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Direct Tax

Whether withholding of tax can be applicable to the reimbursement of expenses to a non-resident?

Bangalore International Airport Vs The Income-tax officer ITA Nos. 536 to 539/Bang/2006

Background

The government had proposed to develop an airport with private sector participation. The Karnataka State Industrial Investment Development Corporation (KSIIDC) was appointed as the Nodal Agency for undertaking all the activities towards the development of the airport as a joint venture. The Government of India also authorized the Airport Authority of India (AAI) to participate in the development of the project.

AAI and KSIIDC floated a global tender for private partners who can hold a 74% stake of the airport. As an outcome consortium consisting of SIEMENS Germany, UNIQUE Switzerland, and L&T, India were chosen as private partners. Ultimately, the taxpayer was incorporated with the chosen private partners, along with AAI and KSIIDC.

Prior to incorporating the taxpayer, the cost was incurred by the private partners for a feasibility study and development of the airport project. As per the shareholders' agreement, such pre-development cost was reimbursed to the non-resident private sector without withholding any taxes. The taxpayer was of the view that the payment was purely reimbursement of expense, and in the absence of any income element, no withholding of tax would be required. The contention was backed by a special bench decision in the case of Mahindra & Mahindra.

The Assessing Officer (AO) considered the reimbursed expenses as Fees for Technical Services (FTS) and made additions. On appeal, the CIT(A) concurred with the AO. Relying on the decision of the Authority of Advance Ruling (AAR) in the case of Danfoss Industries Private Ltd, the CIT(A) was of the opinion that as long as the payments are in the nature of sums chargeable to Indian tax, one need not go to the question of profit element. Since the nature of services rendered for which payment was made is FTS, the payment should be subject to withholding tax.

Held

The Bangalore ITAT was of the view that the non-resident had no obligation to bear expenses in his individual capacity. Even going by the averments of the AO that the payment made to the consultants engaged by the nonresident was in the nature of FTS, the payment in question is not made to the consultants but to the non-resident by way of reimbursement.

The tribunal appreciated the fact that the decisions of the AAR are binding only on the parties to the ruling, and it would have persuasive value as a precedent. However, the special bench's decision, in the case of Mahindra & Mahindra, would be binding as a precedent.

Our Comments

Withholding tax on reimbursement of expenses has always been a persistent issue of debate. There are various judicial precedents, both supporting and against the withholding of taxes on reimbursement.

The decision is rendered based on the favorable special bench decision in the case of Mahindra & Mahindra. However, the revenue has not pointed out any other negative decisions in this context.

This could be a welcome decision in this context; however, while adopting such a view, the taxpayer (especially deductors) should be cautious about the against rulings in this context.

Whether payment for the inspection services rendered by the nonresident can be considered as Fees For Technical Services (FTS)?

DCIT Vs M/s Jeans Knit Pvt. Ld ITA No 383 of 2012 (Karnataka High Court)

Background

The taxpayer is engaged in the business of manufacturing and export of garments and is a 100% export oriented undertaking. The taxpayer requires to import accessories from other countries, mostly from Europe. For the aforesaid purpose, it had engaged a non-resident company to render services such as inspection of fabrics, timely dispatch of material, etc. The taxpayer made payment to the non-resident without withholding of tax. It was of the view that the non-resident does not require any technical knowledge for rendering the aforementioned services. The taxpayer already determines the quality of the material, and the non-resident company is only required to make a physical inspection of the material to examine if it resembles the quality specified by the assessee.

The AO inter-alia held that the nonresident company is a service provider, and the services rendered by the nonresident company would be squarely covered under the definition of FTS. The decision of the AO was concurred by the CIT(A).

The tribunal, vide its order, held that the non-resident company is not involved either in the identification of the exporter or selecting the material and negotiating the price. Only comparing the samples provided by the assessee does not require any technical knowledge.

Aggrieved by order of the tribunal, the revenue filed an appeal with the High Court.

Held

The Hon'ble High Court (HC) upheld the order of the tribunal. The HC went a step ahead and held that it is a well-settled legal proposition that the tribunal is a fact-finding authority and decision on facts rendered by the tribunal can be gone into by HC only if a question is referred to it, which says the finding is perverse. Given that the tribunal's finding has neither been assailed by the revenue as perverse and even in the memo of appeal, no perversity has been even alleged, no substantial question of law arises.

Our Comments

Whether a payment would qualify to be FTS or not cannot be standardized. It is a matter of factual analysis. Individual services need to be analyzed while determining taxability. In cases where the only inspection is required based on the sample provided by the party, the same should not be considered as FTS.

Whether refund of taxes withheld can be allowed on the income not assessable to tax in the hands of the taxpayer?

M/s. ABB AB C/o ABB India Limited Vs DCIT ITA No 464/Bang/2018 & 2878/ Bang/2019

Background

The taxpayer, ABB AB, is a tax resident of Sweden within the meaning of DTAA between India and Sweden. The taxpayer is engaged in power and automation technologies for utility and industry customers. The competent authorities of India and Sweden in the taxpayer's case had arrived at a resolution through Mutual Agreement Procedure (MAP) for the AY 2013-14 and 2014-15 that the receipts under the offshore supply contract and onshore supply contracts are not chargeable to tax in India.

For the concerned year, the taxpayer filed its return of income, claiming a TDS refund to the tune of INR 28,56,25,430. However, the AO passed an order under section 143(3), allowing TDS credit of only INR 1,71,15,646.

The AO was of the view that the income is subject to tax in India as the MAP resolution does not cover the concerned year. Further, the source for the offshore supply contract is in India; hence, the receipts are taxable in India. Since the invoices of the concerned year were relating to advances and not the supply of equipment, the AO concluded that as per section 199, the credit for taxes deducted at source could be given only when the corresponding income is offered to tax.

The taxpayer pleaded that the taxpayer company's payments for the offshore supply contract are not applied in India as the title is passed outside India, and payment is also received in India. The provision of Section 199 of the Act and Rule 37BA of Income Tax Rules will not be applicable, where the payments are not taxable in India.

The CIT(A) upheld the order of the AO. Aggrieved by such order, the taxpayer has filed an appeal with the tribunal.

Held

After considering the argument of both sides, the Bangalore tribunal followed the decision of the co-ordinate bench in the case of Arvind Murjani brands (P) Ltd.

In such case, it was held that section 199 had been enshrined in the Act to give a logical conclusion to the earlier sections under which tax is deducted at source from various items of income as enumerated therein so that credit for the tax deducted at source is allowed to the person while assessing the income in the hands of the payee. The role of section 199 is confined to allowing the credit for the tax deducted at source to the payee of the amount and none else. Thus it is evident that section 199 only deals with allowing of the credit for the tax deducted at source and not with the disallowing of such credit. Since the offshore supply contracts are not taxable in India, but TDS was deducted in India; therefore taxpayer is eligible for a refund of TDS Credit.

However, the case was remitted back to the AO for the limited purpose of verification and examination whether the amounts received are offshore supply contracts by the taxpayer were received outside the country.

Our Comments

The decision highlights the principle that the provisions of the Act are to be interpreted, keeping the spirit of the law into consideration.

Transfer Pricing

Whether business advance to lossmaking AE should be treated as a loan to AE?

KEC International Ltd - ITA No. 17/Mum/2018 and ITA No. 115/ Mum/2018 – AY 2012-13

Facts

The taxpayer is engaged in the business of designing, fabrication, galvanizing, and testing of transmission lines and telecom towers, supply and erection of substation structures and overhead equipment for railway electrification, and managing infrastructure sites for telecommunication services. The taxpayer held a 50% share in a Joint Venture (JV) in South Africa.

During the year, the taxpayer had given advances to its Associated Enterprise (AE), i.e., the JV entity, amounting to INR 27.32 crores to meet the deficit in cash flows while executing projects in South Africa. Since the transaction was stated to be in the nature of advances, no interest was charged during the year. For benchmarking the transaction, the taxpayer selected AE as the tested party. The loan availed by AE from the UK based Bank at three months LIBOR + 120 basis points was used as an internal Comparable Uncontrolled Price (CUP) to benchmark the transaction.

During the course of the assessment, the Transfer Pricing Officer (TPO) rejected the taxpayer's internal CUP and adopted interest rates applicable for fixed rates loans, i.e., LIBOR plus some spread. Adopting the Bloomberg database, the benchmark rates were held to be 15.36% for FY 2010-11 and 11.29% for FY 2011-12. Applying the said rates to opening advances and fresh advances, TPO proposed net Transfer Pricing (TP) adjustment at INR 2.43 crores.

Commissioner of Income Tax – Appeal / CIT (A) confirmed the adjustment, against which the taxpayer filed an appeal before Income Tax Appellate Tribunal (ITAT).

ITAT held as under

  • Based on the financial statements of the AE, it is observed that AE has incurred losses, which had primarily triggered the taxpayer to make the stated advances.
  • The advances were towards the fulfillment of the taxpayer's obligation of being a JV partner as any financial incapacitation of JV would adversely affect the continuation of the project and ultimately jeopardize the interest of the taxpayer.
  • Further, it could not be said that the JV entity derived/gained certain benefits out of such advances, but rather, it was the taxpayer who would ultimately gain by continuing with the projects and taste the fruits of the success of the project.
  • Therefore, the said advances could not be put in the category of loans as done by the lower authorities. Held that, the advances were more in the nature of the capital contribution.

Therefore, ITAT deleted the adjustment.

Our Comments

Under the Indian Transfer Pricing Regulation, advances between AEs are considered as an international transaction and are required to be at arm's length.

The business advances made by the taxpayer to AEs as a matter of commercial prudence (to avoid any financial incapacitation of the AE) cannot be considered in isolation without considering crucial business scenarios and expediency. In such cases, since the cost and benefit would ultimately accrue to the taxpayer, the same cannot be treated as a loan to AE. Consequently, no interest is warranted to be charged on such business advances.

Whether comparable prices from TIPS Data Base are acceptable as a CUP for chemical imports?

Dow Chemical International Pvt Ltd - ITA No. 1786/ Mum/ 2016 – AY 2011-12

Facts

The taxpayer is engaged in manufacturing specialty chemicals, distribution of chemicals, and undertaking marketing support activities for overseas group companies. During the year, the taxpayer has imported raw materials amounting to INR 232 crores from its AEs. Applying the Cost Plus Method (CPM), the taxpayer has compared its gross margin with third party comparable companies and justified the arm's length value of the transaction.

During TP assessment, TPO rejected CPM and adopted the Transactional Net Margin Method (TNMM), thereby proposing a TP adjustment of INR 38 crores in respect of the import of raw materials. In the appeal, the Dispute Resolution Panel (DRP) upheld the adjustment, rejecting the CUP data using ICIS* prices submitted by the taxpayer.

* Market prices published by Independent Chemical Information Services (ICIS), which reports prices based on a contract between third parties and which is relied upon by the chemical industry to fix their prices.

Aggrieved, the taxpayer filed an appeal before ITAT.

ITAT held as under

  • The taxpayer had filed additional evidence to substantiate the comparison of its import price with prices available on the TIPS database for 95.79% of the raw materials imported from AEs. It was noted that ICIS prices covered a lesser percentage of the total value of import transactions from AE.
  • It was observed that TIPS Data Base maintained by the Customs Department has also been accepted by the Delhi Tribunal in the case of Tilda Riceland Pvt. Ltd. and in the taxpayer's own case for AY 2010-11 and AY 2014-15.
  • In view of the fluctuating prices for the product, ITAT directed the TPO to adopt a portfolio approach considering both favorable and adverse prices while benchmarking the import transaction.
  • Remitting the matter for verification, ITAT stated that if the taxpayer's import prices are lower than the comparable prices reported by TIPS Database, the balance imports of 4.21% will also be considered to be at arm's length, thereby not warranting any TP adjustment.

Therefore, ITAT has remitted the matter to TPO to verify the details.

Our Comments

We have observed that the application of CUP is difficult for import transactions considering the high degree of accuracy required in terms of comparability.

However, this ruling has laid down the jurisprudence, whereby we can consider comparable prices available on the ICIS or the TIPS database as valid CUP while benchmarking import transactions pertaining to the chemical and related industries.

This ruling shall help especially in cases for benchmarking import transactions, where there are losses at net level incurred.

Whether royalty payment approved by the Reserve Bank of India (RBI) can be considered at arm's length?

Thyssenkrupp Industries India Pvt. Ltd. - C.O. NO.94/MUM/2014 – AY 2009-10

Facts

The taxpayer is engaged in the manufacturing of industrial machinery and equipment. The taxpayer received technical assistance and know-how from its AE for which a royalty of 2% of the contract value for manufacturing, drawing, and engineering services and 5% of the selling price was paid.

The royalty agreement was approved by the RBI and < a href="https://fifp.gov.in/AboutUs.aspx">Foreign Investment Promotion Board (FIPB). The taxpayer selected itself as the tested party and TNMM as the most appropriate method for benchmarking. During assessment proceedings, the TPO determined the arm's length price (ALP) of the royalty transaction at 'Nil' and proposed a TP adjustment of INR 5.98 crores.

In an appeal, the DRP has deleted the TP adjustment, placing reliance on the taxpayer's own case for AY 2008-09. Aggrieved, the Revenue has filed an appeal before ITAT.

In the taxpayer's own case for AY 2008- 09, ITAT held as under:

  • The taxpayer had applied to the RBI seeking approval in respect of payment of royalty and technical fee through the Central Bank of India. The RBI, vide its letter, requested the Bank to consider the taxpayer's case in accordance with its AP (DIR Series) No.76 Circular* requiring explicit approval from RBI/FIPB only in case royalty payments exceed 5% on net domestic sales and 8% on net export sales. Since the taxpayer's royalty payments to AE did not exceed the threshold, they were deemed to be approved by the RBI under the automatic approval scheme.
  • * In this regard, we wish to highlight that the royalty caps vide the aforementioned Circular have been removed since 2009. It should also be noted that royalty transactions for most of the sectors are currently under the automatic route (not requiring explicit approval from RBI)
  • When the royalty payment has been approved or deemed to be approved by the RBI, the royalty payment is considered to be at arm's length.

Therefore, ITAT deleted the adjustment.

Our Comments

Royalty payments are increasingly coming under tax scrutiny, making it incumbent on the taxpayers to defend their royalty payments made to overseas related parties to be at arm's length.

Divergent views have been taken on the use of RBI guidelines for testing the arm's length nature of royalty transactions. A contrary view was taken in the case of Nestle India Ltd [ITA Nos. 662 & 1202 of 2005, 96 & 294 of 2008, 288 of 2011] wherein the Delhi High Court clarified that RBI's permission for payment would not preclude the TPO from questioning the reasonableness and genuineness of the transaction.

The onus lies on the taxpayer to demonstrate the need and benefit derived from royalty payments as well as to maintain proper documentation, which would serve as a concrete basis for considering royalty payments to be at arm's length.

Indirect Tax

Whether Rule 89(5) of the CGST Rules, 2017 is ultra vires the GST law, and therefore can an applicant be allowed refund of Input Tax Credit (ITC) on input services in case of supplies under inverted duty structure?

Tvl. Transtonnelstroy Afcons Joint Venture Vs. Union of India [2020 (9) (TMI) 931]

Facts

  • The petitioner claims refund of ITC on account of inverted duty structure as per section 54(3) of the CGST Act, 2017;
  • Notification No. 21/2018-CT dated 18 April 2018 amended the said Rule to deny refund on the ITC availed on input services and allowed relief of refund of ITC availed on inputs alone;
  • This amendment was later given a retrospective effect from 1 July 2017;
  • In the case of VKC Footsteps India Pvt. Ltd., (covered in the August 2020 edition of Tax Street), the Gujarat HC held that the formula in Rule 89(5) to exclude refund of tax paid on 'input service' is contrary to the provisions of Section 54(3).

Based on the above facts, the Madras HC ruled as follows:

  • The proviso to Section 54(3) performs a larger function of limiting the entitlement of the refund to credit that accumulates as a result of the rate of tax on input goods being higher than the rate of tax on output supplies;
  • Section 164 confers power on the Central Government to frame rules for carrying out the provisions of the CGST Act, and no fetters are discernible therein;
  • Consequently, Rule 89(5) of the CGST Rules, as amended, is intra vires both the general rulemaking power and Section 54(3) of the CGST Act;
  • Further, the Section uses the word 'inputs,' and this word is defined in Section 2(59) as "any goods other than capital goods ….";
  • Section 54 contains more than a few usages of the terms' inputs' and 'input services' in other sub-sections, thereby indicating the legislative intent to distinguish one from the other;
  • Hence, the statutory definition and the context point in the same direction, namely, that the word 'inputs' encompasses all input goods, other than capital goods, and excludes input services;
  • Consequently, it is not necessary to interpret Rule 89(5) and, in particular, the definition of Net ITC therein so as to include the words input services.

Our Comments

This judgment of the Madras HC has again resulted in a scenario wherein different High Courts have given contrary decisions on the same issue. Nevertheless, the Revenue will definitely see this as a big victory given that the Court has specifically referred to the judgment in VKC Footsteps and disagreed with the same stating, that the Gujarat HC failed to take into consideration the scope, function, and impact of the proviso to Section 54(3).

Businesses may have to revisit and rethink any change in tax positions they may have adopted in light of the VKC Footsteps judgment and will have to wait for the Supreme Court to rule on the matter for it to attain finality.

i. Whether ITC is available to the applicant on GST charged by the service provider on the hiring of bus/motor vehicle having a seating capacity of more than 13 persons for the transportation of employees to and from the workplace?

ii. Whether GST is applicable on the nominal amount recovered by the applicant from its employees for the usage of employee bus transportation facility in non-airconditioned buses?

[Background: Section 17(5)(b)(i) of the CGST Act has been amended, with effect from 1 February 2019 to block ITC on leasing, renting, or hiring of motor vehicles having approved seating capacity of not more than 13 persons.

As per Notification No. 12/2017- CGST, transport of passengers in non air-conditioned contract carriage is exempt from GST]

Tata Motors Ltd - Authority for Advance Ruling (AAR), Maharashtra [2020 (9) TMI 352]

Ruling for Question (i)

  • We have no doubt that in the subject case, the supply of services received by the applicant is used in the course or furtherance of their business, and therefore prima facie, they are eligible to take credit of GST charged by their suppliers;
  • Further, in the subject case, since the applicant has specifically submitted and, as agreed by the jurisdictional officer, that they are using motor vehicles having approved seating capacity of more than 13 persons (including the driver), the applicant shall be eligible for ITC.

Ruling for Question (ii)

  • The applicant is not providing transportation facilities to its employees. In fact, the applicant is a receiver of such services in the instant case;
  • Therefore, the applicant's contentions that they are eligible for exemption from GST in respect of nominal amounts of recoveries made from their employees towards bus transportation service is not correct;
  • Since the applicant is not supplying any services to its employees, in view of Schedule III to the CGST Act, we are of the opinion that GST is not applicable to the nominal amounts recovered by applicants from their employees in the subject case.

Our Comments

Schedule III to the CGST Act excludes services provided by an employee to the employer from the ambit of GST [i.e., in such a case 'consideration' viz. salary, allowance, etc. flows from the employer to the employee]. The AAR's reliance on the same for excluding recovery of nominal amounts by the employer from the employees appears to be misplaced.

However, the applicant has accepted that its ITC will be restricted to the extent of the net cost borne by it in view of the judgment of the Bombay High Court under the erstwhile CENVAT credit rules in the case of CCE, Nagpur vs. Ultratech Cement Ltd., [2010 (10) TMI 13]. Therefore, there is revenue neutrality from the point of the exchequer.


The Madras High Court judgement is bound to take wind out of the sails of the industry which is already reeling under economic hardships inflicted by the pandemic. The contradictory judgements by different Courts once again emphasize the need for legislative clarity on crucial tax issues in the GST regime. Without waiting for the matter to attain finality before the Supreme Court, the GST Council, as a trade facilitation measure, should revisit the issue and bring in an amendment in the GST law to allow refund of ITC pertaining to input services in case of refund on account of supplies under inverted duty structure. The step from GST Council will help industries regarding working capital liquidity and ease of doing business.

Mr. Abhishek Rai
Finance Controller
Bic Cello India