FROM THE JUDICIARY

Whether payment for software maintenance charges would be taxable as royalty under the Incometax Act, 1961 and India-France tax treaty?

CMA CGM Agencies India Pvt. Ltd. vs Dy. CIT [TS-2-ITAT-2020 (Pune)]

Taxpayer, an Indian company, a shipping agent, had made certain payments for software maintenance charges to its associated entity, CMA France without withholding any tax on the basis that the same did not constitute any royalty or fees for technical services under the Income-tax Act, 1961 (the Act) as well as India- France tax treaty.

However, the tax officer rejected the contention of the taxpayer and inferred that the payment made by the taxpayer was for availing IT support services from CMA France and not for the maintenance of software. Hence, placing reliance on CIT vs Synopsis International Old Ltd. (2013) 212 Taxman 454 (Karnataka), it was held that the amount paid by the taxpayer was taxable as royalty under the provisions of the Act.

Held

The tax tribunal observed that CMA France was a company operating in the maritime, possessing a fleet of vessels across the globe. With a view to pursue and expand its shipping business, CMA France roped in its affiliates from other countries, including the taxpayer. Further, the tax tribunal observed that the software provided by CMA France to its affiliates was mainly aimed at facilitating its shipping business. Hence, the provision of the said software was inextricably linked with its shipping activity and thus covered within the ambit of profits derived from shipping operations. In this regard, the tax tribunal placed heavy reliance on the decision of the Supreme Court in the case of A.P. Moller Maersk vs DDIT (2017) 392 ITR 186 (SC).

Further, the tax tribunal also observed that if an item of income was connected either directly or indirectly with the shipping business, then such income has to be understood as profits derived from the shipping business. In this regard, the tax tribunal placed reliance on Article 9(4) of the tax treaty wherein interest income arising on funds connected with shipping operations in international traffic is treated as profits derived from the operation of ships, thus, keeping Article 12 (Interest) out of the picture on such income.

Alternatively, the tax tribunal also observed that the taxpayer was merely allowed to use the software for its business purposes and there was no permission to sub-license the same. Thus, the payment was for using a copyrighted article and not the copyright itself. Hence, the same was not covered within the ambit of “use of, or the right to use, any copyright of software.” Thus, such payments do not constitute royalty under the tax treaty.

Our Comments

This decision assumes significant importance as it brings out the oldest rule of tax treaty interpretation – specific provision over general provision. In other words, where a tax treaty specifically provides for taxation of shipping income, incidental income such as interest or dividend connected with shipping operations would also be governed by it.

Once again, this decision debates over copyrighted article vs copyright wherein the tax tribunal once again favors the view that the use of copyrighted articles does not constitute royalty. However, this position would settle only once the Supreme court ruling in the case of Samsung is pronounced this year.

Whether service fees to be treated as ancillary to the enjoyment of the intangible right and hence should fall under the definition of royalty under Article 12(4)(a) of the India- USA tax treaty?

Kelly Services Inc. vs Dy. CIT (International) [TS-832-ITAT-2019 (Mumbai)]

The taxpayer, a resident of the US, carries on a business of staffing and recruitment outside India and does not have a Permanent Establishment (PE) in India. Pursuant to a royalty agreement with Kelly India, the taxpayer received INR 9,60,026 towards management fees for offering business consulting services. The taxpayer did not offer said management fees to tax basis that the same did not make available technical knowledge, experience, skill, knowhow, etc. as per the India-US tax treaty.

However, The tax officer rejected the claim of the taxpayer and inferred that the management services provided by the taxpayer were, in fact, ancillary and subsidiary to the enjoyment of the rights granted by the taxpayer to Kelly India, accordingly, such management fees would be taxable as royalty as per Article 12 of the tax treaty. Further, the tax officer also held that the services provided by the taxpayer made available technical knowledge, skill, know-how, etc. and hence covered within the ambit of fees for included services under the tax treaty.

Held

The tax tribunal observed that the services provided by the taxpayer against the management fees were independent services on a standalone basis and hence Article 12(4) (a) of the tax treaty does not come into play. Further, the tax tribunal held that a payment of consideration would be regarded as fees for included services only if the twin test of rendering services and making technical knowledge available at the same time would be satisfied, which is not the case presently.

Our Comments

Whether software as a service can be considered as fees for technical services/fees for included services wholly depends upon the factual matrix of each case. There have been divergent views on this issue in the past. However, this decision assumes importance since it has clarified that independent services cannot be termed as ancillary and subsidiary services and hence such services may not be taxable as royalty under Article 12 of the tax treaty.

Whether IT services linked to royalty agreements would be taxable as fees for technical services (FTS) even in the presence of make available clause in the India-Sweden tax treaty read with the protocol?

Aktiebolaget SKF vs Dy. CIT [TS-45- ITAT-2020 (Mumbai)]

The taxpayer, a Swedish company, had entered into two agreements for providing technical collaboration/ assistance and service agreement regarding various management services. However, from AY 2011-12, the taxpayer bifurcated them into three agreements, i.e., Trademark license, Technology license and IT services delivery agreements wherein it offered to tax fees received from first two agreements as royalty and fees received under the third agreement was not in the nature of royalty and hence not taxable in India basis Pune tax tribunal’s decision in the case of Sandvik Australia vs DDIT and the definition of royalty under India- Sweden tax treaty.

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 tax tribunal observed that all the agreements in question are interconnected so much so that the royalty agreements cannot be effectively implemented unless it was properly integrated with the IT service delivery agreement. Further, it was also observed that the taxpayer had bifurcated the agreements so that fees received under IT services delivery agreement could be taken out of the ambit of definition royalty. Also, it was observed that there was no functional change in the services offered or the IT infrastructure set up to render these services subsequent to the change in agreements.

As regards the claim of the tax officer for treating income earned from IT services agreement as FTS in nature, the tax tribunal observed that the said IT services were subservient to the royalty agreement. Further, these services were ancillary and subsidiary to the main royalty agreement as they are inextricably connected to it. Hence, such services are covered within the ambit of Article 12(4)(a) of the tax treaty and once, the same was covered under clause (a) of Article 12(4), the taxpayer cannot claim to move the second clause, i.e. (b) being beneficial to it. Hence, these services were in the nature of FTS and hence taxable in India and make available tests laid down in the second clause would not be applicable in this case.

Our Comments

This decision looks at multiple agreements entered into by the taxpayer and tries to establish the interdependency between the agreements. It becomes imperative for the taxpayer to ensure that agreements are not split for tax purposes and if the agreements are interdependent, then the taxability would have to be considered on an overall basis. Further, even if a company desires to split the agreements, it should be backed by solid commercial reasons and the same should be properly documented to avoid unnecessary litigation.

Mumbai ITAT rules on whether transfer pricing provisions are applicable to shipping company opting tax computation under tonnage tax scheme (Chapter XII-G) and other related issues.

Essar Ports Ltd – ITA No.1831/ MUM/2015

The taxpayer was engaged in shipping operations and, for the current year, has provided ship management services to its AE, which was benchmarked by applying the TNM method. The TPO proposed an adjustment without considering the fact the said income was taxed under the ‘tonnage tax scheme’ under Chapter XII-G of the Act. Placing reliance on the decision of the Mumbai ITAT in case of Van Oord India Private Limited (ITA 7228/Mum/2012)], the taxpayer pleaded that TP provisions would not be applicable.

The ITAT deleted the adjustment based on the following:

1. The services to its AE fall under “Incidental activities” as provided in Section 115-1 read with Rule 11R and the profits from such incidental activities are deemed to be included in the shipping income of the tonnage tax company.
2. The computation of income under the tonnage tax scheme is on a presumptive basis, which is dependant on the daily tonnage capacity of ship and number of days in operation. Therefore, actual receipts and payments have no bearing on the taxability. On the contrary, the TP provisions prescribe the determination of ALP of actual stated transaction. This stated price is absent from the computation mechanism of the tonnage tax scheme.
3. Section 115VA (part of chapter XII-G) overrides computation under Section 28 to 43C of the Act. Hence, the income has to be computed based on registered tonnage of the ships and not as per net profits as per financial statements or adjusted profits as per Chapter-X.

The ITAT relied on the case of Van Oord India Private Limited (supra).

Our Comments

The ruling has provided specific references to the Act for determining the non-applicability of TP provisions to tonnage taxation. It would be worthwhile to see the applicability of TP to other presumptive tax computations, which actually take into account the income earned to determine the profit percentage.

Delhi ITAT sets aside order on advertising, publicity and marketing (AMP) adjustments; confirms Bright Line Test should not be used for justifying an international transaction for AMP.

Xerox Limited - ITA No 5528/DEL/2012

The taxpayer operates in the document management industry with the primary function of distribution of goods that are imported from the AEs. On the basis that the taxpayer has incurred substantial AMP expenses to promote the Xerox brand, the primary beneficiary of which is the AE and the said expenses are higher than comparable companies, the TPO opined that the taxpayer has entered into an international transaction of providing AMP services to its AEs. The TPO applied the Bright-line Test to determine the ALP of the transaction.

The ITAT deleted the adjustment made by the TPO based on the following:

1. Firstly, the revenue must establish the existence of an international transaction, and only then can it proceed with the determination of ALP of the same.
2. Excessive AMP expense or mere use of brand name or logo of AE cannot infer the creation of intangibles for AE. The ITAT observed that the taxpayer has a principle to principle relationship with the AE and the growing sales pattern of the taxpayer shows that the benefit of the AMP has accrued in favor of the taxpayer.
3. It is a settled principle that BLT is not a valid method to justify the existence of international transactions.

However, the ITAT restored the matter to the AO, stating that if the decisions of the HC on which the ITAT has placed reliance on are modified or reversed by the SC, the AO can pass a fresh order based on the decision of the SC.

Our Comments

In conclusion, whether a transaction has actually taken place, a mere reference to an incidental benefit is not enough. Also, the ITAT has given due cognizance to the prescribed methods to decide ALP and viewed that the BLT is not one of them.

Further, on the similar issue of AMP in the case of Diageo India,1 the Mumbai ITAT has upheld AMP-adjustment on the basis that there was a mutual agreement between taxpayer & the AE to incur AMP-expenses & allocate/ apportion AMP-cost. Accordingly, taxpayers should be vigilant to check their inter-company arrangements to assess if there is an existence of such transactions.

1. ITA No. 1228/Mum/2015 & 1813/Mum/2015 AY 10-11

The High Court confirms that omission of transactions under section 40A(2)(b) from specified domestic transaction means the law has never been passed and to be considered as a law that never existed.

Texport Overseas Pvt Ltd - ITA No 392/2018 A/W ITA No 170/2019

The taxpayer (engaged in exports of readymade garments) contended lapse of transfer pricing assessment proceedings, on account of the omission of section 92BA(i) of the Act, considering transactions with related parties under section 40A(2)(b) to be specified domestic transaction.

The Tribunal upheld appellant’s contention placing reliance on Kolhapur Canesugar Works Ltd (SC/2000), which relies on Rayala Corporation (SC/1969) referencing section 6 of General Clauses Act stating repeal of provisions of Central Act do not affect the pre-amendment operation of law. An omission is unlike a repeal, and hence, the omission of provision without a savings clause renders provision retrospectively nonfunctional.

The High court confirmed the resultant effect of omission of transaction under section 40A(2)(b) from the specified domestic transaction, which means the law has never been passed and to be considered as a law that never existed.

Our Comments

Taxpayers having specified domestic transactions (u/s 92BA(i) r.w. 40A(2) (b)] that are under litigation may consider taking reference from the HC ruling to plead that such transactions are not covered under the ambit of transactions since its existence.

Whether merely written down value (“WDV”) of the asset can be considered as arm’s length price under the CUP method without due consideration to the fair market value.

Panasonic Energy India Co Ltd – ITA No 1892/AHD/2014

The taxpayer has sold plant and machinery to its AE at a consideration higher than the value determined by the independent valuer. However, the TPO stated that the WDV of the plant and machinery should be considered as the comparable price, and since the consideration received by the taxpayer was less than the WDV, an upward adjustment was proposed.

The ITAT deleted the adjustment stating that the TPO was not justified in merely relying on the WDV as per books of accounts as the comparable price without making any inquiry for ascertaining the FMV of the asset.

Additionally, the ITAT relied on various judicial pronouncements which have held that when the taxpayer submits a report from an independent valuer indicating the FMV of the assets, before rejecting such a valuation report, TPO is duty-bound to refer the valuations to designated valuation officer as per procedure laid down under statute.

Our Comments

It is important to give due consideration to the fair market value in asset transfer transactions. A valuation report from an independent valuer can provide reliable support for determining the fair market value of such a transaction.

Whether amounts received by an employer from outgoing employees in lieu of notice period would attract service tax?

[Background: As per Section 66E(e) of Chapter V of Finance Act, 1994, agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act is a ‘declared service’.]

GE T & D India Limited vs. Deputy Commissioner of Central Excise, Large Tax Payer Unit, Chennai - Hon’ble High Court of Madras [2020-VIL-39-MAD-ST]

The Hon’ble High Court answering the question in negative, held as follows:

• The employer cannot be said to have rendered any service per se much less a taxable service.
• The employer has merely facilitated the exit of the employee upon imposition of a cost upon him for the sudden exit.
• The employer has not ‘tolerated’ any act of the employee but has permitted a sudden exit upon being compensated by the employee in this regard.

Our Comments

The issue of service tax implications on notice pay recovery has seen numerous litigations between the department and taxpayers. In view of similar provisions in Schedule II of the CGST Act, the issue has transcended to the GST regime as well.

This decision provides a substantive judicial precedent in favor of taxpayers. However, given the significance of the issue involved, it is expected that the government will prefer an appeal against this decision before the Hon’ble Supreme Court.

Whether the double levy of IGST on ocean freight - once under Customs law and again under IGST Act - constitutionally valid?

[Background: On import of goods, Customs duty is payable along with IGST on the CIF value of the goods imported. Further, under Notification No. 10/2017-IGST (Rate) dated 28 June 2017, IGST is payable by the importer under reverse charge mechanism (RCM) on services of a foreign transporter of goods to the foreign supplier of goods.]

Mohit Minerals Pvt Ltd vs. Union of India - Hon’ble High Court of Gujarat [2020 (1) TMI 974]

The Hon’ble High Court while ruling that the levy of IGST under RCM on ocean freight is ultra vires the IGST Act observed as follows:

• Article 265 of the Constitution provides that “No tax shall be levied or collected except by authority of law.”
• Section 5(3) of the IGST Act provides that in case of specified supplies, the tax shall be payable by the recipient under RCM.
• In the present case, the foreign exporter enters into a contract with the shipping line for availing the services of transportation of goods in a vessel.
• The obligation to pay consideration is also of the foreign exporter.
• Thus, the writ-applicant is not the 'recipient' of the transportation service.
• Therefore, the said Notification making the importer liable to pay tax under RCM lacks legislative competence and hence declared to be unconstitutional.

Our Comments

The amount of IGST paid under RCM on ocean freight is available to the taxpayer. However, this results in working capital blockage, especially in cases where the taxpayer already has a substantial ITC balance. In view of this judgment, taxpayers can consider adopting a position to not treat ocean freight on imports as taxable under RCM. However, before adopting such a position, it is important to consider the fact that the government is expected to prefer an appeal before the Hon’ble Supreme Court.