Is importing definition from the act into the tax treaty an automatic process pursuant to the provisions of Article 3(2) of India-Singapore tax treaty?
ACIT vs Reliance Jio Infocomm Ltd. [TS-710-ITAT-2019 (Mumbai)]
Taxpayer (Indian Company), had availed bandwidth services from RJS (Singapore Company) pursuant to bandwidth services agreement. The taxpayer did not withhold tax on payment made to RJS for availing bandwidth services on the premise that it had merely received access to bandwidth services without having access to any equipment deployed for the provision of such services. Further, the related infrastructure and process was always used under the control of RJS and not the taxpayer. Also, the amendments made to the act cannot be read into the tax treaty unless the latter has been amended.
However, the tax officer was of the view that provision of bandwidth services was covered under the term “process” according to the tax treaty. The tax treaty does not define “process”, hence, pursuant to Article 3(2) of the tax treaty, recourse can be taken to the provisions of the act for understanding its meaning and the term “process” as defined by the act covers within its ambit, provision of bandwidth services. Hence, payment for such services was taxable as royalty under the act read with the tax treaty.
The tax tribunal rejected the contention of the tax officer and inferred that the term “process” assumes importance for interpreting the term “royalty” under the tax treaty only. Further, given that the tax treaty has defined the term “royalty”, it is not possible to invoke Article 3(2) for further dissecting each term used in the definition to explore the domestic law meaning of each expression used therein for arriving at conclusions about undertones of royalty.
The tax tribunal also inferred that even if the term “process” is established as an undefined tax treaty term, static interpretation may not be relevant since the aforesaid term was not defined in the act at that time. Further, the tax tribunal opined that which ever approach, i.e., static/ambulatory is adopted, for the purpose of Article 3(2), a unilateral treaty override, even if it is subtle, is not permissible at all. Further, relying on Article 26 of the Vienna Convention, the tax tribunal inferred that if ambulatory interpretation (upheld in the case of Siemens Aktiongesellschaft) reverses judicial precedents in favour of the residence jurisdiction, then such an interpretation has to be discarded as it patronizes and legitimizes unilateral treaty override which has never been the intention of the tax treaty draftsmen.
In light of the above, the payments for availing bandwidth services would not be covered within the ambit of the term “process” as per India-Singapore tax treaty.
This decision is very important as it clearly spells out that if royalty is defined in the treaty, you cannot look at the amended definition under the domestic law to interpret terms used within the definition.
The Tax Tribunal also clarifies that if certain retrospective amendments result in negative repercussions for the taxpayer or completely changes the meaning as provided under the treaty, the same should not be accepted as the same would mean that treaty was unilaterally amended.
The decision is very important in multiple contexts as tax authorities in many cases (like software cases, cases related to process, etc.) are trying to import amended definition from local laws.
Should non-compete and nonsolicitation fees received by the taxpayer be subject to tax in India under India-Qatar DTAA?
ITO vs Prabhakar Raghavendra Rao [TS- 683-ITAT-2019 (Mumbai)]
The taxpayer, a non-resident individual was a Director as well as shareholder in SIPL, an Indian company. The taxpayer sold shares of SIPL to BVCPL (A Singaporean Company) and received the consideration. Further, the nonresident also received non-compete and non-solicitation fees from BVCPL pursuant to an agreement.
During the course of assessment proceedings, the taxpayer adopted a position that in the absence of permanent establishment/business presence in India, he was not liable to pay tax in respect of non-compete and non-solicitation fees received from BVCPL in India as per the relevant DTAA. The capital gains on sale of shares was offered to tax. However, the tax officer observed that the taxpayer had a business connection in India under section 9(1)(i) of the Income-tax Act, 1961 (the Act) since he held shares in SIPL. Further, the non-compete and non-solicitation fees deemed to accrue or arise in India and hence taxable in India.
The Tax Tribunal rejected the contention of the tax officer and inferred that merely because the taxpayer had made investments in an Indian company, he cannot be said to have business connection in India. There is no restriction in law for nonresidents to invest in shares of Indian companies. Tax consequence may arise once such investments were sold by him which has been duly offered to tax in India. As far as non-compete fees or non-solicitation fees were concerned, the tax tribunal held that such fees would have been taxable under the Act but not under the DTAA without having a permanent establishment in India. Since, non-compete fees were received post selling of shares in SIPL, the taxpayer did not have any business connection or permanent establishment in India, the tax tribunal held that such income was not taxable in India by placing reliance on the decision of Kolkata tax tribunal in the case of Trans Global PLC (158 ITD 230).
This decision clarifies that while the definition of business connection is wide but the same would not cover any kind of connection with India. The definition needs to be critically examined for determination as to whether there is any business connection in India or not.
Determination of a business connection is a fact-based exercise and the same needs to be contemplated on a case-tocase basis.
Doshi Accounting Services Private Ltd – Special Bench1
business of providing Business Process Outsourcing services in the field of accounting and tax. The taxpayer provides these services from an STPI unit which was eligible for tax exemption u/s 10A of the act. The taxpayer has benchmarked the transaction of provision of services by adopting internal/external Comparable Uncontrolled Price (CUP) details. Transfer Pricing Officer (TPO) disregarded the applicability of the CUP method and instead adopted Transactional Net Margin Method (TNMM) to benchmark the transaction. Since the margin of comparable companies (33.10%) was higher as compared to the taxpayer (7.97%), TPO made an adjustment to the transfer price. DRP upheld the adjustment.
- It was contended that the taxpayer enjoys the benefit of Section 10A exemption. Moreover, the effective tax rate in the UK would be higher as compared to India (0%) in the instant case. Hence, there was no motive/ incentive in shifting the profit from India to the UK.
- It was argued that the fundamental object of the Transfer Pricing provision is to ensure that India’s tax base should not be eroded or profits taxable in India should not be shifted to other tax jurisdictions.
- It was contended that since none of the provisions (i.e. transfer pricing and tax exemption provisions) has an overriding effect on the other, tax exemption provision should be given preference.
Income Tax Appellate Tribunal (‘ITAT’) ruling
- Courts are not required to look into the object or intention of the legislature by resorting to aids of interpretation where the language used is clear and free from ambiguity.
- The purpose behind the provision of transfer pricing is to determine true profits/income as if such international transaction has been entered with an unrelated party or non-AE, irrespective of the fact that the income of the assessee was eligible for exemption.
- Further, there is no express provision restricting the application of Transfer Pricing proviso where income is eligible for tax exemption under section 10A. On the contrary, there is a provision to section 92C(4) of the Act which prohibits the deduction under section 10A of the Act on the income to the extent enhanced as an effect of a determination of ALP.
- It was also observed that the assessee, though claiming the exemption under section 10A of the act, can also manipulate the ALP with an objective to avoid corporate dividend tax by shifting its profits to AE.
- Even though the income would be ‘exempted income’, it still fits in the definition of ‘income’ as used in Section 92(1) of the act. (The Vodafone India ruling shall not apply since there was no income or potential impact on income)
- Hence, it was held that transfer pricing provision is applicable even if the taxpayer is eligible for tax exemption.
Thus, ITAT dismissed the appeal of the taxpayer.
- In other cases having similar fact patterns, the taxpayers have appealed in higher courts such as the Bombay HC and Delhi HC.
- It would be interesting to witness the judgment from Bombay/Delhi HC on this issue.
- In the meantime, the judgment by Special Bench re-emphasizes the need to justify the arm’s length price disregarding the fact that the income of the Indian taxpayer is exempt.
Can CCDs be characterised as a loan? Can LIBOR be considered as benchmark rate for Rupee denominated CCDs?
Hyderabad Infratech Pvt. Ltd. – ITA No.1891/Hyd/2018
The taxpayer is an Indian company and has paid interest to AEs on Compulsorily Convertible Debentures (‘CCD’). CCDs issued are denominated in Indian currency. Transfer Pricing Officer (‘TPO’) characterised the CCDs as loan and thereafter, determined the arm’s length rate of interest to be LIBOR + 200 basis points. The Dispute Resolution Panel (’DRP’) upheld the adjustment.
- ITAT has relied on the assessee’s own ruling for AY 2013-14 and co-ordinate bench ruling in case of Adama India Private Ltd (ITA 497/Hyd/2016).
- It was observed that that as per DIPB, RBI and FEMA, CCDs are not loans and it should be reckoned as ‘capital instrument’.
- Referring to the Hon’ble Supreme Court’s ruling in case of Sahara India Real Estate Corporation Limited and Sahara Housing Investment Corporation Limited & Ors. vs Securities and Exchange Board of India & Anr. (Civil Appeal No. 9813 of 2011), it was held that CCDs are ‘Hybrid instruments’.
- In view of the above, it was held that CCDs cannot be characterized as loan.
- Further, considering the fact, CCDs are denominated in Indian currency, it was held that rate of interest should be determined based on the borrower country where the amount is consumed. Hence, LIBOR was rejected as benchmarking rate.
Thus, ITAT allowed the appeal of the taxpayer.
Re-characterization of related party transactions by lower level tax authorities have been consistently rejected by the higher Courts/Tribunals.
India Medtronics Pvt Ltd – ITA No.7263/ Mum/2018 – AY 2014-15
The taxpayer is in the business of manufacturing, trading and marketing of drugs and pharmaceuticals. It has imported an Active Pharmaceutical Ingredient (API) used in the manufacturing process from its AE located in Switzerland. The taxpayer has used TNMM to benchmark the said transaction.
The TPO has however adopted CUP as the most appropriate method and made an adjustment to the ALP. DRP upheld the matter.
- The taxpayer contended that even if CUP was used to benchmark the transaction, an adjustment needs to be allowed on account of the quality of API.
- API imported from its AE was manufactured in German plant where quality control requirements are much more stringent than in India.
- The taxpayer also submitted independent laboratory test report conducted by Bee Pharma Ltd to verify physical superiority of the product.
- It was contended that the TPO himself had allowed a quality adjustment of 10% in AY 2011-12 (future year)
- It was observed that as per Rule 10B(1)(a)(ii), the price of the comparable uncontrolled transaction “is adjusted to account for differences, if any…which could materially affect the price in the open market”.
- As long as differences exist, whether having intrinsic value or merely in perceptions, they could “materially affect the price in the open market”, these differences are required to be taken into account.
- Even though the generic product may be the same, the same generic product manufactured in a plant, with higher and more stringent quality control requirements, command a premium in the market and greater acceptability with the end consumers of the resultant end product.
- In view of the above and in line with TPO’s action for AY 2011-12, ITAT has allowed to carry out quality adjustment at 10%.
The Revenue department filed the appeal before HC.
HC held that:
- HC dismissed the appeal of the department.
This ruling emphasizes the need to maintain documentary evidence to justify differences in quality of products/services and reliable adjustment that may be made based on scientific methodology.
[Background: In view of para 5 of Schedule III of the CGST Act, 2017, the sale of land, subject to clause (b) of para 5 of Schedule II of CGST Act, 2017 i.e. sale of building should be treated neither as supply of goods nor supply of services.]
M/s Maarq Spaces Private Limited - Authority of Advance Ruling (AAR), Karnataka [KAR ADRG 119/2019]
Facts of the case
- The applicant had entered into a Joint Development Agreement (JDA) for the development of land into residential layout along with specifications and amenities.
- The applicant will construct roads, lay sanitary pipes and drains, etc. and also bifurcate the land into sites and amenities.
- The revenue generated from the property would be shared with the landowners as per their agreement.
- The activity of development undertaken was covered within the definition of ‘composite supply’ wherein the development activity was incidental to the sale of land.
- Therefore, the sale of developed plot was nothing but sale of land, and hence not chargeable to GST.
- The AAR observed that the applicant represented himself before the landowners as a person having experience and expertise as a land developer.
- The activities undertaken by the applicant are in the nature of development of land into a residential layout.
- Further, from the agreement it was clear that the applicant had no right in title of the land.
- Therefore, the activities undertaken by the applicant cannot be covered under Schedule III as sale of land, and hence would be chargeable to GST.
In case of a joint development agreement, the developer of the land is essentially providing construction and related services to the land owner, and the developer does not have any legal title over the land. Accordingly, the AAR held that the consideration received for such activity cannot be treated as consideration towards the sale of land.
In case of separate contracts for supply of goods and services in EPC contracts, would the taxability of goods and services be determined separately, or as a composite supply?
M/s Solarsys Non-Conventional Energy Private Limited - AAR, Karnataka [KAR ADRG 120/2019]
Facts of the case
- The applicant is engaged in the operation of renewable energy power plants which also includes solar power plant set up.
- The applicant has received goods as well as services in terms of their solar plants being set up by EPC contractors.
- There are two separate contracts, one for the supply of goods and the other for supply of services.
- The goods for construction of solar power plants attract a concessional rate of 5% and related services are taxable at 18%.
- The artificial vivisection of the contract into two smaller contracts was not possible, since the two contracts were indivisible in nature.
- The supply of goods and services was covered in the definition of “works contract” and was to be treated as a single supply in spite of two different contracts.
- However from 1 January 2019, the government, vide Notification 24/2018 dated 31 December 2019, clarified that in solar power contracts, the values of goods and services should be deemed to be 70% and 30% respectively of the total value of contract for applying appropriate GST rates.
The AAR has held that even if there are two separate contracts for the supply of goods and services, the overall transaction is an indivisible EPC contract for construction and installation of a solar power plant. The overall nature of the transaction cannot be modified by entering into separate contractual arrangement for the supply of goods and services.
M/s Shewratan Company Private Limited - AAR, West Bengal [2019 (11) TMI 715]
Facts of the case
- The applicant is engaged in supplying stores like paint, ropes, spare parts, equipment, etc. to foreign-going vessels.
- In certain cases, such goods may be supplied directly from a customs bonded warehouse.
- The applicant referred to Sections 88(a) of the Customs Act, 1962 which extends the exemption from import duty for warehoused goods taken on board of a foreign-going vessel.
- The applicant also referred to the ruling of the AAR, Andhra Pradesh in case of M/s Fairmacs Shipstores Private Limited wherein it was held that outward supplies made to foreign-going merchant ships would be treated as exports.
- The AAR stated that stores supplied to foreign-going vessels would neither be exports nor zero-rated supplies unless they were specifically marked for a location outside India.
- However, in lieu of Schedule III to the CGST Act, 2017, when such supply is of warehoused goods, then they shall neither be treated as supply of goods nor of services.
In the present case, the AAR held that the condition under GST law of movement of goods outside India to be considered as exports was not fulfilled and hence, the activity was classified as taxable supplies.
However, in an earlier ruling by the AAR, West Bengal in case of M/s Fairmacs Shipstores Private Limited, a similar transaction was treated as export of goods.
In view of these contradictory rulings, it is expected that the matter will be litigated further.