From The Judiciary

Subscription-based product sales under reseller agreement are business or royalty income?

Gartner Ireland Ltd TS-399-ITAT-2024 (MUM)

Facts

The assessee, a company incorporated in the Republic of Ireland, is engaged in the business of the sale of subscriptionbased products and related services, including publications, reports and periodicals that highlight industry developments, review new products and technologies that provide independent research and insight on all aspect of a company’s business (IT, Finance, HR, Marketing, Sales, Logistics, etc).

The assessee introduced its subsidiary, Gartner India Research and Advisory Services Pvt. (Garter India) as an intermediary for subscribing to the GIL products. The assessee entered into a ‘reseller agreement’ with Garter India for selling the ‘GIL’ product to Indian customers. The assessee’s income from these subscription-based products comprised of (i) resale by Gartner India to its customers in India on a principalto- principal basis under a reseller agreement and (ii) sale to Gartner India for its internal use in exchange for a research access fee under a research access agreement.

During the assessment proceedings, the AO and Dispute Resolution Panel classified these payments as subscription fees within the ambit of Royalties under the Act and taxed at 10% as per Article 12 of the India- Ireland Double Taxation Avoidance Agreement (DTAA), contending that GIL product involved ‘the right to use or access copyrighted material’, thereby constituting royalty income.

Held

The Mumbai Income Tax Appellate Tribunal (ITAT) held that GIL charged a one-time quarterly fee to Gartner India for products, allowing Gartner to resell these products multiple times. This implies that Gartner purchased both the product and the right to copy and resell it, effectively making the transaction a sale of copyright. Although the invoice did not explicitly state a license fee, it is essentially a fee for the use of copyright.

The assessee failed to correlate resale invoices from Gartner India with its own sales invoices, thus failing to prove a simple trading transaction. The invoices specified only a lump sum quarterly fee without detailing the number of subscriptions sold. Consequently, the sale of the digital products to Gartner, including the rights to copy and resell, constitutes royalty income. Regarding the taxability of the research access fee, the ITAT held that the requisite information and documentation are not available to substantiate whether Gartner India has exploited any copyright in the digital and the matter was remanded to AO.

The appeal filed by the assessee was partly allowed.

Our Comments

It is pertinent to analyze whether subscription-based products or software sold is a mere transfer of ‘copyrights’ a transfer of or ‘copyrighted material’ to draw a conclusion regarding applicable withholding tax liability.

Whether connectivity services, being ancillary to inter-connect services, can be treated as FTS under the Income-tax Act?

Huawei International Co. Ltd. TS-433-ITAT-2024 (DEL)

Facts

The Huawei International Co. Ltd (Huawei Int.) is a Hong Kong-based company engaged in the business of distributing telecommunication products. The assessee received reimbursement of connectivity charges from its Indian Associated Enterprise (AE), Huawei Telecommunication (India) Company Pvt. Ltd. (Huawei India), for the provision of connectivity services for international communication, without deducting Tax Deducted at Source (TDS).

During the assessment proceedings, the AO classified these payments as FTS under the Act, viewing the that the connectivity services provided by the assessee shall fall within the ambit of ‘Consultancy’ or ‘Managerial’ services and would be liable to tax as FTS under Section 9(i)(vii).

Held

The Delhi ITAT held that no tax is deductible at source under Section 195 of the Act on reimbursement received for rendering connectivity services.

ITAT observed that the assessee has only paid for connectivity services and the services are merely ancillary to enabling the provision of inter-connect services and part of the processing of the product. ITAT contended that the receipt cannot be treated as ‘Technical,’ ‘Consultancy’ or ‘Managerial’ in nature. In this regard, ITAT ruled in favor of Huawei Int. by dismissing Revenue’s appeal.

Our Comments

It is essential to understand the underlying nature of services for which reimbursement is provided. The mere provision of ancillary services to the business functions may not qualify as FTS.

WDV in the books of AE cannot be treated as ALP using the CUP method

Sarens Heavy Lift India Private Limited ITA No.256 / Del / 2019

Facts of the case

The taxpayer is engaged in the business of hiring and leasing heavy cranes and also engaged in retail operation and providing of related services. During FY 2009-10, the taxpayer purchased nine used cranes from its AE worth INR 343.2 million, which were benchmarked using the Transactional Net Margin Method (TNMM) by comparing its operating profit margins with that of comparable companies.

The Transfer Pricing Officer (TPO), during the course of the assessment proceeding, disregarded the application of the TNMM method used by the taxpayer for determining the Arm’s Length Price (ALP) and applied the internal Comparable Uncontrolled Price (CUP) method considering the Written Down Value (WDV) of the cranes provided in the books of the AE and made an upward adjustment of INR 184.6 million. Pursuant to the above, the taxpayer filed their objections before the learned Dispute Resolution Panel (Ld. DRP).

Directions of Ld. DRP

On perusing the details furnished by the taxpayer, Ld. DRP observed that the WDV of the cranes in the AE’s books cannot be considered as ALP as it was not derived from the transactions between enterprises other than AEs. Placing reliance on the submission made by the taxpayer, the Ld. DRP held that ALP should be based on a valuation done by a chartered engineer or, accepted by customs authorities or done by the Discounted Cash Flow (DCF) method. The AO and the TPO ignored the valuation done by the independent chartered engineer (at INR 341.5 million), the valuation as per the customs authorities (at INR 344.6 million) and the FMV derived by using the DCF method (at INR 439.2 million).

Ld. DRP, placing reliance on the ruling of Tecumseh Products India Private Limited⁴ directed the TPO to accept the valuation report provided by the taxpayer and delete the addition made on account of ALP of cranes.

Pursuant to the above, the Revenue filed an appeal before the Hon’ble ITAT wherein the Hon’ble ITAT upheld the directions issued by the DRP⁵.

Aggrieved by the order of the Hon’ble ITAT, the Revenue filed an Appeal before the Hon’ble HC.

Held by the Hon’ble HC

The Hon’ble HC upheld the actions of the Ld. DRP and Hon’ble ITAT. Placing reliance on Rule 10B of the Income Tax Rules, 1962 (Rules), the Hon’ble HC stated that identification of ALP from the point of view of uncontrolled price method shall be referable to comparable uncontrolled transactions (transaction between enterprises other than AE). Since the equipment has been purchased by the taxpayer from the AE, reference to WDV would have thus fallen foul of this fundamental percept.

In addition to the above, the Hon’ble HC also held that the Revenue authorities (including TPO during the course of the assessment proceedings) failed to bring forth any other comparable or any other methodology for examination. Accordingly, the Hon’ble HC upheld the actions of the Hon’ble ITAT.

Our Comments

The said ruling outlines the need for the taxpayer to maintain robust documentation and relevant evidence as a pre-requisite to validate the determination of ALP for international transactions relating to the purchase of assets from the AE. It becomes pivotal to have a valuation report from an independent valuer in place, which determines the asset’s independent value to justify the transaction being at ALP. The ruling also highlights the basic principles of applying the CUP method, wherein the premise of the application is to compare transactions between unrelated parties.

Whether customs duty exemptions under the Merchandise Exports from India Scheme (MEIS)/Service Exports from India Scheme (SEIS) duty credit scrips woukd extend to Social Welfare Surcharge (SWS) liability as well?

Gemini Edibles and Fats India Pvt. Ltd. vs Union of India & Ors. TS-219-HC-2024(MAD)-CUST

Facts

• The appellant is engaged in manufacturing and marketing edible oils and fats, for which it imports goods, viz. ‘RBD Palm Oil Edible grade in bulk’ attracting customs duties.
• During the period February 2018 to July 2019, the appellant utilized the MEIS and SEIS scrips, which were procured from various exporters, to offset the customs duties applicable to these imports.
• However, a dispute arose as to whether the SWS, payable at 10% of the aggregate of customs duties, could be debited from the scrips in terms of Notification No. 24/2015- Cus (MEIS) and Notification No. 25/2015-Cus (SEIS).
• The Single Judge Bench of Madras HC inter alia held that the exemption granted vide said Notifications is only in respect of payment of customs duty in cash. The scrips have money value and the act of debiting, in effect, amounts to levy and collection of duty from the importer.
• However, SWS being an independent levy imposed and collected in terms of Section 110 of the Finance Act, 2018, the recovery thereof could not be done by debiting the scrips and that the appellant was liable to discharge the same in cash or through some other mode.
• Aggrieved by the said verdict, the appellant approached the Division bench.

Ruling

• Applying the doctrine of pith and substance, the HC delved into the true nature of the exemption granted under subject Notifications.
• It observed that a Notification, merely by virtue of having been issued under Section 25(1) of the Customs Act, cannot be understood as granting exemption from the levy of customs duty. Instead, one must enquire and find the substance of the Notification.
• The subject Notifications could not be understood as granting exemption from the levy of SWS, in as much as they only refer to Section 25(1) and bear no reference to Section 110 of the Finance Act, 2018.
• The effect of debiting the duty scrips is not administrative, but is a mode of payment of duty and thus, the appellant’s argument that there is neither levy nor collection of customs duty was untenable.
• The HC further observed, the fact that the duty does not form part of the Consolidated Fund of India does not have any bearing on determining the scope and nature of an exemption Notification, nor would have relevance in determining as to whether there was any levy/ collection of duty.
• In this context, HC relied on its decisions in TANFAC Industries Ltd vs. Asst. Commissioner of Customs, Cuddalore [2009 (240) ELT 341] and Commissioner of Central Excise and another vs. SPIC Heavy Chemicals Division and others [2013 SCC Online Mad 4021] wherein it was held that goods cleared under duty credit scrips cannot be treated as exempted goods but only as duty paid goods.
• In view of the above, HC upheld the order of Single Judge bench and dismissed the writ appeals.

Our Comments

The ruling once again highlights the importance of ‘substance’ and the ‘intention’ behind an exemption Notification along with the conditions attached thereto.

The Court has emphasized that when a specific duty is exempted, other duties/cesses/surcharges imposed by the legislation for a different purpose cannot be considered to be included therein.

It is worth noting that this ruling could result in a substantial working capital impact in as much as the Customs authorities could initiate recoveries where importers had utilized the scrips for payment of SWS.

ITAT Nagpur: Valuation not adopted as per Rule 11UA, matter cannot be remanded back for re-determination

Citation: Vedsidha Products Pvt Ltd. v. CIT 1(3) [2024] TS-437-ITAT-2024 (NAG)

Facts of the case

The assessee, a private company, is engaged in manufacturing concrete bricks. The assessee had allotted 3,47,980 equity shares of face value of INR 100 each on 1 October 2012. Out of these, 3,12,980 shares were issued at par to promoters and the remaining 35000 shares were issued to private investors at a premium of INR 450. During the assessment, the assessee submitted a valuation report dated 1 April 2012, computing the FMV of shares at 23,530 each as per Net Asset Value (NAV) method under Rule 11UA. While arriving at the FMV of shares, the assessee had a land parcel in MIDC, Nagpur, which was valued at a rate higher than MIDC. However, the AO rejected the valuation and worked out a negative value (INR -38.13) per share as a result of incurring continuous losses by the company. Accordingly, the AO made an addition of INR 1,57,50,000 under the head Income from Other Sources under Section 56(2)(viib) of the Act with respect to the premium received on shares allotted.

Aggrieved by the order of AO, the assessee filed an appeal before the Commissioner of IT (Appeals) [CIT(A)], who held that the assessee, while arriving at value as per the NAV method, had only replaced the historical cost of land with the value adopted by the registered valuer. Furthermore, even if MIDC rates had to be applied, the value per share would be INR 1193.8 per share, which is still more than INR 550 per share issued by the assessee. Accordingly, the AO erred in rejecting the valuation report and the addition was deleted.

Decision by Nagpur ITAT

Aggrieved, the Revenue appealed the case to Nagpur ITAT, which held as follows:

• The assessee’s Ld. Authorized Representative (AR) failed to produce any evidence or comparable instance to substantiate the FMV of land adopted in the valuation report.
• The ITAT was unable to reconcile the fact as to why no premium was taken from the promoters of the company when shares to three other shareholders were at a premium of INR 450, which was issued to both in the same financial year.
• The valuation report was obtained on 1 April 2024, much before the date of allotment, i.e., 1 October 2024, which was a departure from the requirement of FMV to be considered on the date of issue of shares as per Section 56(2)(viib) of the Act. Accordingly, the valuation could not be considered as per Rule 11UA. Hence, the valuation could neither be remanded back to AO nor referred to the valuation officer. Hence, no cognizance of the valuation report could be taken.
• The FMV of shares had to be determined by the merchant banker or accountant, who the company does not appoint as an auditor under Section 44AB, which was not met in the present case.
• Accordingly, the AO correctly calculated the net worth of the company to be negative because of incurring continuous losses.

Our Comments

It was held that where the valuation is not carried out as per the requirements of Rule 11UA, the matter cannot be remanded back to the AO for re-determination.