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Direct Tax

Whether the remittance of amounts under non-compete agreements to employees performing the services and receiving the payments in the USA are chargeable to tax u/s 5(2) of the Act?

If yes, the head of income under which it is liable for taxation under the Act should be 'Salary' or 'Business profits?'

Director of Income Tax Vs M/s Sasken Communication Technologies Ltd.

[2020] 117 taxmann.com 278 (Karnataka)

Background

The taxpayer is an Indian Company with a subsidiary in the USA. During the year under consideration, the subsidiary was merged with the Indian entity. Two employees who were in employment with the subsidiary company as CEO and COO were retained and offered employment in the Indian entity.

Three agreements, namely, Employer Agreement, Non-Disclosure Agreement, and Employee Non-Compete Agreement (NCA) were signed between the taxpayer and employees. After the aforesaid persons became employees of the taxpayer, payments under the employee NCA were made to each of the two employees. Referring to Article 16 of India USA DTAA, the taxpayer treated the non-compete fees as payment in lieu of salary and did not deduct tax at source.

The Assessing Officer (AO) passed an order considering the transaction as a sham and created for the purposes of avoiding payment of tax in India. The CIT(A) upheld the order of the AO and held that the rights and obligations of the parties under the non compete agreement was to take effect in India and thus the income of the employees would accrue in India and should be taxable under Article 23(3) of DTAA.

On appeal to the Tribunal, it was held that the amount paid to the employees under the NCA would fall under the head 'Salary' or 'profit in lieu of salary' and shall be eligible to claim the benefit of Article 16 of India USA DTAA. In the absence of any business in India, the payments received by the employees cannot be treated as 'Business income.'

Aggrieved by the above decision of the Tribunal, the revenue filed an appeal before the Karnataka High Court (HC).

Held

Providing references to various provisions of the Act, the Hon'ble Karnataka HC upheld the order of the ITAT.

It further provided that, "it is the cardinal principle of law that tribunal is a factfinding authority and a decision on facts on the tribunal can be gone into by the High Court only if a question has been referred to it, which says the finding of the tribunal is perverse." The HC fortified the said statement with various judicial precedents.

Accordingly, the HC found that the findings of fact recorded by the Tribunal have not been assailed as perverse, and thus, the matter stands concluded by findings of facts of the Tribunal.

Our Comments

As evidenced by various judicial precedents in the past, the treatment of non-compete fees is highly fact-specific. However, the precedent is certainly a welcome decision in the said context.

Where a non-resident company constitutes Dependent Agent Permanent Establishment (DAPE) in India and the agent is remunerated at arm's length, can any further profits be attributed to the DAPE?

OT Africa Line Ltd Vs. DDITInternational Tax

[ITA Nos. 2496/Mum/2009, 8423/ Mum/2010]

Facts

The taxpayer is a company incorporated and resident of the United Kingdom. The matter under consideration pertains to AY 2005-06 and AY 2007-08.

During the years under consideration, the AO referred to the agreement between the taxpayer and Freight Connections India Pvt. Ltd and proceeded to hold that taxpayer had a DAPE in India and attributed 10% of the freight income to such DAPE.

The CIT(A) confirmed the action of the AO. Aggrieved by such order, the taxpayer filed an appeal with the Mumbai Tribunal

Held

The Tribunal partially agreed with the AO that the taxpayer constituted DAPE in India. However, it had a different take on the attribution aspect of the order.

The Tribunal grossly followed the view of the Bombay Court in the case of Set Satellite (Singapore) Pte Ltd v. DDIT [(2008) 307 ITR 205 (Bom.)] and held that once an agent has been paid arm's length remuneration, and the income embedded in such remuneration has been taxed in India, no further profits can be taxed in the hands of the DAPE. Since, whether the remuneration is at arm's length or not is not the matter in dispute, the actions of authorities are unsustainable in law.

Our Comments

The precedent of Set Satellite (Singapore) Pte Ltd is based on the circular no 23 dated 23-07-1969. The circular specifically provided that subject to certain conditions, "Where a non-resident's sales to Indian customers are secured through the services of an agent in India, the assessment in India of the income arising out of the transaction will be limited to the amount of profit which is attributable to the agent's services."

Since the board had withdrawn the said circular in 2009, the principle set out in these precedents would not apply to assessment years after AY 2008-09

However, the Tribunal has not provided any comments on the fact that the rate of tax of agent and the foreign company is different. Thus, it is unclear whether there should be additional tax payable by the foreign company for a differential tax rate.

Transfer Pricing

Should guarantee commission be charged on gross amount guaranteed or on actual loan availed?

Omni Active Health Technologies Ltd – ITA No.7284/Mum/2018 – AY 2014-15

Ruling

The taxpayer is engaged in the field of Natural Active Pharmaceutical Ingredients (APIs) and Novel delivery systems for nutrients and active ingredients.

During FY 2013-14, the taxpayer had provided a corporate guarantee of USD 4 million to a bank in the USA towards an extension of credit facilities to one of its wholly-owned subsidiary companies. Based on the benchmarking analysis performed, the guarantee commission at 1.25% was ascertained. However, the said rate was applied to the actual loan availed by the associated enterprise (AE) as against the gross amount guaranteed.

During the ongoing assessment proceedings before Transfer Pricing Officer (TPO), the taxpayer contended that the guarantee commission shall not tantamount as an international transaction. Placing reliance on various judicial proceedings1, the guarantee commission was considered as an international transaction, and the rate, i.e., 1.25% adopted by the taxpayer was accepted. Since the rate was calculated and reported to the extent of the actual loan availed by AE, the TPO made an upward adjustment of INR 0.12 million by applying the rate on gross amount guaranteed.

Aggrieved, the taxpayer filed an appeal with the Dispute Resolution Panel (DRP). Based on various judicial precedents, the DRP upheld the adjustment computed by TPO. Aggrieved by DRP's order, the taxpayer filed an appeal before the Tribunal.

On perusing the order of lower authorities and placing reliance on various judicial proceedings (as well as taxpayer's own case for AY 2012-13 and AY 2013-14), the Tribunal upheld the order passed by DRP and TPO. Thus, the guarantee commission was computed on the gross amount guaranteed.

Our Comments

Ambiguity as to whether guarantee commission constitutes as an international transaction or not is still prevalent, and the issue is not settled yet. However, this ruling not only considers guarantee commission as an international transaction but also provides insights on computing guarantee commission in a case where actual loan availed varies from the amount guaranteed.

Whether TP adjustment should be considered while computing book profits under the Minimum Alternate Tax (MAT) provisions

SSP India (P) Ltd – ITA No. 388/ Del/2016 – AY 2010-11

Ruling

The taxpayer, a wholly-owned subsidiary of SSP Ltd., UK (AE), is engaged in providing support services for the development and maintenance of software to its AE.

During FY 2009-10, the taxpayer had filed a return of income under the normal provision of the Income Tax Act, declaring 'NIL' income. The taxpayer had also made computation under MAT provision wherein, the book profits were calculated at INR 27.9 million. During the course of assessment proceedings, the Assessing Officer (AO) referred the matter to TPO to determine the Arm's Length Price (ALP) of the international transactions undertaken with AE. While determining the ALP of the international transaction undertaken by the taxpayer, TPO proposed an adjustment of INR 13.7 million. The AO, while passing the draft assessment order, made an addition to the book profits of the taxpayer to the extent of transfer pricing adjustment.

Aggrieved, the taxpayer filed an appeal before the DRP. However, the objections filed by the taxpayer were overruled, and the final order was passed by DRP.

The matter was heard before the Tribunal. On perusing the material on record and on hearing the contentions of the taxpayer, the Tribunal held that the addition to book profits (computed as per MAT provisions) on account of transfer pricing adjustment was not permissible. This was further substantiated by placing reliance on various judicial precedents . Further being a settled proposition under the Income Tax Act, only adjustments contemplated under MAT provisions (transfer pricing adjustment being excluded from the ambit) can be adjusted against the book profits. Thus, Tribunal directed the deletion of the entire TP adjustment made to the book profits

Our Comments

Transfer pricing adjustment undertaken during the course of tax proceedings aims at aligning the transfer price with the ALP. The said adjustment does not have any interplay with the book profits computed under MAT provisions of the Income Tax Act.

Determination of ALP for intragroup services availed for cost plus model?

Teradata India Pvt Ltd - ITA No. 2397/Del/2017 – AY 2009-10

Ruling

The taxpayer primarily distributes enterprise data warehousing hardware and associated software in the Indian market. The taxpayer is also engaged in providing data warehousing solutions in the nature of sales support and service of the electronic data warehouse, hardware and software.

During the relevant year under consideration, the taxpayer has also availed intra-group services from its parent entity. TPO has determined the arm's length price of such services as NIL, citing it as duplicative service.

Separately, the taxpayer has entered into an agreement to provide a centralized shared service to its parent entity on a cost plus arrangement basis. Further, the assessee has considered the cost paid towards intra-group services as a part of the cost base for shared service.

Aggrieved, the taxpayer filed an objection before DRP. DRP has deleted the addition on intra-group service.

Aggrieved, tax authority filed an appeal before the Tribunal.

ITAT held as under:

  • It was observed that cost paid towards intra-group services was included in the cost base of share services
  • The cost of shared services (including the cost of intra-group service) was recovered from the parent entity along with mark-up.
  • It was held that addition on account of intra-group service shall lead to double taxation.

Therefore, Tribunal rejected the appeal filed by the tax authorities.

Our Comments

Intra-group service is a contentious issue in India.

This ruling would be useful to those taxpayers who follow cost plus model and recover all costs (including intragroup service cost) with a mark-up to put forth argument of double taxation.

Whether AMP is a separate international transaction in the absence of contractual obligation?

Reckitt Benckiser (I) Pvt Ltd - ITA No.404/Kol/2015 & ITA No.625/ Kol/2016 – AY 2010-11 & AY 2011-12

The taxpayer, subsidiary of Reckitt Benckiser Plc, UK, is engaged in the manufacturing and trading of Fast Moving Consumer Goods (FMCG) products.

Advertising, Marketing, Business Promotion (AMP) expenses:

The taxpayer, a manufacturer, and distributor of FMCG products had incurred AMP expenses (amounting to INR 302.43, which includes discounts and rebates as well) to market and distribute its product in the licensed territory. However, the products sold by the taxpayer stated the brand name of AEs.

During the course of ongoing assessment proceedings, the TPO observed that the AMP expenses incurred by the taxpayer were in excess vis-à-vis the expenses incurred by comparable companies. TPO applied Bright Line Test (BLT) and made an adjustment of INR 1.0445 billion.

Aggrieved, the taxpayer filed an objection before DRP, who upheld the action of the TPO.

Aggrieved, the taxpayer filed an appeal before the Tribunal.

Tribunal held as under:

  • It was observed that the facts of the LG Electronics case were different from that of the taxpayer in as much as that taxpayer was not under obligation to incur AMP expense, and the parent entity had no control over the decision of the taxpayer;
  • There was no transaction/ undertaking/agreement between the parent entity and the taxpayer;
  • AMP expenses incurred by the taxpayer was a unilateral event with no binding obligation on parent and therefore, cannot be construed as a 'Transaction';
  • Tribunal held that the AMP expenses were incurred for promoting the products and not publicizing the brand;
  • Accordingly, AMP expenses were not considered as an international transaction, and it was directed to delete the adjustment.

Our Comments

Indian Courts in most of the cases have ruled that AMP expenses do not qualify the definition of 'International Transaction' in the absence of contractual arrangement/ understanding.

This ruling re-emphasizes the importance of demonstrating the contractual obligation.

1. Mumbai High Court ruling in Everest Kanto Cylinders Ltd. and Mumbai ITAT ruling in case of Glenmark Pharmaceuticals (ITA No. 5031/Mum/2012 dated 13/11/2013)

Indirect Tax

Whether Input Tax Credit (ITC) is available in respect of taxi hire services procured through contractors for transportation of employees?

[Background: As per Section 17(5) (a)(i) of the CGST Act, 2017, ITC is not available in respect of motor vehicles for transportation of persons having approved seating capacity of up to 13 persons, except in certain specified cases.]

Prasar Bharti Broadcasting Corporation of India - Authority for Advance Rulings (AAR), Himachal Pradesh [2020 (6) TMI 519]

Ruling

  • The applicant avails services of hiring taxis for pick-up/drop shift duty of staff in odd hours etc.
  • The availability of ITC as per the provision of the second proviso to section 17(5)(b) is available only on the condition that such goods or services or both are obligatory for an employer to provide to its employees under any law for the time being in force.
  • The applicant has not been able to cite any law under which the service of providing the facility of transportation to its employees is obligatory; therefore, ITC will not be available.

Our Comments

It can be argued that the phrase 'in respect of' as used in the impugned section only restricts the ITC pertaining to the purchase of such motor vehicles and not in respect of other expenses such as hiring charges. This view is also substantiated by the fact that Section 17(5)(ab) specifically restricts the ITC pertaining to general insurance, repairs, etc. in respect of such vehicles. Given the above, we can expect further litigation on this aspect before the issue obtains finality.

Whether GST is applicable on sale of a plot of land for which, as per the requirement of the respective authority (i.e., Jilla Panchayat), primary amenities such as drainage line, water line, electricity line, land leveling, etc. are to be provided by the applicant?

[Background: As per Para 5 of Schedule III to the CGST Act, 2017, the sale of land shall neither be treated as supply of goods nor supply of services.]

Dipesh Anilkumar Naik - AAR, Gujarat [2020 (6) TMI 448]

Ruling

  • As per Schedule III, it is clear that the transaction shall be out of GST net only if the activity is exclusively dealing with the transfer of title or transfer of ownership of land, which is immovable property or earth.
  • The applicant charges the rates on a super built-up basis and not the actual measure of the plot. The super built-up area includes the area used for common amenities, roads, water tanks, and other infrastructure on a proportionate basis.
  • The above indicates that the sale of a developed plot is not equivalent to the sale of land but is a different transaction.
  • The sale of such plotted development is tantamount to the rendering of service.
  • The activity of the sale of developed plots would be a supply of services as covered under Para 5b of Schedule II, i.e., 'construction of a complex intended for sale to a buyer,' and therefore, GST should be applicable on the same.

Our Comments

This ruling is expected to send shock waves in the real estate sector as it is contrary to the prevailing industry view in relation to the sale of plots. Interestingly, the AAR in its ruling has relied on a Supreme Court decision in Narne Construction (P.) Ltd. Vs Union of India under the Consumer Protection Act, 1986 (CPA Act), where under a similar set of facts, such a sale was held as a 'service' for the purpose of the CPA Act.

However, given the difference in objectives and the design of the GST and the CPA Acts, and given the specific entry in Schedule III of the CGST Act, it remains to be seen whether this ruling stands scrutiny at higher appellate fora.