Is the payment for business support services taxable as royalty under the India-Netherlands tax treaty in the absence of imparting of any know-how?
Van Oord Dredging and Marine Contractors BV vs Dy. CIT [TS-596-ITAT-2019 (Mumbai)]
The taxpayer, a tax resident of Netherlands, was engaged in the business of dredging activities. It filed its tax return in India declaring loss for tax year 2009-10. Pursuant to management support agreement, the taxpayer had rendered business support services to VOIPL (Indian affiliate) for a consideration.
The taxpayer did not offer to tax such consideration on the basis that they were provided from outside India. Further, the same would not be taxable as FTS in the absence of not making available any technical know-how, skills, etc. as per the tax treaty. However, the tax officer held that such payment was for the use of information concerning industrial, commercial or scientific experience and hence taxable as royalty under the tax treaty.
The tax tribunal inferred that a person must provide know-how to the recipient so that the recipient can use or has right to use such know-how. Further, the tax tribunal observed that imparting of “know-how” envisions the recipient to make use of such knowhow independently on its own account without recourse to the provider of such know-how in the future. The tax tribunal also inferred that it is imperative that there is alienation or use of or right to use any know-how and in the absence of knowledge, skill or experience, such payments cannot be construed as royalty.
In the instant case, there was no element of imparting any knowhow or there was no transfer of any knowledge, skill, or experience. Hence, the business support services provided by the taxpayer does not fall under the ambit of Article 12 of the India- Netherlands tax treaty.
The issue of taxability of business support services as royalty has been a subject matter of debate before various levels of judicial authorities. There have been divergent views on this issue. However, the Mumbai tax tribunal has made some interesting observation on what can be considered “imparting of know-how” for a payment to be construed as royalty.
Can the offshore supply of equipment contracts be taxable in India under the India- Japan tax treaty?
Nippon Steel Engineering Co. Ltd. [TS- 634-AAR-2019]
The taxpayer, a tax resident of Japan, was engaged in the business of steel and environmental plants [mainly Coke Dry Quenching Units (CDQ)]. The taxpayer entered into 2 contracts with JSW for supplying CDQ equipment to Japan and China. The contract also provided that JSW would be responsible for the carriage of equipment from the port of shipment to the Indian port. Further, the taxpayer had also entered into a separate contract for the supply of drawings and documents, offshore training and supervision services.
On perusal of CDQ equipment contract agreements, the AAR observed that under FOB, transfer of title along with the associated risks and rewards takes place at the port of shipment itself i.e. the foreign port. Further, the invoice as well as the bill of entry was generated in the name of JSW and not the taxpayer. Further, the payment for the said equipment was also received in foreign currency outside India. Hence, by placing reliance on several judicial precedents, the AAR inferred that the supply of equipment was concluded outside India.
The AAR also observed that the taxpayer had entered into two separate contracts, one for supply of equipment and the other for provision of offshore services as the same were from different countries. Thus, the AAR placed reliance on the decision of Alstom Transport SA while accepting the contention of the taxpayer that the contracts were independent from each other and hence did not form part of a single composite contract. In light of the above, off-shore supply of CDQ units was not taxable in India since the entire business was conducted outside India.
Evaluating the taxability of off-shore supply has always been a contentious issue in India having divergent views by the tax authorities at various levels. In this background, this ruling assumes significant importance since it reiterates some of the key factors for determining whether sales have been conducted outside India. Further, this decision is also very important for EPC contracts since it brings out the key differences between composite contracts and independent contracts.
Acceptance of Comparable data from commercial database for Export-Imports as Comparable Uncontrolled Price (CUP)?
M/s Rohm and Haas India Pvt Ltd – ITA No. 2199/Mum/2015 and ITA No. 6577/ Mum/2018 and SA No. 261/Mum/2019
The taxpayer was engaged in the manufacturing & distribution of chemicals and undertaking sales promotion activities. During Assessment Year (AY) 2010-11, the taxpayer benchmarked its imports using Cost Plus Method (CPM) after aggregating it with the export of goods transactions. This approach was accepted by the Transfer Pricing Officer (TPO) under prior years as well.
The TPO rejected CPM as the most appropriate method (MAM) as the taxpayer has incurred loss from its manufacturing business; and instead adopted Transaction Net Margin Method (TNMM) as the MAM by selected operating margin (Operating Profit/Operating Income) as the Profit Level Indicator (PLI). The TPO further rejected the comparables chosen by the taxpayer and adopted a set of fresh comparables. The DRP principally upheld the order of the TPO.
The Income Tax Appellate Tribunal (ITAT) Proceedings:
- ITAT dismissed such rejection of CPM noting that the losses were incurred on account of commercial reasons by having lower sales price realization from a third party customer pursuant to a memorandum of understanding and not on account of import transactions from its AEs.
- ITAT accepted the claim of adoption of CUP method of the taxpayer (which was pleaded by the taxpayer at the DRP level) and confirmed that “When the CUP method using ICIS software covers 68% of the total transactions that too being a direct method and a traditional transaction method, the ld. DRP ought to have accepted the same.”
- ITAT also accepted taxpayer’s additional ground of appeal for using TIPS database under CUP method. ITAT noted that, basis the taxpayer, the TIPS database covers 94.69% of the import transaction value, which according to the DR covers only 70%. ITAT held that since substantial amount of transactions gets covered using TIPS Database, it can be used for benchmarking under CUP method.
- Thus, the ITAT accepted the additional evidence and restored the matter to the AO/TPO and directed that “While comparing the data at or near to the relevant date of transactions with the comparable prices using TIPS Data Base, the TPO is directed to adopt portfolio approach to take both the prices that are favourable to the taxpayer as well as that are adverse to the taxpayer in view of a categorical finding of fluctuating prices for the same product already given by the DR.”
- Comparable information available for commercial purposes can serve the purpose of benchmarking International transactions of imports/ exports, depending upon the facts of the matter.
- The revenue cannot cherry-pick the transactions favoring one way and ignore transactions that are detrimental.
Max New York Life Insurance Company Ltd (Delhi High Court ITA 818/2019)
The Delhi High Court (HC) recently admitted the taxpayer’s appeal against ITAT order, which held that the transfer pricing provisions were applicable to Insurance companies.
The taxpayer is engaged in the business of life insurance and made certain payments to its AEs which were benchmarked using CUP as the MAM and the AE as the tested party.
The TPO rejected CUP and applied TNMM as the MAM and proposed an adjustment of INR 20.2 million. The CIT(A) deleted the entire addition. The revenue appealed against the order of the CIT(A), to which the taxpayer filed a legal ground contending that TP provisions should not be applicable to insurance companies. Instead the income for such companies be computed basis Section 44 of the Income Tax Act (“Act”) read with Schedule 2 of the Act.
The ITAT, while referring to Section 14 of the IT Act, stated that there are two computations made in determining the total income, viz. first is the computation of income under respective heads (i.e. Business Income, House property, Capital gains, etc.) and second is the computation of income from international transaction by determining its ALP, which exercise is done by the TPO.
“Section 44 of the IT Act reads as ‘Notwithstanding anything to the contrary contained in the provisions of this Act relating to the computation of income chargeable under the head "Interest on securities", "Income from house property", "Capital gains" or "Income from other sources", or in section 199 or in sections 28 to 43B, the profits and gains of any business of insurance, including any such business carried on by a mutual insurance company or by a co-operative society, shall be computed in accordance with the rules contained in the First Schedule.”
As seen above, Section 44 of the Act starts with a non-obstante clause (clause that specifically overrides consideration of other provisions stated therein). The ITAT held that, “Since there is no specific reference to section 92 in section 44..., we cannot infer the omission of the second computation of income envisaged under section 92 of the IT Act.”
The ITAT thus held that in case of International transactions entered into by an insurance company, the income shall be first computed in accordance with the First Schedule to the Act, subsequent to which the arm’s length is to be determined basis the application of the provisions of section 92 of the IT Act.
The ITAT has made specific references to the provisions of the IT Act in terms of applicability of TP regulations to Insurance companies.
It would be worthwhile to see the High Court’s views on the impugned issue, since that would have far reaching TP implications for specific Industry sectors.
India Medtronics Pvt Ltd – ITA No.7263/ Mum/2018 – AY 2014-15
The taxpayer is engaged in the business of marketing and distribution of medical life-saving devices. The TPO proposed adjustments on account of AMP expenses, reimbursement and recovery of expenses from AE, and adjustment on account of the import of finished goods.
The DRP in its order allowed partial relief to the taxpayer viz. (i) Recovery of expenses (ii) partial relief for reimbursement of expenses and (iii) direction to the AO to exclude the TP adjustment on account of import of finished goods.
The Income Tax Appellate Tribunal (ITAT) principally decided on the following:
- Whether incurrence of advertising, marketing and promotion (AMP) can be construed as an ‘International transaction’?
- Relying on previous years order in the case of the taxpayer where a similar issue was adjudicated, the Tribunal had observed that i) in the agreements between the taxpayer and its AE there was no condition of sharing of AMP; (ii) the agreements only referred to using best efforts to distribute the products or promote products in a commercially reasonable manner; and (iii) the terms of the agreement did not provide that the taxpayer had to share AMP expenses; (iv) even if the AE was benefitted indirectly by the AMP expenditure incurred by the taxpayer, it could not be inferred that it had entered into an agreement for sharing AMP expenses; and (v) the “Bright Line Test" should not have been applied by the TPO.
- Relying on the above, the ITAT held that the AMP is not an International transaction.
- Whether the DRP was correct in upholding the alternate adjustment (i.e. convention expense)?
- The taxpayer submitted that the “convention expenses” were incurred in the normal course of its business as selling expenses and could not have been considered as part of its AMP expenses.
- The ITAT, following the past years judgement of the taxpayer, allowed the ground of the taxpayer and deleted the proposed adjustment.
Import of finished goods:
The Taxpayer had benchmarked the transaction adopting TNMM taking OP/ OR as the PLI and using multiple year data.
Whether the TPO was correct in rejecting the use of Multiple Year data?
The ITAT upheld TPO’s rejection of multiple year data referring to the exception carved out in proviso to Rule 10B(4) to hold that the taxpayer failed to establish as to how the financial data for earlier two years of its comparables had influenced the determination of the transfer prices.
Whether the TPO was correct in treating forex gain/loss as nonoperating
ITAT held forex gain/loss to be operating in nature, since this was directly attributable to the taxpayer’s business and the forex risk is borne by the taxpayer.
Whether GST paid on procurement of chillers, air handling units, lift etc. for installation in a commercial property regarded as blocked credits under section 17(5) of CGST Act, 2017?
[In view of Section 17(5)(d) of the CGST Act, ITC pertaining to goods or services received for construction of an immovable property is not eligible for set-off against the outward tax liability. However, plant or machinery have been specifically excluded from the ambit of such blocked credit.]
M/s Tarun Realtors Private Limited - Authority of Advance Ruling (AAR), Karnataka [2019 (10) TMI 1021]
Facts of the case
- The applicant is involved in the development of shopping mall and enters into various lease agreements with their tenants.
- To undertake development of the mall, the applicant procured goods and services. These procurements were made for the installation of chillers, air handling unit, escalator, CCTV system, etc.
The installations qualify as ‘plant and machinery’ and hence the GST paid in relation to their procurement cannot be regarded as blocked credit in view of the specific exclusion under section 17(5)(d) of the CGST Act.
- The AAR observed that the goods/ services procured by the applicant were capitalized in the books of accounts and were not considered separate from the immovable property.
- The provision of facilities like transformers, sewage treatment plant etc. are essential for a commercial mall and hence cannot be considered separate from the building or civil structure.
- Accordingly, the GST paid on procurement of goods/services for installation was to be regarded as blocked credit under section 17(5)(d) of the CGST Act.
Interestingly, while dealing with similar facts in a writ petition filed by M/s Safari Retreats, the Hon’ble Orissa High Court read down section 17(5)(d) of the CGST Act and held that if the assessee is required to pay GST on the rental income arising out of the investment in immovable property, he should be allowed ITC on GST paid on inputs.
It appears that the said judgement has not been considered by the AAR in the present case.
Given the above, eligibility of ITC in relation to construction of immovable property may remain an area prone to litigation under the GST regime.
Whether renting of immovable property can be treated as continuous supply of services for the purpose of determining the time of supply (TOS), even after the license agreement has expired but the licensee continues to be in the possession of such immovable property?
[Section 31(5) of the CGST Act contain special provision in relation to time limit for issuance of invoice in case of continuous supply of services, and the TOS in such cases has to be determined accordingly.]
M/s Chennai Port Trust - AAR, Tamil Nadu [2019 (10) TMI 1204]
Facts of the case
- The applicant owns rentable land and building in the port area. As a part of the port activity, these land and buildings are rented/licensed out to the port users.
- Such licensing activity was covered under the purview of continuous supply of services (CSS).
- There were situations when the license agreement was expired but the licensee continued to occupy the licensed premises.
- In such cases, the applicant would not issue a tax invoice, but instead Rent Claim Advice (RCA) were issued.
- The RCA issued by the applicant fulfil all the requirements of a valid tax invoice prescribed by the CGST
- In the absence of a valid agreement, the supply can no longer qualify as CSS, and should be treated as a normal supply of services.
- Given the above, the RCA should be treated as a valid tax invoice and the time of supply (TOS) should be the date of such RCA, provided it is issued within 30 days from the end of the relevant month. [Section 13(2)(a) read with Section 31(2)]
- In cases where the RCA is not issued within 30 days, the TOS should be the end of the relevant month. [Section 13(2)(b) read with Section 31(2)].
The time limit for issuance of invoice for CSS under Section 31(5) revolves mainly around the due date of payment as per the contract. In the present case, the AAR held that in the absence of a contract (i.e. a valid lease agreement), the renting of immovable property cannot be treated as a CSS.
Interestingly, the AAR also ruled that an RCA document should be treated as a valid tax invoice provided it contains all the particulars prescribed for a tax invoice under the CGST Rules.
[According to Notification No. 12/2017-CGST (Rate) dated 28 June 2017, services by way of extending loans or advances in so far as the consideration is represented by way of interest is exempt from GST.]
Indo Thai Securities Limited – Authority for Advance Ruling (AAR), Madhya Pradesh [2019 (9) TMI 693]
Facts of the case
- The applicant is a registered stock broker dealing in the purchase/sale of securities for and on behalf of its clients and charges brokerage for its activities.
- Applicant charges interest from customers for delayed payment.
- The amount on which interest is charged consists of two components – the cost of securities and brokerage.
- The additional amount being charged is in the nature of penalty for failure of the customers to make the payments within the stipulated time.
- According to Section 15 of the CGST Act, the value of supply should include interest or late fee or penalty for delayed payment of consideration.
- In the present case, it cannot be said that the broker has extended any loan or advance to the customer.
- Given the above, exemption should not be available and the amount being charged should be taxed according to the original supply i.e. supply of stock broking services.
The ruling is in line with the Circular issued by the government wherein it was clarified that the amount of penal interest should be included in the value of original supply.
The interest can be said to be exempt from GST only when the supplier is engaged in the activity of extending loans or advances as provided in the exemption notification.