FROM THE JUDICIARY

Whether income earned by foreign Permanent Establishments (PE) of an Indian company can be excluded from its total income if the same is taxable in the other country?

Whether substitution of a provision in an Act renders all notifications in relation thereto inapplicable?

M/s. Technimont Pvt Ltd vs ACIT [TS- 115-ITAT-2020(Mum)]

Background

The taxpayer is an Indian Company with its branch offices located in UAE and Qatar. The taxpayer has not included the income of its branch offices on the pretext that the foreign PEs are liable to tax in the foreign countries i.e. source state and hence, the same shall be considered as exempt in India in the light of Article 7 of DTAA.

The above contention was favored by a supreme court judgment in the case of PAVL Kulandagan Chettiar. However, post the judgment, a new section 90(3) was inserted with effect from (w.e.f) 1 April 2004 by virtue of which the Central Government (CG) was empowered to issue a notification to outline any term which is not defined in the act or DTAA.

In light of the aforementioned power, the CG vide notification dated 28 August 2008, provided that when the income of an Indian resident is taxed in another country by virtue of the provision of DTAA, such income shall be included in the total income of the Indian resident and subsequently relief shall be granted for the taxes paid in the other country.

Subsequently, section 90 was reenacted w.e.f. 1 October 2009. Thus, the assessee believed that under re-enactment of the provision, the notification issued earlier will not hold good and consequently, the principle laid down in the supreme court decision shall be followed.

Held

The tribunal rejecting the contentions of the taxpayer asserted that where any Central Act or Regulation is repealed or re-enacted, then any modification w.r.t. the same shall continue to be in force unless expressly provided, or it is inconsistent with the re-enacted provisions. (reference made from section 24 of General Clauses Act)

Further, taking the above notification into consideration, the ITAT held that the income earned by the foreign PE shall be included while computing the total income of the Indian resident.

Our Comments

The issue of taxability of income of foreign PE and the applicability of the notification has been an area of dispute.

The case law puts an end to the ongoing controversy.

Whether capital reduction tantamount to a transfer for the shareholder if the percentage of holding remains unchanged?

M/s. Carestream Health Inc. vs DCIT [ITA No. 826/Mum/2016]

Background

The taxpayer is a company, tax resident of the USA with a Wholly Owned Subsidiary (WOS) in India. The Indian WOS undertook the capital reduction of its share capital pursuant to a scheme approved by the Hon’ble Bombay High Court. The taxpayer received certain consideration from the WOS under the scheme of capital reduction. The taxpayer attributed part consideration (to the extent of accumulated profits) towards dividends while the balance consideration was attributed towards sale consideration of the capital asset, i.e., shares and reported a capital loss due to benefit of indexation.

The tax officer and DRP disallowed the claim of long-term capital gain. The contention of the authorities was that the capital reduction does not amount to the extinguishment of right as the percentage holding, the intrinsic value of the shares and the rights of the assessee remain unaffected. Thus, authorities denied capital reduction to be considered as transfer under section 2(47).

Held

Relying on various judicial precedents and considering the contentions of both the parties, the Mumbai Tax Tribunal held that definition of transfer under section 2(47) is an inclusive definition which inter alia includes ‘extinguishment of any right.’ Capital reduction results in proportionate extinguishment of:

• Right of the shareholder to dividend on its share capitals; and
• Right to share in the distribution.

Thus, even though post capital reduction, the percentage holding remains unaltered, the first right as a holder of shares stands reduced. Accordingly, the capital reduction would fall under the ambit of a transfer.

Our Comments

It has always been a controversial issue, whether capital reductions can be considered as a transfer. The judgment puts an end to the debate and has laid down the principle in this matter.

While the judgment covers the aspect where the shareholders receive consideration for the capital reduction but the issue in cases where no consideration is received by the shareholder remains untouched. Thus, the debate over the same continues.

Where the income of the foreign Permanent Establishment (PE) is considered as not taxable under the DTAA, is the company obliged to pay tax under Minimum Alternate Tax (MAT) on the said income of foreign PEs?

DCIT vs IRCON International Ltd [TS-60- ITAT-2020(DEL)]

Background

The taxpayer, an Indian company, has earned income from Permanent Establishments (PE) in foreign countries. The assessee has excluded the income from the foreign PEs from its total income on the basis that the DTAA income was not taxable in India. Consequently, the taxpayer contended that it was not obliged to pay tax under MAT.

However, the tax officer rejected the claim of the taxpayer and held that fees received for IT services under the third agreement were in the nature of fees for technical services as per the Act as well as India-Sweden tax treaty and hence taxable in India.

Held

The provisions of MAT, i.e., sec 115JA, overrides all other provisions of the Act. Further, the provisions of the DTAAs are to be considered while calculating ‘Total Income.’ In the absence of any specific provisions in DTAA for the computation of ‘Book Profit,’ the basic tax laws in force in the country would apply.

Further, it was held that the book profit as computed from the books of accounts which was maintained according to the provisions of the Companies Act must be treated as sacrosanct and it must be adjusted only for making an increase or reduction as specifically provided in the explanation to sec 115JA. Since the exclusion of income under the DTAA is nowhere provided in the said explanation, the taxpayer is not entitled to claim a reduction of income earned by foreign PEs while computing book profit for MAT.

Our Comments

This ruling once again highlights that MAT is to be paid on book profits and the same cannot be avoided based on the exemptions available under the tax law.

Does the Assessing Officer (AO)/ Transfer Pricing Officer (TPO) have jurisdiction to re-examine any aspect absent directions from appellate authorities?

Koso India Pvt Ltd. [ITA No. 3044/ PUN/2017]

The taxpayer is engaged in the manufacture and supply of control valves and actuators. The taxpayer has entered into certain purchase and sale transactions with Associated Enterprises (AE). For transfer pricing purposes, the taxpayer has aggregated all the related party transactions and benchmarked by adopting The Transactional Net Margin Method (TNMM) at the entity level.

During the course of transfer pricing scrutiny, TPO disputed on the selection of comparables and made transfer pricing addition. The first level appellate authority, i.e., Dispute Resolution Panel (DRP), directed TPO to consider gain/loss on foreign exchange as the non-operating item and recompute the margin of the taxpayer and comparables. While giving effect to DRP direction, TPO again recomputed working capital adjustments considering a higher rate of interest as compared to previous workings. It is pertinent to note that the DRP had only directed to recompute the margins considering the treatment of Forex loss and gain; there was no direction from the DRP with regards to the working capital adjustments.

The taxpayer challenged the jurisdiction of the TPO beyond the directions of DRP.

Income Tax Appellate Tribunal (ITAT) held as under:

• AO/TPO can examine any issue only up to the stage of the passing of the draft assessment order
• AO/ TPO cannot suo motu make addition/subtraction from the draft assessment order except giving effect to the DRP directions.
• Thus, ITAT allowed the appeal of the taxpayer.

Our 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 appellate authorities) while passing the final assessment order.

Whether issuance of Letter of Comfort is an international transaction?

Tata International Limited (ITA No 4376 and 4451/Mum/2010

The taxpayer has issued a Letter of Comfort (LC) to bankers of AE. The taxpayer did not disclose the said transaction in its transfer pricing compliance form, assuming it to be outside the purview of Indian TP regulations. TPO considered LC as a guarantee and adopted the CUP method (commission charges of HSBC Bank at 1.5%) to benchmark the transaction under Indian TP regulations. The first appellate authority provided relief to the taxpayer; however, the revenue filed an appeal with a higher forum, i.e., ITAT.

ITAT held as under:

• Issuance of LC does not constitute international transaction under section 92B of the Act and is therefore not covered under the ambit of Indian TP regulations
• LC merely indicates the taxpayer’s assurance that AE would comply with terms of the financial transaction without guaranteeing the performance in the event of default
• ITAT relied on the judgment of Hon’ble Karnataka High Court in the case of United Braveries (Holding) Ltd (MFA No 4234 of 2007
• Thus, ITAT dismissed the appeal of the tax department.

Our Comments

This ruling has re-emphasized that the issuance of LC is different from corporate guarantee and hence not covered under the Indian TP regulations.

Is 5% tolerance range applicable even when a single rate is considered for benchmarking?

Sonata Software Ltd. [ITA No 594 and 721/Mum/2017]

The taxpayer is engaged in the business of software development. During the year under consideration, the taxpayer redeemed its investment (preference shares) in its AE at face value of USD 1. TPO determined arm’s length value of shares at USD 1.05 as per valuation report and, thus, made an addition to the difference in valuation. While doing so, TPO did not provide the benefit of 5% tolerance range as per the second proviso to Section 92C(2) since there was only one price available. CIT(A) upheld the decision of TPO.

ITAT held as under:

• Statute does not provide that 5% tolerance benefit is not applicable in the instance of only one comparable rate.
• ITAT has relied in the case of Development Bank of Singapore (2013 155 TTJ Mumbai 265) and Begadiya Brothers Private Ltd (ITA No 387/Bil//2014) wherein 5% tolerance benefit had been granted for the single rate used for benchmarking.

Accordingly, ITAT allowed the appeal of the taxpayer and deleted the addition.

Our Comments

The plain reading of the transfer pricing provisions suggests that the benefit of addition/deduction of 5% safe harbor can be availed only in the instances where the comparable prices are more than 1. This view has also been upheld by courts in India in various judgments.

The two judgments relied upon by the Hon’ble ITAT while giving its view are the cases where comparable prices were ‘quoted prices,’ e.g., LIBOR rate or prices quoted on recognized stock exchanges. These quoted prices are generally a derivative of multiple trades/transactions/statistical data. Therefore, it is a fair assumption to consider these as not a single price.

On the other hand, the facts in the instant case are that the comparable price (valuation report) is a single price.

Whether non-generation of E-way bill in case of transport of capital goods for repairs will attract penal provisions under the GST law?

[Background: The proper officer had levied a penalty of 100% of the GST amount applicable on the value of the capital goods under Section 129 of the CGST Act.]

M/s Neva Plantation Private Limited vs. ACST & E-Cum-Proper Officer North Enforcement Zone, Palampur - GST Appellate Authority (GSTAA), Himachal Pradesh [2020-VIL-08-GSTAA]

Facts and contention

The petitioner submitted as follows:

• The petitioner was engaged exclusively in the business of supplying goods wholly exempt from tax.
• The petitioner was under a bona fide belief that they are not required to issue an e- way bill as the transport of capital goods for repairs is not a ’supply.’

Based on the above contentions and the facts and circumstances of the case, the GSTAA ruled as follows:

• E-way bill is required to be issued for movement of goods even in cases for reasons other than supply.
• However, given the circumstances of the case, a reduced penalty of INR 10,000 is imposable on the taxpayer for transporting goods without cover of specified documents under Section 122 of the CGST Act.
• The tax and penalty deposited by the petitioner under Section 129 is directed to be refunded.

Our Comments

Since the implementation of the e-way bill, the Revenue has been proactively intercepting conveyances and levying heavy penalties in case violations are identified.

However, in most of these instances it is observed that there are only minor discrepancies in the e-way bill without intention of carrying out any fraud. Based on the observations of the GSTAA in this case, taxpayers can seek relief in the mode of a reduced penalty in similar proceedings before the Revenue authorities.

Whether benefit of reduction in GST rate is to be passed on at each supply of Stock Keeping Unit (SKU) to each buyer of such SKU or the same can be netted off by computing profiteered amount at entity/group/company level?

Director General of Anti-profiteering (DGAP) vs M/s Ramaprastha Promoter & Developer Pvt Ltd – National Anti- Profiteering Authority [2020-VIL-15- NAA]

Facts and contention

• The respondent was engaged in real estate business and did not pass on the benefit from additional ITC accrued in GST regime to a flat-buyer on the sale of a flat.
• The respondent contended that the accurate quantum of ITC benefit would be passed on to the recipients once the project was fully completed.

Ruling

The NAA while ruling that the benefit should be passed on at the level of each SKU, observed as follows:

• On comparison of ITC as a percentage of turnover that was available to the respondent in the pre-GST and post-GST period, it is confirmed that the respondent had benefited from additional ITC to the tune of 0.92% of the turnover.
• By netting off the benefit of tax reduction at the entity level, a supplier cannot claim that he passed on more benefits to one customer; therefore, he could pass less benefit to another customer.

Our Comments

In the absence of the GST law providing a standard methodology for computation of the profiteered amount, no straight-jacket formula can be applied to determine the amount of benefit which a supplier is required to pass on to a recipient. This keeps the door open for more litigation on this issue.