From The Judiciary

Can services rendered by a foreign affiliate be taxed as Fees for Technical Services (FTS) under the India-USA DTAA, given that the term "managerial" is not included in the DTAA?

Herbalife International India Private Ltd TS-444-ITAT-2024(Bang)

Facts

Herbalife International India Pvt. Ltd. (the taxpayer) is part of the Herbalife group and is engaged in manufacturing and supplying nutritional products. The taxpayer made payments to its Associated Enterprise (AE), Herbalife International Inc., USA, for Royalty, IT, technical, and administrative services without deducting the tax at source.

The Revenue initiated proceedings in which the taxpayer failed to deduct TDS on these payments, which were classified by the Assessing Officer (AO) as 'Fees for Technical Services' (FTS).

It was contended that the AE had made technical knowledge and expertise available to the taxpayer, which would attract taxability under the relevant provisions.

The taxpayer argued that the payments were in the nature of reimbursements for administrative services provided by the AE on a cost-to-cost basis, without any markup, hence, no TDS was required to be deducted. The taxpayer argued that the term "managerial services" does not appear in the Double Taxation Avoidance Agreement (DTAA) between India and the USA, specifically under Article 12(4), which deals with "fees for included services." Therefore, these payments should not be considered taxable under the DTAA provisions.

Held

The Tribunal ruled in favor of the taxpayer and held that the AE's administrative services were not in the nature of FTS as per Article 12(4) of the India-USA DTAA. The Tribunal emphasized that the term "managerial services" is not mentioned in the DTAA, and thus, the provisions of the DTAA would override the domestic tax laws.

The Tribunal referred to several case laws, including the reversal of the decision in Shell India Markets Pvt. Ltd. by the Bombay High Court and the ruling in CIT vs. De Beers India Minerals Pvt. Ltd. by the Karnataka High Court. It also relied on the Bangalore ITAT's decision in Tyco Fire and Security India Pvt. Ltd., which supported the taxpayer's arguments that technical knowledge was not "made available" to the taxpayer.

Consequently, the appeal filed by the taxpayer was allowed, and the Revenue's demands were dismissed.

Our Comments

This case highlights the principle that DTAA provisions take precedence over domestic tax laws in case of a conflict and the absence of the term "managerial services" in the DTAA between India and the USA played a pivotal role in the Tribunal's decision.

Does the Most Favored Nation (MFN) clause in a DTAA automatically apply when the DTAA with a third state offers more favorable terms, or must specific conditions be met first?

Omar Sebastian Cabrera Cabrera TS-477-FC-2024(Colombia Supreme Court)

Facts

Colombia has several DTAAs, including those with the UK, Switzerland, Spain, and Chile, which contain MFN clauses. Such a clause stipulates that if Colombia enters into a DTAA with a third state offering lower tax rates or different classifications for certain payments, those terms should apply automatically to existing DTAAs.

The Colombia-UK DTAA excludes payments for technical services, assistance, and consulting from being classified as Royalties.

The Colombian tax authority ruled that the MFN clauses in DTAAs with Switzerland, Spain, and Chile did not activate automatically because the Colombia-UK DTAA did not offer a lower tax rate but only changed the classification of payments.

Held

The Supreme Administrative Court of Colombia upheld the tax authority's decision.

Key points which support the decision are:

• The MFN clause requires explicit conditions to be met, such as Colombia agreeing on a lower tax rate with a third state.
• Simply changing the classification of payments, as done in the Colombia- UK DTAA, does not trigger the MFN clause.
• The activation of the MFN clause depends on the specific language and conditions of each DTAA.
• The Court emphasized a literal interpretation of the treaty text where the language is clear.

This decision underlines that the MFN clause does not apply automatically and that taxpayers must meet all stipulated conditions in the treaty to benefit from it.

In the Indian context, recently, the Hon'ble Supreme Court, in the case of Nestle SA [TS-616-SC-2023] ruled that lower tax rates or restricted scope agreed with a third state are not automatically enforceable and must be notified separately by the government under the Income-tax Act, 1961.

Our Comments

The decision highlights the importance of precise language in international tax treaties and the need for clear stipulations in MFN clauses. This decision provides insight into how international courts perceive the MFN clause and its implementation compared to India.

Guarantee ceases on classification of loan as NPA and accordingly, ITAT Deletes TP adjustment qua guarantee

JE Energy Ventures Private Limited TS-272-ITAT-2024(DEL)-TP

Assessment Year – 2017-18

Facts of the case

The assessee is engaged in providing support and other services of air charter, leasing, trading, and lending finance business. The assessee provided a corporate guarantee for two loan arrangements between its AEs and Exim Bank. The AEs were unable to meet the obligation for unpaid dues resulting in the said loan being classified as a non-performing asset by EXIM Bank. Furthermore, the bank has initiated recovery proceedings against the AE and the said fact has been intimated to the assessee.

The Transfer Pricing Officer (TPO) proposed an arm's length adjustment for corporate guarantee and treated the same as an International transaction (which was treated as a shareholder activity by the assessee). Furthermore, TPO arrived at an arm's length rate of 2.01% and accordingly made an adjustment for the underlying International transaction.

Being aggrieved by the order of TPO and further on receipt of an unfavorable order by the Dispute Resolution Panel (DRP), the assessee made an appeal before the honorable Income Tax Appellate Tribunal (ITAT).

ITAT Order

ITAT rejected assessee's approach of treating the transaction as Shareholder activity and treated the same as an international transaction. The ITAT highlighted that in assesses own case in AY 2013-14, the assessee had received a fee for providing a corporate guarantee of INR 27 million, the coordinate bench held that the services provided by the assessee to their stepdown subsidiary fall within the definition of Corporate Guarantee. However, the facts for consideration in this AY are different since the subsidiaries had not serviced the obligation towards the loan they took and the same were classified as non-performing assets (NPA) by the bank. The same was intimated to the assessee in May 2016 and recovery proceedings were initiated by the assessee, who was the primary guarantor.

Furthermore, ITAT states that where the situation of default is apparent and recovery proceedings have commenced, corporate guarantee ceases to exist and accordingly, the repayment obligation of interest and Principal by the assessee becomes crystallized. The service guarantee for the loan availed by the AEs does not exist anymore. Therefore, the Assesse cannot avail any guarantee fees from the borrowers. In continuation of the same, ITAT concluded that there was no international transaction in the case.

Our Comments

When an assessee provides a corporate guarantee to its AE, the assessee needs to assess the credit worthiness (credit risk) of the borrower, i.e., the AE. Furthermore, in the case where there are indications of default, like where the bank has treated the borrower as NPA or where there is clear default exists, the assessee should not charge any guarantee fees for the underlying corporate guarantee for the said period since the guarantee shall cease to exist and hence may not be considered as an international transaction.

Deletes adjustments made solely on the basis of differences in accounting policies

GE Subsidiary Inc. TS-260-ITAT-2024Mum-TP

Assessment Year – 2017-18

Facts of the case

GE Subsidiary Inc., a US-based company, earns royalty income from its Indian AE for using its trade name. The TPO had made a royalty adjustment of INR 79.5 million for FY 2014-15 based on discrepancies between amounts reported in Form 3CEB and financial statements of the Indian AEs and GE Subsidiary Inc.

The ITAT noted that such discrepancies were due to different accounting standards and fiscal year calculations between the USA and India.

Taxpayer's contention before ITAT

GE subsidiary argued that the TPO's adjustment was solely based on these differences without applying any prescribed method for benchmarking the Arm's Length Price (ALP) of international transactions.GE Subsidiary Inc. follows US Generally Accepted Accounting Principles (GAAP) and a calendar year for accounting, whereas its Indian AEs adhere to different revenue recognition principles. These variations led to timing differences in royalty income recognition, which the TPO failed to consider adequately. Furthermore, the India-U.S. DTAA permits royalty taxation on a receipt basis, supporting the differences in reported amounts.

Held by ITAT

The ITAT emphasized that the TPO's adjustment lacked legal foundation as no prescribed methods under Section 92C of the Income Tax Act were applied, making the adjustment ad-hoc and legally unsustainable. Citing precedents, the ITAT reiterated that adjustments based solely on timing differences do not affect the arm's length determination of transactions and do not cause substantial loss to the exchequer.

The Tribunal concluded that the TPO's adjustment was not legally sustainable and ruled in favor of GE Subsidiary Inc., deleting the royalty adjustment. This ruling underscores the necessity for consistent and legally grounded transfer pricing assessments.

Our Comments

The ITAT's decision in favor of GE Subsidiary Inc. highlights the importance of adhering to prescribed methods for transfer pricing assessments. This ruling underscores that adjustments based solely on timing differences and global accounting standards cannot form a legally sustainable basis for transfer pricing adjustments. It is important to maintain appropriate reconciliation for the same. The case reaffirms the need for consistent and legally grounded approaches in transfer pricing evaluations, ensuring that international transactions are fairly assessed.