From The Judiciary

Whether payment made for allowing access to its database or IT infrastructure facility abroad is taxable as Royalty?

M/s. Faurecia Systems D’echappement vs ACIT ITA No.306/PUN/2021

Facts

The taxpayer is a French Company that is a global leader in automotive technology. During the year under consideration, the taxpayer received INR 85.6 million for licensing of software which provided its customers with access to its database situated in France. The taxpayer adopted a view that such charges for licensing of software were not taxable as Royalty under the India-France Double Tax Avoidance Agreement (DTAA) or Indian Domestic Tax Laws (IDTL).

The Assessing Officer (AO) opined that the payments received by the taxpayer should be considered Royalty under the India-France DTAA based on the Dispute Resolution Panel’s (DRP) order. The taxpayer accepted such final assessment order and did not prefer any appeal before the Tribunal, thereby assigning finality to the addition of INR 85.6 million as Royalty income. However, the AO imposed a penalty of INR 8.999 million on such an addition.

The Commissioner of Income-tax (Appeals) [CIT(A)] deleted the penalty relying on the Apex Court ruling in the case of Engineering Analysis. Aggrieved by the order, AO filed an appeal before the Pune Tribunal.

Held

The Tribunal observed that the income primarily pertained to access to database and use of the Infrastructure facility. The Tribunal opined that the amount received by the taxpayer as consideration for allowing access to its database abroad will not be governed by the ruling in Engineering Analysis as this decision applies only to the cases of software transferred without giving any right to copy. Furthermore, the Tribunal explained that the instant transaction pertains to allowing access to its Database or IT Infrastructure facility, which is established with various components, such as software, hardware, and networking, shall qualify as Royalty under both IDTL and India-France DTAA. The Tribunal also distinguished between copyright Royalty and industrial Royalty by stating that consideration for the use of software constitutes copyright royalty, and consideration received for the use of IT infrastructure facility is Industrial Royalty. Accordingly, the Tribunal stated that a penalty cannot be imposed on a debatable issue and deleted the penalty.

Our Comments

The Pune Tribunal emphasized the difference between copyright Royalty and Industrial Royalty and held that consideration received for granting license to access online database falls within the definition of Royalty.

Whether payment to intermediary/ liaison agent for client introduction qualifies as Fees for Technical Services (FTS)?

M/s. Hemera India Private Ltd. vs DCIT ITA No.3092/Del/2019

Facts

The taxpayer is an Indian company trading in agricultural commodities, ferrous and non-ferrous commodities, and energy commodities. During the year under consideration, the taxpayer made a payment to a UK-based entity, an intermediary for its introduction to a client based out of India. The taxpayer adopted a view that made payment to UK entity for its service of client introduction does not qualify as FTS and did not withhold any taxes on the same.

The AO concluded that payment made by the taxpayer to UK entity would amount to rendering market and sales promotion services, which should fall within the ambit of FTS and the taxpayer was liable for withholding tax on such payment.

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

Held

The Tribunal stated that the factual matrix clearly reveals that the foreign entity was not extending any technical know-how or expertise in the field of procurement of business or any other purpose on a permanent basis. The Tribunal opined commission payments to nonresident agents/ service providers for services like sales promotion, marketing, publicity, procuring sales orders, etc., are not FTS, but business profit in the hands of the service provider falling in the scope of Article 7 read with Article 5 of the India-UK DTAA. Thus, the Tribunal held that this payment was not chargeable to tax in India as FTS.

Our Comments

The Delhi Tribunal has re-affirmed that consultancy charges for client introduction or client referral fees shall not qualify as FTS.

Higher interest rate on Unsecured NCD is considered at arm’s length considering the risk involved.

Vena Energy KM Wind Power Pvt Ltd. TS-449-ITAT-2022(Bang)-TP¹

Facts

The taxpayer is principally engaged in generating and selling power generated from renewable energy sources. The taxpayer had made payments towards interest on non-convertible debentures (redeemable after 25 years) issued in INR to its Associated Enterprise (AE) at 14.70% interest. The taxpayer benchmarked the transaction by adopting an internal Comparable Uncontrolled Price (CUP). These comparable transactions were identified based on loans obtained by the taxpayer’s sister concerns from a third-party domestic financial institutions (11.75% to 12%). After considering adjustments to be made for tenure and security, the taxpayer alleged that the interest rate from third-party borrowings would be approximately 15%. However, the Transfer Pricing Officer (TPO) rejected the comparables of the taxpayer, stating that the filters applied were not appropriate and applied fresh filters to choose different comparables, which arrived at a coupon rate of 9.35% and thereby proposed an adjustment.

Aggrieved by the TPO’s decision, the taxpayer raised objections before the Dispute Resolution Panel (DRP), which stated the CUP method requires strict comparability. Key areas of difference noted by the DRP were:

• Nature of Instrument: an Non Convertible Debentures (NCD), is an instrument tradeable in the open market and a hybrid instrument that could be treated as debt as well as equity, whereas the proposed comparable is a bank loan that is only debt.
• Repayment: in an NCD, the amount is required to be paid at maturity, whereas in a loan by the bank, periodic payments are required to be made.

Hence, the internal CUP method was rejected and the DRP upheld the TPO’s adjustment.

Before the DRP, the taxpayer had taken an alternate plea stating that according to Section 194LD(2), the maximum allowable rate of interest for a rupee-denominated bond of an Indian company cannot exceed the SBI base rate on the date of issue plus 500 basis points which works out to 14.85% and therefore no TP adjustment is warranted. However, the DRP rejected this contention, stating Section 194LD(2) of the Act does not provide any guidelines for the determination of arm’s length interest rate in the case of NCD.

Held

ITAT observed that while the taxpayer had adopted filters and adjustments to account for differences in tenure and security, the TPO did not make similar filters and adjustments. ITAT opined that “duration of the debt/loan is a significant factor in the determination of interest rate and the key criteria for determining the interest rate is the risk involved. Given that the debentures are unsecured, the risk is higher, and there would be a higher rate of interest charged for the loan. ITAT also relied on rulings² to uphold benchmarking interest payment on INRdenominated debentures against the prevailing SBI Prime Lending Rate (PLR) + 300 basis points as the appropriate Arm’s Length Price (ALP).

Further reliance was placed on RBI’s Master Direction, which states that the rate of interest shall not be more than the PLR of SBI plus 300 basis points.

Accordingly, applying the aforesaid logic, ITAT stated that the taxpayer was justified in its interest payments.

Our Comments

In financial transaction benchmarking, taxpayers should take due care in documenting the nature of the related party arrangement and adopt relevant comparisons if the CUP method is being applied. The ITAT has acknowledged the adoption of adjustments to account for key factors such as duration and tenure in deciding the arm’s length range.

Yield Spread Method adopted for benchmarking corporate guarantee at 0.35%

Sikka Ports & Terminals Ltd.³ TS-418-ITAT-2022(Mum)-TP

The taxpayer is engaged in the port infrastructure facilities, engineering, construction and consultancy services. In the course of assessment proceedings, the TPO observed that the taxpayer had given certain corporate guarantees to third parties, undertaking the contractual and other obligations of it’s AE. While the taxpayer alleged that extending corporate guarantee was not an international transaction, it produced a benchmarking out of abundant caution. The taxpayer had adopted the “yield spread approach” to benchmark the guarantee commission. On the basis of the quote obtained from the Royal Bank of Scotland (RBS), 70 bps was computed as yield spread and, accordingly, 0.35% computed as ALP of the corporate guarantee benefit.

However, TPO was of the opinion that the quote from RBS could not be a sound basis for computing the interest differential, as it was dated 1 April 2013, i.e., after the end of the relevant previous year. It thereafter requisitioned information from HDFC Bank and State Bank of India, which provided 1.80% and 1.08% - 2.1% for all types of guarantees. On this basis, the TPO ascertained the ALP for issuance of guarantee to be 1.5% and proposed an adjustment.

On appeal, the CIT(A) stated that naked quotes adopted by the TPO are untenable and hence liable to be rejected. However, it restricted the adjustment to 0.5%, following Hon'ble Bombay High court in the case of CIT vs Everest Kento Cylinders Ltd. (2015] 378 ITR 57 (Bom)(HC). After which, both taxpayer and Revenue were in appeal before the ITAT.

Held

ITAT observed that while adopting the yield spread approach, the quotes for the interest rates don't need to be as on the date of entering into a transaction. This is because the material factor is the difference between these rates and not the quantum of these rates; every variation in such rates need not necessarily affect the variation between with and without guarantee interest rates. At the end of the day, the rate differential is an approximation - no matter how scientific or reasonable it is.

The ITAT further observed that if the rate differential between these two interest rates is 70bps at the end of the previous year, it is reasonable to proceed on the basis that such a differential would also prevail during the relevant previous year. ITAT thus held that the objections taken by the revenue authorities to the adoption of the yield spread approach were not legally sustainable. It held that the quotations obtained from HDFC Bank and State Bank of India were for the bank guarantees simplicitor and not corporate guarantees. These two kinds of guarantees are materially different, as has been held by a series of co-ordinate bench decisions. Accordingly, ITAT upheld the taxpayer’s approach in light of the yield spread method adopted.

Our Comments

In the above ruling, it can be noted that in guarantee cases, a yield spread approach has been upheld to benchmark the appropriate guarantee commission.

Entitlement to credit transitioned from the erstwhile indirect tax regime.

Note: In the matter of Filco Trade Centre Pvt. Ltd. vs Union of India [TS-446-HC- 2018(GUJ)-NT], the Gujarat High Court had struck down Section 140(3)(iv) of the CGST Act imposing a one-year time limit to avail transitional credit, as being unconstitutional.

Union of India & Anr. vs Filco Trade Centre Pvt. Ltd. & Anr. [TS-369- SC-2022]

The Court had opined inter alia that “…the benefit of credit of eligible duties on the purchases made by the first stage dealer as per the then existing CENVAT credit rules was a vested right. By virtue of clause (iv) of sub-section (3) of Section 140, such right has been taken away with retrospective effect in relation to goods that were purchased prior to one year from the appointed day. This retrospectivity given to the provision has no rational or reasonable basis for imposition of the condition.”

Background

• One of the teething issues faced by many taxpayers during the transition to the GST regime was the inability to carry forward the existing pool of VAT and CENVAT credit lying in their books. This was largely on account of the technical glitches/difficulties on the GST portal, resulting in a denial of input tax credit which otherwise had crystallized into a vested right for the taxpayers but could not be claimed within the prescribed time limit.
• Various writ petitions were filed before jurisdictional High Courts seeking reliefs, where the Department was directed to re-open the portal so that the petitioners can file their respective TRAN-1 returns or revised returns. However, the government contested these orders and ultimately, the matter reached the Apex Court.

Ruling

Disposing off a batch of 400 appeals, the Supreme Court issued the following directions:

• The GSTN would open the common portal for filing TRAN-1 and TRAN-2 forms for two months w.e.f. 1 September 2022 to 31 October 2022.
• GSTN must ensure that there are no technical glitches during the said time.
• Considering the judgments of the High Courts on the then prevailing peculiar circumstances, any aggrieved taxpayer can file the relevant form or revise the already filed form, irrespective of whether a writ petition has been filed before the High Court or if the taxpayer's case has been decided by the Information Technology Grievance Redressal Committee (ITGRC).
• The concerned officers would thereafter verify the veracity of the claim / transitional credit and pass appropriate orders thereon on merits after giving reasonable opportunities to the concerned parties within 90 days.
• The allowed transitional credit should reflect in the Electronic Credit Ledger.
• If required, the GST Council may also issue appropriate guidelines to the field formations in scrutinizing the claims.

Our Comments

The two-month window granted to claim the transitional credit is a major relief, addressing the genuine concerns of the taxpayers who faced technical glitches and other operational challenges.

This gives an opportunity to the taxpayers to evaluate the missed/ unavailed credit and the reasons therefor – whether on account of technical glitches or legal interpretation - and make appropriate claims.

However, to ensure uniformity in the procedure and avoid undue litigation stemming from the verification process, it would be expedient for the GST Council/ Central Board of Indirect Taxes and Customs (CBIC) to prescribe proper guidelines in this regard.

Whether the telecom services provided by the petitioner to customers of Foreign Telecom Operators (FTO) under roaming arrangement for making international long-distance calls within the territory of India would qualify as ‘export of services’ under the GST law?

Vodafone Idea Limited vs The Union of India & Ors. [2022 (7) TMI 645 – Bombay High Court]

Facts

• Vodafone Idea Limited (the petitioner) provides telecom services in the nature of International Inbound Roaming services (IIR) and International Long Distance (ILD) services to FTOs, under a roaming arrangement.
• As per the said arrangement, a subscriber of FTO traveling to India can use the Home Operator network (viz. the petitioner), and vice versa. For these services, the Home Operator and FTO would issue invoices to each other.
• Taking a stand that such telecom services qualify as exports within the meaning of Section 2(6) of the IGST Act, the petitioner filed GST refund claims. However, the same was rejected by the Department on the ground that the place of supply of services was the State of Maharashtra and cannot be considered as exports.
• Subsequently, the petitioner received favorable orders from the First Appellate Authority, which were challenged by the Revenue before the High Court.
• The petitioner also filed a writ seeking direction to Revenue to implement the order-in-appeal.

Ruling

• High Court found that the petitioner is contractually obligated only to the FTOs for the services rendered under the agreement. The consideration is payable in convertible foreign exchange by the FTOs.
• There is no contract with a subscriber of FTO, making it liable to pay value of service to the petitioner. Hence, the subscriber of the FTO cannot be considered as ‘recipient’ of service. The FTO is undoubtedly the recipient of services, observed the High Court.
• Given this, the provision of Section 13(3)(b) of the IGST Act (place of actual performance) is not attracted in the present case since the same is only applicable to services provided to an individual.
• According to the High Court, when a service is rendered to a third-party customer of FTO (your customer), the service recipient is your customer and not such third-party customer of FTO.
• Since the petitioner has not supplied services specified in sub-sections (3) to (13) of Section 13 of the IGST Act, the place of supply is the location of the service recipient, which is outside India.
• As regards Revenue’s contention that the subscriber and FTO are acting on behalf of each other, High Court stated that the relationship between the two is on a principal to principal basis, and there is no evidence to substantiate otherwise.
• Accordingly, the High Court dismissed Revenue’s writ petition while allowing that of the petitioner. However, the order has been stayed upto 31 August 2022

Our Comments

The ruling rightly identifies the ‘recipient’ of services and consequently the place of supply for international roaming services, based on the concept that the customer’s customer cannot be your customer.

While the ruling pertains to telecom services, the principle can be applied to other scenarios to determine the true nature of transactions and the tax implications thereon.

Pune ITAT disallows set off of losses to the assessee by holding sole underlying purpose of demerger was to obtain tax benefit

Cummins Sales & Services (I) Ltd. (Formerly known as Cummins Diesels Sales & Services Ltd.) [TS-523-ITAT-2022(PUN)]

The assessee, a resulting company, had claimed set-off of brought forward business losses and unabsorbed depreciation pertaining to demerged undertaking. During the course of assessment proceedings, the assessing officer noted that the assets of demerged undertaking were held for sale, which clearly indicated that there was no intention to continue the business of demerged undertaking, thereby defeating the object behind the enactment of the provisions of Section 72A(4) of the Act. The CIT(A) allowed the contention of the assessee that the demerger motive cannot be questioned once the Court approves the scheme.

The Tribunal observed that the assessee did not carry any business of demerged undertaking and put the assets of the demerged unit for sale, this evidenced that the assessee clearly did not have any intention of carrying on the business of demerged undertaking and the sole motive of demerger was tax set-off. Even if the government has not laid down the criteria to determine under what circumstances demerger can be said to be for a non-genuine purpose, the jurisdictional High Court decision holds the legal position that the benefit of set-off of brought forward business losses cannot be allowed when the sole idea behind the scheme was to avail tax benefits. Taking cognizance of the objects behind the enactment of provisions of Section 72A, the claim for depreciation was not allowed.

Our Comments

The General Anti-avoidance Rule (GAAR) provisions could not have been directly applied considering the year to which the matter pertains. However, indirectly the principles of the GAAR provisions have been applied by getting into the rationale for the demerger. The Tribunal taking into consideration the conditionalities of Section 72A implicitly emphasizes that the schemes should be internally scrutinized for the GAAR test as the scheme being approved by National Company Law Tribunal (NCLT) is not going to be a sufficient defense from its applicability. The tax authorities would certainly be entitled to look at the schemes to assess from the lens of the GAAR provisions.

Delhi ITAT holds non-compete fees not to be eligible for depreciation as the same can not be classified as an intangible asset

Sagar Ratna Restaurants (P.) Ltd. v. ACIT [[2022] 139 taxmann.com 87 (Delhi - Trib.)]

The assessee had acquired a restaurant inter-alia included all of the transferor’s rights, copyrights, trademarks, etc. in respect of the restaurant. The assessee has made certain payments relating to noncompete fees to the transferor and treated the same as capital expenditure in the year of acquisition and the assessee claimed depreciation on such expenditure thereon.

The Tribunal observed that the dispute is identical to the jurisdictional Delhi High Court decision in the case of Sharp Business System,⁴ wherein it was held that a non-compete fee though an intangible asset is not similar to know-how, patent, copyright, trademark, licenses, franchises or any other business or commercial right of similar nature. In the case of non-compete fees, unlike the rights mentioned in Section 32(1)(ii), which an owner can exercise against the world at large and can be traded or transferred, the advantage is restricted only against the seller. Therefore, it is not a right in rem but in personam. However, there have been other decisions wherein it has been ruled in favor of the assessee and depreciation has been allowed.

However, the Tribunal proceeded to follow the decision of the jurisdictional High Court and disallowed the claim.

Our Comments

The issue with respect to the allowability of depreciation on non-compete fees has been a matter of debate before Courts. Various conflicting decisions on eligibility for depreciation on payment of non-compete fees exist. While in a few cases, the Courts have held noncompete fees to be an intangible asset eligible for depreciation, others have held it as not an intangible asset. Few of the decisions have also allowed it as revenue expenditure. The present decision has followed the jurisdictional High Court decision in proceeding not to allow the depreciation claim. Considering the conflicting decisions on the matter, it is pertinent that the plausibility of the same is assessed on a case-to-case basis by inter-alia, taking into consideration the prevalent position as per the jurisdiction of the assessee.

Securities and Exchange Board of India (SEBI) Regulations

SEBI prescribes new format for disclosure of shareholding patterns by listed companies

The Securities and Exchange Board of India (SEBI) vide Circular No. CIR/CFD/ CMD/13/2015 dated 30 November 2015, had prescribed formats for disclosure of holding of specified securities and shareholding patterns under Annexure-I to the Circular. In the interest of providing further clarity and transparency in the disclosure of shareholding patterns to the investors in the securities market, the SEBI has vide notification dated 30 June 2022, partially modified the aforesaid Circular. Under the new disclosure formats, SEBI has added a new column for disclosing the sub-categorization of shareholding under the below three sub-categories:

1. Shareholders who are represented by a Nominee Director on the Board of the listed entity or have the right to nominate a representative (director) on the Board of the listed entity.
2. Shareholders who have entered into a Shareholder Agreement with the listed entity.
3. Shareholders who are Persons acting in Concert (PAC) with a promoter.

Furthermore, details pertaining to foreign ownership limits and names of the shareholders who are persons acting in concert, if available, shall also be disclosed separately. This Circular shall come into force with effect from the quarter ending 30 September 2022.

Our Comments

In addition to the disclosures already being given for Public Shareholders holding more than 1% shares, Listed Companies will now have to give additional separate disclosures regarding the sub-category of such shareholders. Also, the regulator has specified that all listed entities will have to disclose details pertaining to foreign ownership limits in a prescribed format. These new disclosure requirements will provide more clarity and transparency to investors but, at the same time, increase the compliance burden of the Listed Company. Companies have time till next quarter to collate additional data/ information as required under these new disclosure formats as disclosure of shareholding as per these new formats will become applicable from the quarter ending 30 September 2022 onwards.