Whether distribution/ advertisement revenue received for operating TV channels for the exhibition of programs, entertainment, education, etc., can be categorized as business income or royalty for use of copyright?
Commissioner of Income Tax vs M/sMSM Satellite (Singapore) Pte Ltd.
The taxpayer is a foreign company engaged in the business of telecasting channels in India and other countries. It received distribution and advertisement revenue from Indian channel companies. The taxpayer contended that the said income is in the nature of business income and is not taxable in India in the absence of a permanent establishment (PE) in India. However, the tax officer held that the distribution charges are in the nature of payment for use of copyright and hence taxable as royalty.
It was held by the tax tribunal that the taxpayer was merely granted a non-exclusive distribution right of the channels and not the right to exploit or use any copyright. In other words, the taxpayer was not parting with any copyright for which distribution charges were made. Furthermore, since the said distribution right is purely a commercial right and differs drastically from the right to use copyright, the income is taxable as business income and in the absence of a PE, there shall be no tax liability.
This decision clearly brings out that in order to tax a receipt as royalty, there must be a right to use or exploit copyright. Any rights transferred (like distribution rights) would not tantamount to royalty.
Whether or not payments made to non-residents for quality inspection of products are taxable as fees for technical services?
M/s Hical Infra Private Limited vs Income Tax Officer (TS-252-ITAT- 2019(BANG))
The taxpayer was engaged in the business of manufacturing and export of electronic components. To expand its business overseas, the taxpayer had paid commission to non-residents. Since the payments were made to ‘brokers’ who were not rendering any technical services, taxes were not withheld.
Tax tribunal held that as per the agreements between the taxpayer and the non-residents, the services being rendered involved procurement, coordination, and quality control, etc., which involves technical expertise. Accordingly, the said payments made to the consultants and not brokers were taxable as ‘technical services’ on which taxes needed to be withheld.
It is a settled tax position that export commission paid overseas, is not taxable in India, based on various judicial precedents. This decision brings out an important aspect that merely the payment of export commission would not result in non-taxation of income in India. It would be important to analyze the services provided by the overseas agent to determine the taxability of income.
Whether the taxpayer, a ‘Resident but Not Ordinarily Resident’ (RNOR), is entitled to claim relief/deduction u/s 91 of the Act.?
Whether the taxpayer being RNOR can claim tax relief u/s 91 of the Act with respect to federal as well as state Income Tax or not.?
Aditya Khanna, c/o M/s Sunil Goel & Associates vs ITO [TS-285-ITAT- 2019(DEL)]
The taxpayer had stayed in India for a period of 224 days and his residential status was RNOR. The taxpayer was working for a US company and had received a salary on which federal taxes, as well as state taxes, were paid in the USA.
Key issues under consideration were i) whether a taxpayer can claim credit of state taxes, paid in the US, in India as per section 91 of the Act or should it be considered for deduction from salary earned abroad. ii) whether taxpayer being RNOR is entitled to claim relief under Section 91 of the Act.
The tax tribunal relied upon a few judicial precedents but leaned on the decision of the Ahmedabad tax tribunal in the case of Dr. Rajeev Modi vs Deputy Commissioner of Income Tax. Among other grounds, it had been held that a taxpayer who is entitled to claim benefit under section 90 of the Act shall not be denied benefit under section 91 of the Act on the ground that there exists a tax treaty with another nation. In the instant case, the taxpayer has claimed the benefit of India-US Tax Treaty, which does not expressly cover state taxes. However, applying the provisions of section 91 of the Act, the taxpayer would be enabled to claim benefit not only of the federal taxes but also the state taxes as section 91 does not demarcate between the two. Hence, restricting the applicability of section 91 to the taxpayer would be inconsistent with the intention of the legislature, i.e., to offer income either under the Act or the tax treaty whichever being more beneficial.
The tax tribunal held that as per section 6 of the Act, ‘not ordinarily resident’ is just another category carved out of the term ‘Resident’. Accordingly, the benefit entitled to a resident shall also be extended to residents being RNOR. Accordingly, the taxpayer should be entitled to claim relief under section 91 of the Act.
This decision is important as it interprets the law in a logical manner rather than interpreting it in a strict sense. It once again brings out the fact that the courts are inclined to look at the intention of law and not merely rely on the literal reading of it.
Accordingly, it would be advisable for the taxpayers to not only look at the provision of law but also at the intention behind the introduction of a law.
Whether segmental accounts to be accepted for the purpose of TNMM when the same does not form part of financial statements?
Netguru Limited [ITA No 1799/Kol/ 2018, AY 2011-12]
The taxpayer is engaged in the business of providing software development services to its AEs during the year under consideration. The taxpayer also has transactions with third party customers that are not comparable transactions with AE.
Taxpayer selected Transactional Net Margin Method (TNMM), wherein margins from AE transactions were compared with the margin of comparable companies.
For this purpose, the taxpayer prepared segmental accounts to bifurcate profits earned from services provided to AE and Non-AEs.
TPO rejected segmental accounts and made a transfer pricing adjustment considering profitability at the entity level.
CIT (A) deleted the adjustment made by TPO.
Revenue’s contention before ITAT :
- Had the segment been prepared having regard to the nature of the business, it ought to have been part of the audited accounts mentioning the difference in risk and returns of the two segments of the assessee company.
Ruling by ITAT :
- There was a valid reason for the taxpayer to not disclose the segmental accounts in its financials. The taxpayer provided diverse services to Non- AEs apart from providing software development services to AEs, which warranted the preparation of segmental accounts for the application of TNMM. The segmental accounts were further verified and certified by an independent statutory auditor.
- TPO’s action to consider the profitability earned by the taxpayer, including profit from Non-AE transaction, was against the basic principles of transfer pricing, and thus ALP determined by TPO is not justified. Hence, the appeal of the revenue was dismissed.
Transactions with different levels of risk cannot be aggregated for transfer pricing analysis. Thus, it is utmost important to prepare segmental accounts having regard to the nature of business, which may or may not form part of financial statements.
Van Oord India Private Limited, [ITA No 7228/Mum/2012, AY 2007-08]
The taxpayer is registered as a Tonnage Tax Company under TTS earning shipping income that is taxable as per computation mechanism provided in relevant regulations.
The TPO made an adjustment in respect of charter hire/lease charges paid to its AE for leasing of a ship for the mobilization and demobilization period.
CIT (A) upheld the order of TPO.
ITAT held as under :
- TTS is a presumptive basis of taxation wherein actual income and expenses are not considered to determine the income chargeable to tax. Computation of income under TTS is merely based on the tonnage capacity of the qualifying ships and the number of days it is held for.
- Determination of income/expense having regard to the arm’s length principle would not affect the computation under these provisions. TTS provisions are applicable for the entire income, including income from Aes, and it is not possible to segregate such income from AE and Non-AE to apply transfer pricing provisions. Thus, ITAT allowed the appeal of the taxpayer.
TTS provisions start with a nonobstante clause and hence, it operates under different computational mechanisms as against normal computational mechanisms. Hence, transfer pricing provisions shall not apply to a company operating under the TTS provisions.
M/s Bekaert Industries Private Limited, [ITA No 146/Pun/14, AY 2009-10]
The taxpayer is engaged in the business of manufacture of steel tire cord and hose Reinforcement wire.
During the year under consideration, the TPO has rejected the Cost Plus Method (CPM) applied by the taxpayer to benchmark its import of raw materials from its AEs and adopted TNMM.
Furthermore, the TPO rejected taxpayer’s approach to using AE as the tested party and also rejected foreign comparables selected on the grounds that the taxpayer failed to furnish Functions, Assets and Risks (FAR) analysis in respect of AEs and the comparables. Further, the taxpayer not only failed to submit financial documents of AEs but also stated that the AEs were engaged in various activities other than the supply of raw materials. The DRP upheld the order of TPO.
ITAT held as under :
- The term ‘enterprise’ used in respect of all transfer pricing methods refers to the Indian taxpayer whose profits are to be tested for its transactions with its foreign AE. The profit realized by the Indian taxpayer cannot be replaced with the profits of foreign AE for the purpose of determining the ALP.
- Foreign AE’s profitability, being more than comparable, indicates the transaction to be at arm’s length. However, it is contrary to the transfer pricing provisions wherein higher profit is shifted outside India.
- Thus, in order to benchmark the transaction, profit margin of the Indian taxpayer, instead of the foreign AE, has to be compared with the comparables. Furthermore, Indian law does not provide statutory sanction to consider foreign AE as the tested party.
- Furthermore, even if foreign AE was to be considered as a tested party, the taxpayer not only failed to furnish any financial details of the AEs but also admitted the fact that the AEs were engaged in multiple business activities. Thus, ITAT allowed the appeal of the taxpayer.
Over the years, courts/tribunals have provided contrary views on the adoption of foreign AE as tested party to benchmark the international transactions. Though it is more of facts specific analysis, interestingly, this ruling has also questioned the legal sanction of the issue as per the Indian tax laws.
It is always advisable to prepare robust analysis and to document the reasons to adopt foreign AE as a tested party, and to maintain all the supporting documents, such as the financial statements of AE/ foreign comparables to substantiate the arm’s length analysis.
Whether interest rate prevailing in the lender’s jurisdiction is an important factor for determining the ALP for interest?
India Debt Management Pvt Ltd [ Income Tax Appeal No 266 Of 2017, AY 2010-11]
The taxpayer is a non-banking finance company engaged in identifying and investing in financially distressed companies. The credit rating of the taxpayer was BBB on account of its high risked investment.
For making such investments, the taxpayer issued Compulsory Convertible Debentures (CCD) in INR denominated currency. The interest rate on CCD varies in different years (7 to 14%) and an average rate works out to be 11.30%. The taxpayer has adopted CUP considering external market data/BSE data on INR denominated debt.
The TPO made a transfer pricing adjustment considering AE as the tested party and stating that AE would have earned interest in USD Corporate Bond Rates. DRP upheld the order of the TPO.
The ITAT held as under :
- Identification of Tested Party is more imperative while applying CPM or RPM or TNMM. Under the CUP method, only the transaction price has to be seen and not the tested party.
- The arm’s length interest needs to be computed based on the market determinant interest rate applicable to a currency (INR in the instant case) in which loan has to be repaid.
- Thus, the High Court considered all the observations made by ITAT and upheld the order of ITAT.
This ruling provides insight into the applicability of the tested party concept under the different transfer pricing methods.
Furthermore, this ruling clarifies that the interest rate prevailing in the borrower’s jurisdiction and the currency in which the loan needs to be repaid are important parameters to be considered amongst other parameters while determining ALP.
Whether ITC for goods and services procured for construction of the immovable property is allowed to be set-off against GST payable on rent received from such immovable property?
[Background: In view of Section 17(5) (d) of the CGST Act, ITC pertaining to goods or services received for construction of immovable property is not eligible for set-off against the outward tax liability.]
M/s Safari Retreats Private Limited – Hon’ble High Court, Orissa [Writ Petition No 20463 of 2018]
- The petitioner was engaged in constructing shopping malls for the purpose of letting out to numerous tenants and lessees.
- The petitioner procured huge quantities of materials and other inputs for the construction of a shopping mall.
- The ITC paid on such procurements was disallowed under section 17(5)(d) of the CGST Act, leading to tax cost.
- When a builder sells units before issuance of completion certificate, he is required to pay GST on the amount of sale. But, the builder at the same time is allowed ITC of the GST paid on the inputs consumed to construct the building.
- The Revenue’s interpretation was in violation of Article 14 of the Constitution of India, which guarantees equality before the law.
- The fundamental right to carry on business under Article 19(1)(g) of the Constitution was violated as wholly unwarranted and an arbitrary restriction was imposed, which led buildings now constructed for letting out to be uncompetitive in view of the increased tax costs.
The Hon’ble High Court agreeing with the contentions of the petitioner held that Section 17(5)(d) of the CGST Act is to be read down as the very purpose of ITC is to give benefit to the assessee. Hence, if the assessee is required to pay GST on the rental income arising out of the investment on which GST is paid, he is required to have ITC on the GST paid.
One of the main objectives of introducing GST was enabling seamless flow of credit.
However, the government/GST Council has powers to impose restrictions in respect of availment of ITC. In view of this, various credits have been blocked under Section 17(5) of the CGST Act. Therefore, it would be interesting to monitor how this case evolves if the Revenue prefers an appeal against this judgement before the Hon’ble Supreme Court.
[Background: In view of Section 16(2) of the CGST Act, 2017, if consideration for supply is not paid within 180 days of issue of invoice, then the recipient is required to reverse the ITC availed on such supplies.]
M/s Senco Gold Limited, Authority for Advance Ruling, West Bengal [2019 (5) TMI 701]
- The applicant had several franchiseeoperated stores where it raised an invoice for supply of jewellery and franchisee support services on the franchisee.
- In turn, the franchisee also raised invoice on the applicant for the supply of old gold, silver, etc. Therefore, the applicant would settle its debt through book adjustment.
- Payment by way of adjustment in books of accounts is a common commercial practice followed by businesses.
The AAR observed that the definition of ‘consideration’ in the GST law is wide and almost no form of payment was excluded from it. In view of this, the AAR held that unless the law specifically restricted the recipient from claiming ITC when payment was made through book adjustment, credit of such input tax could not be denied on any ground.
This ruling should reduce possible litigations and demands that may emerge in the future from the revenue authorities, as settlement of debt by book-adjustments is prevalent in many businesses and should be considered a valid form of payment of consideration.