FROM THE JUDICIARY

Whether the supply of designs, drawings, material information and processes taxable as royalty?

The Majestic Auto Ltd. vs CIT [TS-486- HC-2019 (P & H)]

Taxpayer, a tax resident of India, entered into an agreement with Puch, a company resident in Austria wherein Puch would supply drawings, designs, specifications, processes, etc. to the taxpayer for manufacturing, assembling and selling vehicles in India for a consideration. Besides this, the taxpayer was also required to pay royalty basis the number of cars produced as per the terms of the agreement. The taxpayer did not withhold tax on the amount paid to Puch for supplying designs, drawings, processes, etc. however, the tax officer held that such payment was royalty and hence taxable in India.

The High Court relied on various judicial precedents and held that by supplying necessary materials, designs and granting the right and license to use manufacturing information, Puch had merely authorized its use to the taxpayer. Further, the High Court believed that its actual use would arise only on commencement of production and sale of the vehicles and that would be the stage at which royalty would become payable, thus, fortifying the taxpayer’s contentions. Hence, the aforesaid consideration would not constitute royalty and hence not liable to tax in India.

SKP’s Comments

This is an important decision as it brings out a distinction between “supply” and “use”. The High Court has held that mere supply of design and drawings do not constitute royalty. However, the use of the same constitutes royalty. It is pertinent to note that the taxpayer had received an exclusive right to manufacture vehicles in India as per the designs, drawings, etc. supplied by Puch and even then the payments for the same were not royalty as “use” was deferred to the year when actual commencement or production of vehicles takes place.

Whether foreign tax credit (FTC) is entitled to full foreign taxes paid or tax only on doubly taxed income?

DCIT vs iGate Global Solutions Ltd. [TS- 499-ITAT-2019 (Pune)]

The taxpayer, an Indian company, has overseas branches in five countries. These foreign branches were treated as PE of the taxpayer and hence liable to tax as per the local tax laws of each country. While filing tax return in India, the taxpayer claimed FTC of INR 191 million (of taxes paid outside India). However, the tax officer allowed FTC to the extent of the tax rate at which the income was being offered to tax in India (i.e. Minimum Alternate Tax (MAT) @ 10%) and not the full taxes paid outside India. Further, the tax officer contended that FTC was to be allowed on basic tax rate i.e. without surcharge and cess.

On perusal of provisions of the Act, the tax tribunal observed that even if the taxpayer was chargeable to tax under the Act on its global income, it could be possible that some income is chargeable in the foreign tax jurisdictions but not chargeable under the Act on account of an exemption, etc. Further, the tax tribunal observed that tax treaties also restrict FTC to the extent of taxes paid in home country. In other words, the taxpayer cannot claim refund of excess taxes paid outside India. Hence, if income was included only in the total income under the Act but not under the total income of other country or vice-versa, the same cannot qualify for FTC under the Act. Accordingly, it was inferred that only the doubly taxed income qualifies for FTC and not the remaining amount whose corresponding income was not part of the computation of income under the provisions of the Act.

Further, in respect of surcharge and cess, the tax tribunal held that is the taxes paid overseas exceed the rate of 11.33% then credit to the extent of 11.33% should be allowed.

SKP’s Comments

The issue of FTC on full taxes paid outside India or only on tax paid on doubly taxed income has always been a subject of debate. This decision has brought out the finer aspects of FTC on full foreign taxes paid vs taxes on doubly taxed income only.

This decision affirms the position that tax credit should be allowed on total tax payable in India (i.e. including surcharge and education cess) if income is doubly taxed and taxes paid overseas are higher than the rate of tax in India.

This decision also clarifies that FTC would be allowed only on income doubly taxed. Accordingly, by virtue of any exemptions, if the income is not taxed in India, then proportionate FTC would not be allowed.

Whether royalty payment to Associated Enterprise is justified if the taxpayer is suffering losses?

Bain & Company India Pvt Ltd [ITA Nos.378 & 379/Del/2015] – AY 2008-09 & 2009-10

The taxpayer is engaged in the business of providing management consultant services in India and has been involved in providing/ availing management consulting services to/ from its overseas AE.

The taxpayer had paid royalty to its overseas AE for use of consulting techniques and know-how including consulting toolkits and insights developed and maintained by overseas AE.

The Transfer Pricing Officer (‘TPO’) determined the arm’s length price of royalty at Nil whereas CIT(A) deleted the adjustment.

Tax department contentions before ITAT

• No actual rendering of any services.
• Services are duplicative in nature.
• No actual cost has been incurred by overseas AE.
• No benefit demonstrated by the taxpayer
• “Bain” is not known brand in India and hence, there is not tangible benefit to the taxpayer from right to use such brand.

Taxpayer’s contentions before ITAT

• Detailed economic analysis using both internal and external CUP data has been submitted (as part of TP Study) whereas TPO failed to provide specific reasons for rejecting the same.
• Taxpayer has been provided access to the techniques and know-how (including intangible asset base).
• Actual use of services depends on whether or not use of such services was warranted by the business situations.
• Once it is established that knowhow and technical information was provided, payment of royalty cannot be challenged on the basis of profitability or earnings of the taxpayer.

ITAT Ruling

• Payment of royalty cannot be determined on the basis of profitability or earnings.
• Lower profitability cannot lead to conclusion that no benefits were derived or technology was unproductive.
• ITAT observed that compound annual growth rate of taxpayer was 31% whereas increase in royalty payment was negligible. Further, benchmarking analysis conducted by taxpayer justifies that royalty % paid by taxpayer is far less than royalty % paid by comparable companies.

Thus, ITAT dismissed the appeal of tax authorities.

SKP’s Comments

Over the years, tax authorities have alleged that benefit test is required to be satisfied by taxpayer while justifying payment for royalty/intra-group services. At the same time, courts in India in most of the cases have held that availing of such service is a commercial/business decision of the taxpayers which cannot be questioned. Additionally, profitability/earnings is not a parameter to conclude whether any benefit derived or not from use of intangible.

Whether foreign AE may be considered as tested party for intra-group service transaction?

CWT India Pvt Ltd [ITA Nos.4972 and 5996/Mum/2018] – AY 2013-14 & 2014-15

The taxpayer is engaged in the business of travelling and tourism. During the year, the taxpayer has paid fees for technical assistance services to its AE. In order to benchmark the said transaction, the taxpayer has selected associated enterprise as tested party and selected Transactional Net Margin Method (‘TNMM’) as the most appropriate method.

TPO has adopted CUP method and determined the arm’s length price of such technical assistance fees at Nil which has been upheld by DRP.

ITAT Ruling

• ITAT has relied on the taxpayer’s own case for AY 2011-12 (facts remain same) wherein the matter has been remitted back for limited purpose of verification of margin of tested party vis-à-vis comparable companies.
• In the previous year, it was observed that the taxpayer has provided all documentary evidence to demonstrate that it has availed services and details of benefits received.
• In the previous year, it was observed that the taxpayer has submitted relevant details to compute the cost allocation duly certified by CPA, Singapore and financial of comparable companies.
• Considering the above, the taxpayer’s treatment was accepted to consider foreign AE as tested party and TNMM as most appropriate method.
• CUP method adopted by TPO was rejected on the ground that TPO has not provided any uncontrolled transaction for similar services.

Thus, ITAT allowed the appeal of the taxpayer.

SKP’s Comments

Over the years, Courts/Tribunals have provided contrary views on adoption of foreign AE as tested party to benchmark the international transactions. Considering the fact that it is more of facts specific analysis, it is always advisable to prepare robust documentation to include reasons for the adoption of foreign AE as tested party and also maintain all supporting documents such as financial statement of AE/ CPA certificate on cost allocation.

Whether TPO can re-examine any issue on comparability analysis while effecting DRP’s directions which did not deal with such issue?

MACOM Technology Solutions (India) Private Limited (formerly known as Applied Micro Circuits India Private Limited) – ITA No 2393/Pun/2017 (AY 2013-14)

The taxpayer is engaged in the business of providing data analytics and design engineering services to its AE. In order to benchmark the transactions, the taxpayer had selected 3 companies as comparables.

During the assessment proceedings, TPO modified the set of comparable companies and proposed the transfer pricing adjustment and passed the draft assessment order.

DRP gave the directions on the issues which were assailed before it. While giving effect to the directions of DRP, AO re-calculated the transfer pricing adjustment amount and in this process inserted one more comparable, namely, Acropetal (despite no such direction from DRP) in the list of comparable companies and passed the final AO order.

ITAT Ruling

• It is observed that Section 144C(5) of the Act states that DRP shall issue directions to enable AO to complete the assessment. Further, Section 144C(13) of the Act states that upon receipt of directions, AO shall complete the assessment in conformity with DRP directions.
• Based on the above, ITAT held that once the matter travels to DRP, AO/ TPO become functus officio except to the extent of giving effect to the directions of DRP.
• AO/ TPO can examine issue only upto the stage of passing draft order.
• Since DRP did not direct to include Acropetal as comparable, AO/ TPO were devoid of any power to again include the same and they are ceased to exercise any jurisdiction to re-examine earlier view.

Thus, ITAT allowed the appeal of the taxpayer.

SKP’s Comments

The taxpayers often experience that AO/ TPO exceeds their jurisdictions without having the necessary powers to do so. This ruling would be useful in those cases where AO/ TPO suo-moto makes modifications (without specific directions from DRP) while passing final assessment order.

Whether ad-hoc adjustments for the regional office expenses be made by the TPO?

Det Norske Veritas AS - ITA No 4785/ Mum/2016 (AY 2007-08)

The taxpayer is a branch of Det Norske Veritas AS (part of DNV Group). During the year under consideration, the taxpayer had paid regional office expense to its AE.

In AY 2008-09, TPO has proposed ad-hoc adjustment of 20% of regional office expenses whereas in the year under consideration, TPO proposed 100% adjustment for these regional office expenses on an ad-hoc basis without following any of the prescribed method u/s 92C of the Act. CIT(A) deleted the adjustment.

ITAT Ruling

• ITAT observed that similar addition has been deleted by ITAT in the taxpayer’s own case for AY 2008-09.
• ITAT noted that TPO has not followed any of the prescribed u/s 92C(1) while arriving at arm’s length price of the transactions which is against the provisions of law.

Thus, ITAT dismissed the appeal of the tax authorities.

SKP’s Comments

It is often seen that while making adjustment to transfer price (especially intra-group services/ royalty, etc), TPO make an addition on an ad-hoc basis without following any of the methods prescribed u/s 92C of the Act. Time and again, Courts/ ITAT has emphasised that one of the method is required to be used for making any transfer pricing adjustment.

Whether separate GST registration can be allowed to multiple companies from the same address where they are functioning in a “co-working space”?

M/s Spacelance Office Solutions Private Limited -Authority of Advance Ruling (AAR), Kerala [2019 (8) TMI 817]

Facts of the case

• The applicant is engaged in the business of sub leasing of office spaces as co-working spaces to its clients.
• In this model, each client company was offered a distinct and identifiable work space within the main office.
• The departmental authorities were rejecting registration to these companies as ‘another company is registered in the same address.’

Ruling

• The AAR observed that there is no prohibition under the GST law for obtaining GST registration to a shared office space or virtual office where the landlord permitted it.
• In view of the above, the AAR ruled that a separate GST registration should be granted to such companies provided valid documents such as the rental agreement, monthly utility bill etc. are furnished by them.

SKP’s Comments

With the rising cost of real-estate, co-working spaces have developed significance especially in case of startups where controlling costs is of utmost importance.

In the absence of any contrary provision under the GST law, the advance ruling has taken into account this ground reality and provided a favourable ruling for businesses which should also promote the government’s “ease of doing business” motto.

Whether the amortized cost of capital goods supplied by customers freely on a returnable basis should be added to the transaction value?

M/s Toolcomp Systems Private Limited - Authority of Advance Ruling (AAR), Karnataka [2019 (8) TMI 471]

Facts of the case

• The applicant received capital goods, free of cost on a returnable basis from its customers for manufacture of parts.
• The capital goods received have a specific life and can produce only a certain volume of total production.

Ruling

• The AAR observed that CBIC in Circular No. 47/21/2018-GST dated 8 June 2018 has clarified that moulds and dies owned by Original Equipment Manufacturer (OEM) provided to a component manufacturer on free of cost (FOC) basis do not constitute supply as there is no consideration. Therefore, in such cases, the value of goods provided on FOC basis shall not be added to the value of supply of components.
• Thus, the AAR ruled that the applicant was not required to amortize the cost of the capital goods received from its customers and was not liable to GST on the same.

SKP’s Comments

The present case was squarely covered under the clarification issued by the CBIC. However, the GST implications may change based on facts of each case, such as in cases where the customer is charging any amount for providing the capital goods to the customers.

Whether a Profit-Sharing Agreement (PSA) between an employee of the company and its shareholders would attract GST?

Shri Venkatasamy Jagannathan - Authority of Advance Ruling (AAR), Tamil Nadu [2019 (7) TMI 1000]

Facts of the case

• The applicant is the Chairman and Managing Director (CMD) of Star Health and Allied Insurance Company Limited.
• The applicant entered into a PSA for a strategic sale of equity shares through which he will earn a profit over and above a specified sale price by a set of shareholders of the company.

Applicant’s contention

• The PSA is only due to the contribution of the applicant as CMD and hence it is covered under employer/employee activities which are exempt under GST.
• The above transaction was also covered in the meaning of ‘actionable claim’ and hence outside the scope of GST.

Ruling

The AAR agreed to the applicant’s contention and ruled that the PSA is an ‘actionable claim’ and hence covered under Schedule III of the CGST Act, 2017 i.e. neither a supply of goods nor a supply of services and consequently not taxable under GST.

SKP’s Comments

In this case, the PSA was between the shareholders and the CMD. Therefore, one may argue that the company is a different legal entity independent of the shareholders and hence the said PSA cannot be treated as a transaction in the course of employment as covered under Schedule III of the CGST Act. However, in any case, the AAR ruled that since the PSA is in the nature of an ‘actionable claim’, GST should not be applicable.