From The Judiciary

Whether Interconnected services under a unified agreement constitute a Permanent Establishment (PE) in India?

Telenor ASA Vs. DCIT ITA No. 1307/Del/2015

Facts

The taxpayer is a company incorporated in Norway and entered into Business Service Agreement with Unitech Wireless (Tamil Nadu) India P. Ltd. The taxpayer provided services to Unitech Wireless through different Service Order Form (SOF) under various nature of activities such a Sourcing, Marketing, IT/IS, HR and other contracts for UNINOR group entities. As per Article 12 of the India-Norway Double Taxation Avoidance Agreement (DTAA), such income was offered to tax at 10% on a gross basis, being in the nature of ‘Fees for Technical Services’ (FTS).

The taxpayer’s employees stayed in India for a period of 260 days (which is more than the threshold prescribed under Article 5 of the India-Norway DTAA) in total for all the SOFs.

The AO held that the taxpayer had a PE in India since it was a single project and fees received from Unitech Wireless was in the nature of FTS being effectively connected with PE of the taxpayer and in terms of Article 12(5) of India-Norway DTAA, was liable to tax under Article 7 of the India-Norway DTAA, read with Section 44DA of the IT Act.

Held

The Delhi Income Tax Appellate Tribunal (ITAT) considered the facts and observed that invoices were raised on a quarterly basis, and consolidated invoices were raised irrespective of the SOFs under which the services were rendered. ITAT noted that the common billing by the recipient and the common payments give rise to a conclusion that it was one single contract.

ITAT further observed on perusal of SOFs, that it was continuously mentioned that contracts are performed in accordance with the service agreement between UNINOR and Telenor where the taxpayer was referred to as a contractor and UNINOR as a recipient for all the services.

ITAT referred to Organisation for Economic Cooperation and Development (OECD)’s Commentary on ‘enterprise’ and the ‘connected projects’ and concluded that the taxpayer’s activities were interconnected, interlaced and sequential technical services. Thus, taxpayer’s activities could not be said to be unrelated to each other as none of the activities could stand in isolation and no single activity could give rise to performance and achieving the purpose of the recipient. Based on the unified agreement, consolidated billing pattern and the inter-relation amongst the activities, ITAT held the existence of the taxpayer’s PE. On attributability of income to the PE, ITAT concurred with the taxpayer’s plea that services provided from Norway cannot be attributable to taxpayer’s PE in India and thus remanded the matter back to the tax officer’s file.

Our Comments

This ruling emphasizes that the time period of the enterprise in case of defragmented contracts can be aggregated for same or interconnected projects for PE determination. Accordingly, taxpayers may have to examine the actual fact pattern in detail for determining whether time spent for various interlacing or interconnected projects can be consolidated to determine whether PE is constituted or not.

Whether payments to Facebook, Amazon Web Services for advertising, marketing is taxable as royalty?

Urban Ladder Home Décor Solutions Pvt. Ltd Vs. ACIT IT(IT)A No.615 to 620/Bang/2020

Facts

The taxpayer is a company incorporated in India, dealing in home décor products and sells its products mainly through online marketing. To facilitate such a sale, the taxpayer has placed advertisements on the platform of Facebook, Ireland, it used the bulk mail facility offered by M/s Rocket Science Group, USA and further availed of Amazon’s Web Services (AWS) offered by Amazon Inc., USA. The AO held the payments in the nature of royalty u/s 9(1)(vi) of Act and hence liable for tax deduction at source u/s 195.

Held

ITAT relied on the Supreme Court ruling in the case of Engineering Analysis (125 taxmann.com 42) and observed that the relevant DTAA provisions should also be considered for determining whether the nature of payments is royalty or not.

ITAT observed that Facebook and M/s Rocket Science Group allowed the taxpayer to use facilities provided in their sites, including software facilities. ITAT referred to its Kolkata bench ruling in Right Florists (32 taxmann.com 99), wherein it was held that receipts in respect of online advertising on Google and Yahoo cannot be brought to tax in India under the Income-tax law or the India-Ireland DTAA.

With respect to web hosting charges paid to AWS, ITAT observed that taxpayer is allowed to use IT infrastructure facilities. ITAT referred to the Pune bench ruling in EPRSS Prepaid Recharge Services (100 taxmann. com 52), wherein it was held that mere usage of a facility does not give rise to a provision of any technical service. ITAT observed, under the same analogy, the mere usage of facilities provided by non-residents does not render the payments as ‘royalty’ since the core point of a parting of any copyright attached to the said facilities does not arise at all.

ITAT held that payments made to nonresidents cannot be treated as royalty, and thus, there was no requirement to deduct tax at source u/s 195.

Our Comments

Whether a payment constitutes royalty or not is a long standing debate. The Bangalore tribunal has reiterated the principle that mere use of facility would not be considered as royalty. However, one will have to look at the agreements thoroughly for determining whether a payment would be considered as Royalty or not

Whether Foreign Associated Enterprise can be selected as a tested party?

Onward Technologies Limited - I.T.A. No.266/Mum/2014 [AY 2008- 09] and I.T.A. No.1785/Mum/2014 [AY 2009-10]

Facts

The taxpayer is engaged in providing offshore mechanical Engineering Design Services (EDC) in India for its USA and Germany-based clients. Its Associated Enterprises (AEs) in the USA and Germany act as marketing arm in respective countries and enter into contracts with clients on behalf of the taxpayer. Such AEs act merely as contracting entities on behalf of the taxpayer, wherein the taxpayer bears all underlying risks and obligations. The AEs issue invoices to the third-party clients, retain fees for their marketing activities and pass on balance receipts to the taxpayer.

The Transfer Pricing Officer (TPO) proposed an adjustment in respect of such services by classifying the services rendered by the taxpayer as ITeS and taking ITeS companies as comparables. Also, the TPO recalculated the Profit Level Indicator (PLI) of the taxpayer by reallocating certain indirect costs to the relevant segments.

The taxpayer conducted a separate benchmarking search, taking foreign AE as the tested party as a corroborative approach.

Furthermore, the taxpayer made an equity investment in its AE in the USA. The TPO re-characterized such investment in equity as debt and proposed a TP adjustment in respect of notional interest income on such debt provided.

The taxpayer reimbursed its AE towards software purchase expenses incurred by AE on behalf of the taxpayer.

The TPO proposed adjustment on such expenses on the grounds that it could not verify actual receipt of services.

Ruling by ITAT

ITAT relied on Tribunal’s judgment in the taxpayer’s own case in previous years and rejected the acceptance of foreign AE as a tested party and held that EDC services are considered to be part of the ITeS segment.

However, ITAT ruled in favor of the taxpayer considering the PLI and allocation of expenses as determined by the taxpayer. It also accepted the taxpayer’s plea to exclude certain comparables accepted by TPO. The proposed TP adjustment was deleted as the taxpayer’s PLI is better than the average PLI of comparable companies.

In relation to the re-characterization of equity investment, ITAT observed that the taxpayer infused funds in its AE with a long-term objective. The TPO failed to distinguish loan and capital contribution by way of equity. Therefore, the action of TPO to re-characterize equity as debt was rejected.

In respect of reimbursement of software expenses to AE, ITAT held that the transactions are duly supported by agreement, invoices and consequent debit notes, and thus, TPO’s argument that receipt of services could not be validated was rejected, and accordingly, the adjustment was deleted.

Our Comments

The selection of a foreign AE as a tested party is a litigious issue, with judicial precedents giving both views on the said issue. The identification and selection of a tested party should be based on undertaking a detailed FAR analysis with the least complex entity being characterized as the tested party.

Whether prior years’ data can be used for a comparability purpose?

Hapag Lloyd India Private Limited - ITA No. 6877/MUM/2019 [AY 2011-12]

Facts

The taxpayer runs a shipping agency and had rendered support services to its AE and had benchmarked the said transaction by using Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM). However, the TPO disregarded the taxpayer’s use of TNMM as MAM and considered Comparable Uncontrolled Price (CUP) as the MAM by comparing the fee charged to the AE by the German Express Shipping Agency (GESA) who was a prior agent of the AE in the earlier years. (i.e., the rate which was determined between the AE and GESA basis the service agreement which was subsequently terminated).

The Dispute Resolution Panel (DRP) partly accepted the benchmarking undertaken by the taxpayer and made an adjustment by using CUP data which was available for one month, thereby scaling down the adjustment made by the TPO.

Ruling by ITAT

The ITAT observed that an identical issue relating to benchmarking of the international transaction had come up for consideration before the Co-ordinate Bench in the taxpayer’s own case for the earlier year, i.e., AY 2010-11.

The Co-ordinate Bench had clearly and categorically held that the price charged by GESA to the AE cannot be considered as an internal CUP. Furthermore, there was no external CUP data available as well to benchmark the transaction under consideration.

Accordingly, in view of the above, the ITAT held that in the absence of CUP data and taking recourse to the Coordinate Bench’s ruling in the case of the taxpayer for the earlier year, TNMM should be considered as the MAM to benchmark the international transaction and thereby the adjustment proposed by the lower Tax Authorities was deleted.

Our Comments

Ordinarily, only current year/ contemporaneous data can be used for CUP with the controlled price. Only in the case of exceptional circumstances, the data relating to earlier years but not more than two years prior to the current year can be used if such data reveals facts that can influence the determination of arm’s length price in relation to the international transaction.

Once GESA ceases to be an agent of the AE w.e.f. 31 December 2006, then in the absence of current/contemporary data/uncontrolled price, the price of the prior year cannot be considered for the determination of ALP in relation to the international transaction entered in the current year.

Whether the arm’s length price determination in relation to the international transactions can be done on an ad hoc/estimate basis?

Sanofi India Limited (formerly Aventis Pharma Limited) - I.T.A. No.3092/Mum/2006 [AY 2002-03]

Facts

The taxpayer is engaged in the manufacture and marketing of formulations across the therapeutic segment of anti-infective, arthritis, cardiology, central nervous system, etc.

The taxpayer has entered into various international transactions with its AE, which inter-alia included the transaction pertaining to payment of export commission at 12.5 % to its AE. The taxpayer aggregated all the international transactions and benchmarked the same using TNMM as the MAM.

However, the TPO, during the course of assessment proceedings, treated the transaction pertaining to payment of export commission as a separate transaction and, citing the lack of any direct documentary evidence, computed the ALP in relation to the said transaction at 3% on an ad hoc basis.

The Commissioner of Income-Tax (Appeals) [CIT(A)] also proceeded to determine the ALP of the transaction at 5% on an ad hoc basis without following any of the prescribed methods.

Ruling by ITAT

The ITAT held that the taxpayer had benchmarked the subject transaction by adopting one of the methods prescribed under the statute and furnished supporting evidence to demonstrate that the taxpayer’s payment towards export commission at 12.5% vis-à-vis the comparable companies at 34.06% was at arm’s length.

The CIT(A) and the TPO proceeded to determine the ALP on an ad hoc/ estimate basis without following any of the prescribed methods as mandated under the transfer pricing provisions.

The ITAT observed that the Tax Authorities in the subsequent years had also accepted payment of export commission by the taxpayer at 12.5% to be at arms’ length.

Furthermore, the ITAT opined that even applying the rule of consistency and past history relating to similar transactions, the export commission paid at 12.5% has to be accepted to be at arm’s length.

Our Comments

The arm’s length price in relation to the international transactions undertaken by the taxpayer with its AE has to be determined basis one of the prescribed methods as per the transfer pricing provisions and not by applying any quantitative methods or on an ad hoc/ estimate basis.

i) Whether vouchers or the act of supplying them is taxable?

ii) If the answer to the above question is in the affirmative, what would be the tax rate?

M/s. Premier Sales Promotion Pvt. Ltd., [2021 (8) TMI 350 - AAR, Karnataka]

Facts

• The taxpayer sources e-vouchers for its customers per the orders received and acts as a trader for buying and supplying e-vouchers.
• The taxpayer is a third-party issuer of vouchers, which are redeemable by the beneficiaries for goods/services from the specified merchants from whom the taxpayer has obtained the vouchers.

Ruling

• The taxpayer is only supplying the payment instruments to their clients, and they are not settling any obligation by treating this as a consideration.
• Therefore, the act of supplying vouchers by the taxpayer cannot be termed as ‘money’ at the time of supplying them.
• They would take the color of money only when they are used for payment of consideration for the supply of goods or services procured by the end-user.
• Vouchers are also not covered under ‘actionable claim’ as they are not debt. They have an expiry period.
• Trading of vouchers for a consideration in the course or furtherance of business would amount to ‘supply’ in terms of Section 7 of the CGST Act.
• Furthermore, e-vouchers are intangible, but they still have the capabilities [they can be transmitted, transferred, delivered, stored, possessed, etc.] to be termed as ‘goods.’
• Therefore, the taxpayer is obliged to pay 18% GST for supplying vouchers [residual entry].

Our Comments

Earlier, Appellate AAR, Tamil Nadu in Kalyan Jewellers [2021 (4) TMI 885- AAAR] had held that ‘voucher’ itself is neither ‘goods’ nor ‘services.’ However, in the present case, given that ‘voucher’ itself is being sold by the taxpayer, it has been termed as ‘goods’. It would be interesting to see how the jurisprudence develops on the matter.

Also, interestingly, the AAR, in this case, has held that the rate of GST should be as per the residual entry in case of goods, i.e., 18%, and not as per the underlying goods/services.

Whether ‘carried interest’ in case of Venture Capital Fund (VCF) is liable to service tax?

M/s. ICICI Econet Internet And Technology Fund And Others Versus Commissioner Of Central Tax, Bangalore North [2021 (7) TMI 216 – CESTAT, Bangalore]

Facts

• VCF is established as a ‘Trust’ under the Indian Trusts Act, 1882 and registered with the Securities and Exchange Board of India (SEBI) as a VCF.
• The appellant allotted various classes of units to investors.
• Certain class of investors is entitled to additional returns on their investments in the form of ‘carried interest.’

Ruling

• The principal liability and responsibility of managing the Trust/ Fund rest with the appellants.
• Any amount retained out of income distributable to subscribers is nothing but a charge or a fee for the services rendered. It is nothing but gross consideration in service tax parlance.
• ‘Carried interest’ is a portion of the consideration retained by the Funds for services rendered by them to the investors and passed on, in the disguise of return on investments, to the so-called ‘special class of investors’ who are none other than the Asset Management Company (AMC) and or its nominees.
• The appellants have devised the structure of the fund in such a manner that the AMC and/or their nominees would get huge sums of money in the guise of a Performance fee, carried interest, with the twin motives of benefitting the AMC and/or their nominees at the expense of the subscribers and avoiding the taxes.

Our Comments

The Tribunal’s present ruling can result in a flurry of notices from the department under the service tax as well as GST laws.

The stakes involved in the matter are huge as the ruling is not only relevant for VCFs, but also for other types of funds, asset reconstruction companies, etc., who earn similar nature of returns on their investments.

Given the complexities involved, the matter is expected to be ultimately decided before the Higher Courts

Whether research and development (R&D) services provided to foreign customers on the goods provided by such customers are eligible to be treated as ‘export of services’?

Hilti Manufacturing India Pvt. Ltd. [2021 (8) TMI 781 - AAR, Gujarat]

Facts

• The taxpayer was providing R&D services on the product samples provided by the foreign customer.
• It would conduct tests on various products, providing product development and engineering services such as benchmark testing and feasibility studies, analyzing data and targets, designing the products, making prototypes, verifying and validating the process and product.
• The results of these activities are then provided to the foreign customer comprising in the form of a report.

Ruling

• The sample goods have to be made physically available by the recipient to the taxpayer in order to enable the taxpayer to provide R&D services.
• Therefore, the place of supply of service in the present case will be the location where the services are actually performed i.e. Gujarat [Section 13(3)(a) of IGST Act].
• IGST Act stipulates that for ‘export of service’ to be satisfied, one of the conditions is that the place of supply should be outside India. This condition is not satisfied in subject case.
• The subject services are, therefore, liable to CGST and SGST.

Our Comments

The taxpayer had placed reliance on Tribunal’s judgment in Principal Commissioner of Central Excise, Pune-I Versus Advinus Therapeutics Ltd. under the Service Tax law wherein a similar issue pertaining to the provision of scientific or technical consultancy service to foreign clients, it was held that even if some of the activities are carried out in India, by no stretch can it be asserted that the fulfilment of the activity is in India.

However, the AAR has disregarded the said decision stating that the same would not have relevance under the GST law.

Mumbai ITAT: Directs CIT(A) to re-examine colorable share transactions with dubious valuation

Concord Enviro Systems Pvt. Ltd [TS-611-ITAT-2021(Mum)]

The assessee, a private company, had issued equity shares and Compulsorily Convertible Preference Shares (CCPS) to a Mauritius-based private equity firm at a premium of INR 63,233 and at par, i.e., at INR 1,000 per share respectively. The AO observed that the market value of equity share was INR 1806.75 and that of CCPS was INR 47.24 as per the valuation reports. The AO found this transaction as suspicious and, in view of the unreasonable premium quantum, made an addition of INR 40.20 crore as unexplained credit (Section 68 of Income-tax Act (ITA)). CIT(A) disagreed with AO’s contention and deleted the addition.

Separately, the assessee had also acquired equity shares of a company at INR 1,203 per share, whereas the share was valued at INR 6,875. The AO held that it was a sham transaction and the differential valuation was taxed under Section 56 of ITA. CIT(A) deleted the same, citing that Section 56 had no applicability for the year.

On the second appeal, the Tribunal has redirected the case back to CIT(A) for further examination laying down the below observations:

• The CIT(A) had erred in not verifying the information on the source of funds himself but merely relying on the AO’s observations. This is a complete dereliction of duty on CIT(A)’s part.
• However, in connection to the assessee’s claim that the valuation report was only for the purpose of obtaining permission for the issue of shares to a non-resident from the RBI, no party can be permitted to shift stands on the same transaction.
• The issue under consideration is clearly assessee applying opaque devices and should be analyzed from the purview of Section 68 of ITA.
• With respect to the acquisition of shares, the assessee itself has agreed that shares were acquired at a price lower than the fair value. Hence assessee is using opaque colorable device and subterfuge. The transaction shall be analyzed as per Section 69B (investment not fully disclosed in books) and not Section 56. It is settled law that putting a wrong Section is not fatal to the assessment. The valuation aspect needs to be examined, therefore this matter is also remitted back to CIT(A).

Our Comments

The above decision re-emphasizes taking cognizance of the valuation provisions and maintaining a proper basis for the same. Furthermore, it also becomes pertinent to maintain proper documentation for the source of funds. The onus here now lies on the assessee to substantiate the basis for undertaking transactions at a price varying substantially from the valuation.

Delhi ITAT: 2(22)(e) provisions applicable only in the hands of ‘shareholder’ of the company having substantial interest

Vardhaman Buildtech Pvt. Ltd. [TS- 782-ITAT-2021(Del)]

The assessee has received an unsecured loan of INR 1,18,42,505/- from M/s. Vardhaman Estates and Developers Pvt. Ltd. which has common shareholders having 25% shareholding in both these companies.

While the assessee contended that the provisions shall not be applicable to it but the shareholders, the AO proceeded to make an addition of the said sum as deemed dividend in the hands of the assessee. The CIT(A) upheld the addition citing that the reliance placed by the assessee in the case of Ankitech Pvt. Ltd.¹ is no more tenable in view of the decision of Hon’ble SC in the case of National Travel Services².

The Tribunal deleted the addition based on the following observations:

• The decision in the case of Ankitech has held that deemed dividend is chargeable to tax in the hands of the shareholders and not the recipient of loan and advance in which the shareholder holds a substantial interest. Whereas, the decision of National Travel Services has held that the deemed dividend taxability should be in the hands of beneficial shareholders and not registered shareholders.
• Deemed dividend is always chargeable to tax in the hands of the shareholder of the company having substantial interest. The decision in National Travel Services does not disturb the position that the dividend is always taxable in the hands of the shareholder.

Our Comments

The decision further affirms the settled position that the deemed dividend has to be levied in the hands of the shareholder and not in the hands of the borrower entity in which the shareholder holds a substantial interest.