Whether genuine back-to-back arrangement entered into by taxpayer involving loan from immediate shareholder followed by investment in a group company would result in denying tax treaty benefits to the taxpayer
M/s. Golden Bella vs Dy. CIT [TS-523- ITAT-2019 (Mumbai)]
The taxpayer, a tax resident of Cyprus was engaged in the business of an investment holding company. The taxpayer applied for 5,000 CCDs in an Indian Company at premium, carrying interest at the rate of 15% on the face value of CCD. The said transaction was funded partly by the taxpayer’s capital and partly by shareholder’s loan availed from its immediate shareholder, M/s. GWDL (Mauritius). The taxpayer offered interest income earned from such CCDs in India at the rate of 10% according to the India- Cyprus tax treaty. However, the tax officer denied treaty benefits to the taxpayer in the absence of beneficial ownership of such income.
The Mumbai Tribunal observed that the taxpayer had invested in Indian Company via the CCD route for its personal and exclusive benefit and not for or on behalf of any other entity. Merely because investment was funded partly by capital and partly by interest-free debt, the taxpayer’s status as beneficial owner of such interest income does not get affected since the same was the sole property of the taxpayer. In this regard, the tax tribunal placed reliance on the OECD Commentary of 2017 and held that the taxpayer had the right to use and enjoy the interest income without having any legal or contractual obligation to pass on the same to another person. Hence, the taxpayer was the beneficial owner of the interest income and treaty benefits could be availed on such income.
There is always a thin line of distinction between genuine transactions and sham transactions. The tax tribunal has made an attempt in drawing out distinction between genuine and sham transactions.
This decision assumes importance as it brings out a very important principle that having established an entity in a tax haven does not automatically make a particular transaction a sham transaction. The substance of the transaction has to be clearly analyzed before characterizing the said transaction as a sham transaction or else even a genuine business transaction would be identified as a sham transaction resulting in unnecessary litigation.
Hitachi High Technologies Singapore Pte. Ltd. vs Dy. CIT [TS-558-ITAT-2019 (Delhi)]
The taxpayer, a tax resident of Singapore and a wholly owned subsidiary of Hitachi Japan, had established a liaison office (LO) in India in 1988 for rendering preparatory and auxiliary services including market research and liaison activities. The tax officer carried out survey on the premises of liaison office of the taxpayer wherein they found out that the LO was engaged in executing/ negotiating contracts for the taxpayer in India and hence, constituted PE in India.
The tax tribunal relied on the internal email exchanges and inferred that at least six employees were working in LO which included Japanese expats, key personnel and one senior personnel and all of them were engaged in sales function. Further, these employees were not only involved in LO activities but also trading business of the taxpayer including price negotiation, obtaining purchasing orders, followup jobs, etc. Hence, LO was involved in commercial activities which was not permitted to it under the Indian Exchange Control Regulations. Further, the activities carried out by LO utilized time, attention and labor of “men”. Thus, it was very clear that LO was performing core activities of trading business of the taxpayer.
The tax tribunal negated the contention of the taxpayer that LO was performing auxiliary and preparatory activities by placing reliance on the India-Singapore DTAA wherein it was mentioned that unless LO was engaged in advertisement, supplying information, scientific research, or similar activities having preparatory or auxiliary character, the same would constitute fixed place PE of the taxpayer in India. Hence, with regard to the nature of the activities performed by LO, the tax tribunal held that the LO constituted PE of the taxpayer in India.
This ruling once again brings out the importance of functions performed by a liaison office. It is important for taxpayers to ensure that function performed by liaison office are compliant with the tax and exchange control laws in India. In case of any divergence, there could be huge tax risks in India.
Whether TP adjustment made without reference to the Transfer Pricing Officer (TPO) hold good in law?
S.G Asia Holdings (India) Pvt. Ltd. – SLP (C) No. 12126 of 2019
The taxpayer was engaged in providing broking and clearing services to Associated Enterprises as well as third parties. During the relevant year, the taxpayer received brokerage from its parent company at the rate of 0.06%.
The Assessing Officer (AO) during the assessment proceedings contended the brokerage rate to be lower than the prevalent market rate and made an addition on the brokerage charged by the taxpayer to its parent entity. The TP addition of the AO was confirmed by Commissioner of Income Tax (Appeals) (CIT(A)).
During Tribunal proceedings, the Tribunal observed that by not making any reference to the TPO for the TP adjustment, AO had breached the mandatory instructions of the Central Board of Direct Taxes (CBDT). Instruction No. 3/2003 dated 20.05.2003, which contains guidelines for AOs and TPOs to operationalize TP provisions and have procedural uniformity. The instruction mandated the AO to refer the case to the TPO where the related party transaction value exceeded INR 50 million. The Tribunal also refused to set aside the matter to AO, quoting that any administrative lapse made by AO cannot be made good by the Tribunal. The High Court upheld the ITAT’s decision.
Aggrieved, the revenue filed a Special Leave Petition before the Supreme Court (SC.) On examining the expressions given in the guideline, SC negated the view taken by the Revenue authorities that the discretion for reference to the TPO was vested on the AO and it is not mandatory to refer the issue of computation of Arm’s Length Price to the TPO in every single case. SC upheld the view of the Tribunal that AO had breached the mandatory Instruction No. 3/2003 issued by the CBDT by not making any reference to the TPO.
Further, SC also opined that Tribunal should have accepted Revenue’s plea to restore the matter to the file of AO for making the appropriate reference to the TPO. Accordingly, SC directed AO to take appropriate steps in terms of Instruction No. 3/ 2003.
CBDT Instruction 3/2003 was replaced by Instruction no. 15 of 2015 which was again replaced by CBDT Instruction No. 3/2016.
The latest instruction lays down comprehensive conditions for the AO to refer the case to the TPO which is based on risk-based parameters rather than monetary thresholds. It is important to note that adherence to the CBDT instruction is mandatory on the part of the AO and a default on this account can be one of the grounds for challenging the action.
Can segmental data prepared exclusively for transfer pricing be rejected on the ground that the same do not form a part of audited financials statements?
Net Guru Ltd – ITA No. 2162/Kol/2017
The taxpayer was engaged in provision of software development services and adopted cash profit margin as profit level indicator (PLI) to benchmark the international transaction using Transactional Net Margin Method (TNMM). For AY 2010- 11, Revenue authorities argued that the taxpayer was not operating in a capital intensive industry and therefore using cash PLI is not justified. In addition to this, the TPO rejected the segmental prepared by the taxpayer and made modifications to the list of comparable companies selected.
The additions made by the TPO were quashed by the CIT(A). Aggrieved by the order of the CIT(A), the Revenue filed an appeal before the ITAT.
Tribunal observed that “net profit” under TNMM has not been defined in the Act. There were judicial precedents wherein the Tribunal had approved the use of cash profit margin for placing the tested party and comparable companies on equal footing. These rulings include Delhi Tribunal in case of Schefenacker Motherson Ltd, Bombay High Court in case of Reuters India (P) Ltd, Kolkata Tribunal in cases of AT&S India Private Ltd and EPCOS Ferrites Ltd. Further, nowhere is it stated that cash profit margin ratio is only restricted to capital intensive industries. It was observed that for application of TNMM, the best way of computing operating profit would be to compute profit before depreciation in respect of each of the comparable companies, as it would take out the inconformity or the variation in the profit level of the comparables arising due to adoption of different method of charging depreciation. Further, noting that Revenue authorities had accepted the cash profit margin ration as PLI for AY 2011-12, Tribunal opined that there was no reason to reject it for AY 2010- 11 following the rule of consistency.
Revenue authorities disputed the veracity of the segmental profitability statement produced by the taxpayer since the same did not form a part of the audited financial statements. In absence of sufficient working notes and improper allocation key, the Revenue authorities viewed that the segment report prepared by the taxpayer was an arbitrary exercise.
The Tribunal stated that since the taxpayer belonged to “Small and Medium Sized company”, the Accounting Standard -17 was not mandatory, hence it did not form part of the audited financials. The segmental results were prepared by the management exclusively for TP analysis. Further, the Tribunal observed that the segment report which was used for ALP analysis under TNMM was duly verified by the statutory auditor. The Tribunal noted that the statutory auditor verified and certified in the segment report the headcount of employees (manpower) for AE and non-AE sales. Following Bangalore Tribunal’s decision in case of Cisco Systems (India) (P.)Ltd, the Tribunal observed that segmental accounts were accepted for determining ALP under TNMM where the functions performed by the taxpayer are different under the AE-segment and non-AE segment, though the segmental accounts do not form part of the audit report.
There are significant differences of opinion among appellate forums on the appropriateness of using Cash PLI. The rulings provide a divergent view on cases where Cash PLI is considered suitable for manufacturing and other capital or asset-intensive industries. This ruling clarifies that the use of Cash PLI is not restricted to capita-intensive industries and can also be adopted for service industries.
The ruling clarifies that segmental prepared for benchmarking under transfer pricing cannot be disregarded merely because the same does not form a part of the audited financial statements.
Goodyear South Asia Tyres Pvt Ltd – ITA No. 1068/PUN/2016
The taxpayer was engaged in the manufacturing of tires. During Assessment Year (AY) 2010-11, the taxpayer had paid Regional Service Charges (RSC) to its associated enterprise (AE) for the services relating to general administration, HR services, SAP modules and solutions, and formulation of policies. Barring IT support services (i.e charges for SAP modules and solutions), TPO disregarded the supporting documents presented by the taxpayer and determined the arm’s length price (ALP) of the intra-group service charges at Nil, commenting that the voluminous documents were in the nature of exchange of information and did not prove receipt of services. Thus the TPO made a TP adjustment to that extent.
During Tribunal proceedings, ITAT made the following observations
- The payment for intra-group charges was made in earlier years for which no adjustment was done by the AO, given the fact that there was no change in the terms and conditions of the inter-company service agreement.
- Similar services were provided to all participating Goodyear affiliates and based on appropriate allocation key, in turn, depending on the nature of services availed by each of them, allocation of cost was made. Further the taxpayer was raising monthly service-wise invoices and the quantum of payment was varied.
- The taxpayer had submitted voluminous documentary evidence in the form of e-mails, presentations which clearly demonstrated that services were being availed.
- The taxpayer had submitted an auditor’s certificate by an Independent accounting firm for entity-wise allocation of service charges.
- TPO contended that certain payments under the service agreement for Production and Tire Performance/Product Resolution were similar/duplicative to the royalty payments made by the taxpayer under technical assistance and license agreement.
In light of the above facts, Tribunal held that
- Evidences submitted by taxpayer establish the availment of services under different heads and there is no merit in the TPO order brushing aside the same and holding that there was no rendition of services.
- The analysis done by the TPO is regarding the nature and benefits derived from the intra-group services rather than what an independent enterprise would have paid for similar services. Since the payments for intra-group service charges were accepted to be at ALP in earlier years, there is no merit in the TP adjustment by taking ALP at Nil.
- The Tribunal drew distinction between payments towards reimbursement of cost incurred by regional entities in providing assistance for engineering, quality assurance, safety, etc. as against royalty payments which are towards technology, know-how being made available to the taxpayer by the AE.
- Noting that the intra-group service charges are interlinked to the other transactions undertaken by the taxpayer such as import and sale of raw materials and machineries, the Tribunal accepted taxpayer’s aggregated benchmarking.
In line with OECD Guidelines, most Intra-group service agreements refer to rendering of need-based services and billing of these services on the basis of quantum of service. This ruling is a welcome move in cases where there is a blanket rejection of all evidences by the TPO for intra-group services.
Can Sec 263-proceedings be rendered as invalid in case the final assessment order is passed without draft order?
WSP Consultants India Private Limited – W.P (C) 9636/2019
The Delhi High Court has admitted the writ petition filed by WSP Consultants India Pvt. Ltd. on this litigated issue as to whether the Principal Commissioner of Income Tax ('PCIT) can exercise jurisdiction vested under Section 263 of the Income Tax Act, 1961 (Revision of orders prejudicial to revenue) in cases where an assessment order has been passed by the Assessing Officer (AO) without passing a draft assessment order for an 'Eligible Assessee'. Since the taxpayer has issued a jurisdictional issue vide the subject writ, the HC entertained the writ and categorically held that "since it is a legal issue, we are also inclined to examine the same in these proceedings".
Generally, in cases of assessment of a foreign company or where a reference is made to a TPO, Section 144C (1) mandates the Assessing Officer (AO) to issue a ‘draft assessment order’ to the assessee after receipt of the report from the Transfer Pricing Officer (TPO), thereby affording the assessee the choice of further action. If the assessee chooses to file an objection before the Dispute Resolution Panel (DRP), then the AO shall wait for directions from DRP and incorporate the same in the final assessment order. On the other hand, if the assessee chooses to file an objection before the CIT(A), the AO may proceed to pass the final assessment order. However, on many occasions, it has been seen that the AO passes a final assessment order without issuing a draft assessment order. In other words, AO issues a demand notice u/s. 156 and/or a penalty notice u/s. 274 along with the draft assessment order, which raises questions about the validity of the assessment proceedings. Many taxpayers have challenged the validity of such assessment orders and in most cases, Courts have held that passing of final assessment order sans a draft order is an incurable defect thereby invalidating such assessment order.
However, there are a few cases in favor of Revenue authorities on this subject, wherein Tribunals have viewed that the character of the assessment order is that of the draft assessment order and therefore there is no violation of Section 144C. However, passing the assessment order straightway without passing the draft assessment order would take away the enforceable right of the taxpayer company to approach the DRP. Therefore, such a defect is a curable one and the assessment proceedings will remain valid.
Since the HC has admitted the writ petition, the order of the HC could have material bearing on cases where an assessment order sans a draft order has previously been considered null and void by Tribunals.
An exporter (petitioner) initially claimed a higher rate of duty drawback. Later, on realizing that IGST refund can be availed only if drawback is claimed at the lower rate, the exporter paid back the differential drawback amount along with interest, and claimed IGST refund. Can IGST refund be granted in such a case?
Amit Cotton Industries vs Principal Commissioner of Customs - High Court of Gujarat [2019-VIL-315-GUJ]
- The law clearly provides that IGST refund cannot be claimed by the exporter if he has claimed a higher drawback.
- There is no procedure prescribed under any law/notification that if the differential amount of drawback has been paid, the exporter would be eligible for IGST refund.
- The petitioner has invented a new procedure in order to try to obtain the benefit which has already been forgone while claiming a higher drawback.
- Rule 96(4) of the CGST Rules makes it clear that a refund can be withheld only in two circumstances. The present situation is not covered under these exclusions.
- The Circular relied upon by the department explains the provisions of drawback and it has nothing to do with IGST refund.
- Given the above, the department should immediately sanction the refund of IGST along with simple interest of 7%.
In this case, the exports pertained to the month of July 2017. The Customs drawback notification has since been amended and the concept of higher and lower rate of drawback has been removed. Now, there is only one rate of drawback for each product and the IGST refund can be availed if drawback has been claimed at such rate.
Nevertheless, this ruling should provide relief to exporters who have inadvertently claimed duty drawback at a higher rate prior to the amendment.
Can CENVAT credit of service tax paid on staff health insurance policies be claimed by the appellant?
[Under the erstwhile CENVAT credit rules, CENVAT credit of health insurance is not available. A similar provision is also contained in the GST law.]
ITZ Cash Card Ltd. vs Commissioner, GST & C. Excise, Thane Rural – Customs, Excise and Service Tax Appellate Tribunal (CESTAT), Mumbai – Appeal No. ST/88317/2018
- CENVAT credit can be excluded only when health insurance services are used primarily for personal use or consumption of any employee.
- The word “employee” (singular) does not include the plural. Thus, when the benefit is provided to employees as a group, the employer is entitled to CENVAT credit.
- The CESTAT accepted the contentions of the appellant and held that the CENVAT credit of employee’s health insurance policy should be available to the appellant.
- The CESTAT also observed that the CENVAT credit on health insurance policy was also allowed by the Hon’ble Madras High Court in Ganesan Builders Ltd. Vs. CST [2018 (10) TMI 269].
The CESTAT judgement can have huge implications as even under the GST law, GST paid in respect of health insurance is not allowable as input tax credit.
However, although CESTAT while arriving at its decision has relied on the judgement in Ganesan Builders, it has failed to analyze the fact that in the said case CENVAT credit of health insurance policies was allowed as obtaining such policy was mandatory under the applicable labor laws. Therefore, the decision of CESTAT may be challenged before the higher fora by the Revenue.
[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.