Whether income from rendering of testing and other services would be taxable in India although the process of testing took place outside India?
Outotec (Finland) Oy Vs. DCIT [TS-311- ITAT-2019 (Kolkata)]
Taxpayer resident of Finland is engaged in the business of providing environmentally sound solutions for customers in metal processing industries. While filing tax return in India, income from sale of design and drawings and income from rendition of testing and other services was not offered to tax. Tax officer held these incomes to be taxable in India as royalty and FTS.
The tax tribunal relied on several judicial precedents and held that the designs and drawings sold by the taxpayer were in the nature of copyrighted article and not copyright itself on the premise that the designs were standard technologies and were used by the customers for their internal purposes and not for commercial exploitation. Hence, the said income constituted business income and in the absence of permanent establishment in India, the same wasn’t taxable under the Act and the tax treaty.
In the case of income from rendition of testing services, the tax tribunal held that the exception covered by Article 12 (i.e. the income earned on account of FTS shall be taxable in the country in which they are performed) of the tax treaty does not apply in the instant case since the testing results were consumed within India although the process of testing was conducted outside India. What is to be seen is the place where services were availed and not the place where payment for such services was made. Hence, income from rendition of testing services was taxable in India.
This decision lays down an important principle that where only copyrighted designs are transferred without transferring copyrights in the same, the same would not be taxable as Royalty in India.
India-Finland Tax Treaty provides that services would be considered to be accruing/arising in the country in which the services are performed. Interestingly, the Tax tribunal has not considered this exception and has held that the fees is paid for the results derived from testing and not for the testing activity. Even though the testing has happened outside India, since the results are consumed in India, the same has held to be taxable in India. We believe that this interpretation may not be correct and the same may get challenged before the High Court.
Dy. CIT vs M/s. Reliance Jio Infocomm Ltd. [TS-305-ITAT-2019 (Mumbai)
The taxpayer is an Indian entity engaged in providing telecom services in India. As per the agreement with its group company in Singapore (i.e. RJIPL) to avail bandwidth services, the taxpayer had withheld taxes on the Royalty payments made to RJIPL. Thereafter, the taxpayer appealed before the authorities that it had obtained ‘standard services’ from RJIPL which are not taxable as ‘Royalty’ but as business income. Further, the taxpayer contended that in the absence of a PE in India, the business income of RJIPL shall not be taxable and accordingly taxes are not required to be withheld on the said payments.
The tax tribunal held that the taxpayer had received only standard facilities on account of the agreement. Further, the taxpayer did not have any access to any equipment, or any process deployed by RJIPL for providing bandwidth services. Also, the infrastructure and/ or the process was always used and controlled by RJIPL. Besides, the intellectual property rights in the process was not owned or registered in the name of RJIPL, but the same was a standard commercial process which was followed by the industry at large and hence the same could not be classified as a “secret process” either. Hence, payments made by the taxpayer to RJIPL could neither be termed as royalty under the Income-tax Act, 1961 (the Act) nor under the tax treaty.
The said decision has held that bandwidth services are standard facility and hence not liable to tax as ‘Royalty’.
This could be an important decision for companies in telecom sector as this decision clearly brings out that such payments are not in the nature of royalty as the taxpayer is not entitled to access the equipment or any process but only avails standard service.
Whether support and management services (development of strategies, overall management and coordination, maintaining external relationships, human resource services, etc.) would constitute fees for included services (FIS) as per India-US tax treaty?
The Nielson Company (US LLC) vs DCIT [TS-304-ITAT-2019 (Mumbai)]
The taxpayer, US based company, is engaged in the business of providing customized research services and retail measurement services in India. Pursuant to a services agreement with its Indian group company (Indian entity), the taxpayer received certain consideration for providing support and management services (development of long term strategies, overall management and coordination, maintaining external relationships, human resources, tax services, management and co-ordination of IT policies, etc) which was not offered to tax in India as the same did not make available any technical knowledge or skills to the Indian entity. However, the tax officer held that these payments were FIS and hence taxable under the tax treaty.
The tax tribunal observed that the services rendered by the taxpayer were purely in the nature of support services which did not involve transfer of technology, skills, etc. Further, it was observed that aforesaid services, though may fall under consultancy or technical services, do not make available any technical expertise so that the Indian entity can apply the expertise on its own.
Also, the tax tribunal observed that the Technical Explanation to India-US tax treaty very categorically clarified that only those consultancy services are to be considered which are “technical” in nature for the purpose of FIS. Further, these services do not require transfer of technology, skill set to the Indian entity. In doing so, the tax tribunal placed reliance on various judicial precedents. In light of the above, the aforesaid services were not taxable in India under the tax treaty.
While commenting on whether support and management services would be considered as FIS, the tax tribunal has not only considered the relevant facts and tax treaty provisions but also the Technical Explanation to India-US tax treaty.
This has further enhanced the importance of technical explanation to a tax treaty. In doing so, it has been emphasized that consultancy services which are not technical in nature would not get covered within the ambit of “technical and consultancy” services under FIS. This finding is very liberal as it puts across a preposition that until and unless the consultancy services have technical element the same may not get covered under the definition of FIS.
Whether MAP (Mutual Agreement Procedure) can be applied on transactions entered into with AE and that not covered under MAP?
ANZ Operations & Technology Pvt Ltd, [IT(TP)A No.432/Bang/2012, IT(TP)A No. 483/Bang/2013, AY 2007-08 & 2008-09]
The taxpayer is engaged in providing software development and ITeS services. The taxpayer has adopted MAP resolution w.r.t. transactions undertaken with Australian related parties.
During the year under consideration, the taxpayer contended that the same percentage of profit should be applied for transactions entered into with non-Australian related parties, as admitted in MAP resolution for similar transactions with Australian related parties.
TPO rejected the aforementioned approach adopted by the taxpayer and made an adjustment.
CIT(A) upheld the adjustment made by TPO.
ITAT Ruling :
- ITAT held that same basis could be applied for non-Australian related parties as has been agreed by the taxpayer in the MAP resolution for transactions with Australian entities. This was also in view of the fact that the MAP agreed for transactions with Australian related parties constituted more than 90 % of the total related party transactions entered into by the taxpayer. Thus TPO was directed to compute TP adjustment using the same rate that has been agreed as per MAP resolution. Reliance was placed on taxpayer’s assessment for AY 2009-10 on similar grounds.
The transactions that are already covered and concluded by way of alternate dispute resolution mechanism (APA/MAP, etc.) could be used as a reference point, while arguing before tax authorities. Since similar issues have already been adjudicated, once the existence of similar fact pattern is proved, it can be viewed as a strong argument for defending the taxpayer’s case before lower authorities.
Itochu India Private Ltd, [ITA 1111/2018 & Connected matters, AY 2007-08, 2008-09 & 2009-10]
The taxpayer is engaged in rendering support services in relation to facilitation and market support to its AE. The taxpayer identified potential vendors and passed on the said information to AEs, to take the final purchasing decisions. After finalizing the supplier and subsequently purchasing the goods from them, the taxpayer assisted AEs in identifying potential customers to sell the products purchased.
The taxpayer benchmarked the aforementioned facilitation services using TNMM.
The TPO, during the assessment proceedings, re-characterized the taxpayer’s business model as a trader instead of a business support service provider. The TPO added the value of Free On Board (FOB) goods that are sourced by AEs to the taxpayer’s cost base and proposed a mark-up thereon. The TPO rejected the TP analysis undertaken by the taxpayer and conducted a new search and identified trading companies as comparables for recommending TP adjustment.
CIT(A) held that the taxpayer was a business support service provider and stated that the FOB value of goods should not be added in the taxpayer’s cost base. TP documentation and comparable companies selected by the taxpayer were accepted and TP adjustment was deleted accordingly.
- Relying on the case of Li & Fung India Pvt Ltd, the ITAT held that the cost base of the taxpayer was enhanced artificially by the TPO. The proposed mark-up on FOB value of goods sourced by AEs was not justifiable under TNMM as defined Rule 10 B(1)(e) and thus ITAT upheld the order of CIT(A).
- Thus, the High Court considered all the observations made by ITAT and upheld its order. A reference was also made to the fact that the taxpayer’s determination of arm’s length price has been accepted by the Assessing Officer for the subsequent assessment years. Furthermore, the High Court dismissed the Revenue’s appeal holding that no substantial question of law arises in the present case.
The High Court has consistently rejected the Revenue’s stand of wrongfully adding FOB value to the cost base of Sogo Shosha taxpayers. Furthermore, re-characterization of such taxpayers as a trader is also not sustainable.
Whether entity-level comparison can be made for specified domestic transactions (SDT) for inter-unit transfers?
Sheela Foams Ltd [ITA No.8155/ Del/2018, AY 2014-15]
The taxpayer is engaged in the business of manufacturing and trading of PU foam products and mattresses from various units located across India. One of the units of the taxpayer was eligible for various subsidies and deduction u/s 80IC of Income Tax Act, 1961.
During the year under consideration, the taxpayer entered into an international transaction of purchase and sale of raw material, which was benchmarked using TNMM, at entity level. The taxpayer also entered into SDT of payment of interest, rent, royalty, training fees to AE in India, and inter-unit transfer of raw materials, which was benchmarked using CUP.
The benchmarking carried out w.r.t. international transactions by the taxpayer was accepted by the TPO. However the profit made by the taxpayer w.r.t SDT transactions (80IC unit) was challenged. The eligible unit of the taxpayer earned higher profit than other non-80IC units (noneligible units). The TPO opined that the taxpayer had shifted profits to 80IC unit from non-80IC units, to claim tax benefit. Accordingly, the TPO proposed a downward TP adjustment.
The DRP analyzed the expenses allocated to the 80IC unit and directed the AO/TPO to allocate finance cost in sales/operating revenue ratio and re-compute the SDT expenses for calculating the TP adjustment. The DRP directed AO/TPO to examine the invoices pertaining to the transfer of consumables to the 80IC unit by taxpayer and state findings in the final order.
ITAT Ruling :
- ITAT upheld the application of entity-level TNMM for analyzing comparability. Furthermore, computing the margin of the 80IC unit by excluding the benefit received on account of excise duty and sales tax and comparing with the average margins of the comparable companies selected by the taxpayer has been upheld.
- Verification of invoices for inter-unit transfers was not warranted since TNMM was selected to determine the arm’s length price of SDTs.
- The ITAT directed the TPO to reduce the common/head office expenses that had been allocated to the eligible 80IC unit from the total SDT, for re-computing the TP adjustment.
- To determine the quantum of interest or finance cost to be allocated to the eligible 80IC unit and take effect of the same while computing margins of the unit.
In case of inter-unit transfers, the taxpayers need to be mindful of the segmental allocation and have in place back up supporting documents to prove that the apportionment basis is reasonable. Artificial inflation of profits/losses or allocation without underlying evidence in eligible units could be closely scrutinized by tax authorities.
Whether additional profits should be attributed to foreign AE, post determining the remuneration of Indian subsidiary to be at arm’s length?
Taj TV Ltd [ITA No. 1313/Mum/2018 & ITA No. 1501/Mum/2018, AY 2011-12]
The taxpayer is a tax resident of Mauritius and is engaged in the business of Telecasting of TV Channel (TEN sports).
During the year under consideration, the taxpayer undertook international transactions with its AE in India (Taj Television and Zee Entertainment Ltd) for advertising sales agency services, share of distribution services, recovery of expenses on the sale of broadcasting rights, reimbursement of expenses, and recovery of expenses and applied CUP for benchmarking distribution services.
The TPO rejected the TP analysis conducted by the taxpayer and computed TP adjustment. The TPO placed reliance on the intercompany agreement, wherein it was mentioned that Taj India had exclusive rights to represent the taxpayer before distribution systems/ cable operators and to negotiate with third parties for obtaining cable distribution license agreement. The distribution revenue collected by Taj India was shared with the taxpayer, the TPO/ AO concluded that such an arrangement created a PE in India.
Furthermore, the AO also has allowed programming cost and treated uplinking and transponder fee as royalty under Article 12 of India- US DTAA. Since no withholding was undertaken on the items mentioned above, the same were disallowed under section 40(a)(i).
CIT(A) partly upheld the order of AO and rejected the AO’s claim of disallowing certain expenses by following the decision in the taxpayer’s case.
- Relying on the decision of co-ordinate bench in the taxpayer’s case for earlier years, the ITAT held that the AE of the taxpayer does not constitute agency PE as per India-Mauritius DTAA. With regard to the advertisement revenue it was held that since AE (i.e., Taj India) was remunerated in line with the arm’s length principle, no further income or profit can be said to be attributable to the taxpayer (relied on Supreme court ruling in the case of Morgan Stanley).
- With regard to the issue of royalty, the ITAT relied on an earlier decision made in the taxpayer’s case, wherein it was mentioned that the distribution income does not fall under the definition of royalty and does not amount to transfer of any right over the copyright to cable operators.
- Accordingly, the AO was directed to delete the additions made towards computation of income attributable to the taxpayer in India.
While there are multiple judgments pronounced on the basis of Morgan Stanley case, it is imperative for the taxpayers to analyze its business model and ensure that the arrangement does not tantamount to existence of PE in India under the concerned DTAA.
Whether TNMM can be applied in case of distributor undertaking warehousing, marketing, quality control functions?
Videojet Technologies (I) Pvt Ltd [ITA No.6956/Mum/2012, AY 2008-09]
The taxpayer is engaged in the business of trading of coding and marking equipment, consumables, and spares thereof.
During the year under consideration, the taxpayer made import purchases from AE and sold it to third-party customers without any value addition. RPM was selected as the most appropriate method (MAM).
TPO rejected RPM as MAM stating that different accounting principles were followed by the taxpayer in the accounting of ‘cost of goods sold’ vis-àvis comparable companies. TPO further stated that the gross margin earned does not reflect whether the taxpayer is appropriately remunerated for the host of functions (viz warehousing, marketing, inventory control, quality control, etc.) performed by it as per the Functional, Asset and Risk analysis. Two comparable companies were also rejected on account of product differentiation. Thus TNMM was selected as MAM and entity level margins were computed by the TPO, thereby leading to TP adjustment.
DRP upheld the order of the TPO.
- It was established that the taxpayer imported goods from AE and sold it to third parties without any value addition. This was further substantiated with Rule 10B(1)(b) of the Income-tax rules, 1962, as a primary basis for evaluating the selection of RPM as MAM.
- On perusal of the accounts of the comparable companies, it was held that the taxpayer, as well as comparable companies, followed uniform accounting norms Indian GAAP. Thus, revenue’s ground of appeal was dismissed.
- The taxpayer being a full-fledged distributor performed certain functions viz. warehousing, marketing, inventorycontrol, and quality-control. However, the said functions did not add any value to the goods sold and would ideally be performed by comparable companies undertaking distributor functions. Thus gross profit margin (using RPM as MAM) was considered for benchmarking the import purchases.
- ITAT held that while selecting comparable companies under RPM, emphasis should be laid on functions performed rather than product comparability. Thus TPO was directed to include the two comparables excluded on account of product dissimilarity.
- ITAT selected RPM as MAM and considered gross profit margin as the PLI for determining the ALP of import purchases.
Taxpayers undertaking distribution function need to document the FAR robustly to substantiate entity characterisation.
Once it is established that the taxpayer is a full-fledged distributor and does not perform value added functions, RPM can be selected as the MAM.
DNV GL SE-India Branch [ITA No. 3139/ Mum/2018, AY 2011-12]
The taxpayer (Head Office – HO) is a tax resident of Germany and is engaged in the business of inspection and certification services in Marine Industries.
The taxpayer selected CUP as the most appropriate method to determine the ALP of the international transactions. TPO rejected CUP as MAM and computed upward TP adjustment.
Furthermore, the AO made an addition for HO’s share of invoice raised by the branch office in India (BO) and BO’s share of invoice raised by HO.
AO regarded branch office as service PE of the taxpayer becuase all the services were being rendered by a branch office and no specific work was carried out by the taxpayer for which the branch was liable to pay to the HO. Thus addition was made to the extent of the taxpayers share of income sourced in India.
In the absence of using any of the prescribed methods for computing upward TP adjustment, the same was deleted by CIT(A). Addition made on account of taxpayer’s share of income earned in India was also deleted.
- As per Indo-German DTAA, business profits of permanent establishment in India should only be offered to tax in India. Accordingly, the taxpayer’s share of income earned in India would be taxed in its country of residence i.e., Germany. Thus no profits were attributed to the taxpayer in India. The ITAT drew reference to the taxpayer’s own case in earlier years, wherein similar facts arose and the amount attributed by the BO to the HO was accepted by the co-ordinate bench of the Tribunal and the adjustment proposed was deleted.
- With regard to the TP adjustment proposed, the Tribunal accepted the taxpayer’s reliance on Supreme Court judgment in Morgan Stanley1 case, wherein it was held that once the overall attribution and taxability for HO & BO are accepted, TP analysis would not yield any further result. Thus the adjustment proposed by Revenue was deleted by the Tribunal, and the CIT(A)’s view was upheld.
The taxpayers operating in an HO – BO model are recommended to have in place supporting documents to bifurcate the transactions (cost and revenue) pertaining to respective entity’s operations. Furthermore, taxability of such transactions under the DTAA framework need to be closely evaluated.
Whether GST registration is required in states in which imports are made, even if no supply is made from such states?
M/s Gandhar Oil Refinery (India) Limited - Authority of Advance Ruling (AAR), Maharashtra [2019 (6) TMI 1010]
- The applicant had VAT registrations in various states in which it imported coal.
- At the time of implementation of GST, the applicant received provisional GST ID in all states where it had VAT registration, and therefore applied for GSTIN in all such states.
- Section 11 of the IGST Act, 2017 states that the Place of Supply (POS) in case of import of goods shall be the location of the importer.
- Therefore, the POS is in the state of Maharashtra as the agreement, commercial invoice, bill of lading is with the head office (HO) in Mumbai, Maharashtra.
- The company only has a liaison office in other states. Therefore, when the imported goods are sold by the company, it should be considered as supplies from Maharashtra.
The AAR agreeing with the contentions of the applicant held as follows:
- The applicant is situated in Maharashtra and hence will clear the imported goods by paying IGST from the GSTIN issued in Maharashtra.
- Furthermore, even if the applicant has godowns in different states, it can clear the goods on the basis of invoices issued by the Mumbai HO on payment of IGST in the state of Maharashtra.
- Thus, the applicant is not required to have separate registration in each state.
Under the GST law, a supplier is required to obtain registration in the state from which the taxable supply is made. Furthermore, ‘place of business’ includes a warehouse, godown, etc., where goods are stored. In view of this, the ruling by AAR not requiring the applicant to obtain GST registration in states where the goods are stored and sold from the godown is likely to be challenged by the Revenue authorities.
Whether a business engaged exclusively in supplying exempt supplies liable to obtain registration if it is liable to tax under reverse charge mechanism (RCM)?
[Background: Section 23 of the CGST
Act (‘the Act’) - Any person engaged
exclusively in the business of supplying
goods that are wholly exempt from tax
is not required to obtain registration
under Section 23 of the CGST Act.
Notification No. 13/2017 - Central Tax (Rate)
GTA services are liable to RCM.
Section 24 of the Act - A person liable to pay tax under RCM has to obtain registration compulsorily.]
M/s. Jalaram Feeds - AAR, Maharashtra [2019 (6) TMI 1063]
- It is engaged exclusively in supplying exempt supplies and hence is not required to obtain registration in accordance with section 23 of the Act.
- Most persons engaged in the supply of exempted goods and services require services on which tax is payable under RCM [goods transport agency (GTA) services in this case]. Hence, there would be no need of section 23 of the Act as everyone would be covered under section 24.
- Section 23 of the Act is standalone section and provisions of Section 24 pertaining to compulsory registration are applicable only to a person liable for registration under Section 22(1).
The AAR disagreed with the contentions of the applicant and held that:
- The argument of the applicant makes Section 24 of the Act redundant.
- It is a well-settled principle of law that it should not be interpreted in such a way to make any part of the statute redundant.
- Therefore, the applicant would go out of the scope of Section 23 as it is availing GTA services, which are liable to tax under RCM.
- The applicant would fall within the scope of section 24 and hence, would be required to obtain registration under the Act.
In view of this advance ruling, businesses which are otherwise not required to obtain registration under GST should evaluate the implications in light of Section 24 of the Act, which provides for situations wherein a person is compulsorily required to obtain registration.