Category: Tribunal News : PART B -International Taxation

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.”

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.

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).

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.

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.

• 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.

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.

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.

Payment for development of Balanced Score Card (BSC) management tool is Fees for Technical Services under Article 12 of the India-Singapore DTAA.

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.

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.

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.

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.

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%.

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.