Direct Tax

Whether the presence of equipment in India for grouting activities constituted a fixed place PE of the taxpayer in India under India-UAE DTAA?

M/s ULO Systems LLC vs. DCIT [TS-164-ITAT-2019(Delhi)]

The taxpayer is a UAE company engaged in the business of undertaking grouting work for companies in the oil and gas industry. It had also made some offshore supplies to the Indian companies. The tax officer treated the presence of equipment for grouting activity as a Fixed Place PE in India and attributed profits from offshore supplies to PE in India.

The tax tribunal observed that the taxpayer’s work involved laying out cement layer on underwater structure, pipeline and cable stabilization, pipeline cable protection, stabilization and protection of various sub-sea structures, etc. These activities (collectively known as grouting) carried on by taxpayer cannot be construed as “construction activity” and hence cannot be held as constituting construction PE in India under Article 5(2)(h) of the DTAA.

The tax tribunal observed that for a fixed place PE to be constituted, the taxpayer should have a place of business in India available at its disposal for carrying on its business. In the said case, the equipment along with the personnel of the taxpayer were stationed on the vessel provided by the main contractor, which constituted a fixed place of business through which the taxpayer carried on its business. Furthermore, the taxpayer enjoyed a fair amount of permanence through its personnel and equipment within territorial limits of India. Hence, the tax tribunal placed reliance on the decision of SC in the case of Formula One and held that the equipment along with its personnel constituted a fixed place PE in India.

SKP’s Comments

In recent years, India has witnessed spurt in PE-related disputes, particularly fixed place PE. The courts at various judicial levels are applying the principles laid down in the landmark SC decision in the case of Formula One (pertaining to fixed place PE) to every similar situation. In the present case, the equipment and personnel are treated as being at the disposal of the taxpayer.

Taxpayers carrying on business in India should evaluate the PE exposure in India and tax risks associated with the same. It would be important that the business structure are compliant and appropriate measures are taken to ensure that there is no PE risk in India.

Whether payments for salaries and travel expenses made to Foreign Nationals are in the nature of salary reimbursements or fees for technical services (FTS)?

M/s Nippon Paint (India) Pvt Ltd vs. DCIT [(TS-171-ITAT-2019 (Chennai)]

The taxpayer made payments for salaries and travel expenses to Foreign Nationals who were seconded to the taxpayer by its group company in Japan without deducting taxes on the same as they were not liable to tax in India. However, the tax officer held that such payments are in the nature of FTS and the taxpayer was required to deduct taxes on the same.

The tax tribunal held that pursuant to the technical services agreement, the payments made to the group company in Japan is in the nature of FTS. Also, expenses incurred towards salaries and in relation to the airfare, food expenses, local conveyance, etc., had a clear nexus with the technical services rendered, which form part and parcel of the scope of services to be rendered by them.

The tax tribunal also held that seconded employees were not employees of the taxpayer and hence it becomes income of the group company and not reimbursement of salaries.

Hence, payments made to the group company are taxable as FTS and not merely reimbursements.

SKP’s Comments

Deputation of employees has been a controversial issue in India. All the recent decisions in India have been in favor of revenue either holding services to be in the nature of FTS or holding a PE in India.

It becomes imperative that tax implications on deputation structures are examined appropriately in order to avoid any tax risks in India.

Also, taxpayers should exercise caution while taking any tax position based on the argument of reimbursement of expenses, especially where expenses are linked to the services.

Whether multiple counting of employees on a single day would be allowed to determine the service PE threshold under India-UK DTAA?

Linklaters vs. Dy. DIT [TS-210-ITAT- 2019(Mum)]

The taxpayer, a tax resident of UK, was engaged in the practice of law. He was appointed as a legal advisor for providing services in India for which it received certain fees. Considering the India-UK DTAA, the taxpayer did not offer the same to tax in India in the absence of a PE. However, the tax officer held that employees of taxpayer rendered services in India for a period exceeding 90 days and hence constituted a service PE under the India-UK DTAA.

However, the tax tribunal observed that one of the employees was on study leave and hence he did not render any service to the clients in India. This fact was evidenced by the daily log kept by the taxpayer wherein no chargeable hours have been shown in respect of this employee. Hence, it was held that the period for which the employee was availing study leave has to be excluded from the service PE threshold.

Furthermore, the tax tribunal also observed that the employees of the taxpayer would constitute a service PE in India only if they rendered services exceeding 90 days during any twelve-month period as per Article 5 of the India-UK DTAA. Accordingly, the visits of the employees in India on a particular day had to be considered on a cumulative basis and not independently. Accordingly, the tax tribunal held that multiple counting of employees in India on a single day was inconsistent with the legal provisions.

SKP’s Comments

The decision once again upholds the view that solar days are to be considered and not man days for the determination of service PE threshold. There are few court decisions, on similar lines, wherein it has been held that solar days has to be considered and not man days as the same may lead to absurd results. For instance, if 20 employees were present in India for 25 days then due to multiple counting of man days, presence in India would tally up to 500 days. This is clearly not the intention as the service PE threshold would become redundant in practice. Accordingly, this judgment provides much-needed clarity.

Transfer Pricing

Can high advertising, marketing and promotion (AMP) expenditure per se, be a ground for inferring the presence of an international transaction?

Moet Hennessy India Private Ltd [ITA No.85/Del/2015-AY 2010-11]

The taxpayer engages in distribution. The taxpayer undertakes marketing and sales promotion of products, with assistance of its Associated Enterprises (AE). The taxpayer imports advertising and promotional material from its AE to be given as complimentary products to its customers.

The Transfer Pricing Officer (TPO) disputed that the huge AMP expenses have created marketing intangibles in favour of the AE; thereby making an adjustment on excess AMP expenditure incurred as compared to the comparable companies engaged in similar industry as the taxpayer’s, plus a mark-up of 15% on the same. The Dispute Resolution Panel (DRP) upheld the order of the TPO.

The Income Tax Appellate Tribunal (ITAT) held that:

  • Bright Line Test (BLT) is not a valid basis for determining the existence of an international transaction
  • The Revenue has not been able to produce any cogent material to treat the incurring of AMP expenses as an international transaction between the taxpayer and its AE, except stating that the taxpayer has incurred high AMP/Sales expenses as compared to the comparable companies, i.e., BLT, which is unsustainable.

Consequently adjustments made on account of high AMP expenses were deleted.

SKP’s Comments

The Tribunals and Courts have repeatedly pronounced in various rulings that the application of ‘Bright Line Test’ is not sustainable to prove the presence of AMP expenditure as an international transaction.

It order to determine whether there exists an International transaction pertaining to AMP, contractual relationships between the taxpayer and the AE, economic rational and beneficiary from the incurrence of expenses, etc., are some important aspects to be studied.

Is charging guarantee commission necessary in case of issuance of Corporate guarantee?

Adani Ports and Special Economic Zone Ltd [ITA No: 3481 and 3482/Ahd/14 AY 2009-10 & 2010-11

The taxpayer had extended a corporate guarantee to the State Bank of India, for acquisition of an aircraft by its AE, for which the taxpayer did not charge a commission. The taxpayer explained that the guarantee given by the taxpayer is a generic and non-explicit guarantee which binds the principal shareholders in general anyway, and that it did not lower the credit risk to the AE, since the AE derives the same benefit by affiliation with the group. It was also submitted that SBI Hong Kong has granted a loan to the AE at LIBOR plus 145 bps which is as per market norms, and that the AE was required to ensure that the value of security does not fall below 1.33 times the borrowings by the AE. As a result, the guarantee did not confer any benefits to the AE.

In spite of the above explanations, the TPO went ahead and made an adjustment at the rate of - 3% of guarantee amount as guarantee commission. CIT upheld the observations of the TPO, however, reduced the rate of the guarantee commission to 2%.

ITAT held that

Relying on Micro ink co-ordinate bench ruling, the ITAT noted the following points:

  • The guarantees do not have any impact on income, profits, losses or assets of the taxpayer.
  • No bank would be willing to issue guarantee without underlying asset/guarantee, to taxpayer's subsidiaries. Such a guarantee transaction is and can only be, motivated by the shareholder or owner considerations and may be considered to be the Shareholder’s activity.
  • The taxpayer did not incur any cost and the taxpayer could not have realized money by giving it to someone else.

Basis the above, ITAT held that the issuance of guarantees, without incurring any specific costs, does not constitute an international transaction, and, accordingly, no arm’s length price adjustment can be made in respect of the same.

SKP’s Comments

The taxpayers should analyze the following points to determine whether the issuance of Corporate guarantee warrants a guarantee commission:

Whether the guarantee provided has an impact on income, profits, losses or assets of the taxpayer i.e. whether the taxpayer has actually incurred any costs.

Whether the said guarantee can be considered as a Shareholder’s activity or not.

Whether the existence of guarantee has actually helped the AE in material way.

Is the TP adjustment made by TPO in relation to a Specified Domestic Transaction (SDT) sustainable in the absence of a specific reference by AO for that particular SDT, under Section 92CA of the Income Tax Act, 1961?

Times Global Broadcasting Company Ltd [WRIT PETITION NO. 3386 of 2018 AY 2015-16]

The taxpayer, engaged in the business of distribution of television channels, had reported the transaction of payment made to AEs in relation to distribution services in Form 3CEB.

The AO made a reference to the TPO for determining the ALP of the SDT reported in Form 3CEB. During the assessment, apart from the reported transaction, the TPO also observed another transaction of payment to creditors in a demerger process, which was not reported in Form 3CEB, on which he made an adjustment amongst other adjustments.

Aggrieved against TPO’s order, the taxpayer filed a writ petition before the Bombay HC stating that there was no specific reference by the AO to the TPO for the said transaction.

HC held that:

  • HC elaborated that sub-sections (2A) and (2B) of Section 92CA were introduced in the Act to overcome the limitation and expand the scope of TPO to examine an international transaction which has either not been reported by the AO under sub-section (1) or which the assessee has omitted to report as required u/s 92E. However, the section makes a reference to only an international transaction and not to any specified domestic transaction.
  • HC opined that “We must, therefore, presume that the legislature consciously decided not to include a reference to a specified domestic transaction under subsection (2A) and (2B) of Section 92CA.”

HC held that the requirement of the AO for obtaining an approval from a senior revenue Authority (Principal Commissioner or Commissioner) before a reference to the TPO cannot be jettisoned by the TPO exercising sue motu jurisdiction over the transaction not reported to him and accordingly dismissed the contentions of the respondent and deleted the adjustment pertaining to the transaction under consideration.

SKP’s Comments

The Hon’ble Bombay HC has categorically stated that ‘When a statute that too, fiscal statute makes detail provisions for assessment, appeals and revisions, ordinarily the Court would not examine the issues on merits bypassing such statutory remedies’. Drawing a positive reference from this ruling, for the taxpayers, it becomes imperative to check all the corners of statutory framework while rebutting against the tax adjustments proposed by the AO/ TPO.

Indirect Tax

Whether interest under Section 50 of CGST Act, 2017 is payable on the net tax liability or the gross tax liability including the portion which can be set-off against Input Tax Credit (ITC)?

[Background: In view of Section 50(1) of the CGST Act, 2017, interest is payable at prescribed rates on delayed payment of tax.]

M/s Megha Engineering and Infrastructures Limited, Hon’ble High Court of Telangana [2019-VIL-175-TEL]

The High Court observed that:

  • The petitioner paid interest on the net tax liability after deducting ITC from the total tax liability whereas the Department demanded interest on the total tax liability.
  • The GST portal is designed in such a way that a return cannot be filed unless the entire tax liability is discharged by the assessee.
  • As per the GST law, interest is compensatory in nature and imposed for non-filing of return within the period prescribed.
  • Under Section 41(1) of the CGST Act, 2017 a person gets credited with input tax, in his electronic credit ledger, only upon filing of the return on a self-assessment basis. Till a return is filed, no credit becomes available to his electronic credit ledger.
  • Hence, until a return is filed, no entitlement to credit and no actual entry of credit in the electronic credit ledger takes place. Consequently, no payment can be made from such credit entry.

In view of the above observations, the High Court dismissed the Writ petition and held that interest under Section 50(1) of the CGST Act is to be calculated on the gross tax liability, without considering the ITC available to be set off.

SKP’s Comments

There have always been divergent opinions on whether interest under section 50(1) of CGST Act is to be computed on the gross tax liability, or the net tax liability after claiming set-off of ITC. Interestingly, the GST Council in its 31st meeting accepted the proposal by the Law Committee to amend Section 50 and allow payment of interest on net cash liability. However, the GST law is yet to be amended to give effect to this decision of the Council. Consequently, it can be inferred that presently interest under Section 50 should be calculated on the gross tax liability.

Whether GST is applicable on interest free security deposit and notional interest, if any?

M/s E-Square Leisure Private Limited - Authority for Advance Ruling (AAR), Maharashtra [2019 (4) TMI 805]

The AAR observed that:

  • The applicant has engaged in renting out of immovable property to business entities for commercial purpose.
  • The applicant collected an interest free security deposit from the lessee on account of security against any damages caused by the lessee.
  • As per proviso to Section 2(31) of the CGST Act [definition of ‘consideration’], a deposit would not form part of payment for the supply unless the supplier has applied such deposit as consideration for the supply.

In view of the above observations, the AAR held that the applicant had taken a security deposit as a guarantee, which was returnable on the completion of the lease tenure, and hence not liable to GST. However, if any portion of the deposit is withheld as a charge against damages, etc., the amount so withheld will be liable to GST.

SKP’s Comments

Even under the erstwhile service tax law, the appellate authorities had the opportunity to determine the validity of charging service tax on notional interest on security deposit received by a service provider. The Customs, Excise and Service Tax Appellate Tribunal (CESTAT) in many cases had held that unless there is evidence to show that the security deposit has influenced the consideration for renting of property, no service tax can be levied on notional interest on such deposit.

Whether GST is levied on reimbursement of expenses such as electricity, water charges, property tax and cooking fuel incurred by the lessor and reimbursed by the lessee at actuals?

M/s E-Square Leisure Private Limited – AAR, Maharashtra [2019 (4) TMI 421]

The AAR observed that:

  • The applicant is engaged in renting out of immovable property to the lessee and collects the expenses from the lessee at actuals as per their agreement.
  • There are a plethora of judgements in the pre-GST regime wherein reimbursement of expenses, without any value addition or without the character of revenue were not taxed.

The applicant submitted that:

  • It is acting as a pure agent and that it fulfilled all the conditions prescribed under Rule 33 of the CGST Rules, 2017 [valuation in case of pure agent].
  • Reimbursement of expenses was nothing but repayment of certain expenses incurred by the applicant.

The AAR ruled that electricity and water were not provided by a third party and were provided by the applicant himself. Hence, the applicant is not a pure agent, but is providing a separate taxable supply. Therefore, GST is leviable on reimbursement of expenses from the lessee by the lessor on actuals. Further, reimbursement of expenses constitute composite supply and GST would be payable at a rate as applicable to the principal supply.

SKP’s Comments

Under the CGST Rule, one of the conditions for qualifying as a pure agent is that the payment of expenditure is made on an authorization from the recipient (i.e., the lessee in this case). In the instant case, the lessee was never liable to make the payment of electricity, water charges, etc., to the third party and hence there is no question of seeking its authorization. Therefore, since the lessor was liable to pay these charges on its own account, it cannot claim to be a ‘pure agent’ for the lessee merely because such expenses were reimbursed by the lessee as per their contractual agreement. Businesses should carefully evaluate the nature of expenditure incurred by them before qualifying the same under ‘pure agent’ services.