From The Judiciary

Whether payment made by an Indian Advertising agency for advertising space owned by a nonresident is taxable as Royalty?

M/s. Interactive Avenues Private Limited Vs DCIT ITA No.3130/Mum/2019

Facts

The taxpayer is a company incorporated in India conducting business in the field of an internet advertising agency for Indian clients. During the year under consideration, the taxpayer had made certain payments to Facebook Ireland Limited towards the cost of advertisements carried by Facebook for placing its clients’ advertisements. The taxpayer adopted a view that such charges for the use of digital space were not taxable as Royalty under the India-Ireland Double Tax Avoidance Agreement (DTAA) or Indian Domestic Tax Laws (IDTL) and made such payments without deduction of tax.

The Assessing Officer (AO) stated that the payments received by taxpayer should be considered as Royalty both under India-Ireland DTAA and IDTL since Facebook’s Ad platform is driven by complex algorithms and involves ‘the right to use or access the Facebook Ad Platform’. This was upheld by the first appellate authority. Aggrieved by the order, the taxpayer filed an appeal before the Mumbai Tribunal

Held

The Tribunal referred to the Bangalore bench ruling in Urban Ladder Home Decor Solutions Pvt. Ltd¹, wherein it was held that payment for online advertising on Facebook and Rocket Science Group cannot be brought to tax in India under the IDTL or the India-Ireland DTAA. The Tribunal emphasized the said ruling and held that the amount paid by the taxpayer is not for ‘use’ of equipment (server) or for any process nor imparting any information concerning technical, industrial, commercial, or scientific knowledge, experience or skill. Furthermore, the copyright attached to the server or website belonging to Facebook is not parted or conferred to the taxpayer. The taxpayer merely places its clients’ advertisements on a space it purchases on Facebook’s website.

The Tribunal also stated that the taxpayer was an independent agent of an Indian client, thereby earning commission income and was not working on behalf of Facebook. Furthermore, the Tribunal observed that the taxpayer did not use Facebook’s logo even while raising invoices to its clients. Thus, Tribunal concluded that the taxpayer did not constitute a Agency Permanent Establishment (PE) of Facebook in India.

Our Comments

Whether a payment constitutes Royalty or not is a long-standing debate. The Mumbai Tribunal followed suite of earlier rulings and stated that mere use of the standard facility would not be considered as Royalty. However, it is imperative to look at the agreements thoroughly to determine whether a payment would be considered as Royalty or not.

Whether payment made for research activity and collaboration of research project is taxable as Fees for Technical Services (FTS) or Royalty?

Oil and Natural Gas Corporation Limited vs ITO ITA Nos. 1881-1882/AHD/2019

Facts

The taxpayer is a Central Public Sector Undertaking engaged in the extraction and production of mineral oil and natural gas. The taxpayer entered into an agreement with the University of Texas at Austin, USA to carry out research activity in collaboration with the taxpayer for a project. During the year under consideration, the taxpayer had to pay USD 4.95 million in aggregate towards research activity.

Hence, the taxpayer applied for a lower deduction certificate to determine the proportion of the sum chargeable to tax on which tax is required to be deducted.

The AO observed that the payments to be made to University of Texas are in the nature of Royalties/FTS and directed the taxpayer to deduct the TDS at 10% (excluding education cess/surcharge) on gross payments.

This was upheld by the first appellate authority. Aggrieved by the order, the taxpayer filed an appeal before the Ahmedabad Tribunal.

Held

The Tribunal held that there was no material evidence to demonstrate that while doing the research activity, the University of Texas has made available any technical knowledge, know-how, skill, etc., to enable the recipient of such service to use it independently. The Tribunal stated that since the make available condition of Article 12 under India-USA DTAA is not satisfied, the amount received will not be treated as FTS.

On the issue of classification of income from research activity as Royalty, the Tribunal stated that there was no patent/copyright used by the taxpayer against which the Royalty was paid. Based on the same, the Tribunal held that the payment cannot be categorized as Royalty.

Our Comments

The Tribunal had observed that a payment cannot be taxable as Royalty/ FTS when neither patent nor copyright was used by the taxpayer against which the royalty was paid nor any technical know-how made available to the taxpayer.

Whether the credit score of the borrowing entity can be ignored while computing ALP with respect to the interest payment?

Greenko Rayala Wind Power Private Limited TS-486-ITAT-2022 (HYD)-TP

Facts

The taxpayer is engaged in the business of generation of wind power. The taxpayer had issued non-convertible debentures (NCD) to its Associated Enterprise (AE) and benchmarked the same by using Comparable Uncontrolled Price (CUP) Method and Other Method. The taxpayer paid 11% interest on NCD to its AE.

TPO’s Contentions

The Transfer Pricing Officer (TPO) held that the said transaction was quasicapital in nature on the grounds that the recipient of the interest amount had substantial losses and therefore was not liable to tax.

The TPO thereby determined the arm’s length price (ALP) by rejecting the approach adopted by the taxpayer and determining the ALP at 9.88%.

CIT(A)’s Contentions

The CIT(A) was not in agreement with the approach adopted by the TPO with respect to disregarding the credit score of the taxpayer, being i.e. ‘BBB ’. The said credit rating indicates that there is risk involved with regard to lending to the taxpayer. Furthermore, the CIT(A) observed that the TPO calculated the risk free return of the ten year government bond yield rates for the financial year 2014-15 of the Government of India at 8.28%, but failed to adopt the same in final calculation.

Furthermore, CIT(A) benchmarked the transaction considering interest rates of comparable transactions above INR 50 million BBB rating and MCLR rate of SBI for lending as on 1 April 2016. On the basis of this working the CIT(A) held that no TP adjustment is required in the instant case.

Held by the ITAT

On perusal of the relevant information on record, the ITAT observed that the CIT(A) has provided a reasonable basis to determine the ALP in the instant case. Accordingly, relying on the ALP determination done by CIT(A), the ITAT agreed to delete the TP addition made by the TPO. The ITAT held that instruments having credit rating which falls in the category of ‘BBB’ denote some sort of moderate risk, therefore the AO to say that there is absolutely no risk involved in this transaction firstly because it is a debenture not a loan and secondly because the transaction was with an AE would not be appropriate.

All in all, the ITAT deleted the TP addition in the instant case.

Our Comments

In the above ruling, the Tribunal emphasized on the fact that computing the credit rating of the borrowing entity is the core factor in determining the interest rate on lending transactions.

ITAT upholds Transactional Net Margin Method (TNMM) over CUP, says cannot adopt two methods for benchmarking same class of transactions by cherry picking few transactions undertaken by the taxpayer.

Madura Coats Pvt Ltd. TS–538–ITAT–2022 (CHNY)-TP

Facts

The taxpayer is engaged in the business of manufacture and sale of threads and accessories. The taxpayer entered into various international transactions with its AEs (including import of raw materials, export of threads, payment of royalty and management service fee, import of machinery, reimbursements, etc). It benchmarked the transactions using TNMM as Most Appropriate Method (MAM) on an aggregated basis.

TPO’s contention

In the course of assessment proceedings, the TPO rejected TNMM method and applied CUP method only in respect of certain transactions pertaining to export of threads to AEs, thereby passing an order making an adjustment to total income.

DRP’s contention

Aggrieved by the order of TPO, it filed an objection before DRP-2, which rejected the arguments of the taxpayer stating that an identical issue had been considered in previous year by ITAT, where taxpayer had undertaken external comparables in respect of transactions considered for CUP method.

TPO’s contention

In the course of assessment proceedings, the TPO rejected TNMM method and applied CUP method only in respect of certain transactions pertaining to export of threads to AEs, thereby passing an order making an adjustment to total income.

Held

The High Court observed that the TPO never disputed TNMM as MAM in respect of all transactions including export of threads to the extent of 99.95% of transactions. However, in respect of 0.05% transactions, TPO applied external CUP method by cherry picking 12-13 transactions without assigning any reason as to why and how a small portion of transactions are not at ALP. The High Court held that it is incorrect to adopt two methods for one class of transactions and benchmark such transactions by cherry picking few transactions out of a lot of transactions undertaken by the taxpayer with its AEs. It also referred to two relevant rulings², where it was held that when TPO had accepted TNMM as MAM for overwhelming majority of exports, there is no reason why TNMM shouldn’t be applied to balance exports. Accordingly, the High court directed AO/ TPO to delete the TP adjustment made towards few transactions by adopting CUP as MAM.

Our Comments

Two methods cannot be adopted for a similar class and nature of transaction, by cherry picking few transactions out of a whole lot of transactions.

Taxability of composite works contracts prior to 1 June 2007, i.e., before the introduction of Section 65(105)(zzzza) pertaining to “works contracts services.”

Total Environment Building Systems Pvt. Ltd. & Ors. vs. The Deputy Commissioner of Commercial Taxes & Ors. 2022 (8) TMI 168 – Supreme Court

Note: In the case of CCE, Kerala vs. Larsen and Toubro Limited [(2016) 1 SCC 170], the Supreme Court had held that service tax was not leviable on indivisible works contracts for the period prior to 2007. It was specifically observed that the works contracts on which service tax was levied under the Finance Act, 1994, were distinct from contracts of service.

Facts

• Aggrieved by the judgments of the lower Courts, viz. High Courts and Customs Excise and Service Tax Appellate Tribunal (CESTAT), the appellants preferred appeals before the Supreme Court.
• The issue involved in these appeals was whether service tax could be levied on composite works contracts before introducing the Finance Act, 2007.
• While the Revenue did not dispute that this issue was squarely covered by the decision of Apex Court in the case of Larsen and Toubro Limited, it was of the view that the same needed to be re-considered and, therefore, be referred to the Larger Bench.
• According to the Revenue, even prior to 2007, there was an elaborate mechanism for segregating the value of goods and services in a works contract. Therefore, it could not be said that there was no machinery provision to charge as such the service component in a composite works contract.

Our Comments

The judgment has sealed the law on the taxability of ‘works contract’. The Supreme Court has confirmed that the service element in a works contract is leviable to tax only w.e.f. 2007. Said decision would greatly relieve the taxpayers who had to indulge in prolonged litigation despite a favorable binding precedent.

Whether the service provider is required to hold a valid Importer -Exporter Code (IEC) while rendering services in order to claim Services Export from India Scheme (SEIS) benefit?

Smarte Solutions Pvt Ltd. vs. Union of India and Ors. TS-326-HC-2022 (BOM)-FTP

Facts

• The Director General of Foreign Trade (DGFT) authorities, including the Policy Relaxation Committee, had rejected the petitioner’s SEIS applications for FY 2015-16 and 2016-17 on the ground that there was no valid IEC at the time of rendition of export services.

Ruling

• High Court observed that the language employed in Section 7 of the Foreign Trade (Development and Regulation) Act, 1992 (FTDR Act) pertaining to IEC and its requirement is in the negative form, which states that no one shall make any import or export except under a valid IEC.
• However, an exception thereto has been carved out by way of a proviso which clarifies that an IEC is necessary only when the import or export is of services or technology and the service provider is taking benefits under the Foreign Trade Policy (FTP).
• Hence, it is abundantly clear that the eligibility criterion of Para 3.08(f) has imposed additional restrictions on having IEC at the time of rendering services which was not the intent or purport of the statute.
• Accordingly, High Court held that the said condition was against the principal legislation and could not be termed as of mandatory nature for availing benefits under the scheme.
• In the present case, it was admitted that when the services were rendered, the petitioner did not have a valid IEC; however, the same was obtained while applying for the reward / benefit under the scheme.
• In view of the above, the High Court allowed the petition and directed the DGFT authorities to consider the petitioner’s applications without insisting for an active IEC at the time of rendering services.

Our Comments

The ruling reiterates the settled principle that delegated legislation cannot be contrary to the original statute.

This decision would provide impetus to similarly placed service exporters whose SEIS claims have not been processed/ have been rejected for want of valid IEC at the time of rendition of services.

With the new FTP slated to be introduced in the coming months, it would be interesting to see if benefits similar to SEIS are extended to the service exporters and if so, the eligibility criteria prescribed thereto.

Terming consideration to be wider than receipt of money, conversion of CCDs into equity shares held to be covered under Section 56(2) (viib)

Milk Mantra Dairy Pvt. Ltd TS-525-ITAT-2022 (Kol)

During the period under consideration, i.e., FY 2012-13, the assessee had converted completely convertible debentures (CCDs) into equity shares basis the pre-agreed conversion price. The AO sought to invoke the provisions of Section 56(2)(viib) of the ITA, which deals with the taxability of excess premium over the fair market valuation received by a company in which the public is not substantially interested.

The provisions of Section 56(2)(viib) were introduced effective FY 2012-13. Amongst other issues, one of the issues under consideration was whether these provisions shall apply in the present case as the CCDs were issued and money was received during FY 2010-11 and FY 2011-12 (before the provisions became applicable) however, the conversion of the CCDs into shares took place in FY 2012-13 (after the provisions became applicable).

The contention of the assessee for nonapplicability of the provisions was that the entire consideration was received by the assessee at the time of issuance of CCDs, i.e., in AY 2011-12 and AY 2012- 13, when the provisions were not under the statute. Furthermore, conversion of CCDs by issuing equity shares did not entail any further payment of money.

The Kolkata bench of the Income Tax Appellate Tribunal (ITAT) observed that the word ‘consideration’ is a wider term and not only restricted to ‘receipt of money’. The receipt of money is one of the several modes for having a consideration in a transaction. Consideration can partake in many forms.

Some of the ‘considerations’ which the assessee ‘receives’ on the conversion of its CCDs into equity shares would be an extinguishment of the debt obligation, the release of the charge created on the assets/properties, interest cost saving, widening of the capital base, debt equity ratio, etc. The terms of the Investment Agreement corroborate some of the considerations listed above. Thus, when looked at from these aspects, Section 56(2)(viib) of the Act envisages a much wider outlook to the ‘receipt of any consideration,’ which cannot be limited to just receipt of money.

Our Comments

As technically, CCDs are not equity shares, while the provisions could not be applied at the time of its issuance, the same certainly should hold applicability at the time of conversion. The decision has been rendered with due regard to the spirit and objective with which the same was introduced and not merely on its literal reading.

The valuation at the time of conversion into equity shares would be taken into consideration while assessing the implications under Section 56(2)(viib). However, this may have an adverse impact where the conversion price/ratio is pre-determined and in the interim period, valuation stands negatively impacted. It is imperative that the applicability of the provision must be tested basis the valuation at the time of issuance of the original instrument and the commercial consideration, future events/developments for future conversion.

The ruling may raise concerns around fund raisings in the form of convertible instruments where loans are converted into equity on account of commercial difficulties/challenges.

SEBI makes use of digital signature certificate mandatory for announcements submitted by listed companies.

Considering the advantages of using digital signature certifications for authentication of documents/filings, Stock Exchanges, in consultation with each other and SEBI, has decided to make it mandatory to file announcements under various SEBI Regulations using digital signature certification to the Stock Exchange except for Outcome of Board Meeting which includes only financial result, any disclosure in which documents issued by entities other than listed company are included (For e.g., Auditors certificate, NCLT/other court’s order, Credit Rating, etc.), newspaper advertisement and any other disclosure as specified by Stock Exchanges from time to time. The circular shall be effective from 1 September 2022.

Our Comments

In the wake of the COVID-19 pandemic, SEBI had initially permitted the use of digital signature certification for authentication/certification of filings/ submissions made to Stock Exchanges. However, as this aforesaid measure has been received well by the market participants and considering the advantages of using digital signature certifications for authentication of documents/filings, Stock Exchanges, in consultation with each other and SEBI, have decided to make it mandatory to file all announcements to the Stock Exchanges under various SEBI Regulations using digital signature certification (except for certain exempted category of disclosures/ events) w.e.f. 1 September 2022.

NSE tracks insider trading rules compliance.

The country's largest bourse, National Stock Exchange (NSE), recently shared a compliance certificate format with Listed Companies instructing them to give a specific declaration on whether they are maintaining a Structured Digital Database (SDD) to store Unpublished Price Sensitive Information (UPSI), they have control over who can access UPSI, if the information shared is timestamped to keep a track on who is receiving it and when, and whether there is a chance of anyone tampering with the records. This move is to scrutinize whether large and actively traded companies are falling in line with the rules to curb insider trading, one of the scourges of the Indian stock market.

Our Comments

As per SEBI (Prohibition of Insider Trading) Regulations, 2015, listed companies have to maintain an SDD to store UPSI, which includes a range of information like financial numbers, business plan, decision to sell off a factory, merger, demerger, dividend, etc., that can move the stock price. But currently, there is no proper system to ensure that all listed companies have a proper SDD in place.

NSE vide this compliance certificate has sought a confirmation of compliance from companies, probably to ensure whether companies have been maintaining SDD in a duly compliant manner. The current move seems to be in line with SEBI’s objective of curbing insider trading and reviewing the compliance status of databases maintained by listed entities.