence) is applicable to the facts of the present case, as per which the capital gains would be taxable in Netherlands. On exemption u/s. 10(23G):

• Since the Indian Company was already approved as an infrastructure company and was allowed deduction u/s. 80IA and further at the time of sale of shares the conditions as provided u/s. 10(23G) are satisfied, the sale of shares of an infrastructural company, is eligible for exemption as provided u/s. 10(23G).

• The fact that the approval was received post the date of investment is not relevant. On taxability of interest:

• As per Section 9 of the Act, interest is taxable in India if the same is towards a debt incurred or moneys borrowed and used for the purpose of a business or profession carried on by non-resident in India. In the facts, neither the Taxpayer nor BuyCo is carrying on any business in India, nor is the interest payable in respect of any debt incurred or moneys borrowed and used for the purpose of business in India. Therefore, the interest received by the Taxpayer which was paid and received outside India, cannot be taxed u/s. 9 of the Act.

• Even if interest were to be considered as part of consideration it would form part of the sale consideration and will be considered like capital gains.

levitra

Nirav Shah

S/s. 9(1)(vii), 195 and 201 – Payments made abroad for services in respect of arrangement of logistics for shooting of films outside India does not amount to fees for technical services.

Facts:

Yash Raj Films (taxpayer) is engaged in the business of production of films, the shooting of which is often done outside India. During the relevant previous year, the taxpayer made payments to overseas service providers (OSPs) for the services availed in connection with the shooting of different films which mainly included arranging for extras, security, locations, accommodation of cast and crew, necessary permissions from local authorities, makeup of the stars, insurance cover, shipping and custom clearances, obtaining visas. The tax authority considered the payments for obtaining the above services to be in the nature of fees for technical services (FTS) and considered the taxpayer as an assessee-in-default for not withholding taxes.

Held:

Considering the nature of the services rendered by OSPs to the taxpayer as spelt out in the relevant agreements, the said services cannot be treated as technical services within the meaning given in Explanation 2 to section 9(1)(vii).
The said services rendered outside India by the OSPs in connection with making logistic arrangement are in the nature of ‘commercial services’ and the amount received by them from the taxpayer for such services constitutes their business profit which is not chargeable to tax in India in the absence of any Permanent Establishment (PE) in India of the said service providers. The taxpayer, therefore, is not liable to withhold taxes on the payments made.

levitra

Nirav Shah

Taxation of Long Term Capital Gains on Transfer of Unlisted Securities

Clause (c) of the section 112 (1) of the Income tax Act, 1961 provides for reduced rate of tax on transfer of securities by non-residents. The reduced rate of tax applicable till the F.Y. 2011-12 for all listed securities or units or zero coupon bonds was 10%; whereas, for unlisted securities, e.g. shares of a private limited company, the rate of tax was 20%. In order to bring parity of tax rate on the transfer of unlisted securities, an amendment is made by the Finance Act, 2012, w.e.f. 1-4-2013, whereby it is provided that gains on transfer of unlisted securities also would be subject to 10% tax. This Article analyses the impact of this amendment as certain unwarranted controversies are likely to crop up.

1.0 Introduction and Background

Section 10 (38) of the Income tax Act, 1961 (Act) provides that long term capital gains (LTCG) arising from transfer of equity shares in a company or units of an equity linked units will be exempt from tax provided Security Transaction Tax (STT) is being paid on such transfer. Essentially, all transactions on a recognised stock exchange are subject to STT. In other words, LTCG on transfer of all listed shares will be exempt. This exemption, is applicable equally to residents as well as non-residents.

In this article, we will restrict our discussion to taxability of LTCG on transfer of unlisted securities in the hands of non-residents. Section 112(1)(c) of the Act deals with taxability of the LTCG in the hands of non-residents.

Proviso to section 112(1), inserted w.e.f. 1-4-2000, provided a rate of tax @ 10% in respect of LTCG on transfer of “listed securities, units and zero coupon bonds”. For the meaning of the term “listed securities”, reference has been made to the Securities Contracts (Regulation) Act, 1956 (32 of 1956) (SCRA). As stated earlier, LTCG, on listed securities, being equity shares, on which STT is paid, is exempt u/s 10(38), and it is assumed that this provision would be useful in respect of other listed securities. However, the unlisted securities continued to be taxed @ 20 %.

In order to bring about parity and encourage investment by Private Equity players in Unlisted Shares, an amendment was made to section 112 (1)(c) vide the Finance Act, 2012 w.e.f. 1-4-2013 to provide for a rate of tax @ 10% on the LTCG on transfer of unlisted securities.

The amendment assumes significance for Private Equity Investors (PEI) who invests in India in large numbers through Private Limited Companies. Even the Memorandum explaining amendment to section 112 (1) (c) refers to extending benefit of reduced rate of 10% to the PEI. Let us examine whether this intention is fulfilled by the amendment to section 112 carried out by the Finance Act, 2012.

2.0 Law as amended

Relevant extract of the section 112(1)(c), as amended, is as follows:

The following sub-clauses (ii) and (iii) shall be substituted for sub-clause (ii) of clause (c) of s/s. (1) of section 112 by the Finance Act, 2012, w.e.f. 1-4-2013:

(ii) the amount of income-tax calculated on longterm capital gains [except where such gain arises from transfer of capital asset referred to in sub-clause (iii)] at the rate of twenty %; and

(iii) the amount of income-tax on long-term capital gains arising from the transfer of a capital asset, being unlisted securities, calculated at the rate of ten % on the capital gains in respect of such asset as computed without giving effect to the first and second provisos to section 48; Relevant extract [Clause 43 & First Schedule] of the Supplementary Memorandum Explaining the Official Amendments Moved per the Finance Bill, 2012 is as follows:

Circular No. 3/2012, Dated: June 12, 2012

Concessional rate of taxation on Long Term Capital Gains in case of non-resident investors

“Currently, under the Income-tax Act, a long term capital gain arising from sale of unlisted securities in the case of Foreign Institutional Investors (FIIs) is taxed at the rate of 10 % without giving the benefit of indexation or of currency fluctuation. In the case of other non-resident investors, including Private Equity investors, such capital gains are taxable at the rate of 20% with the benefit of currency fluctuation but without indexation. In order to give parity to such non-resident investors, the Finance Act reduces the rate of tax on LTCG arising from transfer of unlisted securities from 20% to 10% on the gains computed without giving the benefit of currency fluctuations and indexation by amending section 112 of the Income-tax Act.

This amendment is to take effect from 1st April, 2013 and would, accordingly, apply in relation to the assessment year 2013-14 and subsequent assessment years.

Consequential amendments to provide for tax deduction at source have also been made in the First Schedule and will be effective from 1st April, 2012.” One distinction persisting between taxability of LTCG of listed and unlisted securities @ 10 % u/s. 112 is that, while listed securities (being shares and debentures) will get the benefit of the first proviso of section 48 of the Act (meaning gains shall be computed in the same currency in which the investment was made), such unlisted securities will not get a similar benefit.

Except for the aforenoted distinction, the intention of the legislature appears to be very clear and that is to give parity in the case of other non-resident investors [other than the FIIs], including Private Equity investors.

However, in fact, the amendment has led to some ambiguity/controversy which is discussed hereunder:

2.0 Meaning of the term “Securities”

Explanation to the section 112 (1), as replaced by the Finance Act, 2012 w.e.f. 1-4-2013, reads as follows:

(a) the expression “securities” shall have the meaning assigned to it in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (32 of 1956);

(aa) “listed securities” means the securities which are listed on any recognised stock exchange in India;

(ab) “unlisted securities” means securities other than listed securities;

(b) “unit” shall have the meaning assigned to it in clause (b) of Explanation to section 115AB.

As the Act refers to the SCRA, let us examine the definition of “Securities” as defined in section 2(h) of SCRA as follows:
“2(h) ‘securities’ include –
(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate; (emphasis supplied)

(ii) Government securities; and
(iii) rights or interests in securities”.

2.1 Meaning of the term “Unlisted Securities”:

Unlisted Securities are defined to mean securities other than listed securities. Listed Securities, in turn, are defined to mean the securities which are listed on any recognised stock exchange in India.

A plain reading of the definition of “Securities” under the SCRA would mean:

“shares, scrips, stocks, bonds, debentures, debenture stock in or of any incorporated company or a body corporate” or “other marketable securities of a like nature in or of any incorporated company or other body corporate”. If the above interpretation is adopted, then there is no issue and one can interpret that the benefit of reduced rate of tax would be available to LTCG arising on transfer of any securities of a private limited company as well.

However, there is a strong view that the term “other marketable securities of a like nature” goes with other securities mentioned therein, according to which, the definition of securities as per SCRA covers only shares which are ‘marketable’ i.e. freely transferable in the nature. Thus, since the shares of a private company normally have restrictions on free transferability, they would fail to meet the ‘marketable’ test and hence, may not be covered under the ambit of the definition of unlisted securities and would be liable for the higher rate of tax of 20% instead of concessional rate of tax of 10%, as provided in the newly inserted clause (iii) u/s. 112 (1) (c) of the Act.

The above interpretation derives strength from two old decisions of the Bombay High Court and one decision of Kolkata High Court as discussed in the subsequent paragraphs:

2.2 Judicial Interpretation

In the case of Dahiben Umedbhai Patel And Others vs Norman James Hamilton and Others [(1983) 85 BOMLR 275, 1985 57 CompCas 700 Bom.], the Division Bench of the Honourable High Court interpreted “marketable securities” as appearing in SCRA as follows:

“Now, it is difficult for us to accept the argument of the appellants that the definition of “securities” must be so read that the words “other marketable securities of a like nature” were not intended to indicate an element of marketability in so far as the preceding categories were concerned. A reading of the inclusive part of the definition shows that the Legislature has enumerated different kinds of securities and by way of a residuary clause used the words “or other marketable securities of a like nature”. The use of these words was clearly intended to mean that the earlier categories of securities had to be marketable and any other securities of “like nature”, that is to say, like those which were categorised or enumerated earlier were also to be marketable before they could be held to fall within the definition of “securities”.

In Webster’s Third New International Dictionary, “marketable” is stated to mean “fit to be offered for sale in a market; being such as may be justly or lawfully sold or bought”. In order that securities may be marketable in the market, namely, the stock exchange, the shares of a company must be capable of being sold and purchased without any restrictions. In other words, the transfer of a share in a company must vest title in the purchaser and this vesting of title in the purchaser should not be made to depend on any other circumstance except the circumstance of sale and purchase. A market, therefore, contemplates a free transaction where shares can be sold and purchased without any restriction as to title. The shares which are sold in a market must, therefore, have a high degree of liquidity by virtue of their character of free transferability. Such character of free transferability is to be found in the shares of a public company. The definition of a “private company” in section 3 of the Companies Act, 1956, speaks of the restrictions for which the articles of the private company must provide. The articles of a private company must :

“3(1)(iii)(a) restricts the right to transfer its shares, if any;

(b) limits the number of its members to 50, not including –

(i) persons who are in the employment of the company, and

(ii) persons who, having been formerly in the employment of the company, were members of the company while in that employment and have continued to be members after the employment ceased; and

c) prohibits any invitation to the public to subscribe for any shares in or debentures of, a company.”

“It is thus clear that the shares of a private company do not possess the character of liquidity, which means that the purchaser of shares cannot be guaranteed that he will be registered as a member of the company. Such shares cannot be sold in the market or in other words, they cannot be said to be marketable and cannot, therefore, be said to fall within the definition of “securities” as a “marketable security”. On the other hand, in the case of a sale of share of a public company, the transfer is completed and even if the transfer is not registered, the transferor holds the shares for the benefit of the transferee”.

Based on the above observations, the Court Ruled that “it is thus clear to us that the definition of “securities” will only take in shares of a public limited company notwithstanding the use of the words “any incorporated company or other body corporate” in the definition.”

In the case of Norman J. Hamilton vs. Umedbhai S. Patel and Ors. [(1979) 81 BOMLR 340, (1979) 49 CompCas 1 Bom], also the single bench judge held a similar view that “the definition of “securities” would exclude from its purview shares which are not marketable, such as shares in a private limited company.”

In yet another case of B. K. Holdings (P.) Ltd. v. Prem Chand Jute Mills [1983] 53 Comp. Cas. 367 (Cal.), the Kolkata High Court held as follows:

“Whatever is capable of being bought and sold in a market is marketable. There is no reason whatsoever for limiting the expression “marketable securities” only to those securities which are quoted in the stock exchange.” Therefore, transaction of purchase and sale of shares of public limited company would be covered by the provisions of the Act even if the shares are not quoted in stock exchange.

2.3 Summary of Judicial Pronouncements

The rationale or the principles laid down by the above judicial pronouncements can be summarised as follows:

i) The term “Marketable” when used in conjunction with the word “securities”, connotes that the securities which are to be termed as marketable possess a high degree of liquidity;

ii) A private limited company by its very definition restricts the right to transfer its shares. Hence, its shares cannot be said to be “marketable”, as normally interpreted or understood.

iii) The words “other marketable securities of a like nature” are words of a general character which would apply to all the preceding words, namely, “shares, scrips, stocks, bonds and debentures, applying the principle of “Noscitur a sociis”, which means that “the meaning of a word to be judge by the company it keeps”.

The sum and substance of the above interpretations could be that the amendment carried out by the Finance Act, 2012 has little or no effect as far as securities of the Private Limited Companies are concerned. However, the restrictions on transfer of shares of Private Limited Companies as provided in section 3 of the Companies Act, 1956 are not applicable to an unlisted public company and therefore, one can take a view that the reduced rate of 10 % will be applicable only in respect of LTCG on transfer shares of unlisted public company.

Table: Summary of Tax Implication under Different Situations

3.0 Conclusion

The moot point dealt with herein is : What is the intention of amending the expression “unlisted securities”. If we apply the restrictive meanings applied by the Bombay and Kolkata High Courts as discussed above, then it would not include securities of a private limited company. In that scenario, the amendment to section 112 would be meaningful only to the extent of unlisted securities of a public limited company. This does not seem to be the intention of the legislature as flowing from the Explanatory Memorandum explaining amendment of section 112 by the Finance Bill, 2012 wherein it is clearly mentioned that the intention of amendment is to bring about parity in taxability of LTCG in the hands of NRs other than FIs, including Private Equity Investors @ 10% who also invest heavily in private limited companies.

In the light of the foregoing, a suitable retrospective amendment is imperative to remove doubts, if any, and obviate avoidable litigations. After all, the intent of the legislative and the words conveying the said intent need to be synchronised.

Nirav Shah

Protocol to India-UK Tax Treaty – Impact Analysis

Introduction

During the calendar year 2012, the Indian Government put a lot of focus on improving bilateral relationships with countries across the globe. In this regard, it entered into some new Double Tax Avoidance Agreements (‘Tax Treaty’) by extending its treaty network and entered into Protocols with countries with whom it already had Tax Treaties. Last in this list (but a significant one) is the Protocol entered into with the UK. This Protocol due to Articles on Exchange of Information and Collection of Taxes dealing with procedural aspects, apart from some changes in the aspects of taxation as well is important. In this article, we have tried to broadly capture impact of the Protocol on tax payers from both the countries.

Treaty Benefits to UK Partnerships:

The India-UK Tax Treaty (prior to insertion of the Protocol) specifically excluded ‘partnership’ from the definition of ‘person’ under Article 3(1) (f). However, an Indian partnership, which is a taxable unit under the Indian Income-tax Act, 1961 (‘the Act’), was considered as ‘person’ as per Article 3(2).

Under the UK domestic law, a UK partnership is not treated as an entity separate and distinct from the partners. Hence, the UK partnership is considered as tax transparent or a pass-through entity, and the income of the partnership is directly taxed in the hands of the partners based on their residential status and their share in the partnership income.

Due to the tax transparent status of the partnership in the UK, a UK partnership was specifically excluded from the definition of ‘person’ under Article 3(1)(f) of the India-UK Tax Treaty. The effect of such specific exclusion suggested that in case a UK partnership earns income from India, it was not eligible to have access to the India-UK Tax Treaty, even though such income was taxed in the UK (in the hands of its partners).

In this regard, contrary to the literal interpretation, Mumbai Income-tax Appellate Tribunal (‘Tribunal’) in the case of Linklaters LLP vs. ITO (132 TTJ 20) extended the benefits under the India-UK Tax Treaty to a UK Limited Liability Partnership (‘LLP’). The Hon’ble Tribunal observed that where a partnership is taxable in respect of its profits, not in its own right but in the hands of partners, as long as the entire income of the partnership firm is taxed in the country of residence (i.e. UK), treaty benefits could not be denied. The Article 3(1)(f) of India-UK Tax Treaty clearly excluded a UK partnership from the definition of ‘person’, and hence, the Tribunal had to analyse this aspect in greater detail. By applying legal analogy based on past judicial precedents, it granted the Treaty benefit to a UK LLP. Thus, this aspect was highly debatable and involved an extensive legal analysis of interpretation of the international tax framework.

Similarly, the Mumbai Tribunal in the case of Clifford Chance vs. DCIT (82 ITD 106) [which was subsequently affirmed by the Bombay High Court (318 ITR 237)] also granted benefits of the India-UK Tax Treaty to a UK partnership firm comprising lawyers. However, a detailed evaluation of the eligibility of the UK partnership claiming benefits under the India- UK Tax Treaty was not done in the said decision.

This controversy has now been put to rest by the Protocol, which has proposed to amend the definition of ‘person’ under the India-UK Tax Treaty by deleting the specific exclusion of partnership from the definition.

Further, an amendment is also proposed in Article 4(1), which defines the term ‘resident of a Contracting State’, to provide that, in case of a partnership, only so much of income as derived by such partnership, which is subject to tax in a Contracting State as the income of the resident of such Contracting State either in its hands or in the hands of its partners, would be eligible for claiming benefits under the India-UK Tax Treaty. Hence, in the case of a UK partnership earning income from India, only so much of income which is subject to tax in the UK as the income of the UK resident partner would be eligible for India-UK Tax Treaty benefits.

It is interesting to note that similar to the UK, US partnerships are also treated as tax transparent entities under the US domestic tax law, and their income is taxed in the hands of partners directly. The definition of the term ‘resident of a Contracting State’ is pari-materia to the India-USA Tax Treaty. In this context, it would be noteworthy to refer to the definition of the term ‘person’ provided under Article 4(1)(b) of the India-USA Tax Treaty and the Technical Explanation thereof issued by the Treasury Department, which acts as guidance for the interpretation of the terms referred in the India-USA Tax Treaty. The Technical Explanation clarifies that to the extent the partners of a US partnership are subject to tax in US as US residents, the income received by such US partnership will be eligible for India-USA Tax Treaty benefit. Hence, the eligibility of a US partnership to access the India- USA Tax Treaty depends upon the residential status of the partners in such partnership.

Considering the Technical Explanation to the India- USA Tax Treaty and the wordings of the proposed amendment to the definition of ‘resident of Contracting State’ under the India-UK Tax Treaty, an analogy may be drawn that a UK partnership may not be granted benefits under the India-UK Tax Treaty in respect of income that belongs to a person who is not a tax resident of the UK. In other words, if, a UK partnership firm has a Canadian individual as a partner who is not a tax resident of UK (as his income is not taxable in the UK on account of his residence or similar criteria) then, the income earned by the UK partnership (from India), to the extent of such Canadian partner’s share would not be eligible for the India-UK Tax Treaty benefit.

It is pertinent to note that the Technical Explanation issued with reference to the India-USA Tax Treaty though, not binding while interpretating of the terms under India-UK Tax Treaty, it would be of relevance since, the Indian Government had agreed to such interpretation in the past while signing the Technical Explanation to the India-USA Tax Treaty. Hence, it will have a persuasive value on the application of India-UK Tax Treaty as well.

In light of the above, once the Protocol to India-UK Tax Treaty comes into force, an Indian entity will have to consider the tax residence of the partners of the UK partnership at the withholding stage, while granting Treaty benefits to the UK partnership. In this context, attention is invited to the recently introduced section 90(4) of the Act, which requires a non-resident claiming Treaty benefits in India to obtain a certificate containing prescribed particulars (i.e. Tax Residency Certificate or TRC) from the Government of the home country. It would be interesting to observe how a TRC would be issued by the UK Government to a UK partnership earning income from India (specifically, where one of the partners therein is a non-resident).

Treaty benefits to Trusts and Other Entities

Under the current India-UK Tax Treaty, a ‘trust’ or an ‘estate’ may qualify as a ‘person’ under Article 3(1) (f) of India-UK Tax Treaty, only if they are treated as a separate taxable unit under the taxation laws in force of the concerned country. Hence, in a scenario, where a UK trust is treated as a pass-through entity (and not a separate taxable unit) for taxation purposes in the UK and its income is taxable in the hands of its beneficiaries, then the income derived by such a trust from India may not be eligible for the India-UK Tax Treaty benefits.

The Protocol has proposed to amend the definition of the ‘resident of the Contracting State’ in Article 4(1) to provide that in case of an income derived by a ‘trust’ or an ‘estate’, if such income is subject to tax in tge resident country in the hands of its beneficiaries as tax resident of that country, then to that extent it would be eligible for benefits under the India-UK Tax Treaty. Hence, even if the UK trust is not treated as a separate taxable unit under the UK domestic tax laws, if certain portion of the income of the UK trust is taxable in the UK in the hands of beneficiaries who are residents of the UK, then to that extent, income of the UK trust would be eligible for benefits under the India-UK Tax Treaty.

Tax Withholding on Dividend:

One of the much discussed benefits proposed to be granted under the Protocol is the reduced rate of tax withholding on payment of dividend by replacing the existing Article 11 of the India UK Tax Treaty. The Protocol has provided for revised withholding tax rate as follows –

a. 15% of the gross amount of dividends where such dividend is paid out of income derived directly or indirectly from immovable property by an investment vehicle which distributes most of its income annually and whose income from such immovable property is exempted from tax;

b. 10% of gross amount of dividends in all other cases.

Dividend by Investment Vehicle Earning Income from Immovable Property
The new Article 11(2)(a) proposed to be introduced by the Protocol provides 15% withholding rate on declaration of dividend by an investment vehicle earning income from immovable property where such income is exempt in its hands. It seems to cover investment vehicle like Real-Estate Investment Trusts (REITs) registered in India, even though the income earned by such REITs are not currently exempted in India. Hence, it does not seem to have any significant impact from the Indian perspective. However, an investment vehicle in the UK (like UK REITs) earning income from immovable property, which is exempt in its hands in UK, may fall within the ambit of this provision.

Dividend in Other Cases
The Protocol proposes to amend the withholding tax on dividend (other than the dividends covered above) to 10% vide Article 11(2)(b) in line with the withholding tax rate applicable for other OECD countries.

This amendment does not appear to bring any impact on the investors from either country (except in certain cases)n due to the current tax regime under the domestic tax laws of India and the UK.

UK Shareholder Earning Dividend from Indian Company
Under the Income-tax Act, 1961, an Indian company declaring dividend has to pay Dividend Distribution Tax (DDT) . Such dividend is tax exempt in India in the hands of resident as well as non-resident share-holder and there is no withholding tax. Hence, under the current domestic tax law, the reduction in with-holding tax rate will not have any impact, though it would be critical if in the future, the DDT regime is withdrawn from the domestic tax law in India.

Interestingly, the Protocol does not throw any light on tax credit to UK shareholder in the UK with respect to DDT suffered on distribution of dividend by an Indian company. It has been over a decade now since the concept of DDT has been in place under the Income-tax Act. Issue of credit for the DDT paid in India in the hands of foreign investor in their home country is unclear and has been a matter of debate. In the past, while entering into a Protocol with Hungary, some clarity has been provided to this effect.

It is pertinent to note that the UK domestic tax law provides for the underlying tax credit for taxes paid on income earned in overseas country (i.e. corporate tax). Hence, the UK shareholder earning dividend from an Indian company would be entitled to tax credit for corporate tax paid by the Indian company on its profits from which dividends are distributed. Hence, uncertainty on the tax credit for DDT practically does not have a serious bearing.

Indian Shareholder Earning Dividend from a UK Company
Under the current UK domestic tax laws; in most of the cases, there is no tax withholding on distribution of dividend by a UK Company (subject to satisfaction of certain conditions).

In a scenario, where the Indian shareholder does not satisfy any of the prescribed conditions and is unable to claim exemption under the UK domestic tax laws, he suffers tax withholding in the UK. Only in such case, the UK company will have to withhold tax on distribution of dividend to Indian shareholder. Currently, the tax withholding rate on dividend as per the India-UK Tax Treaty is 15% which is proposed to be reduced to 10% by the Protocol.

Article on Limitation of Benefits (LOB):

UK government as well as the Indian government intend to introduce General Anti-Avoidance Rules (GAAR) under their respective domestic tax laws. UK is intending to implement the same from the next fiscal year and the Indian gvernment has recently deferred the implementation of GAAR by two years and is proposed to be introduced with effect from 1st April, 2016. Pending this, GAAR provisions have been introduced under the Protocol. Article 28C on LOB clause proposes to deny the Treaty benefits with respect to a transaction if the main purpose or one of the main purposes of the transaction was to obtain benefits under the India-UK Tax Treaty. Further, it is also provided, that the treaty benefits may also be denied if the main purpose or one of the main purpose of creation or existence of any entity in either of the country was to obtain benefits under the India-UK Tax Treaty.

This type of LOB clause is also inserted in many recently concluded Indian Tax Treaties, for example, treaties with Georgia, Uzbekistan, Nepal, Iceland, Finland, etc. The effect of the LOB clause can be far-reaching and its implementation would depend largely upon the implementation of GAAR provisions by both the countries in their domestic tax laws.

Exchange of Information and Assistance in Collection of Taxes:

The Protocol also proposes to introduce certain other measures to curb tax evasion practices by introducing Article 28 on Exchange of Information, Article 28A on Tax Examinations Abroad and Article 28B on Assistance in Collection of Taxes in the India-UK Tax Treaty.

As one of the purposes of double tax avoidance agreements is to enable and facilitate the exchange of information between the tax authorities, Article 28 on Exchange of Information gives a statutory recognition to the formal process of information exchange between the competent authorities. The information that can be exchanged under this Article is that which enables the carrying out the provisions of the Treaty or enforcement of domestic law of the Contracting States effectively. However, inspite of exchange of information, under the principle of procedural autonomy, collection of taxes by one Contracting State from the residents of the other Contracting state remains a difficult task. Thus, to overcome this, Protocol proposes to introduce Article 28B on Assistance in Collection of Taxes in the Treaty for smoothing the process of recovery of taxes. This Article is also found in tax treaties entered into by India with countries like Norway, Denmark, Sweden, Ukraine, South Africa, etc.

Entry into force:

The provisions of this Protocol will take effect only when both the governments complete the necessary implementing measures by notification to this effect.

Conclusion:

The clarity on allowability of Treaty benefits to the UK partnerships and other tax transparent entities (like trust, estates, etc.) is a welcome step; though the Indian Judicial Authorities have evaluated this aspect in the past. The reduced withholding rate on dividend seems to suggest very limited applicability. However, the implementation of LOB clause with respect to invocation of GAAR may have a far reaching impact and guidelines under the domestic tax laws on this aspect would bring in more clarity.

The procedural amendments like Article on exchange of information and assistance in collection of taxes would help to bring more transparency for the Governments of both the countries.

Nirav Shah

Taxability of Payments for Online Advertisement Charges

Introduction
E-Commerce has changed the dynamics of doing business. Online advertising is gaining ground against the traditional print media advertising. Fixation of tax liability was easier in case of print media as compared to the online advertising, with virtual presence of the advertising companies on the internet. It is not easy to determine the place of accrual of income in the e-commerce scenario. Trade on the internet, many a time, is fully automated i.e. software driven, for e.g. advertisements are posted, monitored, displayed without human intervention. Even sale of goods, its delivery (e.g. downloading of software, book or a song) and receipt of payment are fully automated. Determination of income becomes complex with location of server, website, advertiser, search engine, internet service provider, buyer, seller and/or advertising company being located in different tax jurisdictions.

Basic Understanding of Online Transactions
Taxability of income would depend upon the place of accrual or source of income. In order to understand the concept of accrual or source of income, let us dissect various parts of a business transaction. Any transaction of services or sale can be dissected as follows:

i) Marketing
ii) Order Placement
iii) Execution of Service/Manufacturing
iv) Delivery
v) Payment

Whether location of all the above aspects of business has any bearing on the source or accrual of income?

Let us understand this with the help of an illustration :

ABC Ltd. of India avails services of XYZ Inc. of USA for a Study Report in Transfer Pricing

Analysing this transaction, one would find that the mode of completion of various legs of this transaction is electronic but that per se cannot make this transaction as E-commerce. It appears that there is a human intervention in rendering/execution/delivery of services by XYZ Inc. However, with a slight variation in the above model i.e. instead of XYZ Inc., if services are rendered by the internet portal of XYZ Inc. on an automated basis, then the entire transaction would become an e-commerce transac-tion and then, the determination of source or place of accrual of income would become complex.

Again, the taxability of income in India, in the hands of the service provider (SP), would depend upon the characterisation of such income i.e. whether it is in the nature of business income or royalty or fees for technical services (FTS).

Indian Revenue Authorities hold the view that as long as the service recipient is in India the source of income for the service provider is in India regardless of the place or mode of rendering service or location of the service provider. This view was incorporated by way of amendment to section 9(1) of the Income tax Act, 1961 (the “Act”) to provide that for determining the place of accrual or arising of the income by way of royalty or FTS, the existence or otherwise of the place of business, residence or business connection of a non-resident is of no consequence whatever. Further, it provided that for the purpose of taxability of royalty and FTS, it is not necessary for the non-resident to render services in India.

However, Business Income stands on a different footing. Even though the source of income is in India, Section 9(1) of the Act, plus and the provisions of tax treaties provide that income of a service provider is taxed in the “Source State” only if the source link is powerful enough to establish “Business Connection” (BC): under the Act or “Per-manent Establishment” (PE) under a Tax Treaty.

The above discussion is based on the premise that income in the hands of service provider is neither received nor deemed to have been received in India and therefore, section 5(2)(a) of the Act has no applicability.

Even section 5(2)(b) fastens the tax liability in the hands of the SP if the income accrues or arises in India or deemed to accrue or arise in India under section 9 of the Act (as discussed above).

The term “income accruing or arising in India” as provided u/s 5(2)(b) of the Act is not defined in the Act. However, the Supreme Court, in the case of Hyundai Heavy Industries Ltd. (2007-TII-02-SC-INTL) inter alia observed as follows:

“……as far as the income accruing or arising in India, an income which accrues or arises to a foreign enterprise in India can be only such portion of income accruing or arising to such a foreign enterprise as is attributable to its business carried out in India. This business could be carried out through its branch(es) or through some other form of its presence in India such as office, project site, factory, sales outlet etc. (hereinafter called as “PE of foreign enterprise”) ……..”

Interestingly, the term PE is restrictively defined in the Act and that is in the context of transfer pric-ing and section 44DA of the Act (special provisions for taxation of royalty and FTS which are effectively connected with PE), otherwise it has its origin in the tax treaties. Definition of a PE u/s 92F (iiia) of the Act is an inclusive one, according to which, PE includes a fixed place of business through which the business of the enterprise is wholly or partly carried on. Basically, it refers to “fixed place PE” and not to other variants of PE such as “Project PE”, “Dependent Agent PE”, “Service PE” etc. as defined in a treaty . However, the Supreme Court’s observation as mentioned above [which is regarded as “judge made law” and followed in the case of ITO vs. Right Florists Pvt. Ltd. 2013-TII-61-ITAT-KOL-INTL] explains PE on the lines of a treaty definition.

One thing is clear from the provisions of section 9 and interpretation of section 5(2)(b) of the Act by the Apex Court – that in either case of a PE or BC, only so much of income would be taxed in India as is attributable to such a PE or BC in India.

Thus, taxability in India of online services can be summarised as follow:

Therefore, characterisation of income in the hands of a service provider assumes great significance.

Characterisation of income in the hands of a service provider – Royalty/FTS vs. Business Income

There are various kinds of online transactions. However, for the sake of simplicity and understanding the principles involved, let us restrict our discussion to the most frequent transaction of “online advertisement” through popular search engines, say, “Yahoo” and “Google”. However, the concepts discussed herein would be applicable to other forms of online business transactions as well.

Payment for online advertisement – Is it Royalty in the hands of the Service Provider?

Royalty and FTS are Business Income essentially. The distinction is carved out only for the purposes of taxation in the hands of the non-residents. If the income is characterised as royalty or FTS, it is taxed on gross basis unless such income is effectively connected with a PE situated in India.

Where such income is not characterised as Royalty/ FTS, it is treated as business income and is taxed in the source state (say, India) only if the foreign enterprise has a PE/BC in India. Such taxability of the business income in the source state is always on net basis i.e. net profits computed as per domestic tax laws of the source state.

Section 9(1)(vi) of the Act deals with royalty income whereas section 9(1)(vii) thereof deals with FTS. In fact, every payment must be examined from the point of view of royalty/FTS under an applicable tax treaty and also under the provisions of the domestic tax laws of the source state (India) such that the taxpayer can opt for the most beneficial provisions out of these.

Let us first examine whether payment for online advertisement can be termed as royalty income in the hands of the service provider?

The definition of royalty under section 9(1)(vi) of the Act is quite exhaustive and inter alia includes payment for computer software and the use or right to use any industrial, commercial or scientific equipment. Thus, the question arises for consideration is whether payment for online advertisement/ services can be construed as payment for the use or right to use industrial, commercial or scientific equipment or for computer software?

The payment for online advertisement/services is certainly not for buying or using computer software. Though computer software is used for delivering the services of hosting advertisement or for online selling of services/product, the payment is for ser-vices and not for the underlying computer software. Similarly, one must ask a question as to whether one is paying for the “use” of equipment or for the “services” which are provided by the “service provider” by using equipment in its possession. For example, payment for online advertisement may involve renting an earmarked space by the service provider on the website and server owned by it (i.e. equipment at its disposal and control), but one is paying for the display and advertisement and not for rent of server. The same may well be the case in respect of print media, e.g. when one advertises in a newspaper, one pays for the services of a published advertisement and not for the equipment used by the newspaper for its production.

As far as use of equipment is concerned, the issue was aptly dealt with by the Mumbai Tribunal in the recent decision of Pinstorm Technologies [54 SOT 78] / TS-536-ITAT-2012(Mum). In this case, an Indian company, which is engaged in the business of digital advertising and internet marketing, utilised the internet search engines such as Google, Yahoo etc. to buy banner advertising space on the inter-net on behalf of its clients. The Assessing Officer held that the payment was in the nature of FTS whereas the CIT(A) held that it was in the nature of royalty as Google or Yahoo etc. would allot the space to the appellant company and its clients in their server and that whenever any internet user search for certain web sites, the appellant’s or its client’s name would appear and its contents be displayed on the computer screen.

However, the ITAT observed that the search engine renders this service outside India through internet. Google does such online advertising business in Asia from its office in Ireland. The search engine service is on a worldwide basis and thus is not relatable to any specific country. The entire transaction takes place through the internet and even the invoice is raised and payment is made through internet. The ITAT relying on the decision in case of Yahoo India [140 TTJ 195] / TS-290-ITAT-2011(Mum), held that the amount paid by the assessee to Google Ireland Ltd. for the services rendered for uploading and display of banner advertisement on its portal was in the nature of business profit on which no tax was deductible at source, as the same was not chargeable to tax in India in the absence of any PE of Google Ireland Ltd. in India.

In the case of Yahoo India (supra) the assessee made payment to Yahoo Holdings (Hong Kong) Ltd. [Yahoo Hong Kong] for services rendered for uploading and display of the banner advertisement of the Department of Tourism of India on its portal. The banner advertisement hosting services did not involve use or right to use by the assessee (i.e. Yahoo India) of any industrial, commercial or scientific equipment and no such use was actually granted by Yahoo Hong Kong to the Yahoo India. Uploading and display of banner advertisement on its portal was entirely the responsibility of Yahoo Hong Kong and the Yahoo India was only required to provide the banner advertisement to Yahoo Hong Kong for uploading the same on its portal. Yahoo India thus had no right to access the portal of Yahoo Hong Kong Having regard to all these facts of the case and keeping in view the decision of the Authority of Advance Rulings in the case of ISRO Satellite Centre 307 ITR 59 and Dell International Services (India) P. Ltd. 305 ITR 37, it was held that the payment made by the assessee to Yahoo Hong Kong Ltd. for the services rendered for uploading and display of the banner advertisement of the Department of Tourism of India on its portal was not in the nature of royalty was business profit and in the absence of any PE of Yahoo Hong Kong in India, it was not chargeable to tax in India.

In the case of Dell International Services (India) P. Ltd., it was held by the AAR that the word “use” in relation to equipment occurring in clause (iva) of Explanation to section 9(1)(vi) of the Act is not to be understood in the broad sense of availing of the benefit of an equipment. The context and collocation of the two expressions “use” and “right to use” followed by the word “equipment” indicated that there must be some positive act of utilisation, application or employment of equipment for the desired purpose.

If an advantage was taken from sophisticated equipment installed and provided by another, it could not be said that the recipient/customer “used” the equipment as such. The customer merely made use of the facility, though he did not himself use the equipment. What was contemplated by the word “use” in clause (iva) of Explanation 2 to section 9(1)(vi) of the Act was that the customer came face to face with the equipment, operated it or controlled its functions in some manner. But if it did nothing to or with the equipment and did not exercise any possessory rights in relation thereto, it only made use of the facility created by the service provider who was the owner of the entire network and related equipment. There was no scope to invoke clause (iva) in such a case because the element of service predominated. The predominant features and underlying object of the agreement unerringly emphasised the concept of service. That even where an earmarked circuit was provided for offering the facility, unless there was material to establish that the circuit/equipment could be accessed and put to use by the customer by means of positive acts, it did not fall within the category of “royalty” in clause (iva) of Explanation 2 to section 9(1)(vi) of the Act.

Characterisation under a Treaty Scenario

The definition of royalty is narrower in scope in a tax treaty than under the Act (e.g. Computer Software is not explicitly covered under a tax treaty), therefore the above discussion would hold good even under a treaty scenario and the payment in question would not be regarded as royalty in the hands of the Service Provider.

Payment for online advertisement – Is it FTS in the hands of the Service Provider?

Explanation 2 to section 9(1)(vii) of the Act defines FTS to mean “any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head “Salaries”.

There is no doubt that providing a sponsored search facility, as also placing a banner advertisement on another person’s website would amount rendering of services to the advertiser. There is also no doubt that these services are technical in nature. However, the question here is whether these online advertising services could be covered by the connotation of ‘technical services’ as defined in Explanation 2 to section 9(1)(vii) of the Act?

The Kolkata Tribunal in the case of Right Florists (supra) observed that “it is significant that the expression ‘technical’ appears along with expression ‘managerial’ and ‘consultancy’ and all the three words refer to various types of services, consid-eration for which is included in the scope of FTS. The lowest common factor in ‘managerial, technical and consultancy services’ seems to be the “human intervention”. A managerial or consultancy service can only be rendered with human interface, while technical service can be rendered with or without human interface. The Tribunal further observed that as long as there is no human intervention in a technical service, it cannot be treated as a technical service under section 9(1)(vii) of the Act. The Tribunal, in reaching this conclusion relied on the decision of the Delhi High Court, in the case of “CIT vs. Bharati Cellular Limited (319 ITR 139) [2008-TIOL-557-HC-DEL-IT) wherein it was held that “the word technical is preceded by the word managerial and succeeded by the word consultancy. Since the expression technical services is in doubt and is unclear, the rule of noscitur a sociis is clearly applicable”. [The Rule noscitur a sociis states that when two or more words which are susceptible of analogous meaning are coupled together they are to be understood in their cognate sense. They take their colour from each other, the meaning of the more general being restricted to a sense analogous to that of the less general].

Applying the above principle, the Kolkata Tribunal held that there is no human touch involved in the whole process of actual advertising service provided by Google and therefore receipts for online advertisements by the Google cannot be treated as FTS under the Act.

Characterisation under a Treaty Scenario

Google is a tax resident of Ireland. Definition of the FTS under Article 12(2)(b) of the India-Ireland tax treaty is materially similar to the definition under the Income tax Act and therefore the legal position discussed hereinabove would be equally applicable in the case of India Ireland tax treaty. In some treaties, the scope of FTS is further reduced by provision of the concept called ‘make available’ (e.g. India’s tax treaties with USA, UK, Singapore etc.). Payment to Yahoo USA would be governed by the India-US tax treaty which provides for “make available” concept in the Article on Fees for Included Services. The term “make available” was examined by, inter alia, by the Mumbai Tribunal in the case of Raymond Ltd. vs. DCIT (86 ITD 793) [2003-TII-05-ITAT-MUM-INTL] wherein it observed that “Thus, the normal, plain and grammatical meaning of the language employed, in our understanding, is that a mere rendering of services is not roped in unless the person utilising the services is able to make use of technical knowledge, etc. by himself in his business and or for his own benefit and without recourse to the performer of services.” The Tribunal also held that rendering of technical services cannot be equated with “making available” the technical services.

Thus, it can be concluded that receipt for online advertisement is neither royalty nor FTS in the hands of the service provider. Therefore, it would be considered as business income.

Business Income vis-a-vis BC and PE

As stated earlier, business income of the owners of the search engines like Yahoo or Google is taxable in India provided it has a BC or a PE in India. The concept of BC was very well explained in the CBDT Circular 23 dated 23rd July 1969. It clarified that the expression ‘Business Connection’ admits of no precise definition. ‘The question whether a non-resident has a business connection in India from or through which income, profits or gains can be said to accrue or arise to him within the meaning of Section 9 of the Income-tax Act, 1961 has to be determined on the facts of each case.’ Then the circular went on to illustrate what would constitute BC and what would not. However, the said circular was withdrawn in 2009.

The Supreme Court had an occasion to define BC in the case of CIT vs. R. D. Agarwal and Co. (1965) 56 ITR 20; wherein it held that “Business Connection” means something more than business. It presupposes an element of continuity between the business of the Non-Resident and his activity in the taxable territory, rather than a stray or an isolated transaction”.

The concept of PE was formulated in the twentieth Century prior to the advent of computers. Therefore, the rules for determination of source links through PE do not hold good in today’s virtual world of e-commerce. The need for physical presence in case of e-commerce transactions in the source State (the chief determining criterion for existence of a PE) is totally obviated. Search engines like Google or Yahoo operate through their respective websites which in turn are hosted on a server. So the question arises as to what constitutes a PE, a Website or a Server?

“Website” – Is it a PE?

The OECD commentary on its Model Convention states that “website per se, which is a combination of software and electronic data, does not in itself constitute a tangible property. It, therefore, does not have a location that can constitute “place of business” as there is no “facility such as premises or, in certain instances, machinery or equipment” as far as software and data constituting that website is concerned”.

Therefore website per se cannot constitute a PE. Thus, the traditional tests for determination of PE fail in a virtual world of E-commerce. In order to study the tax impact of e-commerce, CBDT had appointed a High Powered Committee (HPC) in the year 1999. The HPC also observed that applying the existing principles and rules to e-commerce does not ensure certainty of tax burden and maintenance of the equilibrium in the sharing of tax revenues between countries of residence and source. “The Committee, therefore, supports the view that the concept of PE should be abandoned and a serious attempt should be made within OECD or the UN to find an alternative to the concept of PE”.

Interestingly, India has expressed its reservations on the OECD Model Commentary and has taken a stand that website may constitute a PE in certain circumstances. India expressed a view that depend-ing on the facts, an enterprise can be considered to have acquired a place of business by virtue of hosting its website on a particular server at a particular location.

However, the Kolkata Tribunal in the case of Right Florists (supra) held that the reservations of the Indian Government do not specify the circumstances in which, according to tax administration, a website could constitute a PE. Therefore, in the opinion of the Tribunal, the reservations so expressed by India as of now, cannot have any practical impact on a website being treated as a PE.

The Kolkata Tribunal in the case of Right Florists (supra) concluded that “a website per se, which is the only form of Google’s presence in India – so far as test of primary meaning i.e. basic rule PE is concerned, cannot be a permanent establishment under the domestic law. We are in considered agreement with the views of the HPC on this issue.”

“Server” Is it a PE?

The server on which the website is hosted and through which it is accessed is a piece of equipment having a physical location and such location may constitute a “fixed place of business” of the enterprise that operates that server. However, if the enterprise uses the services of an Internet Service Provider (ISP) for hosting website, then the location of such server may not constitute PE for such enterprise, if the ISP is an independent contractor and acting in its ordinary course of business. In such an event even if the enterprise is able to dictate that its website may be hosted on a particular server at a particular location, it will not be in possession or control of that server and therefore, such server will not result into PE. However, if the enterprise carrying on business through a website has the server at its own disposal, e.g., it owns (or leases) and operates the server on which the website is stored and used, the place where that server is located could constitute a PE of the enterprise if the other requirements of the PE Article are met, e.g. location of server at a certain place for a sufficient period of time so as to fulfill the fixed place criterion as envisaged in paragraph 1 of Article 5 of a tax treaty.

Even when server is found to be “fixed”, and results in a PE, it may not result in any tax taxability for the enterprise, if the activities of that enterprise are not carried on through that server or activities so carried on are restricted to the preparatory or auxiliary nature such as (i) provid-ing a communication link, (ii) advertising of goods and services, (iii) relaying information through a mirror server for security and efficiency purposes,

(iv) gathering marketing data and/or (v) supplying information etc.

Based on the above analysis, it can be concluded that search engines, which have their presence through their respective websites cannot constitute PE in India, unless their servers are located in India.

Based on the above discussions, the Kolkata Tribunal in the case of Right Florists (supra) held that “the receipts in respect of online advertising on Google and Yahoo cannot be brought to tax in India under the provisions of the Income tax Act as also under the provisions of India-US and India-Ireland tax treaty”.

Withholding tax obligation

A question often arises as to whether the payer needs to deduct tax at source if the income arising from such payment is not taxable in the hands of the recipient. The question became more serious with the decision of the Karnataka High Court in the case of CIT vs. Samsung Electronics Co. Ltd. [2010] 320 ITR 209 wherein it was held that the resident payer is obliged to deduct tax at source in respect of any type of payment to a non resident, be it on account of buying/purchasing/acquiring a pack-aged software product and as such, a commercial transaction or even in the nature of a royalty payment. Also the decision of the Supreme Court in case of Transmission Corporation of A. P. Ltd. vs. CIT (infra) was interpreted in a manner that payer has to deduct tax at source whether the income is chargeable to tax in India or not.

However, the Kolkata Tribunal in the case of Right Florists (supra) relying on the Supreme Court’s decision in the case of GE India Technology Centre P. Ltd. held that “when recipient of an income does not have the primary tax liability in respect of an income, the payer cannot have vicarious tax withholding liability either.”

All controversies arising out of interpretation of section 195 regarding non-deduction of tax at source, where the income is not taxable in the hands of the recipient, were laid to rest with the decision of the Supreme Court in case of GE India Technology Centre P. Ltd. vs. CIT [2010] 327 ITR 456 wherein the Apex Court following Vijay Ship Breaking Corporation vs. CIT [2009] 314 ITR 309 (SC) held that “The payer is bound to deduct tax at source only if the tax is assessable in India. If tax is not so assessable, there is no question of tax at source being deducted.”

The decision of GE India Technology Centre P. Ltd. (supra) assumes special significance as it explained the decision of the Supreme Court in case of Transmission Corporation of A. P. Ltd. vs. CIT [1999] 239 ITR 587 (SC) in the proper perspective. The said decision is often invoked by the Income-tax Department to fasten TDS obligation on the payer on a gross basis even when the income is not chargeable to tax in the hands of the recipient thereof. The Apex Court stated that in case of decision of the Transmission Corporation (supra), the issue was of deciding on what amount of tax is to be deducted at source, as the payment was in respect of a composite contract. 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.

With the above mentioned correct interpretation of the decision in case of Transmission Corporation (supra), the Supreme Court set aside the decision of the Karnataka High Court in case of CIT vs. Samsung Electronics Co. Ltd. (supra).

Thus, the payer is not obliged to deduct tax at source if the recipient is not chargeable to tax on such income. Secondly, no disallowance can be made u/s. 40(a)(i) on account of non-deduction of tax at source by the payer where the income per se is not taxable in India.

Summation:

Determination of tax liability in an e- commerce scenario is a difficult task as the age old methods of determination of PE/BC do not hold good in the modern ways of doing business. Though existence of a BC or PE has to be case specific, broadly we can conclude that website per se does not constitute either a PE or a BC and the location of server is a determinative criterion for PE. This conclusion is only in relation to fixed place PE, whereas PE/BC may exist in the form of Dependent Agent or otherwise.

As far the withholding tax liability of the payer is concerned, one needs to look at the entire transaction from the recipient’s perspective. As long as the income from such online payment is not taxable in the hands of the non-resident service provider, the payer is not obliged to deduct tax at source. For determining the taxability in the hands of the SP, the characterisation of income is of utmost importance as income in the nature of royalty and FTS can be taxed without any PE or BC in India whereas, business income per se, is not taxable in India unless the SP has a BC/ PE in India.

Even though the taxability and characterisation of income is explained in this article by taking an example of online advertisement through search engines like Google and Yahoo, the underlying principles could help in determination of the taxability of other online transactions such as subscription of online data bases, purchase of videos, books etc.

We do hope that on the lines of recommendations of the HPC, OECD and UN may come out with alternative methods for taxing e-commerce transactions. However, we are fortunate that in absence of clarity, we have Supreme Court decisions – judge made laws, to guide us.

Nirav Shah

TS-187-ITAT-2013(Del) Convergys Customer Management Group Inc. vs. ADIT A.Ys: 2006-07 & 2008-09, Dated: 10.05.2013

India-US DTAA – Frequent visits of employees of FCo to premises of Indian subsidiary (IndCo), their having a “fixed place” at their disposal and their occupying key positions in IndCo constituted PE of FCo in India, which was practically the projection of FCo’s business in India. On facts, profit to be attributed to Indian PE was to be calculated based on formulary apportionment.

Facts:
Convergys Customer Management Group Inc (FCo) provides information technology (IT) enabled customer management services by utilising its advanced information system capabilities, human resource management skills and industry experience. FCo has a subsidiary in India, IndCo, which provides IT-enabled call centre/back office support services to FCo on a principal-to-principal basis.
FCo claimed that it procured from ICo services on a principal-to-principal basis and FCo’s business was not carried out in India. Furthermore, substantial risks of business such as market, price, R&D, service liability risks etc., vested with FCo outside India. Additionally, there was no tax liability as procurement of services was akin to purchasing goods/merchandise and, accordingly, the benefit of the PE exclusion for purchase/preparatory or auxiliary function should also be available.
The Tax Authority alleged that FCo, in its activities in India through its employees and subsidiary, satisfied the requirement of a fixed place, services and also a Dependant Agent PE (DAPE) in India. For the purposes of attributing profits, the Tax Authority recomputed the taxable income by allocating global revenue in proportion to the number of employees. On appeal, CIT(A) agreed with the Tax Authority that a fixed place PE was constituted. On attribution of profits, the CIT(A) however held that no further profits can be attributed to FCo’s PE as the transfer pricing (TP) study of IndCo supported that ICo was remunerated at ALP.
Both FCo and the Tax Authority appealed before the Tribunal.

Held:
On existence of a PE

Considering the entirety of facts, the view of CIT(A) on fixed place PE was upheld for the following reasons:
FCo’s employees frequently visited the premises of IndCo to provide supervision, direction and control over the business operations of IndCo. Accordingly, such employees had a “fixed place” at their disposal. IndCo was practically the projection of FCo’s business in India and IndCo carried out its business under the control and guidance of FCo, without assuming any significant risk in relation to such functions. FCo has also provided certain assets/software on “free of cost” basis to IndCo.

On attribution of profits
An overall attribution of profits to the PE is a TP issue and no further profits can be attributed once an arm’s length price has been determined for IndCo, as TP analysis subsumes the risk profile of the alleged PE. Thus, there can however be further attribution if it is found that PE has risk profile which is not captured in IndCo TP analysis.

The correct approach thereafter to arrive at the profits attributable to the PE is to compute global operating income percentage of a particular line of business as per annual report of FCo and applying such percentage to the end customer revenue with regard to contracts/projects, where services are procured from IndCo. The amount arrived at is the operating income from Indian operations and such operating income is to be reduced by the profit before tax of IndCo. This residual profit which represents income of FCo is to be apportioned to the US and India. Profit attributable to the PE should be estimated on residual profits.

levitra

Nirav Shah

“Other Income” – Article 21- Whether Items of Income Not Taxable Under Other Articles (6 to 20) of a Tax Treaty would be Assessable Under “Other Income” Article?

1. Background

1.1 Quite often, an item of income may not be taxed under Articles 6 to 20 of a Tax Treaty due to application of distributive rules agreed between the two Contracting States. For example, an item of income may not be taxable as “Business Profits” under Article 7 or as “Shipping or Aircraft Profits” under Article 8 or as “Fees for Technical Services” (FTS) under Article 12 of a Tax treaty either because the income does not satisfy the definition of FTS as contained in that Treaty or it does not satisfy other conditionalities stipulated in Article 12 e.g., it may not meet the test of “make available concept” embedded in a particular treaty. The item of income may also not be taxable due to various exclusions/exemptions contained in the respective Articles. Similarly, an item of Business Income may not be taxable in the Source Country (say, India) under Article 7 of the applicable Tax treaty, as the Non-Resident (NR) Assessee does not have a Permanent Establishment (PE) in India as defined in Article 5 of the Tax Treaty. In such cases, a question arises whether such an item of income would be assessable to tax as “Other Income” under Article 21 (or the corresponding Article of the applicable Tax Treaty.)

1.2 In such cases, the Tax Department argues that even if the income of a NR is not taxable in India under Article 7 as business profits or under Article 12 as fees for technical services, such income is still taxable in India as ‘Other Income’ under Article 21.

1.3 The Department’s interpretation of the scope of Article 21 is that when taxability fails under all articles of the applicable tax treaty, the taxability automatically arises under this article. In other words, for example, when a business profit is not taxable under Article 7, it is taxable under Article 21 which in turn gives right to the Source State to tax it as per its domestic tax laws.

In this article, we shall examine the limited aspect of the scope of Article 21 and the judicial interpretation thereof. We shall focus on the applicability of article 21 on “Other Income” vis-à-vis income dealt with by other articles of a tax treaty.

2. Text of “Other Income” – Article 21 of OECD MC

“21(1): Items of Income of a Resident of a Contracting State, wherever arising, not dealt with in the foregoing articles of this Convention shall be taxable only in that State.”

Paragraph 2 is not reproduced, as it is not relevant for the purpose of our discussion. Paragraph 1 of Article 21 of UN Model Convention is identical to that Article 21(1) of OECD MC.

The dispute centers around the correct interpretation of the words “not dealt with” contained in Para 1 of Article 21, as reproduced above.

3. Essar Oil Ltd. vs DCIT 2005-TII-24-ITAT-MUMINTL

The controversy was analyzed and discussed at length in this case in the context of Article 8 of India-Singapore DTAA.

3.1 Facts of the Case: The assessee, a resident company had taken a tanker on voyage charter basis from a non-resident company (HMPL) based in Singapore for transportation of petroleum products from the port of Chennai to the port of Hazira, both in India. The AO held that the assessee had defaulted in not deducting TDS while making payment since it did not operate in international waters and had a PE in India and so protection under Article 8 would not be available. Also, section 44B would be applicable in case of the non-resident company. The same was upheld by the CIT(A).

3.2 Decision: After elaborate discussion, the Tribunal decided the issue in favour of the assessee, by observing as follows:

“38. We do not also agree with the argument of the revenue that income of HMPL is straight away covered by article 23 of Singapore DTAA. Article 23 of Singapore DTAA deals with income not expressly mentioned elsewhere in the DTAA. It deals with items of income which are not expressly mentioned in the foregoing articles of the said agreement may be taxed in accordance with the taxation laws of the Contracting States.

39. Prof. Klaus Vogel, the authority on the subject, has again held that the application of the residuary provision in article 23 is very narrow and it is generally applied to such residual receipts or income such as social insurance, annuity arising out of previous contributions, maintenance payments to relatives, accident benefit payments, income from so-called derivatives, lottery winnings and income from gambling, etc. Article 23 does not cover income arising out of business. In the present case, the income earned by M/s. HMPL is income earned out of business. Income earned by an assessee out of shipping operations is invariably business income which is recognised by the provisions of Indian Income-tax Act itself. Even according to the assessing authority, if the assessee falls under article 23 of the Singapore DTAA, the assessee is governed by provisions of section 44B of the Incometax Act, 1961. The heading given to section 44B is – “Special provision for computing profits and gains of shipping business in the case of non-residents”. The Act itself provides that income earned out of shipping business by a non-resident is to be considered as profits and gains and it is for that reason the taxability of such profit has been brought u/s. 44B which is brought under Part D of Chapter IV of the Income-tax Act, 1961. Part D deals with computation of income under the head ‘Profits and gains of business or profession’ in sections 28 to 44DA. The income attributable to operations carried out by M/s. HMPL is nothing but germane to the regular business of shipping carried on by it. Therefore, by the basic concept of Indian income taxation itself is that such income is ‘income from business’. (Emphasis supplied)

4 0. ….

41. Even if, for the sake of arguments one holds that the case is not covered by article 8 of Singapore DTAA, still it does not preclude the assessee to claim the immunity under article 7. The income attributable to the Singapore shipping company is business profit and de hors article 8, the case is still coming under article 7 of the DTAA which deals with the taxability of business profit. Article 8 is a specific provision over and above the general provision of business profits provided in article 7. If the case of the assessee does not fall under the specific provision of article 8, still, the assessee could not be deprived of the benefit already available to it under the general provisions of article 7. Only for the reason that the assessee does not come under article 8, the assessee could not be placed under a lesser advantage than article 7. ………..Article 8 provides for a specific benefit carved out of the general benefit given in article 7. Therefore, if the special benefit of article 8 is not available, let the matter be closed there. One cannot go further and cannot say that the assessee is not even entitled for the benefit of article 7.

42. Therefore, we hold that the profit attributable to M/s. HMPL was in the nature of business income and business income is covered by article 7 of DTAA even if the assessee is driven out of article 8.”

4. DCIT vs. Andaman Sea Food Pvt. Ltd. 2012-TII- 67-ITAT-KOL-INTL

The controversy was again analyzed and discussed at length in this case in the context of Article 23 of India-Singapore DTAA.

4.1 Facts of the Case: In this case, the assessee did not deduct tax at source from Consultancy Charges to the Singapore based NR. The CIT(A) held that the consultancy fees paid by the assessee to the NR was not covered by the scope of the expression ‘fees for technical services’ under Article 12 of the DTAA; that since the NR did not have any PE in India, the income of the assessee was also not taxable as ‘business profits’ in India. The Tax Department argued that even if the income was not taxable in India under Article 7 as business profits or under Article 12 as fees for technical services, still the amounts were taxable as other income under Article 23 of India-Singapore DTAA.

4.2 Decision: After elaborate discussion, the Tribunal decided the issue in favour of the assessee, as follows:

a) With regard to the Department’s Contention that the amount paid to the Non-resident fell within the category of the “other sum”, the Tribunal noted that “the CIT(A) had stated that “Section 40(a)(i) of the Income-tax Act provides that in computing income of an assessee under the head ‘profits and gains of business’, deduction will not be allowed for any expenditure being royalty, fees for technical services and other sum chargeable under the Act, if it is payable outside India, or in India to a non resident, and on which tax is deductible at source under Chapter XVII B and such tax has not been deducted”, and it was in this context that the CIT(A) noted that though the fee paid was not covered by fees for technical services, it could fall under the head ‘other sum’ but since the said other sum was not chargeable to tax in India, the assessee did not have any tax withholding obligation. This classification of income was not in the context of treaty classification but in the context of, what he believed to be, two categories of income referred to under section 40(a)(i), i.e. ‘royalties and fees for technical services’ and ‘other sums chargeable to tax’……………… What is material is that the expression ‘other income’ was used in the context of mandate of Section 40(a)(i) and not in the context of treaty classification of income.” (Emphasis Supplied).

b) With regard to the Department’s argument that “consultancy charges, brokerage, com-mission, and incomes of like nature which are covered by the expression “other sums” as stated in Section 40(a)(i) and chargeable to tax in India as per the Income Tax Act, and also are squarely covered by Article 23 of the India Singapore tax treaty, the Tribunal observed that “This argument proceeds on the fallacious assumption that ‘other sums’ u/s. 40(a)(i) constitutes an income which is not chargeable under the specific provisions of different articles of India Singapore tax treaty, whereas not only this expression ‘other income’ is to be read in conjunction with the words immediately following the expression ‘chargeable under the provisions of this (i.e. the Income-tax Act 1961) Act’, it is important to bear in mind that this expression, i.e. ‘other sums, also covers all types of incomes other than (a) interest, and (ii) royalties and fees for technical services. Even business profits are covered by the expression ‘other sums chargeable under the provisions of the Act’ so far as the provisions of section 40(a)(i) and section 195 are concerned and, therefore, going by this logic, even a business income, when not taxable under article 7, can always be taxed under article 23. That is clearly an absurd result.”

c) The Tribunal further observed that “A tax treaty assigns taxing rights of various types of income to the source state upon fulfill-ment of conditions laid down in respective clauses of the treaty. When these conditions are satisfied, the source state gets the right to tax the same, but when those conditions are not satisfied, the source state does not have the taxing right in respect of the said income. When a tax treaty does not assign taxation rights of a particular kind of income to the source state under the treaty provision dealing with that particular kind of income, such taxability cannot also be invoked under the residuary provisions of Article 23 either. The interpretation canvassed by the learned Departmental Representative, if accepted, will render allocation of taxing rights under a treaty redundant. In any case, to suggest that consultancy charges, brokerage and commission can be taxed under article 23, as has been suggested by the learned Departmental Representative, overlooks the fact that these incomes can indeed be taxed under article 7, article 12 or article 14 when conditions laid down in the respective articles are satisfied.” (Emphasis Supplied)

d) The Tribunal held that “It is also important to bear in mind the fact that article 23 begins with the words ‘items of income not expressly covered’ by provisions of Articles 6-22. There-fore, it is not the fact of taxability under articles 6-22 which leads to taxability under article 23, but the fact of income of that nature not being covered by articles 6-22 which can lead to taxability under article 23. There could be many such items of income which are not covered by these specific treaty provisions, such as alimony, lottery income, gambling income, rent paid by resident of a contracting state for the use of an immovable property in a third state, and damages (other than for loss of income covered by articles 6-22) etc. In our humble understanding, therefore, article 23 does not apply to items of income which can be classified under sections 6-22 whether or not taxable under these articles, and the income from consultancy charges is covered by Article 7, Article 12 or Article 14 when conditions laid down therein are satisfied. Learned Departmental Representative’s argument, emphatic and enthusiastic as it was, lacks legally sustainable merits and is contrary to the scheme of the tax treaty.” (Emphasis Supplied).

e) The Tribunal referred to and relied upon certain observations of the AAR in the case of Gearbulk AG – 318 ITR 66 (AAR) (2009-TII-09-ARA-INTL), discussed below.

5. ADIT vs. Mediterranean Shipping Co., S.A. [2012] 27 taxmann.com 77:

5.1 Facts of the case:

• Assessee was a Swiss company engaged in the business of operations of ships in the international waters through chartered ships. During the A.Y. 2003-04, the assessee had total collection of freight to the tune of Rs. 295.63 crore on which a sum of Rs. 9.33 crore was paid towards the tax liability. In its return of income, however, the assessee declared ‘nil’ income on the ground that there was no article in the Indo-Swiss treaty dealing specifically with taxability of shipping profit; that article 7 of the treaty, dealing with the business profits, specifically excluded profits from the operation of ships in international traffic; that article 22 of the treaty, dealing with other income, subjected shipping profits to tax only in the State of residence, i.e., the Switzerland. Accordingly, the stand of the assessee was that the international shipping profits was not taxable in India and the entire tax of Rs. 9.33 crore paid was liable to be refunded.

• The Assessing Officer, however, rejected the stand of the assessee relying upon the CBDT Circular No. 333, dated 02-04-1982 whereby it was clarified that where there is no specific provision in the agreement, it is the basic law, i.e., the Indian Income-tax Act which will govern the taxation of the income. Accordingly, the shipping profits of the assessee were held taxable under section 44B of the Income-tax Act at the rate of 7.5 per cent of the total freight collection of Rs. 295.63 crore.

• On appeal by the assessee, the Commissioner (Appeals) upheld the claim of the assessee that article 22 applied to the profits earned from shipping business in question. The Commissioner (Appeals), however, proceeded to determine as to whether the case of the assessee was covered under article 22(2), which provides for an exception to the applicability of article 22. Under sub- article (2) of article 22 it is provided, inter alia, that provisions of article 22(1) shall not apply to income if the recipient of such income, being a resident of contracting state, carries on business in the other contracting State through a PE therein and the right or property in respect of which income is paid is effectively connected with such PE. After referring to the relevant clauses of the agreement of assessee with MSC, the Commissioner (Appeals) held MSC to be assessee’s PE in India.

• After holding MSC to be assessee’s PE in India, the Commissioner (Appeals) proceeded to examine as to whether the shipping prof-its derived from operation of ships were effectively connected with said PE; and held that they were not. Accordingly, the Commissioner (Appeals) held that article 22(1) was applicable in the case of the assessee and, therefore, the profits from shipping business was taxable in Switzerland and not in India.

5.2 Decision:

The Tribunal decided the issue in favor of the assessee. The Tribunal observed and held as under:

“A reading of article 22 especially paragraph 1 thereof makes it clear that the items of income of a resident of a contracting State, i.e., Switzerland which are not dealt with in the foregoing articles of the Indo-Swiss treaty shall be taxable only that State. In the instant case, the assessee company being a resident of Switzerland, the income, wherever arising, would fall within the scope of the residuary article 22 if the same is not dealt with in any other articles of the treaty.

The question, therefore, is whether the shipping profits are dealt with in any other articles of the Indo-Swiss treaty or not. The contention raised by the revenue is that by agreeing to exclude the shipping profits from article 8 as well as article 7 of the Indo-Swiss treaty, India and Switzerland had agreed to leave the shipping profits to be taxed by each State according to its domestic law and this undisputed position prevailing up to 2001 did not change as a result of introduction of article 22 of the treaty with effect from 01-04-2001. The contention cannot be agreed with. It is held that as a result of introduction of article 22, the items of income not dealt with in the other articles of the Indo-Swiss treaty are covered in the residuary article 22 and their taxability is governed by the said article with effect from 01-04-2001. Articles 7 and 8 of the treaty, therefore, cannot be relied upon to say that by agreeing to exclude the shipping profits from said articles, the shipping profits are left to be taxed by each contracting State according to its domestic law. It is no doubt true that this was the position prior to introduction of article 22 in the Indo-Swiss treaty in the year 2001 but the same was altered as a result of introduction of the said article inasmuch as it become necessary to find out as to whether shipping profits have been dealt with in any other article of the treaty. Mere exclusion of shipping profits from the scope of treaty could have resulted in leaving the same to be taxed by the concerned contracting State according to its domestic law prior to introduction of article 22. However, such exclusion alone will not take it out of the scope of article 22 unless it is established that the shipping profits have been dealt within any other article of the treaty. The language of article 22(1) in this regard is plain and simple and the requirement for application of the said article is explicitly clear. [Para 33]

In order to say that a particular item of income has been dealt with, it is necessary that the relevant article must state whether Switzerland or India or both have a right to tax such item of income. Vesting of such jurisdiction must positively and explicitly stated and it cannot be inferred by implication as sought to be contended by the revenue relying upon articles 7 and 8 of the treaty. The mere exclusion of international shipping profit from article 7 can-not be regarded as an item of income dealt with by the said article as envisaged in article 22(1). The expression ‘dealt with’ contemplates a positive action and such positive action in the instant context would be when there is an article categorically stating the source of country or the country of residence or both have a right to tax that item of income. The fact that the expression used in article 22(1) of the Indo-Swiss treaty is ‘dealt with’ vis-a-vis the expression ‘mentioned’ used in some other treaties clearly demonstrates that the expression ‘dealt with’ is some thing more than a mere mention of such income in the article. The international shipping profits can at the most be said to have mentioned in article 7 but the same cannot be said to have been dealt with in the said article. [Para 35]

Up to assessment year 2001-02, international ship-ping profits no doubt were being taxed under the domestic laws as per the provisions of section 44B. However, it was not because of the exclusion contained in Article 7 that India was vested with the authority to tax such international shipping profit but it was because there was no other article in the Indo-Swiss treaty dealing with international shipping profits which could override the provisions of section 44B in terms of section 90(2) being more beneficial to the assessee. This position, however, has changed as a result of introduction of article 22 in the Indo-Swiss treaty which now governs the international shipping profits not being dealt with specifically by any other article of the treaty and if the provisions of article 22 are beneficial to the assessee, the same are bound to prevail over the provisions of section 44B. [Para 41]

It is held that the item of income in question, i.e., international shipping profit cannot be said to be dealt with in any other articles of the Indo- Swiss treaty and the taxability of the said income, thus, is governed by residuary article 22 introduced in the treaty with effect from 01-04-2002. [Para 48]”

We may mention that Article 8 of the Indo-Swiss DTAA has been amended vide Notification dated 27-12-2011 to include Shipping Profits within its scope and accordingly, the controversy no longer survives.

6. AAR Ruling in the case of Gearbulk AG – 318 ITR 66 (AAR) (2009-TII-09-ARA-INTL)

6.1 Similar issue arose in the case of Gearbulk AG, a Shipping Company, in the context of India-Switzerland DTAA. In this case, the Applicant, a Swiss Company, had income from Shipping Business. At the relevant point in time, Article 8 of India-Switzerland DTAA dealt with only profits from the operation of Aircraft and did not deal with profits from Operation of Ships. The issue before the AAR was whether tax-ability of such Shipping Profits was governed by Article 7 of India – Swiss DTAA or whether the same was taxable in India in terms of “Other Income” – Article 22 of the Treaty.

6.2 After discussing the meaning of the expression ‘deal with’ as given in various dictionaries, the AAR held in favor of the revenue. The AAR held that the Freight Income received by the Applicant is liable to be taxed in India under the provisions of the Income-tax Act and that such income is not covered by he provisions of Indo-Swiss DTAA.

7. ACIT vs. Viceroy Hotels Ltd. Hyderabad 2011-TII-97-ITAT-HYD-INTL

7.1 In this case, the assessee, engaged in the business of running a Five Star Hotel by the name of “VICEROY”, was being converted into Marriott Chain Hotel under the franchisee granted by the International Licensing Company SARL (Marriott USA). To meet the standard for Marriott Group, the assessee embarked upon an expansion programme by way of adding new blocks in the hotel and also upgradation by way of bringing about interior and exterior changes, landscaping etc. For this purpose the assessee entered into four separate and independent agreements with one Anthony Corbett & As-sociates of UK; Marriott International Design & Constructions of USA; Bensly Design Group International Construction Company Ltd., Thailand and Lim Hong Lian of Singapore.

7.2 With regard to payment of landscape architectural consultancy services to a Thai Company, the issue arose whether in the absence of an Article relating to fee for technical services in the India-Thailand DTAA, services of landscape architectural consultancy can be taxed under the residuary Article 22 of the DTAA.

7.3 With regard to non deduction of tax at source on the amount paid to M/s. Bensly Design, Thailand which is engaged in the business of landscape architectural consultancy, the lower authorities were of the opinion that though the DTAA does not clearly spell out the taxation of fees for technical services, the amount paid by the assessee to M/s Bensly group would fall within the purview of article 22 of the Agreement which is residuary clause dealing with other income not expressly dealt in other articles of DTAA.

7.4 According to lower authorities, the services rendered by Bensly group do not constitute professional or independent personal services under article 14 of the DTAA between India and Kingdom of Thailand. Without prejudice to this, the A.O. observed that even if the payments made to the NR is treated as fees for professional services or independent activities within the meaning of article 14 of the DTAA, then also such fees can be taxed under the IT Act. It is because, the exemption provided under article 14 is available only to such payments that are not borne by an enterprise or a PE situated in India. In the present case, the payment has been made by an enterprise situated in India and accordingly, the non-resident company is not entitled to claim any exemption on the strength of Article 14 of the DTAA.

7.5 The A.O. also stated that the instruction con-tained in CBDT circular No. 333 (F.506/42/81-FTD) dated 02-04-1982 is in effect complementary to Article 22 of the DTAA which provide that where there is no specific provision under the DTAA, it is the basic law which will govern the taxation of the income of the non-resident. Following the aforesaid stand, the A.O. invoked provision of section 9(1) r.w.s. 115A(1)(b)(B) of the IT Act and treated the entire fees as income chargeable to tax in India since all the expenses of the NR were reimbursed by the assessee deductor. The A.O. further stated that the agreement under which the technical services are rendered is neither approved by the central govt. nor does it relate to a matter included in the industrial policy and hence the deductor should have deducted tax at source at the rate of 40% plus surcharge as prescribed in the relevant Finance Act for any other income arising to a non resident company in India and since the deductor had failed to discharge its statutory obligation, the assessee was treated as an assessee in default.

7.6 According to the assessee, as there is no PE for M/s Bensly Design, Thailand in India, and no foreign employee stayed in India for more than 90 days, the CIT (A) should have exempted the business profit of the company from taxation in India. Under Article 7 of the DTAA income earned by a NR in India under the head business, can be taxed in India only if the NR has a PE in India. If the business is carried on through employees and if those employees stay in India for less than 183 days in the case of Thailand, there will be no PE in India and the corresponding business profit of the NR becomes non taxable. According to the assessee, as per Indo-Thai DTAA, there is no article in the relevant DTAA dealing with fees for technical services, there is only an article dealing with royalties, and of course, there is an article dealing with business profits. The A.O. wrongly applied the residuary Article 22 and taxed the income arising in India for the Thai company at the rate of 40%.

7.7 The Tribunal negatived the contentions of the Tax Department and held, “The fees paid to M/s Bensly Design, Thailand for rendering services of landscape architectural consultancy is not covered as per the DTAA since there is no article in the relevant DTAA dealing with this nature of payments. There is only one article dealing with Royalties and another dealing with business profit. Under Article 7 of the DTAA, income earned by a non resident in India under the head ‘business’ can be taxed in India only if the non-resident has a permanent establishment in India. In this case, the business was carried on through employees and there is no record that these employees stayed in India for more than 183 days. Accordingly there is no PE in India and corresponding business profit of non-resident cannot be taxed in India and provision of section 195 is not applicable.”

8. Credit Suisse (Singapore) Ltd. vs. ADIT – 2012-TII-214-ITAT-MUM-INTL

8.1 In this case, the assessee company incorporated in Singapore and a tax resident there was registered with SEBI as a sub-account of Credit Suisse. The assessee had inter alia, conducted portfolio investments in Indian securities. The assessee had shown net short-term capital loss from sale of shares and sale of shares underlying FCCBs besides gains from exchange traded derivative contracts. The net resultant gains were claimed as exempt under Article 13(4) of the tax treaty. The dividend income was also claimed as exempt u/s. 10(34).

8.2 The assessee also claimed that gains made by it from cancellation of forward contracts were not chargeable to tax. The assessee claimed that the foreign exchange forward contracts were entered to hedge its exposures in respect of its Indian Investments being shares/exchange traded derivative contracts; that being an FII sub-account, in view of the provisions of Section 115AD, wherein the transactions in underlying assets against which the foreign exchange forward cover contracts were entered into, were taxed as ‘capital gains’, the foreign exchange forward cover contracts also took on the color of their underlying assets, being capital assets. Consequently, the gains realised from cancellation of such forward cover contracts had to be regarded as capital gains, which were not liable to tax in India as per Article 13(4) of the tax treaty. It was claimed that although these gains could be taxed as business profits since the assessee did not have a PE in India, the same could not be taxed in India.

The AO rejected the assessee’s explanation and held that the transaction in forward purchase of foreign exchange and settlement could not be said to be resulting in capital gains as the same was never held by the assessee as capital asset but was meant to be settled by price difference. Also, as the assessee was not eligible to carry on business in India as per SEBI regulations, the income arising from settlement of forward contracts could not be treated as business income. Thus, the AO held that the assessee’s income from cancellation of foreign exchange forward contracts was neither capital gains income nor business income but ‘income from other sources’ under Article 23 of the tax treaty. However, the Tribunal, relying on the decisions in the case of Citicorp Investment Bank (Singapore) Ltd. vs. Dy. Director of Income Tax (International Taxation)(2012-TII-86-ITAT-MUM-INTL) and Citicorp Banking Corporation, Bahrain vs. Addl. Director of Income Tax (International Taxation) (2011-TII-40- ITAT-MUM-INTL), held that gains arising from early settlement of forward foreign exchange contract has to be treated as capital gain and that the A.O. and the DRP were not justified in treating the said gain as ‘income from other sources’.

8.3 We may mention that the Tribunal, while deciding the issue in favour of the assessee, did not discuss the controversy of application of Article 23 vis-à-vis application of Article 7 or Article 13 of India – Singapore DTAA.

9. Lanka Hydraulic Institute Ltd (2011-TII-09-ARA-INTL)

9.1 In this case, the applicant, a Tax Resident of Sri Lanka, had sought an advance ruling from the Authority on the taxability of the payment received under its contract with WAPCOS and in the absence of a specific article for the taxation of fees for technical services, in the India-Sri Lanka DTAA, whether this payment would be governed by Article 7 of the tax treaty which dealt with taxation of business profits.

9.2 The AAR held, without much discussion and reasoning, as follows:

“It is true that the treaty does not contain a specific article for the taxation of fees for technical services. In that event reference is to be made to Article 22 of the Tax Treaty which reads as follows:

‘Item of income of a resident of a Contract-ing State which are not expressly mentioned in the foregoing Article of this Agreement in respect of which he is subject to tax in that state shall be taxable only in that state.’

Accordingly, the fees for technical services shall be governed by Article 22 of the Tax Treaty and not as per Article 7 of the Tax Treaty which deals with taxation of business profits.”

We may mention that, effectively the Ruling was in favor of the Sri Lankan Applicant since Indo-Sri Lankan DTAA provides that income falling under the scope of Article 22 shall be taxable only in the state of the Resident i.e. in Sri Lanka. However, since the income in question was essentially in the nature of Business Profits, in our humble opinion, in the absence of FTS Article in Indo-Sri Lankan DTAA, such income should be taxable in accordance with provisions of Article 7 and not in accordance with provisions of Article 22 of the DTAA. Thus, in principle, we are not in agreement with the aforesaid AAR Ruling.

9.3 Following its Ruling in the case of Lanka Hydraulic Institute Ltd (2011-TII-09-ARA-INTL), similar view was taken by the AAR in case of XYZ (AAR Nos. 886 to 911, 913 to 924, 927, 929 and 930 of 2010)(2012) 20 taxmann.com 88 (AAR); and held that in absence of FTS Article, services would get covered by “Other Income” Article. In this case the income was in the nature of inspection, verification, testing and certification services (IVTC).

In our humble opinion, both the AAR Rulings mentioned herein above are not in accordance with Principles of Interpretation of Tax Treaties and require reconsideration.

10. Conclusion

In some Indian DTAAs, under Article 21 exclusive right of taxation is given to source state like Brazil, United Mexican States, Namibia and South Africa. In few Indian DTAAs, Right of taxation is in accordance with laws of the respective Contracting States/both the contracting states like in case of Singapore and Italy. India’s DTAAs with Greece, Netherlands and Libya does not contain ‘Other Income’ Article. In many other Indian DTAAs, Primary right of taxation to ‘State of Residence’ and Correlative right to the ‘State of Source’. In such cases, issue regarding applicability of Article 7 instead of Article 21, is of great relevance.

The issue is yet to be tested before the higher judiciary. However, in our humble view, the analysis and reasoning advanced by the Tribunal in the case of DCIT vs. Andaman Sea Food Pvt. Ltd appears to be very sound and in accordance with well accepted principles of Interpretation of Tax Treaties and is worth following.

Nirav Shah

Article 12 of Indo US DTAA – Co-ordination fees business profits under DTAA – No PE and hence not chargeable to tax – Creative fees and database costs chargeable as they are not royalties and services not ancilliary or subsidary to enjoyment of property

15. DDIT v Euro RSCG Worldwide, inc (ITA No
7094/Mum/2010) (unreported)
Asst Year: 2010-11. Dated 27-11-2012

Article 12 of Indo US DTAA – Co-ordination fees business profits under DTAA – No PE and hence not chargeable to tax – Creative fees and database costs chargeable as they are not royalties and services not ancilliary or subsidary to enjoyment of property

Facts:

The taxpayer was an American company, which was a resident of USA (“USCo”). USCo was acting as a communicating interface between its Group entities and multinational clients. To ensure work of international standards that would meet client’s expectations, USCo had set up a team of persons to coordinate between a Group entity and a client.

USCo incurred expenditure on providing the coordination services. Hence, it charged the Group entities for these services. Further, it also provided need-based business development and managerial assistance to Group entities. During the year, USCo provided certain assistance to a Group entity in India (“ICo”) and received consideration thereof, which was split into creative fees, database costs and coordination fees. USCo contended that the consideration was in the nature of business profits under Article 7 of India-USA DTAA, and since USCo did not have a PE in India, the consideration was not chargeable to tax in India.

However, the AO concluded that the consideration was in the nature of royalties and was chargeable to tax @15% under India-USA DTAA.

The CIT(A) held that client coordination fees were in the nature of business profits, which, in absence of PE in India, were not chargeable to tax in India. As regards the creative fees and the database costs, he held that they were in the nature of FIS and accordingly, were chargeable to the tax in India. While the taxpayer accepted the findings of CIT(A), the tax department appealed to Tribunal against the order of CIT(A).

Held

The Tribunal observed and held as follows.

(i) The Tribunal concurred with the finding of the CIT(A) that USCo maintained communication channel between ICo and the clients. These services did not involve consideration for use of, or right to use, any of the specified terms in Article 12(3) of India-USA DTAA. Hence, the consideration was not royalties but business profits. As USCo did not have a PE in India, the question of taxability of consideration did not arise.

(ii) In terms of Article 12(2)(b) of India-USA DTAA, royalties (under Article 12(3)) and FIS (under Article 12(4)) are chargeable to tax @10%. However, payments for the creative fees and the database costs were neither royalties as defined in Article 12(3)(b) nor the services were ancillary or subsidiary to enjoyment of property. Hence rate of 10% was not applicable. As there was nothing on record to indicate that the rate specified under Article 12(2)(b) was applicable, rate specified under Article 12(2)(a)(ii) was applicable. Hence, the creative fees and the database costs were chargeable to tax @15%.

levitra

Nirav Shah

Ss. 40 (a) (i) 195, Article 12 of Indo US DTAA On facts, marketing, quality assurance, e-publishing and turnkey services provided by American company to Indian company did not ‘make available’ knowledge, etc. Hence, payment was not Fees for Included Services (FIS)

14. ACIT v Tax Technology International Pvt Ltd
[2012] 27 taxman.com 190 Chennai
A.Y.: 2007-08. Dated: 11-10-2012

Ss. 40 (a) (i) 195, Article 12 of Indo US DTAA on facts, marketing, quality assurance, e-publishing and turnkey services provided by American company to Indian company did not ‘make available’ knowledge, etc. Hence, payment was not Fees for Included Services (FIS)

Facts:

The taxpayer was an Indian company (“ICo”) engaged in the business of e-publishing. ICo had an American Subsidiary (USCo”). ICo executed three types of Agreements – Marketing Agreement, Offshore Development Agreement and Overseas Services Agreement – with USCo. The services provided under the respective agreement were as follows.

Marketing Agreement

USCo was to provide support to the customers and also provide market information to ICo.

Offshore Development Agreement

USCo was to scan manuscripts, upload them to India and intimate ICo by e-mail. After ICo had done typesetting in India and uploaded it to USCo, USCo was to download it, print pages and courier it to customers.

Overseas Services Agreement

USCo was to use its expertise, tools and infrastructure for e-publishing and preparation and typesetting of manuscript of printing pages and delivering it to customers. 14 For the aforementioned services, during the year, ICo made certain payments to USCo. ICo did not withhold tax from the same as, according to it, USCo was only a marketing agent and no technical services were ‘made available’ by USCo.

According to AO, USCo was rendering technical services and pursuant to introduction of Explanation u/s. 9(2) of I T Act, business connection or territorial nexus with India was not required. Further, if according to ICo, tax was not required to be withheld, it should have obtained the relevant certificate u/s. 195(2) or (3). Since neither tax was withheld nor certificate was obtained, section 40(a)(i) was attracted and the payment was disallowable.

Held:

The Tribunal observed and held as follows. To constitute FIS under Article 12(4)(b) of India-USA DTAA, it is necessary that technical knowledge, etc should be ‘made available’.

Definition of FTS under Explanation No 2 to section 9(1)(vii) of I T Act is not in pari materia with definition of FIS in Article 12(4) of India-USA DTAA. Services provided by USCo could be FIS only if such services ‘made available’ technical knowledge, etc. The Tribunal considered the scope of services under each Agreement as follows. No technical service was involved in respect of services under Marketing Agreement as no technical knowledge was ‘made available’;

Scope of services under Overseas Services Agreement, clearly indicated that USCo was to use its expertise, tools and infrastructure for receiving manuscripts for production of book using its own resources, including servicing the customers and effecting dispatches to customer locations. In other words, it provided comprehensive services. If entire work was done by USCo, it cannot be said that ICo was receiving any technical knowledge, etc.

As regards Offshore Development Agreement: In terms of Clause 3.1 USCo processed customer materials, prepared instructions and prepared files. Based on these, ICo carried out e-publishing services. Though the services provided by USCo involved technical know-how, they were not FIS as they did not ‘make available’ technical knowledge (which will give enduring benefit) to ICo. In terms of Clause 3.3, USCo was to provide quality assurance. While this too may involve some technical expertise, it cannot be said that USCo ‘made available’ such technology to ICo.

In terms of Clause 3.2, USCo provided files and instructions for carrying out digitalization services to ICo. The instructions would constitute FIS if they resulted in ICo imbibing technical expertise, etc. that gave it an enduring benefit in its e-publication business. Separate invoices were raised by USCo on ICo under three different agreements. Hence, three agreements did not constitute a composite agreement. On the issue of ‘making available’:

Based on this interpretation of the term ‘making available’ in CIT v De Beers India Minerals P Ltd [2012] 346 ITR 467 (Karn), services performed were not FIS since they were not ‘made available’. Income in respect of any service under Marketing Agreement and Overseas Services Agreement was not covered under Article 12(4) of India–USA DTAA. Therefore, ICo had no obligation to deduct tax at source.

One of the services under Offshore Development Agreement could be considered FIS since it could involve ‘making available’ technical knowledge to ICo in which case section 195 of I T Act could apply. As ICo had not applied for lower/nil deduction u/s. 195, section 40(a)(i) could be attracted. Hence, the issue in respect of payments made under Offshore Development Agreement was remitted to AO for reconsideration.

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Nirav Shah

Ss. 9 40 (a) (i), Article 12 of Indo/US DTAA – Voice call charges to USCO not managerial, technical or consultancy services – USCO having no PE in India – Payment not chargeable to tax section 195, 40 (a) (i) not applicable

13. Clearwater Technology Services Pvt Ltd v
ITO [2012] 27 taxman.com 238 (Bang)
A.Y.: 2008-09. Dated: 28-9-2012

Ss. 9 40 (a) (i), Article 12 of Indo/US DTAA – Voice call charges to USCo not managerial, technical or consultancy services – USCo having no PE in India – Payment not chargeable to tax section 195, 40 (a) (i) not applicable

Facts:

The taxpayer was an Indian company (“ICo”) engaged in providing voice based call centre services to its clients in USA. An American telecom voice service provider (“USCo”) assisted ICo in connecting to the American telecom network in respect of the calls made to USA by ICo, or calls received from USA by ICo.

During the year, ICo had made certain payments to USCo for its services. However, ICo did not withhold tax from these payments since USCo had no PE in India.

According to AO, the payments made by ICo to USCo were in the nature of Fees for Technical Services (FTS) and subject to withholding of tax u/s. 195 of I T Act. Further, since no tax was withheld, the entire expenditure was disallowable u/s. 40(a)(i).

Held:

The Tribunal observed and held as follows. Neither the I T Act nor DTAA has defined the term managerial, technical and consultancy. Hence, dictionary meaning of those terms should be referred to. On the basis of dictionary meanings, payments made to a non-resident in respect of telecom services cannot be termed as FTS.

The Tribunal referred to the following decisions : In CIT v De Beers India Minerals P Ltd [2012] 346 ITR 467 (Karn), services performed using technical knowledge, etc. were not considered as FTS since they were not ‘made available’.

Further, in DCIT v Sandoz (P) Ltd [2012] 137 ITD 326 (Mom), the Tribunal has held that even if payment for advertisement could be assessed as business profits under section 9, in absence of PE in India they could not be charged to tax. In GE India Technology Centre P Ltd v CIT [2010] 327 ITR 456 (SC), Supreme Court has held that the obligation to withhold tax u/s. 195 arises only if the income is chargeable to tax. If income is not chargeable to tax, provisions of section 40(a)(i) do not apply.

Therefore, the Tribunal held that ICo had no obligation to withhold tax on payment made to USCo. Accordingly, the payment cannot be disallowed u/s. 40(a)(i).

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Nirav Shah

USA – Advance agreements between related parties properly characterized as equity

The US Tax Court has held that advance agreements executed between related parties were appropriately characterised as equity for US Federal income tax purposes. PepsiCo Puerto Rico, Inc. v. Commissioner of Internal Revenue; PepsiCo, Inc. and Affiliates v. Commissioner of Internal Revenue, T.C. Memo. 2012-269 (Docket Nos. 13676-09, 13677-09, 20th September 2012).

The case involved a US parent corporation (PepsiCo) and its group of affiliated corporations that included Netherlands Antilles companies. The Netherland Antilles companies held promissory notes issued by the group’s US affiliated corporations (Frito-Lay, Metro Bottling, and PepsiCo) and held interests in foreign entities that were treated as partnerships for US Federal income tax purposes (foreign partnerships).

The deficits of the foreign partnerships reduced the earnings and profits of the Netherland Antilles companies, which in turn reduced the amount of the interest income from the notes that would otherwise have flowed-through to PepsiCo as subpart F income. To avoid the adverse consequences that would result from the pending termination of the extension of the US-Netherlands treaty to the Netherlands Antilles, and also to benefit from the favourable tax treatments of the US-Netherlands DTAA and Dutch corporate income tax, PepsiCo transferred the ownership of some of the foreign partnerships from the Netherland Antilles companies to newly-formed Dutch companies (PWI and PGI).

During this global restructuring, Frito-Lay, Metro Bottling, and PepsiCo issued new promissory notes to replace the existing promissory notes and the new promissory notes were ultimately contributed to PWI and PGI. In exchange for the contributed promissory notes, PWI and PGI issued advance agreements to the group’s US affiliates (BFSI and PPR). The advance agreements had terms of 40 years, which could be unilaterally extended by PWI and PGI for an additional 15 years.

The advance agreements, however, would be rendered perpetual if a related party defaulted on any loan receivables held by PGI or PWI. A preferred return unconditionally accrued on any unpaid principal amounts of the advance agreements. The preferred return included a base rate determined by reference to LIBOR plus a premium rate. However, PWI and PGI were required to make any payments of the accrued preferred return only to the extent their net cash flow exceeded the sum of accrued but unpaid operating expenses and capital expenditures made or approved by them, but in no event could the cash-flow amount be less than the interest received from the affiliated companies.

PWI and PGI were allowed to make payments on the advance agreements in full or in part at any time. In addition, the rights of the creditors of PWI and PGI were superior to the holders of the advance agreements. The group treated payments of preferred return on the advance agreements as distributions on equity on its US Federal income tax returns. Interest payments on the promissory notes were deducted by Frito-Lay, Metro Bottling, and PepsiCo u/s. 163 of the US Internal Revenue Code (IRC) and were also exempt from US withholding tax pursuant to the US-Netherlands tax treaty.

The issue of the case was whether the advance agreements were appropriately characterised as equity for US Federal income tax purposes. The US Internal Revenue Service (IRS) asserted that the advance agreements and the promissory notes were merely intercompany loans between commonly controlled related companies. The US Tax Court stated that, while the substance of a transaction governs for tax purposes, the form of a transaction often informs its substance.

The US Tax Court further stated that, although the greater scrutiny should be afforded to relatedparty transactions, disregarding the taxpayers’ international corporate structure based solely on the entities’ interrelatedness is, without more, unjustified. The US Tax Court noted that the focus of a debt-versus-equity inquiry is whether there was intent to create a debt with a reasonable expectation of payment and, if so, whether that intent comports with the economic reality of creating a debtor-creditor relationship.

The US Tax Court then applied 13 factors that it has articulated for the debt-versus-equity inquiry. After analysing those factors, the US Tax Court concluded that the advance agreements exhibited more qualitative and quantitative indicia of equity than debt. The US Tax Court determined that the advance agreements were appropriately characterised as equity for US Federal income tax purposes. 10. Netherlands Supreme Court: burden of proof regarding transfer of legal seat on taxpayer On 30th November 2012, the Supreme Court of the Netherlands (Hoge Raad der Nederlanden) gave its decision in case No. 11/05198 as to whether or not, in the context of the transfer of the legal seat of a company, the burden of proof (of the transfer) rests on the taxpayer. For the facts, legal background and issues of the case, as well as the opinion of the Advocate General (AG), the Taxpayer presented the Supreme Court with two arguments:

• Firstly, the Taxpayer appealed against the finding of the Court of Appeal (Gerechtshof) of Arnhem that it (the Taxpayer) had not shown that the place of effective management had, since 1st July 2001, been transferred to the Netherlands Antilles. The Court dismissed this appeal on the grounds that it is a reasonable finding of facts, which can as such not be considered by the Supreme Court.

• Secondly, the Taxpayer essentially argued that the burden of proof regarding its (Netherlands Antilles) residence status only extends to the year in which the transfer takes place, i.e. to 2001. The AG had concluded that the shift in the burden of proof to the Taxpayer applies for a period of 1 year after the transfer of the place of effective management has been “made plausible”.

• The Court noted, as the Court of Appeal had, that the aim of article 35b(7) of the Tax Regulation for the Kingdom of the Netherlands, as deduced from parliamentary and legislative documentation, is to combat tax avoidance which may arise from the nominal (paper) transfer of the legal seat of a company. This article provides for a shift in the burden of proof to the taxpayer in certain situations where there is a transfer of the legal seat.

• On this point, the Supreme Court agreed with the Court of Appeal, and decided that the burden of proof is shifted to the taxpayer until that taxpayer can make plausible the transfer of the place of effective management.

• This second argument, the Court noted, was somewhat academic as the first hurdle, namely proving that the place of effective management had indeed been transferred, had not been taken by the taxpayer.

[Acknowledgement/Source: We have compiled the above summary of decisions from the Tax News Service of IBFD for the period 18-09-2012 to 17-12-2012.]

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Nirav Shah

Netherland’s Supreme Court decides that Dutch thin capitalisation provisions are not incompatible with EC law and article 9 of Dutch tax treaties with France, Germany and Portugal

On 21st September 2012, the Dutch Supreme Court (Hoge Raad der Nederlanden) gave its decision in X BV v. the Tax Administration (case No. 10/05268) on the compatibility of the Dutch thin capitalisation rules with EC law and article 9 of the tax treaties Dutch tax treaties with France, Germany and Portugal.

The Supreme Court rejected the taxpayer’s argument that the thin capitalisation rules are incompatible with the EC Treaty. In the taxpayer’s view this is the case because the rules apply if a Dutch company for 95% or more is owned by a foreign company, which means that in such case mainly foreign companies are affected. The Court based its judgment on an earlier decision of 24th June 2011 (LJN BN3537) in which it was held that domestic and foreign holding companies are not in a comparable situation.

Referring to the decision of the European Court of Justice (ECJ) of 21st July 2011 in Scheuten (Case C-397/09), the Court also held that the thin capitalization rules are not incompatible with the Interest and Royalties Directive (2003/49) because that Directive deals with the position of the creditor and not with that of the debtor.

Following the opinion of the AG, the Court rejected the appeal based on article 25(5) (Non-discrimination) under the treaty with France, because the Taxpayer is not treated differently from another company which is not part of a group and is not comparable with a group company.

Thereafter, the Court decided that the provision at issue is also not incompatible with the arm’s length provisions under article 9 of the France – Netherlands Income and Capital Tax Treaty (1973) (as amended through 2004) and article 9 of the Germany – Netherlands Income and Capital Tax Treaty (1959) (as amended through 1991) because those provisions only provide for a corresponding adjustment in case of contracts and financial relations between related parties which are not at arm’s length, while the Dutch thin capitalisation rules concern the entire financing structure of a company.

Finally, the thin capitalisation rules are also not incompatible with article 9 of the Netherlands – Portugal DTAA because article X of the protocol specifically allows the Member States to apply their domestic thin capitalisation rules. Those rules may only not be applied if related companies prove that their agreements are at arm’s length based on their activities or their specific economic circumstances.

The term “thin capitalisation” is not defined in the Treaty, the term must be interpreted by means of article 31(1) of the Vienna Convention on tax treaty interpretation, which means that the meaning of the term must be determined in good faith based on the subject and purpose of the treaty. Based on the thin capitalisation rules applicable in Portugal at the time of signing of the Treaty, the Court held that the term refers to interest deduction restrictions concerning interest paid on loans to related companies. This is in line with article 9 of that Treaty, which aims to determine whether the conditions in a concrete legal case are at arm’s length. Therefore, the Court held that the term “thin capitalisation” in the Treaty with Portugal only concerns certain loans and not a general thin capitalisation rule which concerns the total financing structure of a company.

Consequently, the Supreme Court held that Dutch thin capitalisation provisions are not incompatible with EC law and article 9 of the Dutch tax treaties with France, Germany and Portugal.

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Nirav Shah

ECJ rules on definition of fixed establishment: taxable person carrying out only technical testing or research work in another Member State does not have a “fixed establishment from which business transactions are effected”

On 25th October 2012, the Court of Justice of the European Union (ECJ) gave its decision in the joined cases of Daimler AG v Skatteverket (C-318/11) and Widex A/S v Skatteverket (C-319/11). The Swedish Administrative Court of Falun (Förvaltningsrätten i Falun) had requested a preliminary ruling from the ECJ on 27th June 2011. No Advocate General’s opinion regarding this case was issued. Details of the judgment are summarised below:

(a) Facts:

In C-318/11, Daimler AG (Daimler) is a company having the seat of its economic activity in Germany and carrying out winter testing of cars in Sweden. Daimler does not carry out any activity subject to VAT at the installations in Sweden, but has a wholly-owned subsidiary there which provides it with premises, test tracks and related services. Daimler applied for a refund of input VAT paid on the purchases it had made, which had not been used for any activity subject to VAT in Sweden (i.e. the testing of cars).

In C-319/11, Widex A/S (Widex) is a company established in Denmark manufacturing hearing aids and has a research centre in Sweden carrying out research into audiology, which constitutes a division within Widex. Widex acquires goods and services for the research activity which it carries out in its division in Sweden. Widex also has a subsidiary in Sweden which sells and distributes its goods in Sweden, but the subsidiary operates totally independently from the research activities of the division.

The Swedish tax authorities rejected Daimler’s and Widex’s applications for the refund of VAT paid in Sweden on the grounds that the applicants have a fixed establishment in Sweden.

(b) Legal background: Under articles 170 and 171 of the EU VAT Directive (2006/112) taxable persons who are not established in the Member State in which they purchase goods and services or import goods subject to VAT but are established in another Member State may obtain a refund of that VAT in so far as the goods and services are used for the purposes of certain specific transactions. Under article 1 of the Eighth VAT Directive (79/1072) and, now, under article 3 of the Directive 2008/9, a taxable person is not established within a Member State and qualifies for a refund of input VAT if that person has neither the seat of his economic activity, nor a fixed establishment from which business transactions are affected in that particular Member State.

The issue was whether a taxable person for VAT established in one Member State and carrying out in another Member State only technical testing or research work, not including taxable transactions, can be regarded as having in that other Member State a “fixed establishment from which business transactions are effected” within the meaning of article 1 of the Eighth Directive and, now, in article 3(a) of Directive 2008/9 and as such be denied the right to refund of VAT in that State.

(d) Decision:

The ECJ pointed out that the criterion under which a refund of VAT can be denied due to the fact that there is a “fixed establishment from which business transactions are effected” includes two cumulative conditions: firstly, the existence of a “fixed establishment”; and secondly that “transactions” are carried out from that establishment. By referring to Commission v. Italy (Case C-244/08), the ECJ emphasised that the expression “fixed establishment from which business transactions are effected”, must be interpreted as regarding a non-resident taxable person as a person who does not have a fixed establishment carrying out taxable transactions in general. The existence of active transactions in the Member State concerned constitutes the determining factor for exclusion of the right to refund of VAT. Furthermore, the term “transactions” used in the phrase “from which business transactions are effected” can affect only output transactions. Consequently, in order to deny the right to refund, taxable transactions must actually be carried out by the fixed establishment in the State where the application for refund is made, while the mere ability to carry out such transactions does not suffice. In the cases at hand, it is not in dispute that the undertakings concerned do not carry out input taxable transactions in the Member State where the refund applications have been made through their technical testing and research departments. As such, a right to refund of the output VAT paid must be granted. As this criterion is cumulative, there is no need to examine whether Daimler and Widex do actually have a “fixed establishment”. The purpose of the Directives is to enable taxable persons to obtain a refund of the output VAT where they could not deduct output VAT paid from input VAT due because they have no active taxable transactions in the Member State of refund. The actual carrying out of taxable transactions in the Member State of refund is therefore the common requirement for excluding the right to refund, whether or not the applicant taxable person has a fixed establishment in that State.

The ECJ concluded that a taxable person for VAT established in one Member State and carrying out in another Member State only technical testing or research work, not including taxable transactions, cannot be regarded as having in the other Member State a “fixed establishment from which business transactions are effected” within the meaning of article 1 of the Eighth Directive and article 3(a) of Directive 2008/9.

In respect of the third question in Case C-318/11 on whether the fact that the taxable person has in the Member State where it has applied for the refund a wholly-owned subsidiary whose purpose is almost exclusively to supply the person with services in respect of technical testing activity influences the interpretation given to the concept of “fixed establishment from which business transactions are affected”, the ECJ noted that a subsidiary is a taxable person on its own account and that the purchases of goods and services in the main proceedings were not made by it. The case at hand also differed from DFDS (Case C-260/95) where the independent status of the subsidiary was disregarded due to the commercial reality under which both the parent and the subsidiary had carried out the active taxable transactions of supplies of services in the Member State concerned. The condition that there are active input taxable transactions carried out by the technical department is not met and hence the existence of a wholly-owned subsidiary did not influence the interpretation given to the concept.

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Nirav Shah

FCE Bank case – Court of Appeal holds UK’s former group relief rules in breach of treaty non-discrimination article

On 17th October 2012, the Court of Appeal dismissed HMRC’s appeal in CRC v FCE Bank Plc. (a) Facts and legal background HMRC had appealed against a decision from the Upper Tribunal that the UK’s pre-2000 group relief rules breached the non-discrimination article in the United Kingdom – United States DTAA (1975). The Upper Tribunal’s decision itself upheld that of the First Tier Tribunal. The domestic tax rules at issue provided for the surrender of losses between two companies in a 75% group. As respects the subsidiaries, the rules provided that either (a) one company should be a 75% subsidiary of the other, or (b) that both companies should be 75% subsidiaries of a third company. The rules however provided that, where both the claimant and the surrendering company were 75% subsidiaries of a third company, that third company had to be resident in the United Kingdom. Two UK subsidiaries (FCE Bank Plc and Ford Motor Company Ltd.) wished to avail of the group relief provisions. Their parent company Ford Motor Company was resident in the United States of America. HMRC had refused the claim for group relief. FCE Bank argued that the denial of group relief was based on the fact that their parent company was not UK-resident, and contended that the provision was in breach of the non-discrimination article of the 1975 United Kingdom – United States double taxation treaty. (b) Decision The Court of Appeal accepted the taxpayer’s argument. The Court did not accept HMRC’s argument that the discrimination was not as a result of the place of residence of the parent company, but rather, was because the parent company was not subject to UK corporation tax. According to the Court, the parent company’s liability to UK corporation tax was immaterial for the purposes of the group relief provisions at issue. HMRC’s appeal was dismissed.

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Nirav Shah

Residence Tie-Breaker Test – A home is not a home once you lease it – Australia

The Australian Taxation Office released Interpretative Decision ATO ID 2012/93 that deals with a definition of a “permanent home available to the taxpayer” in the residence tie-breaker article of the Australia – Malaysia DTAA.

The taxpayer, after living in his own house in Australia, contracts to work in Malaysia for two years. The taxpayer anticipates that after two years, he will return to Australia and leases his house for a fixed term of two years. The taxpayer is a tax resident in both countries and therefore article 2.a of the Treaty will determine the residence of the taxpayer by reference to the country in which the taxpayer has a permanent home available to him. The question is therefore whether a permanent home that the taxpayer owns in Australia, but leases while he is away in Malaysia, continues to be a permanent home available to him.

The Interpretative Decision focuses on “available” and finds, through article 3.3, that the Oxford dictionary defines “available” as “capable of being used” and since the home is temporarily rented, it is not capable of being used by the taxpayer, in a sense that he cannot occupy it. It follows that the home is not available to him for the term of the lease agreement.

The Interpretative Decision also finds that the home would not be “permanent” under the OECD Commentaries, as the taxpayer has not “arranged to have the home available to him at all times continuously” (paragraph 13 of the Commentary on article 4).

It could perhaps be noted that the full sentence in the Commentaries says “… continuously, and not occasionally for the purpose of stay which is of short duration”.

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Nirav Shah

Belgian Constitutional Court decides that denial of carry-forward of non-deductible part of 95% foreign dividend deduction re non-EEA countries is compatible with equality principle of Belgian constitution – DTAA between Belgium and Korea (Rep) and between Belgium and Venezuela

On 10th November 2012, the Belgian Constitutional Court(Cour Constitutionelle/Grondwettelijk Hof) gave its decision in the case of Agfa Gevaert NV v. Belgische Staat, FOD Financiën, Administratie der Directe Belastingen en de Belgische Staat, Fod Financiën (No. 5259) on the constitutionality and compatibility with the 1994 protocol to the Belgium – Korea (Rep.) DTAA (1977) (as amended through 1994) and the 1993 protocol to the Belgium – Venezuela DTAA (1993) of the denial of a carry-forward of the non-deductible part of foreign dividends received from a Korean and Venezuelan subsidiary.

Court of Appeal Antwerp (Hof van Beroep Antwerpen) requested a preliminary ruling from the Belgian Constitutional Court on 22nd November 2011.

The Court first held that the denial of the carryforward possibility with respect to the non-deductible part of the 95% foreign dividend deduction for non EEA-countries is not incompatible with the equality principle of articles 10 and 11 of the Belgian Constitution. The Court held decisive that the EEA constitutes a special legal order which may justify that cross-border economic activities within the EEA are not always taxed in the same manner as economic activities between an EU/EEA Member State and third countries.

Furthermore, the Court considered that the legislature may take into consideration the budgetary consequences, when deciding whether or not to expand the carry-forward possibility with respect to non-deductible part of 95% foreign dividend deduction to third countries. In this context, the Court held that its decision will not be different if the budgetary aspect is not mentioned in the Parliamentary Documentation. Based on those arguments, the Court held that the different treatment is not incorrect or unreasonable.

With respect to the compatibility with articles 63 and 64 of the DTAA on the Functioning of the EU (TFEU) on the free movement of capital in respect of third countries, the Court held that the different treatment at issue does not result from the domestic provision at issue, but from the relevant EU provisions. The Court held that it is not competent to decide on such different treatment.

Finally, the Court also held that the laws concerning the ratification of the protocol to the tax treaty with Korea (Rep.) and the treaty with Venezuela are compatible with the equality principle of the Belgian Constitution. The Court based its decision on the fact that it held that a different treatment of dividends received from an EEA Member State and a third state is compatible. This means that the legislator also has the leeway to ratify a tax treaty which maintains such distinction.

In addition, the Court held that the equality principle neither requires that Belgium under each tax treaty signed guarantees the most beneficial outcome for the taxpayer under the laws existing at the time of signing nor that the same issues are regulated in the same manner under all tax treaties. Note: It has to be seen whether the different treatment at issue will also be EU compatible. In the first place, it must be noted that with respect to domestic provisions whose application does not depend on the size of the participation, both the freedom of establishment as well as the freedom of capital can be applicable.

If the freedom of capital would be applicable, the European Court of Justice (ECJ) has repeatedly held that the freedom of capital, generally, precludes all restrictions of the freedom of capital between EU Member States and third countries. For the determination whether a restriction nevertheless can be justified, it must be considered that capital flows with third countries take place in a different legal context than capital flows with EU Member States.

Finally, the ECJ has decided that movement of capital vis-à-vis third countries may, however, be justified for a reason, which would not constitute a valid justification for a restriction on capital movements between Member States. The different treatment in such cases can be based on the need to ensure the effectiveness of fiscal supervision or fiscal coherence.

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Nirav Shah

France – Court of Appeals – Hertogenbosch decision that sportsman is entitled to avoidance of double taxation for foreign employment income attributable to a test match not appealed before Supreme Court

In a Circular (No. 2012/03814HR) of 9th October 2012, the State Secretary for Finance announced that the decision of the Court of Appeals-Hertogenbosch that a sportsman is entitled to avoidance of double taxation for foreign employment income attributable to a test match will not be appealed before the Supreme Court.

The State Secretary held decisive that the test matches (held in Spain and Thailand) were open for the public, which means that the sportsman’s performance was aimed at an audience. In addition, he took the view that the Dutch Supreme Court would confirm its earlier decision of 7th February 2007, in which it was decided that if the employment contract obliges a sportsman to participate in games and races in foreign countries, the basic salary, generally, has to be allocated to his income from personal activities in the state of performance on a pro-rata basis, unless the employment contract indicates otherwise. In that case, the Supreme Court indicated that the term “personal activities” covers the performance aimed at an audience and time spent for activities related to such performance as training, availability services, travel and a necessary stay in the country of performance.

Furthermore, avoidance of double taxation was in that case also granted for training activities, sponsoring activities and contacts with the press.

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Nirav Shah

US Supreme Court grants certiorari regarding allowance of foreign tax credit for UK windfall tax

On 29th October 2012, the US Supreme Court granted a petition for a writ of certiorari filed by PPL Corporation and Subsidiaries (petitioner). PPL Corporation and Subsidiaries v. Commissioner of Internal Revenue, No. 12-43 (29th October 2012).

The petitioner filed the petition for a writ of certiorari on 9th July 2012 to request the US Supreme Court to resolve the conflicts between the US Third Circuit and Fifth Circuit regarding whether the US foreign tax credit (FTC) should be granted u/s. 901 of the US Internal Revenue Code (IRC) for the windfall tax imposed in the United Kingdom.

The question presented in the petition is whether, in determining the creditability of a foreign tax, courts should employ a formalistic approach that looks solely at the form of the foreign tax statute and ignores how the tax actually operates, or should employ a substance-based approach that considers factors such as the practical operation and intended effect of the foreign tax.

The windfall tax is a UK tax that was imposed on the privatised UK utilities as a one-time 23% assessment on the difference between the company’s “profit-making value” and its “floating value”, i.e. the price for which the UK government sold the company to investors. In the PPL Corporation case, the Court of Appeals for the Third Circuit concluded that the UK windfall tax fails to satisfy the gross receipts requirement and thus is not an income tax that is creditable against the US income tax.

PPL Corporation and Subsidiaries v. Commissioner of Internal Revenue, Docket No. 11-1069 (22nd December 2011). The Third Circuit made this conclusion on the ground that the UK windfall tax can be formulated as a 23% tax on a 2.25 multiple (i.e. 225%) of profits, which leads to the calculation of a tax base that begins with an amount greater than 100% of gross receipts.

In a similar case involving the UK windfall tax, the Fifth Circuit found the Third Circuit’s analysis to be too formalistic and determined that the UK tax is an income tax for which a US FTC is allowable. Entergy Corporation and Affiliated Subsidiaries v. Commissioner of Internal Revenue, Docket No. 10- 60988 (5th June 2012) Certiorari is a procedure by which the US Supreme Court exercises its discretion in selecting the cases it will review.

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Nirav Shah

Belgian Constitutional Court held that retroactive effect of 2009 Protocol is not unconstitutional – DTAA between Belgium and France

On 30th October 2012, the Belgian Constitutional Court (Grondwettelijk Hof/Court Constitutionelle) gave its decision in Xavier Deceunick and Stéphanie Coquard v. Belgian State (Case No. 5054) on the constitutionality of the retroactive effect of the 2008 protocol to the Belgium-France DTAA (“the Protocol”), with respect to the municipal surcharge. A preliminary ruling was requested by the Court of First Instance Bergen on 23th January 2012. Details of the case are summarised below:

(a) Facts:

The taxpayers were both residents in Belgium in 2008. One of the Taxpayers was a frontier worker who received employment income from France. Based on the Protocol, which became effective on 1st January 2010, the French employment income was included in the taxable base for the calculation of the municipal surcharge. Because several provisions of the Protocol for frontier-workers applied retroactively from 1st January 2009, the tax administration imposed municipal surcharges on the employment income derived in 2008, because it was taxed in the assessment year 2009. The Taxpayer reasoned that the retroactive effect was incompatible with the non-discrimination principle of articles 10 and 11 and 172 of the Belgian Constitution.

(b) Article 1 of the Protocol provides that employment income derived by frontier-workers is taxable in the source state. Articles 2 and 3 of the Protocol provide that:

• employment income derived by a Belgian resident in France, may be included in the taxable base for the municipal surcharge, which is in Mayur Nayak Tarunkumar G. Singhal, Anil D. Doshi Chartered Accountants International taxation line with article 466 of the Belgian Income Tax Act; and

• the Protocol will have retroactive effect from 1st January 2009.

(c) Decision: The Court observed that the retroactive effect creates legal uncertainty and therefore, only can be accepted if it can be justified by overriding reasons in the general interest. The Belgian government stipulated that it was necessary to include foreign employment income derived by frontier workers in the tax base for the municipal surcharge to decrease the financial problems of Belgian municipalities located in the frontier zone.

In the Explanatory Memorandum to the Protocol, it was indicated that it would be applied to income derived in the tax year 2008 (assessment year 2009). The Court held that the retroactive imposition does not disproportionately infringe the Taxpayer’s rights. The Court based its view on the fact that:

• taxpayers were sufficiently informed about the Protocol when it was signed; and

• taxpayers in France are taxed at a lower rate than in Belgium.

Consequently, the Court held that the retroactive effect of the Protocol was not unconstitutional.

Note: The decision deviates from a decision of the Court of First Instance (Gerecht van Eerste Aanleg) Leuven of 6th April 2012, in which it was decided that municipal surtax was due on income derived in the year that the 2008 protocol became effective. Article 167(2) of the Belgian Constitution regulates that Belgian tax treaties and protocols can only take effect after ratification. The decision of the Court of First Instance Leuven ignores the fact that contracting states often agree that a treaty or protocol should have retroactive effect. Nevertheless, it can be argued that the decision of the Court could be correct because article 3 of the Protocol provides that it will only take effect from 1st January 2009. Therefore, it can be reasoned that it was not the intention of the contracting states that the protocol applies to foreign employment income derived in 2008.

levitra

Nirav Shah

[2013] 32 taxmann.com 250 (Delhi – Trib.) Zeppelin Mobile System GmbH vs. ADIT A.Y.:2007-08, Dated: 12-04-2013

Section 48 – RBI guidelines for valuation of shares for transfer of shares are issued for FEMA purposes. Any addition to income on the ground of violation of same guidelines is not justified since the obligation to examine compliance with guidelines is that of RBI and Authorised Dealers.

Facts:
The taxpayer was a German company, and also a tax resident of Germany. The taxpayer had a closely held shares of unlisted subsidiary company in India. During the year under consideration, the taxpayer sold a portion of the shares held by it in the subsidiary to another unrelated Indian company @ Rs. 390 per share. AO assessed capital gain taking selling price of Rs. 400 per share on the ground that the value of the said shares was Rs. 400 per share as per the guidelines prescribed by RBI, and observing that since the transfer of shares was from non-residents to residents, RBI guidelines were binding. The DRP confirmed the addition made by the AO.

Held:
Perusal of guidelines shows that they are addressed to the Authorised Dealer banks and hence, they are required to examine the compliance and to take appropriate action for non-compliance. However, RBI had accorded its approval for transaction. Since lower authorities had not brought any adverse material on record, the DRP was not justified in confirming the addition.

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Nirav Shah

[2013] 33 taxmann.com 23 (Mumbai – Trib.) KPMG vs. JCIT A.Y.: 2004-05, Dated: 22-02-2013

Articles 4, 14 of India-UAE DTAA; Section 40(a)(i) – Mere right of a contracting state to tax a person is sufficient to treat him as resident even if no tax is paid in residence country

Facts
The taxpayer had paid professional fee and had reimbursed expenses to ‘V’ who was the sole proprietor of a professional firm in UAE without withholding tax at source, since the payee had not stayed in India for more than 183 days and he did not have a fixed base in India in terms of Article 14 of India-UAE DTAA.

According to the AO, under Article 4(1) of India- UAE DTAA, only a person who paid tax in UAE could be treated as a resident of UAE and since ‘V’ was not liable to pay tax in UAE, he cannot be treated as resident of UAE and hence, he disallowed the payments under section 40(a)(i) of the Act.

Held
a) The term “liable to tax” in the contracting State does not necessarily imply that the person should actually pay the tax in that contracting State. Right to tax on such person is sufficient.

b) Taxability in one country is not sine qua non for availing relief under DTAA. What is necessary is that a person should be liable to tax by reason of domicile, residence, place of management, place of incorporation or any other similar criterion which refers to fiscal domicile of such person. If the fiscal domicile of a person is in the contracting State, he is to be treated as resident of that contracting State irrespective of whether that person is actually liable to pay tax in that country.

c) Since fiscal domicile of ‘V’ in UAE has not been doubted, he should be treated as resident of UAE.

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Nirav Shah

Section 9 (i) (vii), Article 12 of India UK DTAA – Person exercising control and supervision real and economic employer of seconded employees – on facts payments by ICO to UK Co pure reimbursement – mere secondment does not result in rendering of services and hence not FTS – services did not make available any technical knowledge

16. Abbey Business Services (P) Ltd v DCIT
[2012] 53 SOT 401 (Bang)
Asst Years: 2005-06 & 2006-07. Dated: 18/07/2012

Section 9 (i) (vii), Article 12 of India UK DTAA – Person exercising control and supervision real and economic employer of seconded employees – on facts payments by ICO to UK Co pure reimbursement – mere secondment does not result in rendering of services and hence not FTS – services did not make available any technical knowledge

Facts:

The taxpayer was an Indian subsidiary company of a foreign company (“FCo”). FCo was a group company of a British company (“UKCo”). UKCo entered into an agreement with an Indian company (“ICo”) to outsource the provision of certain process and call centres to ICo. ICo was to provide financial and insurance services to customers of UKCo in the UK.

In order to ensure that high quality services were provided by ICo, UKCo entered into a consultancy agreement with the taxpayer for which the taxpayer was to be compensated at cost plus 12 %. Further, to facilitate the outsourcing agreement between UKCo and ICo, UKCo entered into an agreement for secondment of employees (“Secondment Agreement”) from UKCo to the taxpayer.

In terms of the Secondment Agreement, secondees were under the direct management, supervision and control of the taxpayer during the period of secondment. UKCo was not responsible for any loss or damage occasioned by the works done by the secondees. Secondees performed the tasks at such place, as instructed by taxpayer. At the same time, the secondees remained employees of. UKCo during secondment. Accordingly, UKCo (and not the taxpayer) was responsible to pay remuneration and any other employment benefits to secondees. In terms of section 192 of I T Act, UKCo withheld tax at source on salaries paid to secondees.

The taxpayer reimbursed to UKCo all payments and expenses incurred by UKCo in respect of seconded employees. However, the taxpayer did not withheld taxes on the amount reimbursed to UKCo. The AO was of the view that the reimbursements made to UKCo were in the nature of FTS and hence, the taxpayer ought to have withheld taxes on the same.

In appeal, the CIT(A) held that while reimbursement of salary cost was not subject to withholding, only reimbursement of other administrative expenses was liable for withholding. The issues before the Tribunal were as follows.

1. Whether the taxpayer can be regarded as the real and economic employer of the seconded employees?

2. Whether the payments made by the taxpayer to UKCo were pure reimbursement of expenses and if so, whether they constituted income of UKCo?

3. Whether the payments made by the taxpayer to UKCo constituted FTS u/s. 9(1)(vii) of I T Act?

4. Whether the payments made by the taxpayer to UKCo constituted FTS under Article 13(4) of India-UK DTAA?

Held:

The Tribunal observed and held as follows.

(i) Whether the taxpayer can be regarded as the real and economic employer of the seconded employees. The Tribunal reviewed the Secondment Agreement to determine who was vested with control and supervision of the seconded employees. It found that the taxpayer had control of the seconded employees and if the taxpayer so required, UKCo was obligated to withdraw any seconded employee. Also, UKCo was not liable or responsible for any loss or damage caused due to work of secondees. Thus, direct control and supervision of the seconded employees vested in the taxpayer. The clause stating that UKCo was to remain the employer was for ensuring social security and other benefit to the seconded employees. Hence, UKCo was mere ‘legal employer’ while the taxpayer was ‘real and economic employer’.

(ii) Whether the payments made by the taxpayer to UKCo were pure reimbursement of expenses and if so, whether they constituted income of UKCo

The Tribunal referred to the clause of the Secondment Agreement stating that in consideration for secondment of staff by UKCo, the taxpayer shall make payments equivalent to costs and expenses incurred by UKCo in respect of seconded employees. It further referred to the relevant account in the ledger of the taxpayer as also the Notes to Accounts which stated that the taxpayer reimburse all expenses incurred by UKCo in respect of seconded employees. Hence, following IDS Software Solutions (India) (P) Ltd v ITO [2009] 32 SOT 25 (Bang) (URO), the Tribunal held that the payments were mere reimbursements of salary and other costs.

As regards the second limb of the issue (i.e., whether these payments would be regarded as income chargeable in the hands of UKCo), the Tribunal reiterated the principle laid down in the case of TISCO v Union of India [2001] 2 SCC 41 that reimbursement of salary cost and other expenses cannot be regarded as income in the hands of the recipient since there was no profit or gain element in it.

(iii) Whether the payments made by the taxpayer to UKCo constituted FTS u/s. 9(1)(vii) of I T Act To constitute FTS u/s. 9(1)(vii) of I T Act, the consideration paid should have been for rendition of managerial, technical or consultancy services. Under the Secondment Agreement, the taxpayer had paid consideration only for secondment of staff and not for rendition of any services.
Therefore, the payments made by the taxpayer did not constitute FTS.

(iv) Whether the payments made by the taxpayer to UKCo constituted FTS under Article 13(4) of India-UK DTAA. As held earlier, the reimbursement cannot be regarded as income of UKCo. Also, it does not constitute FTS u/s. 9(1(vii) of I T Act. Since a DTAA cannot impose tax which is not contemplated or levied under I T Act, question of such payments constituting FTS under India-UK DTAA does not survive. In terms of Article 13(4) of India-UK DTAA, to constitute FTS, following two conditions should be satisfied.

(a) The consideration is paid for rendering of technical or consultancy services; and

(b) Such services ‘make available’ technical knowledge, experience, skill, know-how or process or consist of the development and transfer of a technical plant or design.

UKCo has not rendered any service to the taxpayer. Hence, condition (a) would not be satisfied. Further, even if secondment were to be considered as ‘service’, it could only be ‘managerial service’ (mentioned in section 9(1(vii)). However, Article 13(4) (c) includes only technical or consultancy services. Hence, the payment fails the test in (a) above. Additionally, condition (b) requires that services ‘make available’ technical knowledge, etc. As no technical knowledge, etc. was ‘made available’ by UKCo, it also fails the test in (b) above.

levitra

Nirav Shah

Section 9(1)(vii) – Royalty received by a non resident (NR) from various NR manufacturers of CDMA equipments (which were sold worldwide, including India) is not taxable in India, as the NR manufacturer did not carry on a business in India nor did the customers who purchased the equipment constitute the source of income in India.

21. TS-35-ITAT-2013(Del)
Qualcomm Incorporated vs. ADIT
A.Ys.: 2000-2001 to 2004-05, Dated: 31-1-2013

Section 9(1)(vii) – Royalty received by a non resident (NR) from various NR manufacturers of CDMA equipments (which were sold worldwide, including India) is not taxable in India, as the NR manufacturer did not carry on a business in India nor did the customers who purchased the equipment constitute the source of income in India.

Facts

A US Company (Taxpayer) had licensed certain intellectual property (IP) relating to the manufacture of Code Division Multiple Access (CDMA) mobile handsets and network equipment to non-resident Original Equipment Manufacturers (OEMs). The OEMs used the licensed IP to manufacture CDMA handsets and wireless equipment outside of India and sold them to customers worldwide, including India. The Indian customers, in turn, sold the handsets to end-users of telecom services in India.

The tax authority assessed a part of royalty, to the extent it related to equipment sold to customers in India by suggesting that part was taxable in India as the IP that was licensed was utilised in a business carried on in India or was for earning income from India sources (the secondary source rule) as per section 9(1)(vii)(c) of the Act. The CIT(A) upheld the order of the tax authority. Aggrieved, the Taxpayer filed an appeal before the Tribunal.

Held

The Tribunal based on the following ruled that the secondary source rule was not applicable to the facts of the case, as the OEMs did not carry on a business in India nor did the Indian customers who purchased the equipment constitute the source of income. Accordingly, the royalty was not taxable in the hands of the taxpayer.

Onus of proof is on tax authority to establish that the non-resident (NR) was carrying on business in India. It is not important whether the right or property is used “in” or “for the purpose of a business”, but to determine whether such business is “carried on by the NR in India”.

Sale to Indian customers without any operations being carried out in India would amount to business ‘with’ India and not business ‘in’ India. For business to be carried out in India, there should be some activity carried out in India.

Further, the IP was not used in India. Use of the products by Indian customers which embed the licensed technology does not amount to use of the IP by the OEMs in India. The OEMs manufactured the products outside India. Hence, the license for the IP of the Taxpayer was used by the OEMs in manufacturing the products outside India. The source of royalty is the place where patent (right, property or information) was exploited, and in the facts of the case, it is where the manufacturing activity took place, which was outside India. Further, as per the agreement, the title of the equipment passed to the Indian customers in high seas before arrival in India. Notwithstanding this, the mere passing of the title with no other activity in India does not result in any income being attributable to the NR for taxation in India.

The clarification inserted to the definition of royalty by the Finance Act, 2012 with regard to taxability of computer software as royalty, has no effect in the present case as the issue on hand was regarding taxability of royalty on patents relating to licensing of IP for manufacture of CDMA handsets and equipment and not on licensing of any computer software.

levitra

Nirav Shah

Taxability of Capital Gains in India in Respect of Transfer of Shares of a Non-resident Entity Holding Shares of an Indian Company, Between two Non-residents in a Tax treaty Situation

Background

In the present era of globalisation, cross border movement of goods, services, capital and people has gone up significantly over the years. With the increased quantum of international trade, commerce and services, issues relating to double taxation of income in two different countries/ jurisdictions assume a lot of significance. Issues and considerations relating to cross border taxation of income have become a very important part of the structuring of businesses, entities and transactions, in the case of Multinational Enterprises/corporations [MNCs].

In order to encourage cross border movement of goods, services, capital and people and avoidance of double taxation, various bilateral Double Taxation Avoidance Agreements [DTAAs] have been entered into, between various countries. India has so far entered into DTAAs with 84 countries.

To minimise the tax cost of undertaking the cross border business/commerce, various measures are evaluated in depth and adopted in structuring various cross border business entities/transactions. This has led to growth/ identifications of various low tax jurisdictions/ tax havens, through which business entities/ transactions are structured/entered into, to save/ lower overall tax cost of the MNCs and/or to shift profits to low tax jurisdictions.

One of the most common measures used is to Mayur Nayak Tarunkumar G. Singhal, Anil D. Doshi Chartered Accountants International taxation create intermediate holding companies in the low tax/nil tax jurisdictions which would hold shares in the operating subsidiary companies in the source countries where the operations of the MNCs are carried out through the wholly owned subsidiaries and/or joint ventures. At the intended time of exit/transfer of business of the subsidiary, instead of transfer of the shares in the subsidiary company in the source country, the shares of the intermediate company are transferred by the MNCs to the prospective nonresident buyers, whereby no tax is payable in the source country, but at the same time, business is effectively transferred to the prospective nonresident buyers. This kind of practice has led to erosion of tax base of various countries and significantly impacted the tax revenues of those countries. Accordingly, the governments/ revenue department of various counties have, in order to protect their tax base, taxed such transactions based on various prevalent/innovative legal principles.

In this regard, in the Indian context, the case of Vodafone International Holdings BV (Vodafone) generated a lot of discussions and has been intensely debated in the country and outside.

Vodafone’s case

Vodafone International Holdings BV (Vodafone), a company resident for tax purposes in Netherlands, acquired the entire share capital of CGP Investments (Holdings) Ltd. (CGP), a company resident for tax purposes in Cayman Islands qua a transaction dated 11-2-2007. On 31-05-2010, the Revenue passed an order u/s. 201(1) and 201(1A) of the Income-tax Act, 1961 [the Act] declaring the transaction to be taxable under the Act. Revenue raised a demand for tax on capital gains arising out of the sale of CGP share capital contending that CGP, while not a tax resident in India, held the underlying Indian assets of Hutchison Essar Ltd. [HEL] and the aim of the transaction was the acquisition of a 67% controlling interest in HEL, an Indian company. On a writ petition by Vodafone against the order u/s. 201(1)/201(1A), the Bombay High Court held against the assessee. Vodafone challenged this decision successfully before the Supreme Court [SC] where SC held in favour of Vodafone. [Vodafone International Holdings B.V. vs. Union of India [2012] 341 ITR 0001 (SC)].

Hutch group (Hong Kong) through participation in a joint venture vehicle invested in telecommunications business in India in 1992. The JV later came to be known as Hutchison Essar Ltd. (HEL). In 1998, CGP was incorporated in Cayman Islands, with limited liability and as an “exempted company”. CGP later became a wholly owned subsidiary of a company which in turn became a wholly owned subsidiary of a Hong Kong company – HTL, which was later listed on the Hong Kong and New York Stock Exchanges in September, 2004.

Vodafone, though not directly a case involving Tax-Treaty implications on domestic tax laws (there being no tax Treaty between India and Cayman Islands), nevertheless considered the application and interpretation of Indian Tax Legislation (the ‘Act’) in the context of an applicable and operative tax treaty, since the correctness of Union of India vs. Azadi Bachao Andolan [2003] 263 ITR 703 [SC] [Azadi Bachao] was raised by Revenue. Revenue contended that Azadi Bachao requires to be over-ruled to the extent it departs from McDowell and Co. Ltd. vs. CTO [1985] 154 ITR 148 [SC] [McDowell] and on the ground that Azadi Bachao misconstrued the essential ratio of McDowell and had erroneously concluded that Chinnappa Reddy, J’s observations were not wholly approved by the McDowell majority qua the leading opinion of Ranganath Misra, J.

Relevant observations/conclusions in Vodafone

Tracing the history and evolution of relevant principles by the English Courts commencing with IRC vs. Duke of Westminster 1936 AC 1[Duke of Westminster] through W.T. Ramsay vs. IRC 982 AC 300 [ Ramsay]; Furniss (Inspector of Taxes) vs. Dawson [1984] 1 All E. R. 530 [Furniss] and Craven vs. White (1988) 3 All E. R. 495 [Craven], the Supreme Court in Vodafone explained that the Westminster principle was neither dead nor abandoned; Westminster did not compel the court to look at a document or transaction isolated from the context to which it properly belonged and it is the task of the court to ascertain the legal nature of the transaction and while so doing, to look at the entire transaction as a whole and not adopt a dissecting approach;

The Court ruled that Westminster, read in the proper context, permitted a “device” which was colourable in nature to be ignored as a fiscal nullity; Ramsay enunciated the principle of statutory interpretation rather than an over-arching anti-avoidance doctrine imposed upon tax laws; Furniss re-structured the relevant transaction, not on any fancied principle that anything done to defer the tax must be ignored, but on the premise that the inserted transaction did not constitute “disposal” under the relevant Finance Act; from Craven the principle is clear that Revenue cannot start with the question as to whether the transaction was a tax deferment/saving device but must apply the “look at” test to ascertain its true legal nature; and that strategic tax planning has not been abandoned.

McDowell majority held that tax planning may be legitimate, provided it is within the framework of law; colourable devices cannot be a part of tax planning and it would be wrong to encourage the belief that it is honourable to avoid payment of tax by resorting to dubious methods; and agreed with Chinnappa Reddy, J’s observations only in relation to piercing the (corporate) veil in circumstances where tax evasion is resorted to through use of colourable devices, dubious methods and subterfuges.

McDowell does not hold that all tax planning is illegal/illegitimate/impermissible. While artificial schemes and colourable devices which constitute dubious methods and subterfuges for tax avoidance are impermissible, they must be distinguished from legitimate avoidance of tax measures.

The court held that reading McDowell properly and as above, in cases of treaty shopping and/ or tax avoidance, there is no conflict between McDowell and Azadi Bachao or between McDowell and Mathuram Agrawal vs. State of Madhya Pradesh [1999] 8 SCC 667 [Mathuram].

Vodafone on International Tax aspects of holding structures

In matters of corporate taxation, provisions of the Act delineate the principle of independence of companies and other entities subject to income tax. Companies and other entities are viewed as economic entities with legal independence vis-à-vis their shareholders/participants. A subsidiary and its parent are distinct taxpayers. Consequently, entities subject to income tax are taxed on profits derived by them on stand-alone basis, irrespective of their actual degree of economic independence and regardless of whether profits are reserved or distributed to shareholders/participants.

It is fairly well-settled that for tax treaty purposes, a subsidiary and its parent are totally separate and distinct taxpayers.

The fact that a group parent company gives principle guidance to group companies by providing generic policy guidelines to group subsidiaries and the parent company exercises shareholder’s influence on its subsidiaries, does not legitimise the assumption that subsidiaries are to be deemed residents of the State in which the parent company resides. Mere shareholder’s influence (which is the inevitable consequence of any group structure) and absence of wholesale subordination of the subsidiaries’ decision making to the parent company, would not per se legitimise ignoring the separate corporate existence of the subsidiary.

Whether a transaction is used principally as a colourable device for the division of earnings, profits and gains, must be determined by a review of all the facts and circumstances surrounding the transaction. It is in the aforementioned circumstances that the principle of lifting the corporate veil or the doctrine of substance over form or the concept of beneficial ownership or of the concept of alter ego arises.

It is a common practice in international law and is the basis of international taxation, for foreign investors to invest in Indian companies through an interposed foreign holding company or operating company (such as Cayman Islands or Mauritius based) for both tax and business purposes. In doing so, foreign investors are able to avoid the lengthy approval and registration processes required for a direct transfer, (i.e., without a foreign holding or operating company) of an equity interest in a foreign invested Indian company.

Holding structures are recognised in corporate as well as tax law. Special purpose vehicles (SPV) and holding companies are legitimate structures in India, be it in Company law or Takeover Code under the SEBI and provisions of the Act.

When it comes to taxation of a holding structure, at the threshold, the burden is on Revenue to allege and establish abuse in the sense of tax avoidance in the creation and/or use of such structure(s). To invite application of the judicial anti-avoidance rule, Revenue may invoke the “substance over form” principle or “piercing the corporate veil” test only after Revenue establishes, on the basis of the facts and circumstances surrounding the transaction, that the impugned transaction is a sham or tax- avoidant. If a structure is used for circular trading or round tripping or to pay bribes (for instance), then such transactions, though having a legal form, could be discarded by applying the test of fiscal nullity. Again, where Revenue finds that in a holding structure an entity with no commercial/ business substance was interposed only to avoid tax, the test of fiscal nullity could be applied and Revenue may discard such inter-positioning. This has however to be done at the threshold. In any event, Revenue/Courts must ascertain the legal nature of the transaction and while doing so, look at the entire transaction holistically and not adopt a dissecting approach.

Every strategic FDI coming to India as an investment destination should be seen in a holistic manner; and in doing so, must keep in mind several factors: the concept of participation in investment; the duration of time during which the holding structure exists; the period of business operations in India; generation of taxable Revenues in India; the timing of the exit; and the continuity of business on such exit. The onus is on the Revenue to identify the scheme and its dominant purpose.

There is a conceptual difference between a pre-ordained transaction which is created for tax avoidance purposes, on the one hand, and a transaction which evidences investment to participate in India. In order to find out whether a given transaction evidences a preordained transaction in the sense indicated above or constitutes investment to participate, one has to take into account the factors enumerated hereinabove, namely, duration of the time during which the holding structure existed, the period of business operations in India, generation of taxable revenue in India during the period of business operations in India, the timing of the exit, the continuity of business on such exit, etc. Where the court is satisfied that the transaction satisfies all the parameters of “participation in investment”, then in such a case, the court need not go into the questions such as de-facto control vs. legal control, legal rights vs. practical rights, etc.

A company is a separate legal persona and the fact that all its shares are owned by one person or by its parent company has nothing to do with its separate legal existence. If the owned company is wound up, the liquidator, and not the parent company, would get hold of the assets of the subsidiary and the assets of the subsidiary would in no circumstance be held to be those of the parent, unless the subsidiary is acting as an agent. Even though a subsidiary may normally comply with the request of the parent company, it is not a mere puppet of the parent. The dis-tinction is between having power and having a persuasive position.

Unlike in the case of a one man company (where one individual has a 99% shareholdings and his control over the company may be so complete as to be his alter ego), in the case of a multinational entity, its subsidiaries have a great measure of autonomy in the country concerned, except where subsidiaries are created or used as sham. The fact that the parent company exercises shareholders’ influence on its subsidiary cannot obliterate the decision making power or authority of its (subsidiary’s) Directors. The decisive criterion is whether the parent company’s management has such steering interference with the subsidiary’s core activities that the subsidiary could no longer be regarded to perform those activities on the authority of its own managerial discretion.

Exit is an important right of an investor in every strategic investment and exit coupled with continuity of business is an important telltale circumstance, which indicates the commercial/ business substance of the transaction.

Court’s Analysis of the transaction and persona of CGP

Two options were available for Vodafone acquiring a controlling participation in HTIL, the CGP route and the Mauritius route. The parties could have opted for anyone of the options and opted for the CGP route, for a smooth transition of business on divestment by HTIL. From the surrounding circumstances and economic consequences of the transaction, the sole purpose of CGP was not merely to hold shares in subsidiary companies but also to enable a smooth transition of business, which is the basis of the SPA. Therefore, it cannot be said that the intervened entity (CGP) had no business or commercial purpose.

The above conclusions, of the business and commercial purpose of CGP, were arrived at despite noticing that under the Company laws of Cayman Islands an exempted company was not entitled to conduct business in the Cayman Islands; that CGP was an exempted company; and its sole purpose is to hold shares in a subsidiary company situated outside Cayman Islands.

Revenue’s contention that the situs of CGP shares exist where the underlying assets are situated (i.e., in India), was rejected on the ground that under the Companies Act, 1956, the situs of the shares would be where the company is incorporated and where its shares can be transferred. On the material on record and the pleadings, the court held that the situs of the CGP shares was situated not in India where the underlying assets (of HEL) are situated but in Cayman Islands where CGP is incorporated, transfer of its shares was recorded and the register of CGP shareholders was maintained.

The Supreme Court in Vodafone concluded that the High Court erred in assuming that Vodafone acquired 67% of the equity capital of HEL. The transaction is one of sale of CGP shares and not sale of CGP or HEL assets. The transaction does not involve sale of assets on itemised basis. As a general rule, where a transaction involves transfer of the entire shareholding, it cannot be broken up into separate individual component assets or rights such as right to vote, right to participate in company meetings, management right, controlling right, controlled premium, brand licenses and so on, since shares constitute a bundle of rights – Charanjit Lal Chowdhury vs. UoI AI 1951 SC 41; Venkatesh (Minor) vs. CIT [1999] 243 ITR 367 (Mad) and Smt. Maharani Ushadevi vs. CIT [ 1981] 131 ITR 445 [MP] were referred to with approval and followed.

Merely since at the time of exit capital gains tax does not become payable or the transaction is not assessable to tax, would not make the entire sale of shares a sham or tax avoidant.

Parties to the transaction have not agreed upon a separate price for the CGP share and a separate price for what is called “other rights and entitlements” [including options, right to non-compete, control premium, customer base, etc]. It is therefore impermissible for Revenue to split the payment and consider a part of such payment for each of the above items. The essential character of the transaction as an alienation is not altered by the form of consideration, the payment of the consideration in installments or on the basis that the payment is related to a contingency (“options”, in this case), particularly when the transaction does not contemplate such a split up.

Retrospective amendments in sections 2(14), 2(47) and 9(1)(i) of the Act by the Finance Act, 2012

Provisions of sections 2(14), 2(47) and 9(1) (i) of the Act were amended by the Finance Act, 2012, to operate with retrospective effect from 1-4-1962, effectively to nullify the impact of the judgement of the Supreme Court in the case of Vodafone and to protect the tax base as well as to safeguard revenue’s interest in many such similar cases.

In this connection, it is important to note the relevant portion of the Finance Minister’s speech on 7-5-2012, while introducing the Finance Bill, 2012, which reads as under:

“7. Hon’ble Members are aware that a provision in the Finance Bill which seeks to retrospectively clarify the provisions of the Income Tax Act relating to capital gains on sale of assets located in India through indirect transfers abroad, has been intensely debated in the country and outside. I would like to confirm that clarificatory amendments do not override the provisions of Double Taxation Avoidance Agreement (DTAA) which India has with 82 countries. It would impact those cases where the transaction has been routed through low tax or no tax countries with whom India does not have a DTAA.” (emphasis added)

Taxability of capital gains in India in respect of transfer of shares of a non-resident entity holding shares of an Indian Company, between two non-residents in a tax treaty situation

As mentioned above, in the Vodafone’s case, there was no Tax treaty involved as shares of a Cayman Islands company were transferred by the Hongkong based holding company to the Netherlands based Buyer company Vodafone and India does not have any DTAA with Cayman Islands or Hong Kong.

In the context of taxability of capital gains in India in respect of transfer of shares of a non-resident entity holding shares of an Indian Company, between two non-residents, in a similar case but in a tax treaty situation, some very important questions arise for consideration, which are, inter alia, as follows:

(1) Whether an intermediate entity [IE] is not with commercial substance; is a sham or illusory contrivance, a mere nominee of its holding company and/or holding company being the real, legal and beneficial owner(s) of Indian Company’s [Indco] shares; and a device incorporated and pursued only for the purpose of avoiding capital gains liability under the Act?

(2) Whether it can be said that an investment, initially made by the holding company through IE in Indco, a colourable device designed for tax avoidance? If so, whether the corporate veil of IE must be lifted and the transaction (of the sale of the entirety of IE shares by Holdco to non -resident buyer) treated as a sale of Indco’s shares?

(3) Is such a transaction (on a holistic and proper interpretation of relevant provisions of the Act and the applicable DTAA), liable to tax in India?

(4) Whether retrospective amendments to provisions of the Act (by the Finance Act, 2012) alter the trajectory or impact provisions of the DTAA and/or otherwise render the trans-action liable to tax under the provisions of the Act?

Andhra Pradesh High Court’s [High Court] land-mark decision in the case of Sanofi Pasteur Holding SA [2013] 30 taxmann.com 222 (AP) dated 15-2-2013

On similar issues which arose for consideration of the Andhra Pradesh High Court in the Writ petitions filed by Sanofi Pasteur Holding SA and others, the AP High Court, in a very detailed, very well considered and articulated judgement, has affirmed certain long established principles. Primarily, it has reiterated the view that the retrospective amendment does not alter the provisions of tax treaty. It has also reaffirmed the various factors brought out in the Vodafone decision while considering whether an entity is a sham entity or conceived only for tax-avoidance purposes.

The court also refused to lift the corporate veil in the absence of sound justification and more so where a case of tax avoidance is not established. This decision also reiterated that an Indian Tribunal or Court is bound by the ruling of jurisdictional superior judicial authority.

The brief facts of the case, issues before court, the tax department’s contention, the petitioner’s contention and the conclusions of the High Court are summarised below.

Brief facts:

Shantha Biotechnics Limited (SBL) is a company incorporated under the Companies Act, 1956 having its registered office in Hyderabad, India. Sanofi Pasteur Holding (Sanofi) is a company incorporated under the laws of France. During the year 2009, Sanofi had purchased 80.37 % of the share capital of another French company (i.e. ShanH) from Merieux Alliance (MA), a French company, and balance 19.63 % share capital of ShanH from Groupe Industriel Marcel Dassault (GIMD), another French company. ShanH held 82.5 % of the share capital of SBL.

The tax department passed an order on Sanofi dated 25th May 2010, u/s. 201(1)/(1A) of the Act, holding Sanofi as an `assessee-in-default’ for not withholding taxes on payments made to MA and GIMD on acquisition of shares of ShanH. MA and GIMD made an application to the Authority for Advance Ruling (the AAR) on the taxability of the transaction. The AAR in November 2011 ruled that the capital gain arising from the sale of shares of ShanH by MA and GIMD was taxable in India in terms of Article 14(5) of the India-France tax treaty.

Later, both the parties i.e. the Buyer (Sanofi) and Sellers (MA and GIMD) filed writ petitions before the High Court.

Department’s contentions

The Share Purchase Agreement (SPA) dated 10th July, 2009 between MA, GIMD and Sanofi was only for the acquisition of the control, management and business interests in SBL and was not mere divestment of shares of ShanH. As a result, capital assets in India were transferred and capital gains had accrued to MA and GIMD in India. ShanH is not a company with an independent status and is only an alter ego of MA and GIMD, the latter are the legal and beneficial owners of shares of SBL. ShanH had no control over SBL management nor enjoyed any rights and privileges in SBL as a shareholder. ShanH is at best a nominee of MA in relation to SBL’s shares.

There was no conflict between the provisions of the Act pursuant to the retrospective amendments carried out by the Finance Act, 2012 and the tax treaty. The transaction was taxable in India since the right was allocated to India under Article 14(5) of the tax treaty. For a proper and purposeful construction of the tax treaty provisions, the expression ‘alienation of shares’ in Article 14(5) of the tax treaty must be understood as direct as well as indirect alienation.

The retrospective amendments to section 2(47) of the Act, by the Finance Act, 2012, clarifies that ‘transfer’ would mean and would deem to have always meant the disposal of an asset whether directly or indirectly or voluntarily or involuntarily. The retrospective clarificatory amendments do not seek to override the tax treaty. In case of a conflict between the domestic law and the tax treaty, the tax treaty will prevail in terms of Section 90 of the Act. In the present case, there is however, no conflict between the tax treaty and the provisions of the Act. Therefore, once the right to tax the gains stand allocated to the source country, domestic law provisions of the source country will have to be read into the tax treaty in terms of Article 3(2) of the tax treaty, where any expression has not been defined in a tax treaty. Since ‘alienation’ is not defined in the tax treaty, its meaning has to be imported from the domestic law, as amended by the FA 2012. This exercise does not amount to overriding the tax treaty and in fact amounts to giving effect to Article 3(2) of the tax treaty.

Since MA and GIMD are owners of SBL shares, both legal and beneficial, it is MA and GIMD which have the participating interest in SBL. The disposal of participating interest, whether directly or through a nominee entity like ShanH would not take the capital gains out of the ambit of Article 14(5) of the tax treaty. If the right to tax vests in India, the mode of disposal was immaterial, whether direct, indirect or deemed disposal.

Petitioner’s contentions

On a reading of section 90 of the Act with relevant provisions of the tax treaty, the capital gain in the Sanofi’s transaction was taxable only in France. Only Article 14(4) of the tax treaty permits a limited ‘see through’, not Article 14(5) of the tax treaty. Neither in law nor qua Article 14 of the tax treaty could an asset held by a company be treated as an asset held by a shareholder.

Controlling interest is not a separate asset independent of shares. Even if controlling interest over SBL by ShanH is viewed as a separate right or asset, the situs of the controlling Interest was located and taxable only in France under Article 14(6) of the tax treaty.

Since the cost of acquisition was not determinable for controlling rights and underlying assets; there being no date of acquisition nor there being any part of the consideration apportionable to these rights, the computation provision of capital gains would fail and taxing the transaction on the underlying assets theory would be inoperative.

ShanH is a company incorporated in France. It is a joint venture between MA and GIMD to act as an investment vehicle. It had a separate Board of Directors and was filing tax returns in France. Setting up of SPVs (France) is considered necessary to protect the interest of investors. Without incorporation of ShanH as a distinct investment entity, it would not have been possible to interest GIMD (with no expertise in the field of vaccines to come on board ShanH, as an investment partner.)

Further, ShanH obtained FIPB approval for investment in the shares of SBL. The AAR ruling is contrary to settled legal principles and erroneous. Since the transaction was not taxable in India, Sanofi was not required to withhold tax.

Relevant issues before High Court

Is ShanH not an entity with commercial substance? Is it a mere nominee of MA and/or MA/ GIMD who are the real, legal and beneficial owners of SBL’s shares? Is ShanH a device incorporated and pursued only for the purpose of avoiding capital gains liability under the Act?

Was the investment, initially by MA and thereafter by MA and GIMD through ShanH in SBL, a colourable device designed for tax avoidance? If so, whether the corporate veil of ShanH must be lifted and the transaction (of the sale of the entirety of ShanH shares by MA/GIMD to Sanofi) treated as a sale of SBL shares?

Is the transaction (on a holistic and proper interpretation of relevant provisions of the Act and the tax treaty), liable to tax in India?

Whether retrospective amendments to provisions of the Act (by the Finance Act, 2012) alter the trajectory or impact provisions of the tax treaty and/or otherwise render the transaction liable to tax under the provisions of the Act?

Decision of the High Court

In respect of commercial substance of ShanH

The High Court observed that ShanH as a French resident corporate entity is a distinct entity of commercial substance, distinct from MA and GIMD. It was incorporated to serve as an investment vehicle, this being the commercial substance and business purpose i.e. of foreign direct investment in India by way of participation in SBL.

ShanH received and continues to receive dividends on its SBL shareholding which have been and are assessable to tax under provisions of the Act; and even post the transaction in issue, the commercial and business purpose of ShanH as an investment vehicle is intact. These indicators/ factors are, in the light of Vodafone International Holdings B.V., adequate base to legitimise the conclusion that ShanH is not a sham or conceived only for Indian tax-avoidance structure.

In respect of lifting of corporate veil of ShanH

The High Court observed that, on an analysis of the transactional documents and surrounding circumstances, ShanH was not conceived for avoiding capital gains liability under the provi-sions of the Act. The same has also not been contested by the tax department. Further, the High Court observed that in the light of the ratio laid down by the SC in Azadi Bachao Andolan and Vodafone International Holdings B.V., ShanH is not a corporate entity brought into existence and pursued only or substantially for avoiding capital gains tax liability under the provisions of the Act.

As observed in the Vodafone International Holdings B.V. factual context (equally applicable in this case), ShanH was conceived and incorporated in conformity with MA’s established business prac-tices and organisational structure.

The fact that a higher rate of capital gains tax is payable and has been remitted to Revenue in France, lends further support to the Sanofi’s contention that ShanH was not conceived, pursued and persisted with, to serve as an India tax-avoidance device. Since the tax department failed to establish that the genesis and continuance of ShanH establishes as an entity of no commercial substance and/or that ShanH was interposed only as a tax avoidant device, no case was made out for piercing or lifting the corporate veil of ShanH. Even subsequent to the transaction in issue and currently as well, ShanH continues in existence as a registered French resident corporate entity and as the legal and beneficial owner of shares of SBL.

Independent of the conclusion that there was no case piercing the corporate veil of ShanH, the transaction in issue was clearly one of transfer by MA and GIMD of their shareholding in ShanH to Sanofi and it was not a case of transfer of shareholding in SBL, which continues with ShanH.

In respect of impact of retrospective amendments

The meaning and trajectory of the retrospective amendments to the Act must be identified by ascertaining the legal meaning of the amendments, considered in the light of the provisions of the Act and the mischief that the amendments are intended to address. The retrospective amendments do not alter the provisions of the tax treaty and given the text of section 90(2) of the Act, these amendments do not alter the taxability of the present transaction.

Further, the retrospective amendments in section 2(14), 2(47) and section 9 of the Act are not fortified by a non -obstante clause to override the provisions of the tax treaties.

No liability to tax in India

The present transaction was for alienation of 100 % of shares of ShanH held by MA and GIMD in favour of Sanofi and such transaction falls within Article 14(5) of the tax treaty. The transaction neither constitutes the transfer nor deemed transfer of shares or of the control/management or underlying assets of SBL.

The controlling interest of ShanH over the affairs, assets and management of SBL being identical to its shareholding and not a separate asset, it cannot be considered or computed as a distinctive value. The assets of SBL cannot be considered as belonging to a shareholder (even if a majority shareholder). The value of the controlling rights over SBL attributable to ShanH shareholding is also incapable of determination and computation. There was also the issue of value of Shantha West, a subsidiary of SBL. For these reasons, the computation component which is inextricably integrated to the charging provision (section 45 of the Act) fails, and consequently the charging provision would not apply. The transaction was not liable to tax in India under the provisions of the Act read with the provisions of the tax treaty.

Conclusions
It appears that in the case of Sanofi, the fact that the intermediate company ShanH was located in France and tax was paid in France on the capital gains at a rate of tax higher than in India, may have had significant influence in deciding the case in favour of the petitioners.

In this connection, attention of the readers is invited to the Report of the Expert Committee on Retrospective Amendments relating to Indirect Transfer headed by Shri Parthasarathi Shome.

Considering the decision of Vodafone, subsequent retrospective amendments by the Finance Act, 2012 and the landmark decision of the AP high Court in Sanofi’s case, it may be plausible to take a view that in similar transactions, in a tax treaty situation, the same may not be liable to tax in India. Media reports indicate that many such cases are pending before various high courts. However, keeping in mind the past trend and the approach of the tax department, surely the final word on the subject would be probably said only after the decision of the SC is rendered on the issue.

Nirav Shah

US Tax Goes Global

Introduction

Ensuring tax compliance and establishing tax discipline is the basic objective of lawmakers and for some unexplained reasons, jumping the tax payments is many tax payers’ delight across the world. Eventually when law enforcers realise the weakness of the stick, they offer carrots of amnesty schemes now and then and the United States of America is no exception.

In 2009 and 2011 the Internal Revenue Service (IRS) offered schemes of Overseas Voluntary Disclosure Initiatives (OVDI) for tax defaulters to come clean about paying their taxes on their hitherto undisclosed foreign income and also to adhere to the requirements of yearly disclosure of foreign financial assets under the Foreign Bank Account Reporting (FBAR). Having received a lukewarm response to the OVDI, the IRS introduced Overseas Voluntary Disclosure Programme (OVDP), which is presently open. Apart from this, Foreign Assets Tax Compliance Act (FATCA) has become effective from the year 2011.

Under FATCA, tax payers who are US citizens, Green Card holders or resident aliens are required to declare their foreign financial assets to the IRS. However, through FATCA, US lawmakers have, probably for the first time, also sought to stretch the geographical limits of the IRS jurisdiction to almost all the nations, and the responsibility of collecting taxpayer’s information is cast on global institutions. No doubt, Double Tax Treaties grant abundant rights to tax authorities to seek tax payer’s information, but FATCA turns the tables by entrusting the responsibility of collecting and providing information as regarding financial affairs of all US citizens and US address accounts on banks, mutual funds, insurance companies, broking houses and other financial institutions across the world, thereby tightening the IRS grip to control possible tax evasion.

[http://www.treasury.gov/press-center/press-releases/ Pages/tg1759.aspx]

Effective 1st January, 2014 many Non-Resident Indians (NRI) of US who by ignorance or otherwise have failed to submit FBAR and FATCA reports or declare Indian income in US tax returns may face punitive action. It would therefore, be prudent for every NRI to understand and address these important changes being implemented next year. The most innocent mistake NRIs residing in the US tend to make is the non-declaration of their Indian assets owned prior to migration and financial assets inherited or received through partition of family which are otherwise covered by reporting requirements of FBAR and FATCA and non-payment of tax on income generated out of such assets.

US Engaging with India for compliance

US Treasury has initiated the signing of agreements with various Governments requiring domestic financial institutions operating in their country to provide requisite information for the calendar year 2013 of all US citizens and US addressee customers to the IRS from 1st January, 2014. While governments of UK, Denmark and Mexico have already signed such an agreement. France, Germany, Spain, and Italy are in the process of concluding the agreements. Efforts are being made to enter into similar agreements with many other countries.

As posted in the US Embassy report, US Treasury Secretary Mr. Timothy Geithner and US Federal Reserve Chairman Mr. Ben Bernanke met the Finance Minister of India and the Prime Minister of India on the 9th October, 2012 and discussed various options and possible actions for combating tax evasion by US-based NRIs.[http://newdelhi.usembassy.gov/sr100913.html].

As a consequence, the Reserve Bank of India has been asked to draft a domestic legislation requiring Indian banks, mutual funds, insurance companies, broking houses and other financial institutions to provide information of investments of US citizens and US addressees to the IRS from 1st January, 2014. [http://articles.economictimes.indiatimes.com/2012-11- 27/news/35385827_1_financial-assets-fatca-financialinstitutions ]

To take an overview of the subject, salient features of the FBAR, FATCA and taxability of global income under US tax laws are briefly discussed below.

FBAR

It is a simple form to collect basic information of US citizens or US residents of their overseas financial accounts in their names or wherein they have signing authority or control.

Applicability: The FBAR is required to be filed by a person who is a US citizen, resident of US, a US partnership firm, a Limited Liability Company (LLC) or trust (referred as United States Person) which has financial interest or signing authority in overseas financial investment exceeding INR621,672 during a calendar year. It may be noted that filing of tax returns jointly by a married couple is common in US but the limit of INR621,672 is for each individual.

Foreign Financial Account:
It includes all accounts maintained with a financial institution and also includes:

• Securities or brokerage account;
• Bank account including savings, current or deposits held as NRE, NRO, FCNR account and also Resident account.
• Commodity Futures & Options Accounts;
• Whole life insurance policy and any annuity with cash value;
• Mutual fund or similar pooled fund and
• Any account maintained with a foreign financial institution or other person performing the services of a financial institution. It may be noted that investment in a partnership or proprietorship firm, private limited company, personal loans and personal assets like jewellery are not included and hence not required to be reported. Immovable properties are also not covered under FBAR but bank balances generated by funds remitted for purchase of immovable property in India need to be reported. Financial Interest: A United States person is said to have a financial interest in a foreign financial account if:
• He is the owner of record or holder of legal title, or
• The owner of record or holder of legal title is another person who may be:

a) an agent, nominee, attorney or a person acting on behalf of the US person with respect to the account;

b) a corporation/company in which the US person owns directly or indirectly more than 50% of the total value of shares or voting power;

c) a partnership in which the US person owns directly or indirectly or has interest greater than 50% of the profits or capital;

d) a trust of which the US person is the trust grantor and has an ownership interest in the trust for US federal tax purposes;

e) a trust in which the US person has a more than 50% beneficial interest in the assets or income of the trust for the calendar year; or

f) any other entity in which the US person owns directly or indirectly more than 50% of the voting power or total value of equity interest or total assets or interest in profits.

Joint Owners: A husband and wife owning a joint account need not file separate reports. But if either spouse has a financial interest in any other account not held jointly then such a person should file a separate report for all accounts including those owned jointly with the spouse.

Form and Filing: The report is to be submitted in form TD F 90-22.1 with the US Department of the Treasury, Detroit by June 30 of the following year.

Penalty: Improper filing of FBAR attracts penalty of $10,000 whereas wilful failure to file FBAR is liable to penalty of greater of $100,000 or 50% of the balance at the time of violation and also is subjected to criminal penalties.

FATCA

FATCA is enacted with the primary goal to gain information about US persons and requires US persons to report their foreign financial assets to the IRS and also requires foreign financial institutions to report directly to the IRS details of financial accounts of US persons held with them.

Applicability: Individuals who are US citizens, tax residents, non-residents who elect to be resident aliens and non-residents who are bonafide residents of American Samoa or Puerto Rico having foreign financial assets above the threshold limit.

Foreign Financial Assets: It includes following financial assets:

• Checking, savings and deposit accounts with banks held as NRE, NRO, FCNR or Resident accounts;

• Brokerage accounts held with brokers & dealers;

• Stocks or securities issued by a foreign corporation;

• Note, bond or debenture issued by a foreign person;

• Swaps of all kinds including interest rate, currency, equity, index, commodity and similar agreements with a foreign counterparty;

• Options or other derivative instruments of any currency, commodity or any other kind that is entered into with a foreign counterparty or issuer;

• Partnership interest in a foreign partnership;

• Interest in a foreign retirement plan or deferred compensation plan;

• Interest in a foreign estate;

• Any interest in a foreign-issued insurance contract or annuity with a cash-surrender value; and

• Any account maintained with a foreign financial institution and every foreign financial asset, income or gain whereof is to be reported in the tax return to be filed with the IRS.

It is significant to note, that unlike FBAR, FATCA covers investments of any and every size in equity shares of a private limited company, capital in partnership or proprietorship, loans and advances including personal loans, etc. Immovable properties are excluded. If the US person is not required to file US tax return for any reason, then he is not required to file the FATCA report.

Both FBAR and FATCA cover erstwhile investments in India and inherited or partitioned family assets.

Reporting Threshold: Individuals are covered by FATCA if the value of foreign financial assets exceeds $50,000 as on 31st December or $75,000 during the tax year and in case of married couple tax-payers $100,000 and $150,000 respectively.

For individual tax-payers living abroad these limits are raised to $200,000 and $300,000 respectively and $400,000 and $600,000 for a married couple filing joint return.

Joint Owners: The tax return of a married couple will include assets of both the spouses.

Form and Filing: The report is to be submitted in form 8938 with the IRS with the tax return. The due dates for filing tax returns with the IRS including extension provisions will apply accordingly.

Penalty: Failure to file Form 8938 by the due date or filing an incomplete form attracts a penalty of $10,000. Additional penalty of $10,000 per month up to a maximum penalty of $ 50,000 may become payable for failure to file inspite of IRS notice.

Tax Withholding: FATCA also requires 30% tax withholding on certain payments of US source income paid to non participating foreign financial institution or account holders who fail to provide requisite information. [http://www.irs.gov/uac/Treasury,-IRS-Issue-Proposed-Regulations-for-FATCA-Implementation]

Global Income of US Persons being Taxed in the US

Internal Revenue Code (IRC) requires a US citizen irrespective of his place of residence or resident of the US to declare and pay income tax on worldwide income. Of course, taxpayers having income in India can choose between the IRC and the regulations of India-USA Double Tax Treaty for income arising in India, and opt to be governed by provisions which are more beneficial to him, subject to conditions as may be applicable.

US Offshore Voluntary Disclosure Programme

The IRS has once again given an opportunity for voluntary disclosure of overseas assets and income thereon under the OVDP.

The OVDP is similar to the earlier OVDI under which tax payers are required to pay tax on hitherto undisclosed income of earlier eight tax years together with interest thereon, and in addition to a penalty of 27.5% of the highest balance of hitherto undisclosed foreign bank accounts and/or value of foreign assets over the last eight years. For balance upto $ 75,000 reduced penalty of 12.5% applies. In cases of tax payers disclosing and paying tax on foreign incomes but failing only to file FBAR returns, delinquent reports may be filed possibly saving oneself from penal provisions. [http://www.irs.gov/uac/2012-Offshore-Voluntary-Disclosure-Program]

Many NRIs may not have abided by the FBAR provisions and few by ignorance have also failed to pay tax on their Indian income in the US but ignorance of law cannot be an excuse, and therefore, it would be appropriate for US-based NRIs and Chartered Accountants advising them to take advantage of the OVDP before the programme is discontinued.

Nirav Shah

Safe Harbour Provisions in Indian Transfer Pricing Regime

Recently, CBDT has notified the much awaited “Safe Harbour Rules”, which at present are applicable to certain select International Transactions. Rules 10TA to 10TG and Form no. 3CEFA have been notified and the same have come into force from the date of their publication in the Official Gazette i.e. 18th September, 2013. These Rules aim at reducing litigation in the arena of Transfer Pricing. This article analyses various provisions, their impact and potential issues that may arise there from.

Introduction

The genesis of “Safe Harbour Rules” (SHR) in India is found in the Finance (No. 2) Act, 2009 whereby the Government of India empowered CBDT to formulate safe harbour rules vide insertion of section 92CB. The Memorandum explaining provisions of the Finance Bill mentioned the objective for introduction of SHR is to reduce litigation. A safe harbour has been defined 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 follows: “Safe harbour rules are 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.”

Globally, SHR aim at reducing litigation and compliance cost, providing certainty, reduction in documentation etc. It would be pertinent to note that Indian SHR does not give any relief from maintenance of rigorous documentation to justify arm’s length pricing.

Let us proceed to analyse some of the salient features of the Indian SHR.

Applicability of SHR

Selection of Option (Rule 10TE)

Safe Harbour provisions are applicable in respect of select international transactions (Refer Table below) in respect of those assesses who specifically opts for the same by filing a declaration in Form 3CEFA. The validly exercised option shall continue to remain in force for the period specified in Form 3CEFA or a period of five years, whichever is less. An Assessee has an option to opt out of the safe harbour provisions for any assessment year by fur-nishing a declaration to the Assessing Office (AO) to that effect.

SHR applicability is subject to filing the return of income of the relevant Assessment Year (AY) in time as well as furnishing every year a statement to the AO, before furnishing the return of income of that year, providing details of eligible transactions, their quantum and profit margins or the rate of interest or commission.

Transactions with Tax Havens (Rule 10TF)

Benefit of safe harbour rules is not available in respect of transactions entered into with an associ-ated enterprise located in any country or territory notified u/s. 94A or in a no tax or low tax country or territory. To illustrate, an Indian company who has given a loan to its wholly owned subsidiary in one of the free trade zones of UAE, cannot opt for the safe harbour provisions.

Select International Transactions and Safe Harbour Limits

Other Important Features

Eligible Assessee

Rule 10TB defines “Eligible Assessee” to mean a person who has exercised a valid option for application of safe harbour rules in accordance with the procedure laid down in Rule 10E [refer paragraph on Selection of Option (Rule 10TE) supra] and is engaged in eligible international transactions (as mentioned in the Table herein above).

Significance of “Insignificant Risk”

Rule 10TB further provides that in case of assessees who are engaged in software development, ITES, KPO or contract R&D services in software or generic pharmaceutical drug sectors, they must be working with “insignificant risk” profile. Insignificant risk of the assessee is broadly classified as circumstances wherein foreign principal takes all major risks relating to capital and funds, performs most of the economically significant functions, conceptualises and designs the product, controls and supervises the assessee and owns legal, economic and commercial rights in the intangible generated or outcome of the services. (Refer Clauses 2 & 3 of the Rule 10TB)

Mutual Agreement Procedure

Rule 10TG provides that where the transfer price is accepted by the income tax authorities u/s. 92CB, the assessee shall not be entitled to invoke mutual agreement procedure under a DTAA or specified territory outside India as referred to in sections 90 or 90A.

Operating Expenses

Rule 10TA (j) defines “Operating Expense” as mentioned below:

“Operating Expense” means the costs incurred in the previous year by the assessee in relation to the international transaction during the course of its normal operations including depreciation and amortization expenses relating to the assets used by the assessee, but not including the following, namely:-

(i) interest expense;

(ii)    provision for unascertained liabilities;
(iii)    pre-operating expenses;
(iv)    loss arising on account of foreign currency fluctuations;
(v)    extra-ordinary expenses;
(vi)    loss on transfer of assets or investments;
(vii)    expense on account of income-tax; and
(viii)    other expenses not relating to normal operations of the assessee;

Rule 10TA (k) defines “ Operating Revenue” as mentioned below:

“Operating Revenue” means the revenue earned by the assessee in the previous year in relation to the international transaction during the course of its normal operations but not including the following, namely:-

(i)    interest income;
(ii)    income arising on account of foreign currency fluctuations;
(iii)    income on transfer of assets or investments;
(iv)    refunds relating to income-tax;
(v)    provisions written back;
(vi)    extraordinary incomes; and
(vii)    other incomes not relating to normal operations of the assessee;

From the above definition, one can draw the conclusion that while doing benchmarking analysis (even otherwise than for safe harbour), one may adjust expenses and income on above lines such that revenue and expenses of other companies/entities become comparable by removing abnormality. For the purpose of safe harbour we need to consider depreciation and amortisation expenses, however for doing a normal TP analysis one may compare profits before depreciation and amortisation if there is a significant difference in assets employed of comparable companies.

Some issues/important points to be noted

Safe harbour provisions as notified now do leave some gaps or issues unanswered. Some of these issues which come to our mind are as follows:

(i) Documentation

Clause (5) of Rule 10TD provides that the provisions of section 92D (pertaining to maintenance of documentation) in respect of international transaction shall apply irrespective of the fact that the assessee exercises his option for safe harbour in respect of such transaction. There is no respite from maintaining documentation even if one opts for safe harbour provisions.

(ii) No Comparability Adjustment

Clause (4) of Rule 10TD provides that once the assessee opts for safe harbour provi-sions, he is not eligible for comparability adjustment and allowance under the second proviso to s/s. 92C which provides for al-lowance/variation of 3 % between the arm’s length price determined under the Income-tax Act, 1961 and the price at which the international transactions have actually been undertaken. This provision is appropriate in that if additional allowance/adjustment of 3 % is allowed to the safe harbour margin then it will dilute the acceptable profit margin to that extent.

However, the difficulty may arise when the foreign country does not accept the safe harbour margin of an Indian entity and disallows excess compensation/expenses (which may be required to fall within Indian SHR). In this situation, if Indian entity has opted for safe harbour benefit, then it cannot invoke Mutual Agreement Procedure also and it will have to live with some double taxation.

(iii)No Threshold-Safe Harbour

Unlike Domestic Transfer Pricing, there is no threshold for application of transfer pricing in respect of international transactions.

Global Trends

Developments at OECD

OECD has revised its stand on safe harbour pro-visions in the recently amended guidelines on Transfer Pricing. Earlier OECD members did not favour safe harbour rules as they challenge the fundamental concept of arm’s length principle. However, as number of countries have adopted safe harbour rules especially for smaller taxpayers and/or less complex transactions, even OECD recognized the need and importance of these rules.

The revised Section “E” on Safe Harbours in Chapter IV of the OECD Transfer Pricing Guidelines (issued on 16th May 2013) discusses some potential advantages and disadvantages of safe harbour provisions as follows:

Advantages of Safe Harbours:

(i) They may simplify compliance and reduce compliance costs for eligible taxpayers;

(ii) They provide certainty about the acceptance of the transactions with limited or no scrutiny;

(iii) They allow tax administrations to allocate their administrative resources efficiently.

Disadvantages of Safe Harbours:

(i) They deviate from arm’s length principle;

(ii) They may increase the risk of double taxation especially when adopted unilaterally;

(iii) They may provide an opportunity for tax planning;

(iv) They may result in issues of equity and uniformity as taxpayers are allowed to adopt differential pricing for similar transactions in similar set of circumstances.

In light of the above analysis, the OECD Guidelines recommends bilateral or multilateral safe harbours and for that purpose it provides a sample MOU.

The United Nation’s Practical Manual on Transfer Pricing for Developing Nations released in 2013

Though apparently United Nations has not taken any stand in favour or against safe harbour rules, it recognises advantages and limitations of these provisions. Chapter 3 of the Manual contains discussion on Safe Harbour Rules. It states that Safe harbour rules can be an attractive option for developing countries, mainly because they can provide predictability and ease of administration of the transfer pricing regime by a simplified method of establishing taxable profit.

Korean Experience on Safe Harbour1

Before joining the OECD, the Republic of Korea’s national tax authority, the National Tax Service (NTS), employed a so-called “standard offer-commission rate” for import and export business taxation. Under this scheme, the NTS used a standard offer commission rate based on a survey on actual commission rates. This was available as a last resort under its ruling only in cases where other methods for identifying the arm’s length rate were inapplicable in determining commission rates received from a foreign party. The NTS finally repealed this ruling as it considered the ruling to be contrary to the arm’s length principle.

Summation/Way Forward

Unilateral safe harbour provisions may result in some double taxation as tax treaties by and large provide relief from double taxation only in cases where income is taxed in accordance with provisions of the relevant tax treaty. Since safe harbour provisions are in the domestic tax law, relief may not be available under a tax treaty. Therefore, to avoid potential double taxation, the recent amendment to the OECD Transfer Pricing Guidelines advocates bilateral or multilateral safe harbour agreements. In fact bilateral or multilateral safe harbour agreements could be quite useful also in case of Cost Contribution or Cost Sharing Arrangements among Associated Enterprises of Multinational Enterprises situated in various jurisdictions.

Despite limitations, safe harbour provisions provide much needed certainty and will reduces litigation and compliance cost for small taxpayers. Some companies may like to bear the brunt of some additional tax as an additional cost of capturing a developing market.

Even if one feels that the prescribed margins provided in the Indian Safe Harbour provisions are higher, they may found to be acceptable considering the cost of litigation in terms of time, energy and money. Secondly, as it is a voluntary provision, if the assessee strongly feels that it can justify lower margin, it can opt out of the safe harbour provisions. There is an option to hop on and hop off from the safe harbour provisions which provides great flexibility to taxpayers. The only point of concern is that opting for safe harbour provisions should not become precedence in the year of opting out of it.

All in all, safe harbour provisions can land companies in the safe territory in a blissful state free of litigation if these provisions are administered in a fair, equitable and judicious manner.

1The United Nation’s Practical Manual on Transfer Pricing for Developing Nations released in 2013

2A maquiladora or maquila is the Mexican name for manufacturing operations in a free trade zone (FTZ), where factories import material and equipment on a duty-free and tariff-free basis for assembly, processing, or manufacturing and then export the assembled, processed and/or manufactured products, sometimes back to the raw materials’ country of origin.

Nirav Shah

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