From The Judiciary

Whether cost to cost salary reimbursement of deputed employee triggers Fees for Technical Services (FTS)?

M/s Yum! Restaurants (Asia) Pte. Ltd. Vs DDIT [ITA No.6018/ Del/2012]

Background

The taxpayer is a non-resident company incorporated in Singapore. It is engaged in the business of franchising KFC, Pizza Hut, and Taco Bell for several territories in the Asia Pacific region including, India. The taxpayer entered into Technology License Agreement (TLA) with Yum! Restaurants (India) Private Limited (YRIPL), which in turn appoints various franchisees for operating restaurants in India under the brand name KFC and Pizza Hut. YRIPL also operated company-owned KFC restaurants in India.

Under the TLA, the taxpayer has deputed its Vice President to YRIPL. The employee has actively participated in the day to day activities of YRIPL, including attending the board meetings and signing the financial statements. The salary of the employee was paid by the assessee and reimbursed by YRIPL.

Relying on the jurisdictional Delhi High Court decision in the case of Centrica India Offshore Pvt. Ltd, the Assessing Officer (AO), was of the view that the reimbursement of the salary by YRIPL was taxable in the hands of the taxpayer as FTS.

On appeal to the CIT(A), the taxpayer in its justification has referred to various clauses of the agreement whereby it was clear that the employee was under direct control and superintendence of YRIPL and the appellant discharged the employee from all obligations and rights whatsoever, including a lien on employment. Further, the employee was deputed to India as a replacement for a former employee, and once his deputation period expired, he was permanently moved to the payroll of YRIPL to continue his employment with YRIPL. Considering all the arguments, CIT(A) passed an order favoring the taxpayer. Aggrieved by the decision of the CIT appeals, the Revenue filed an appeal before the New Delhi ITAT.

Held

Upholding the findings of the CIT(A), the Delhi ITAT opined that the facts in the case of Centrica India Offshore Pvt. Ltd was very different than the facts of the present case. The agreement made it clear that the assessee was working as an employee of YRIPL and as an employee of the assessee company. In any case, in the absence of fulfillment of the ’make available’ clause, it is not possible to hold that there is any taxability of FTS under Article 12 of the India-Singapore. Further, the reimbursement of salary had no element of income and was not taxable.

Also, since the employee has already paid taxes in India on the aforesaid salary, the same amount being taxed as FTS in the hands of the assessee company, would amount to double taxation.

Our Comments

The case of Centrica India Offshore Pvt. Ltd was a turning point for taxation in the deputation arrangements. However, the tax treatment for such an arrangement cannot be standardized as it would be dependent on the facts of each of the cases.

Whether providing access to the market research report, generated based on the data and information collected for a specific sector, provided for a predetermined subscription price be categorized as Royalty?

IMS AG Vs DCIT [ITA No.6445/ Mum/2016]

Background

The taxpayer is a company incorporated and fiscally domiciled in Switzerland. It is engaged in the business of providing market research reports on the pharmaceutical sector to its customers across the world at a predetermined subscription price. The license access so granted is a non-exclusive and nontransferable right. It is consideration received, as allowing this non-exclusive, non-transferable access to the database, and IMS reports. In essence, the IMS reports, based on the module selected, are statistical database compilations, providing geo-economical data, about a pharma molecule, providing insight into the connected issues related to information and development.

The Revenue has held that the aforesaid receipts were taxable as Royalty as per section 9(1)(vi) of ITA as well as under Article 12(3) of the Indo Swiss DTAA. Aggrieved by the decision of the Revenue, the taxpayer filed an appeal before the Mumbai ITAT.

Held

The ITAT placed reliance on AAR ruling (subsequently approved by the jurisdictional High Court) in case of Dun and Bradstreet Information Services India Pvt. Ltd. (D&B) whereby on the similar facts, it was held that the sale of standard business information reports derived out of publicly available data by the subsidiaries of Dun and Bradstreet US in Spain, Europe and V. K. to the assessee did not attract the provisions of section 195 of the Act.

The tribunal has appreciated the fact that the ruling of AAR is binding only on the concerned appellant. However, where the Hon’ble jurisdictional High Court has approved the same, it cannot be open for the tribunal to be swayed by a contrary view.

Our Comments

There are a plethora of decisions over the taxability of consideration received for access to standardized data. This judgment is an addition to the group.

Whether payment of fees to a nonresident for web hosting services, on-site promotion activities, etc. could be treated as FTS?

M/s. Esm Sys Pvt. Ltd. Vs ITO [ITA No. 350/Ahd/2018]

Background

The taxpayer is an Indian Company engaged in the business of web designing, web advertising services and had made a payment to one of its group companies residing in the US for obtaining the services of data promotion, social media management, and general consulting. According to the assessee, the US Company was paid for managing and overseeing the various on-page and off-page activities that drove traffic to a specific website, and accordingly, services were provided for site promotion activities.

The Revenue was of the view that hiring a server and the provision of web hosting services came under the technical services, thereby regarding it as Fees for Technical Services as per Section 9(1)(vii) of the Act. He was also of the view that payment made to the US company was in the nature of Royalty as per Section 9(1)(vi) of the Act and thus passed an order holding the assessee as an assessee in default for failure to withhold taxes. On appeal, the CIT(A) affirmed that such services would qualify to be FTS.

Aggrieved by the decision of the CIT(A), the taxpayer filed an appeal before the Ahmedabad Tribunal.

Held

On hearing the contentions of both the parties, the ITAT was of the view that the taxpayer had obtained the services of web promotion, social media management from the US Company. The said company had used various techniques including web content development, search engine optimization, to increase the website traffic. It was emphasized that the entire transaction took place over the internet through virtual servers, which were ‘located across the world and were not under the control of payer.’ It was used for hiring space for domain hosting and display of advertisement on the server located worldwide.

Thus, upholding the contentions of the taxpayer, the ITAT held thnat since there was no sharing of knowledge or knowhow or any technology to the taxpayer during the provision of Web Hosting Services the said payment cannot be considered as fees for included services as per Article 12 of India-USA DTAA as technical knowledge or know-how are not made available to the taxpayer.

The tribunal placed reliance on following judicial precedents Pinstorm Technologies (P.) Ltd. vs. ITO [2012] 24 taxman.com 345 (Mumbai) and ITO vs. Right Florists (P.) Ltd. [2013] 32 taxman. com 99 (Kolkata-Trib)

Our Comments

It has always been a debatable issue whether a particular service is covered under FTS. This decision is certainly welcome in the context.

Whether management charges paid to AE can be disallowed in the absence of specific need and benefit reasoning?

Michelin India Pvt. Ltd. - ITA No.2415/Del/2014

Ruling

The taxpayer was engaged in manufacturing and trading of tires and tubes and had availed certain management support services from its Associated Enterprise (AE).

The Assessing Officer (AO) observed an increase in personnel and establishment cost and that the taxpayer had a full team of management staff performing similar functions as availed from the AE. Hence, AO claimed that management support was not genuine and should be disallowed, citing diversion of income.

The taxpayer stated before the Commissioner of Income Tax (Appeals) CIT(A) that the management support services constitute genuine business assistance needed to conduct its business operations efficiently. Further, the financial profits and condition of the taxpayer have improved as a result of these expenses, which can be said as benefits derived from such support services availed. However, CIT(A) rejected the taxpayer’s contention stating the documentation was not sufficient to justify actual receipt of services.

Income Tax Appellate Tribunal (ITAT) observed the taxpayer’s need to avail such services to carry on its business operations with a global presence and maintain international standards for providing services to its customers. It was a necessity to avail of management support from its AE. The fact that the taxpayer was increasing expenditure on its personnel and other management teams cannot be a factor in deciding the need for services availed from AE.

Further, it is outside the AO’s domain to decide the need for availing such a service. Considering the improvement in the financial state of the taxpayer, it was viewed as a result of benefits reaped by the taxpayer. Hence, the disallowance made by the officer was unfounded.

Our Comments

Indian courts, in various rulings, have stated that need and benefit are not the only relevant parameters to determine the arm’s length nature of intra-group service transactions. While it has been reiterated that the tax officer cannot question the need for an expense and fill the shoes of a businessman, practical analysis of the transaction coupled with the maintenance of robust documentation helps in justifying the presence and need of such payments.

Whether notional interest is to be charged on outstanding AE receivables?

ValueLabs LLP - ITA No. 1909/ HYD/2017

Ruling

The taxpayer was engaged in rendering software development services, and the Transfer Pricing Officer (TPO) had observed that there were outstanding trade receivables. However, the taxpayer contended that the effects of outstanding receivables were considered in the working capital adjustment for benchmarking. The TPO rejected the taxpayer’s argument and made an adjustment on account of interest on overdue receivables considering interest rate at 14.45% for the period beyond the due date. The DRP upheld the contention of TPO.

The taxpayer pointed out the following before the ITAT:

• Outstanding receivables cannot be termed as an international transaction;
• The margins of the taxpayer were higher than that of the comparables;
• The working capital adjustment that considers the effect of receivables should be allowed;
• The credit period allowed to AE was 72 days as against 90 days for comparables.

Hence, no transfer pricing adjustment should be made;

However, the tax authorities contended that working capital adjustment takes care of the period within the financial year but does not cover outstanding receivables. Further, the agreement between the taxpayer and the AEs states the terms of payment and the prescribed number of credit days to be allowed. Hence, the master agreement should be concerned about determining the ALP of outstanding receivables and not the comparables.

The ITAT, relying on the case of M/s. Global Logic India Ltd. and Pr. CIT-V vs Kusum Health Care Pvt. Ltd. stated this is a covered matter wherein it was held that no adjustment is to be made on account of notional interest on receivables by treating continued debit balance as an international transaction. Moreover, when the taxpayer is a debtfree company, there is no question of charging any interest on receivables.

The taxpayer, during the year under consideration, had not availed any loan from AEs or unrelated third parties and has not incurred any interest cost. The master agreement stipulated to allow 90 days of credit, and this in itself cannot form a basis for an international transaction. Further, it has been settled in the above case that receivables adjustment is not warranted if they are commensurate with the comparables. Hence, the ground of appeal raised by the taxpayer was allowed.

Our Comments

The inter-company agreement stipulating credit period in itself cannot form the basis of warranting a notional interest charge. Other factors such as terms followed by comparables, debt structure of the taxpayer, working capital adjusted profit margins, etc. should be taken into consideration.

Can advertisement, marketing, and promotion expenses (AMP) incurred by the Indian group be construed as a brand-building exercise to benefit AE if the shares of AE are listed at a premium on the stock exchange.

MakeMy Trip (India) Pvt. Ltd – ITA No.2307 & 4757/Del/2013

Ruling

The taxpayer is engaged in the online sale of travel products and solutions and had entered into certain service transactions with its AE. The taxpayer had adopted an aggregate benchmarking approach using the Transactional Net Margin Method (TNMM).

The TPO observed that the taxpayer had incurred certain expenses in the nature of AMP, which was partially recovered from the AE. The TPO held that the expenses provided an endearing benefit to a multinational group and had to be capitalized, as the expenses were not incurred exclusively for the taxpayer’s business and had to be fully recovered from the AE. Accordingly, the TPO adopted the Bright Line Test (comparing taxpayer’s AMP expense percent to sales at 50% with a similar ratio of comparable companies that was 40%) and made a TP adjustment on account of the development of the brand, which benefits AE outside India.

Additionally, the TPO also observed that the AE had been recently listed on a stock exchange (at a premium), while the taxpayer was incurring losses. The TPO viewed this as the AE benefiting from brand building exercise incurred by the taxpayer.

The CIT(A) observed that the brand was owned by the taxpayer, and the Bright Line Test was generally to be adopted in case of marketing of an overseas brand. Further, judicial precedent in the taxpayer’s case has accepted AMP expense as ‘not an international transaction.’ Accordingly, CIT(A) deleted the AMP adjustment.

The ITAT observed that TPO had not considered the AMP expense as international transactions during the tax period 2010-11 to 2016-17. In respect of the nature of the expense, ITAT recognized the taxpayer’s reliance on settled case laws stating that advertisement expenditure incurred for launching products is necessary to address the competition in the market for selling that product. Such nature of expenses to increase the sales of products are allowable as revenue expenditure as no permanent character or advantage is achieved via the same, and such expenses are a part of the process of profit earning and not in the nature of capital outlay.

Our Comments

The Indian courts have divergent views in relation to construing AMP to be an international transaction. Expenses incurred are in the nature of product promotion, and not brand promotion. Thus, the same can be considered as revenue expenditure.

Whether outstanding receivables can be justified citing consistent losses and cash crunch faced by AE.

Techbooks International Pvt. Ltd – ITA No.6102/Del/2016

The taxpayer is a wholly-owned subsidiary of the US-based entity engaged in the provision of IT-enabled data conversion service to its AE and adopting TNMM as a benchmarking approach.

The TPO observed that the taxpayer’s credit period allowance was agreed for 60 days with the AE as opposed to extra credit period that had been allowed to the AE. The TPO made an adjustment characterizing overdue receivables as an unsecured loan applying the SBI base rate plus 300 bps as an interest charge. The aggrieved taxpayer filed an appeal to the DRP.

The DRP noted that outstanding receivables are international transactions, and the TPO was correct in his contention for the interest charge. However, the interest could only be applied for receivables beyond 150 days, as held in taxpayer’s earlier rulings. Further, LIBOR should be used as opposed to the SBI base rate as held by majority High Court rulings in relation to foreign currency based invoices.

During the ITAT appeal, the taxpayer differentiated financial and operational creditors, contending that the receivable/payable is the outcome of the transaction of services provided. Hence, trade receivable per se is not an independent international transaction. Further, it submitted the financials of the AE, depicting consistent losses while pleading genuine hardship and cash crunch faced by AE for payment of receivables. The taxpayer proposed an additional ground during ITAT appeal aggregating receivables with the provision of service transaction. Additionally, the taxpayer claimed a working capital adjustment on the service transaction, contending that the impact of receivables would subside within it.

The ITAT relying on taxpayer’s ruling for earlier years held receivables as separate international transactions citing retrospective amendment to section 92B of the Act. Further, it observed a change in facts vis-àvis in the previous years. The total value of receivables due from AE had exceeded the amount of shareholder funds employed by the taxpayer. This implies that the total profit earned by the taxpayer over the years (reflected in reserves) is enjoyed by its AE outside India. Hence, the whole of shareholder funds was loaned to AE in the form of receivables. With respect to the working capital argument, it’s devoid of any merit in the present case where receivables are more than shareholder’s fund. Further, The TP documentation nowhere proposes a working capital adjustment.

Hence, the contention and adjustment effected by TPO and DRP are upheld for charging interest on re-characterized receivables as an unsecured loan for a period beyond 150 days.

Our Comments

The court rulings have consistently decided in favor of the taxpayers by allowing working capital adjustment over the years. However, in this particular scenario, the fund flow structure of the taxpayer was given a high degree of importance for allowing the charge of interest on outstanding receivables

Whether GST is applicable to the accounting entry made in the books of accounts of Project Office (PO) for the salary cost of Expat employees?

[Background: As per Para 1 of Schedule III of the CGST Act, 2017, Services provided by an employee to the employer in course or in relation to employment, shall be treated neither as a supply of goods nor services.]

Hitachi Power Europe GmbH - Authority for Advance Rulings (AAR), Maharashtra [2020 (7) TMI 79]

Ruling

• The applicant is a PO in India of Hitachi Power Europe GmbH;
• It is established to undertake an activity of executing power projects awarded to it by an Indian company;
• Many employees of the Head Office (HO) (i.e., expat employees) work in the PO in India, and statutory obligations like Form 16 under the Income Tax Act are fulfilled by the PO;
• In order to comply with the accounting guidelines and Companies Act, the PO records the salary cost for the expat employees at the PO.

Based on the above, the AAR ruled as follows:

• The Indian PO is a branch office of the foreign company set up in India for the limited purpose of executing a specific project;
• Hence, there is an employeremployee relationship between the PO and the expat employees;
• The services provided by the expat employees to the PO are covered under Schedule III and are not to be construed as a supply under the GST law.

Our Comments

This ruling is in line with the earlier ruling by the AAR, Rajasthan, in the case of Habufa Meubelen B.V [2018 (7) TMI 883], where a similar arrangement was present in case of a Liaison Office established in India.

However, implications on salaries of foreign expat employees paid by Indiansubsidiaries where they are deputed is open to debate.

Whether transfer of business unit from one state to another state would amount to supply of goods or supply of services or supply of goods and services?

Whether in the above case, GST ITC-02 can be filed for the transfer of unutilized ITC from a business unit in one state to a business unit in another state?

Shilpa Medicare Limited - AAR, Andhra Pradesh [2020 (7) TMI 345]

Ruling

• The applicant has its R&D unit in Andhra Pradesh (AP) and business unit in Karnataka (KR).
• The applicant has shifted its AP unit, as a whole along with the capital assets as a going concern to the KR unit for a monetary consideration.

Based on the above facts, the AAR ruled as follows:

• In the instant case, the business in its entirety was transferred along with capital assets;
• Therefore, the said transaction being a transfer of going concern is exempt from GST in accordance with Notification No. 12/2017 - Central Tax (Rate) dated 28 June 2017;
• Furthermore, the transferor can transfer unutilized input tax credit (ITC) to the transferee unit located in another state, by filing GST ITC-02.

Our Comments

As per Circular No. 133/03/2020-GST dated 23 March 2020, GST ITC-02 has to be filed in the state in which both the transferor and transferee are registered. Even from a practical standpoint, the GSTN portal does not allow the filing of GST ITC-02, when parties are located in different states.

Thus, it appears that the ruling of the AAR is not viable from a practical standpoint, and further clarity is awaited from the government.