Direct Tax

Whether advertisement expenditure incurred post production of films can be claimed as deductible expenditure under section 37 of the Income Tax Act (the Act)?

CIT vs Dharma Productions Pvt Ltd [TS-147-HC-2019 (Bom)]

The taxpayer is a company engaged in the business of production and distribution of films. It incurred certain advertisement expenditure in relation to two films, which was claimed as business expenditure under section 37(1) of the Act.

It was held that Rule 9A (deduction of expenditure on production of feature films) would not have any applicability if such expenditure has been claimed by the taxpayer as business expenditure not forming part of the cost of production of feature film. Thus, if the expenditure meets the requirements of section 37 of the Act, it is ought to be allowed as a deductible business expenditure. The High Court (HC) observed that the cost of publicity and advertisement (incurred in the post production stage) did not form part of cost of production of feature film and in any case, such expenditure was specifically excluded from the scope of Rule 9A. Hence, the HC overruled the order of CIT (A).

SKP’s Comments

This decision applies to film production companies. It brings the much-needed relief to film production houses as major expenditure (advertisement and promotion) is incurred post production of a film. There are divergent views on the same, where the revenue is more inclined towards disallowing post production expenditure, basis the literal interpretation of the provisions of the Act. This decision also once again highlights the significance of understanding the intention behind the introduction of any provision in the Act or the related rules to determine the correct stand on the same.

Whether stamp duty value under section 50C (deemed consideration) can be considered while claiming exemption under section 54EC?

Jagdish C. Dhabalia vs ITO TS-143- HC-2019 (Bom)

The taxpayer is a joint owner of a plot of land, with 25% undivided share in the plot. The taxpayer transferred the plot and invested the entire sales consideration (INR 2.5 million) in RECL Bonds on which he claimed capital gains exemption under section 54EC. The tax officer adopted the stamp duty value (INR 7.617 million) as the sale consideration under section 50C (deemed consideration) while determining capital gains exemption under section 54EC.

It was held that while determining capital gains as per the computation mechanism provided under section 48, provisions of deemed consideration would apply. Further, there is no conflict or any contrasting consequences of applying the provisions of deemed consideration for computing Capital Gain Tax post claiming exemption under section 54EC.

The HC rejected the contention of the taxpayer that deeming fiction must be applied only in situations for which it has been enacted. The HC observed that the provisions of deemed consideration would have to be compulsorily adhered to while determining capital gains exemption and any interpretation to the contrary would render the provisions of deemed consideration redundant.

SKP’s Comments

This decision highlights a very important point that deeming provision have to be compulsorily applied and cannot be challenged.

Even though the tax incentives are provided, there will always be tax liability cast upon all taxpayers. Corporate Tax payers will have to compute and discharge their tax liability under Minimum Alternate Tax and non-corporate tax payers under Alternate Minimum Tax subject to certain conditions.

Transfer Pricing

Whether royalty below the prescribed rate under Press Note No. 9 (2000 series) be considered at Arm’s length Price (ALP)?

Carraro India Private Limited [ITA No.1260/PUN/2018]

Income Tax Appellate Tribunal (ITAT) accepted taxpayer’s royalty payment of 0.5% for use of brand/trademark to be at arm’s length, since it was below the rate prescribed under Press Note No. 9 (2000 series) issued by the Ministry of Commerce and Industry, Govt. of India. Under the press note, payments of royalty up to 2% for exports and 1% for domestic sales are allowed under automatic route for use of trademark and brand name of the foreign collaborator without technology transfer.

In this regard, the ITAT relied on the Bombay High Court ruling in the case of SGS India Pvt Ltd (ITA No. 1807 OF 2013), wherein the Transfer Pricing Officer (TPO)had relied on the aforementioned press note to benchmark royalty payment. Furthermore, noting that the taxpayer had made royalty payments twice, pursuant to the two overlapping license agreements, the ITAT directed the TPO to work out and disallow the duplicate amount of royalty paid for the use of brand/logo. The ITAT also rejected the action of the Assessing Officer (AO) in holding brand royalty as capital expenditure.

SKP’s Comments

The said ruling can be relied upon wherein it has been held that the FIPB/ RBI approvals cannot be equated to the ALP, and thus emphasizes on the persuasive value of FIPB/RBI approvals for benchmarking royalty payments.

Can foreign AE be considered as a tested party to benchmark international transaction of payment of corporate/management services fee by a taxpayer?

At the outset, the ITAT rejected the TPO’s observation that the corporate/ management services were in the nature of shareholder services, and that no benefit was derived by the taxpayer. The ITAT examined the intragroup services agreement and other voluminous documents, including e-mails exchanged between the taxpayer and AEs on a wide spectrum of the matters, and established that the services were actually availed. The ITAT held that the TPO cannot determine “NIL” ALP by concluding that no benefit was received by the taxpayer, and highlighted that once it is proved that such services were availed by the taxpayer, the TPO’s jurisdiction becomes restricted to determining the ALP of such a transaction only.

The ITAT rejected the taxpayer’s selection of foreign AE as a tested partyholding that it has no statutory sanction as a general principle of law. In this regard, the ITAT made the following observations:

  • Provisions of Chapter X of the Act "Special Provisions Relating to Avoidance of Tax" deal with computation of income from international transaction, which needs to be at ALP
  • The profit margin of the Indian enterprise, and not that of the foreign AE, should be compared with the comparables to see if any increase in the total income of the enterprise, chargeable to tax in India, is warranted on account of transfer pricing adjustment.
  • If the foreign AE had charged more, then its profit rate would shoot up and the corresponding profit of the Indian enterprise would be squeezed. In that scenario, a comparison of the profit rate of the foreign/AE will run contrary to the rule and spirit of transfer pricing provisions.
  • The exercise of considering foreign AE as the tested party renders the substantive section 92 otiose and the definition of 'international transaction' u/s 92B and rule 10B becoming redundant. This is patently an unacceptable proposition having no sanction under the Indian transfer pricing law.
  • Thus, ITAT held that there is an overt obligation under the Indian law that foreign AE cannot be considered as a tested party for determining the ALP of the international transaction.

SKP’s Comments

The ruling could have an adverse impact on cases where foreign tested parties have been selected. It is pertinent to note here that despite the above ruling, the India Country Chapter to the UN TP Manual acknowledges the selection of foreign associated enterprise as the tested party, in case it is the least complex party.

Whether payment for corporate/ managerial services can be aggregated with other international transactions and benchmarked applying TNMM at an entity level?

In this regard, the ITAT viewed that two or more closely linked transactions can be aggregated for the determination of ALP. However, the onus is on the taxpayer to establish that such transactions are part of an international transaction pursuant to an understanding between various members of the group. ITAT noted that the payment for corporate/managerial services by taxpayer did not fall in any of the three cases wherein the aggregation of transactions for purposes of benchmarking is permissible:

  1. Transactions should be part of a package deal with a composite price instead of each item being valued separately
  2. Transactions that are priced differently but are accepted by assessee together (i.e., either takeall or leave-all)
  3. Transactions, though priced differently, are inextricably linked such that one cannot survive without other.
  4. Merely because purchase of goods and acceptance of services lead to the manufacture of final product, it does not follow that they are dependent transactions

Thus, the ITAT held that the managerial service fees paid by taxpayer was not closely linked to the other international transactions, and should not be aggregated for benchmarking under TNMM.

SKP’s Comments

In this case, the Tribunal has restored the matter back to the TPO for determination of the most appropriate method and ALP. However, the ruling could have an adverse impact on cases where entity level TNMM, using a foreign AE as tested party, has been considered for benchmarking payment of intra-group services.

Whether common un-allocable costs can be apportioned on headcount basis instead of proportionate turnover basis?

Fujitsu India Pvt Ltd [ITA 604/2017]

The Delhi HC has ruled in favour of the taxpayer and accepted a headcount based allocation of unallocable costs among its segments, while benchmarking the international transaction of receipt for online marketing support services.

Earlier the taxpayer’s arguments with respect to the application of the “headcount” basis were rejected by the TPO as well as by the Dispute Resolution Panel (DRP), and later by the ITAT in the impugned order. The ITAT had held that the headcount principle was irrational given the disparity of salaries of the employees of the different segments.

The HC placed reliance on co-ordinate bench ruling in the case of EHTP India, wherein it was observed that headcount basis is an acceptable principle for proportionate allocation of costs, and that there was no objection or illegality about it, and that it was being consistently followed. The HC also distinguished the present case with the HC judgement in case of Continental Carriers (2016) 384 ITR 102 citing that rejection of the headcount principle was on account of the same not being consistently applied by the taxpayer in the past, and was also in the context of section 80(4) deduction.

In the present case, the HC opined that there were two possible choices, i.e., turnover method as well as the headcount method. Even though tax authorities broadly agreed to allocate common costs on the basis of proportionate turnover of the concerned segment, HC viewed that the alternative was left open to the taxpayer to accept one or the other principle. Consequently, HC held that the choice of the taxpayer in relying upon the headcount principle per se could not have been rejected.

SKP’s Comments

The ruling provides relief to the taxpayers opting for allocation of common costs on headcount basis rather than turnover basis, and highlights that despite there being multiple allocation basis, the taxpayer has the choice to opt for the appropriate allocation key, while preparing segmental accounts.

Whether the TP provisions are applicable to buy-back of equity shares from associated enterprise? Can the TPO recharacterize the transaction of buy-back of equity shares as a deemed loan?

Earnest Towers Pvt Ltd [I.T.A. No. 2530/ Kol/2017] Held

The taxpayer during the year undertook buy-back of fully paid up equity shares at Rs. 70 per share (Face value of Rs. 10 at a premium at Rs. 60) from its Mauritius based holding company. The TPO valued the shares at Net Asset Value, rejecting the Discounted Cash Flow method adopted by the valuer, and the excess amount paid to AE was treated as deemed loan on which the notional interest was computed as TP adjustment.

The ITAT placed reliance on the judgement of Bombay HC in case of Vodafone India Services Pvt Ltd and CBDT circular No. 2/ 2015 accepting the judgement of the Bombay HC for the proposition that the share premium issued was on account of the capital transaction not giving rise to any income, and thereby not liable to transfer pricing adjustment. The ITAT held that the issue was covered in case of Topsgroup ruling ITA No. 2115/Mum/2015, which had upheld the principles laid down in the case of Vodafone India Services Pvt Ltd for inbound transactions that were applicable to outbound investments as well. The ITAT held that the said transaction of equity buyback was an outbound transaction, which is also in nature of a capital transaction, and since it does not give rise to income chargeable to tax in India, Chapter X of theAct is not applicable.

SKP’s Comments

This ruling further strengthens the principle that though issue/buyback of equity shares may qualify as an international transaction, transfer pricing provisions will not be applicable in the absence of any income arising from them.

Whether Resale Price method (RPM) can be adopted over Transactional Net Margin Method (TNMM) for a routine distributor incurring substantial AMP expenses?

Celio Future Fashion Pvt Ltd [ITA No. 1928/Mum/2016] Held

The ITAT accepted the taxpayer’s approach to consider RPM over TNMM as the most appropriate method to benchmark its import transactions despite incurring heavy expenses for advertisement, marketing and promotion. Revenue authorities had taken the view that since the taxpayer incurred high AMP expenses, benchmarking trading function using TNMM would factor the AMP, and hence should be considered as the most appropriate method. It is pertinent to note that the taxpayer had also adopted TNMM (based on single year data) in its TP study to justify the transaction of import of goods to be at arm’s length, albeit proposed RPM as the most appropriate method before the DRP. The ITAT observed that a taxpayer is a mere distributor of men’s wear, imported from its AE and did not carry out any value addition. Also, pursuant to the Burberry India ITA No.- 758/Del/2017 and other rulings (relied upon by taxpayer), the ITAT noted that the RPM is the most appropriate method to benchmark the international transactions, when finished goods in ready-to-sell condition are purchased from its AE, and sold in the market, without any value addition.

The ITAT opined that though the taxpayer is alleged to have incurred huge expenses on advertisement and market promotion, the same would not increase the inherent value of the products. ITAT held that RPM profits are compared at gross margin level, in which case the AMP expenses will not be deducted while arriving at the gross margins. Stating that the taxpayer’s case is that of a simple distributor of products, wherein the RPM has been consistently applied by the courts, the ITAT rejected the TNMM method adopted, and restored the file to the TPO/ AO to for examining the issue afresh.

SKP’s Comments

Benchmarking of trading function for routine distributors incurring heavy AMP expenditure under TNMM/RPM has been a litigated issue. This ruling supports adoption of RPM in case of simple distributor of products on the premise that heavy AMP does not increase the inherent value of the products and thus need not be factored while benchmarking the trading function.

Whether AE invoices form sufficient information to demonstrate technical fees reimbursed by assessee?

During TP assessment proceedings, the taxpayer had merely furnished copies of invoices raised by the AE and had not furnished any information to demonstrate the nature of services received by the taxpayer. Consequently, the TPO determined the ALP of the reimbursement as “Nil,” which was also confirmed by the DRP.

ITAT noted that the TPO had not questioned the genuineness of the transaction, and agreed with the TPO’s view that mere copies of invoices from AE would not demonstrate the details of services received by the taxpayer. Noting that the taxpayer had submitted additional evidence by way of a detailed note on the nature of services rendered by the AE, ITAT admitted the evidence and restored the matter to the file of AO/TPO to provide the taxpayer with one more opportunity in this matter.

SKP’s Comments

The ruling throws some light on the kind of documentation required by Indian tax authorities for reimbursement of expenses to AEs.

Indirect Tax

Whether ITC is admissible on an ambulance, i.e., a motor vehicle, purchased for the benefit of the employees under legal requirement of the Factories Act, 1948?

[Background: The CGST Act as amended with effect from 1 February 2019 allows admissibility of ITC in relation to, inter alia, motor vehicles, provided it is obligatory for the employer to provide the same to its employees under any law.]

Nipha Exports Private Limited- Authority for Advance Ruling (AAR), West Bengal [2019 (2) TMI 1604]

The AAR observed that:

  • The applicant had purchased an ambulance for the benefit of the employees as mandated by the Factories Act.
  • The CGST Amendment Act, 2018 w.e.f. 1 February 2019 allowed taxpayers to claim ITC on certain inward supplies, which is otherwise restricted under Section 17(5), provided it is obligatory for an employer to provide the same to employee under any law.
  • In the present case, the applicant had purchased the ambulance on 22 November 2018.

In view of the above observations, the AAR held that the ITC was not admissible as the ambulance was purchased before the amendment was made applicable.

SKP’s Comments

The confusion regarding the date of applicability of the amendments to the CGST law seems to stem from the fact that the amendments were passed by the Parliament in August 2018.

However, there are judicial precedents under the erstwhile service tax law, wherein the ITC, in respect of expenses mandated by any law, were held as eligible irrespective of a restriction under the service tax law. Therefore, in view of the existing principle laid under the service tax law, it can be argued that such ITC was allowable under GST even before the amendment of the GST law.

Whether accommodation, food, beverages and other services supplied by a hotel located in Special Economic Zone (SEZ) to visitors not located in SEZ are liable to GST?

M/s Sapthagiri Hospitality Pvt Ltd- Appellate Authority for Advance Ruling (AAAR), Gujarat [2019-VIL-19-AAAR]

The appellant contended as follows:

  • Since the services were provided in direct relation to an immovable property located in the SEZ, and such services were part of the authorized operation of the SEZ, IGST should not be applicable as the said services are received within the SEZ, which is deemed to be a territory outside India.
  • It was further submitted that in view of Section 53 of the SEZ Act, 2005, the provisions of the IGST Act would not apply to the services rendered in the SEZ.

The AAAR observed that:

  • Under section 16 of the IGST Act, to qualify as 'zero rated' supply, the law specifically refers the supply 'to' SEZ developer/unit and not 'to or by' SEZ developer/unit.
  • Section 53 (1) of the SEZ Act creates a deeming fiction whereby an SEZ shall be deemed to be outside the customs’ territory of India, and that too for the specific purposes of undertaking the authorized operations. Furthermore, the interpretation advanced by the appellant would lead to a situation where a Special Economic Zone would not be subject to any laws of India whatsoever.

In view of the above observations, the AAAR rejected the appeal and held that the services provided by it to non-SEZ visitors would be liable to GST.

SKP’s Comments

The AAAR has held that for the purpose of obtaining the benefit of zero-rating under Section 16 of the IGST Act, the services have to be provided ‘to’ an SEZ developer/unit. Merely because the services have been provided ‘by’ an SEZ developer/unit would not automatically make such services zero-rated.

Whether an advance ruling is admissible if it pertains to a supply already effected prior to the date of filing an advance ruling?

[Background: The appeal before the AAAR pertained to the ruling pronounced by the AAR on merits in relation to the eligibility of exemption in accordance with Notification No. 3/2017]

Kei Industries Limited - Appellate Authority for Advance Ruling (AAAR), Rajasthan [2019-VIL-16-AAAR]

The AAAR had raised question on the validity of the advance ruling application as it was filed in respect of past transactions. In this regard, the appellant contended as follows:

  • Supply was not complete on the date of filing the advance ruling application as the period of warranty services had not expired.
  • There were similar purchase orders pending on the date of the advance ruling application as well.
  • Maintainability of the advance ruling application cannot be reconsidered at the appellate stage.

The AAAR rejecting the contentions of the appellant held that:

  • AAAR is an independent forum, and is at a higher pedestal than the AAR.
  • The continued existence of the warranty does not put the transaction under the category of ‘supplies being undertaken.’
  • The appellant has asked for advance ruling with respect to particular transactions, and hence we are bound to pronounce our verdict on these transactions only, irrespective of the pending purchase orders.

Therefore, as the question posed by the appellant is related to the supplies undertaken by them, prior to the date of filing of the application for advance ruling, no ruling can be given on the question.

SKP’s Comments

The ruling of the AAAR has laid down that merely because an advance ruling application is ruled on its merits by the AAR, it will not mean that the AAAR is bound to assume that the advance ruling application fulfils the criteria given in the CGST law.

However, the rejection of the application, even after the appellant produced the purchase orders to prove that it was entering into similar transactions on the date of filing of the application, should be a warning to the other taxpayers to file the initial advance ruling application based on the documents relating to transaction being undertaken or proposed to be undertaken on the date of filing the application.