From The Judiciary

Whether payment for reimbursement of obligatory payments for an expatriate can be taxable as Fees for Technical Services (FTS)?

CTBT Pvt.Ltd AAR No. 1366 of 2012

Facts

CTBT Pvt.Ltd is a company incorporated under the laws of India. It is a whollyowned subsidiary of M/s. PMK, Switzerland, which is part of K Group. The applicant has signed a Memorandum of Understanding (MoU) with the State Government of a certain Indian state for establishing the K tire manufacturing plant. Considering the large-scale FDI investment in India and ensuring consistent application of K quality and safety standards, the applicant requested KRP, a whollyowned subsidiary of PMK, for the supply of experienced expatriate personnel.

The applicant entered into an Intercompany Agreement with KRP for disbursing social security contribution, insurance and relocation expenses payable by the applicant to expatriate personnel in their home country, which is proposed to be disbursed by KRP and subsequently reimbursed by the applicant. KRP act as payroll disbursement agency portion of salary and other social security obligations of the expatriate in their home country on behalf of the applicant for which an administration fee would be charged. Appropriate taxes were deducted on the administrative charges under Section 195 by the applicant.

The Revenue was of the opinion that the amount reimbursed should be considered as FTS. Heavy reliance was placed on Hon’ble Delhi High Court’s judgment in the case of Centrica India Offshore (P.) Ltd. V. Commissioner of Income Tax (1) (2014) 364 ITR 336.

On the aforementioned facts, the applicant has sought an advance ruling for taxability of the cost to cost reimbursement of the social security contribution paid by KRP in the home country of the expatriate on behalf of the applicant.

Ruling

On perusal of the agreements on record, the AAR noted that there is no lien on employment of the seconded employees with the applicant and also the applicant has the power to terminate the employment, and the employee is forbidden to supply his capacity to work to someone else during the period of employment. The applicant is exercising full operational control and the employee is required to abide by policy regulations and guidelines of the applicant company. It is also seen that to meet the obligation of the expatriate personnel abroad, social security contribution, insurance, relocation cost, etc., were deposited by KRP on behalf of the personnel and the said contribution, which forms part of the salary, is reimbursed on cost to cost basis by the applicant to KRP.

The AAR distinguished the ruling of Centrica on the basis that the expatriate personnel in the current case were indeed employees of the applicant, and there does exist an employee-employer relationship between the personnel and the application company. It exercises control and issues directions to the employees who are required to supply their complete time and labor to the applicant. The applicant also has the power to terminate the employment.

Thus, reimbursement of obligated payment shall not be considered as FTS.

Our Comments

In the case of expatriates, reimbursement of obligatory payments by another group entity or original employer of the employee is a common industrial practice. Yet, the taxability of the reimbursement has been a common everlasting debate. The taxability of such payments cannot be given a standard treatment and would depend on the intricacies of the agreement.

Whether treaty benefit can be denied to a non-resident company pursuant to the “limitation of benefit” clause merely because the major shareholder is a non-resident of both the contracting state?

Interworld Shipping Agency LLC Vs. DCIT ITA No. 7805/Mum/19

Facts

The taxpayer is a limited company incorporated and tax resident of the UAE and is engaged in the business of services like ship chartering, freight forwarding, sea cargo services, shipping line agents. The taxpayer charters the ships to transport goods and containers in international waters, including Kandla and Mundra ports and other ports in India and elsewhere. During the relevant year, the taxpayer earned freight from India. Pursuant to Article 8, the same was not offered to tax in India.

The Assessing Officer (AO) did not agree with the contentions of the taxpayer. He noted that as much as 80% of the profits of the taxpayer entity were to go to one Dimosthenis Lalagiannis, a Greek national. The AO was of the view that the person receiving 80% of the profits was a Greek national, and there is no evidence that Mr. Dimosthenis Lalagiannis has operated the company wholly and exclusively from the UAE.

Thus, in light of Article 29 "Limitation of Benefits" of the India — UAE Treaty, it could be safely concluded that the business was not managed or controlled wholly from the UAE.

He was of the view that the only purpose of the taxpayer company was to avail of the benefits of the India-UAE tax treaty. He then referred to the ‘look at’ principle in the Vodafone judgment and noted that even the tax residency certificates of the partners were not provided to the AO. He further noted that it was a clear case of abuse of the organization as the owner and manager of the entity is a Greek national. He also believed that the taxpayer company is a colorable device for the avoidance of taxes, and thus the benefit of the India- UAE treaty was denied.

The Dispute Resolution Panel (DRP) confirmed the actions of the AO. Aggrieved by the final assessment order, the taxpayer approached the Mumbai Tribunal.

Held

After due consideration of the argument from both the parties and material on record, the Tribunal noted that the taxpayer had fourteen expatriate employees who were issued work permits by the UAE Government for working with the taxpayer. Thus, clearly, the taxpayer was being run from UAE itself. Further, the partner Dimosthenis Lalagiannis was in UAE for 300 days during the relevant previous year.

The UAE is a major financial center in which not only a large number of foreigners work but also from where a large number of foreigners conduct their business. When a person lives in a country for 300 days, it would be reasonable to assume that he would be running a business from that country.

Even if we are to keep aside his actual stay in UAE for 300 days aside, whether the main director stays in UAE for 180 days or even less is immaterial as long as there is nothing to show, or even indicate, that business was not carried from UAE. The requirement for presence in UAE for 183 days, for residence status under the India-UAE tax treaty, is for the individual and not the directors of the companies which claim such a residence status. As for the companies, the only test for a company being termed as ‘resident of UAE’ is that it should be incorporated in UAE and wholly managed and controlled in the UAE. The taxpayer company has its office in UAE, it is in business there since 2000, it has expatriate employees who have been given a work permit to work in UAE for the taxpayer company, the main driving force of the company and its director is an expatriate resident in the UAE.

Further, when an entity was established in 2000, and the relevance of the India- UAE tax treaty comes into play only in 2015, it cannot be said that the “main purpose of creation of such an entity was to obtain the benefits” of the India- UAE tax treaty. Unless the purpose of creating the entity in question is to avail the India-UAE tax treaty benefits, the “limitation of benefit” clause in article 29 cannot come into play.

Our Comments

This is a welcome decision.

Whether Identification of testedparty is mandatory despite Comparable Uncontrolled Price (CUP) being the Most Appropriate Method (MAM) for Specified Domestic Transactions (SDT) of inter-unit power-transfer and acceptance of the ‘market value’ as the purchase price of electricity is an uncontrolled transaction for the purpose of determining the Arm’s Length Price (ALP)

Balarampur Chini Mills Ltd [TS-200-ITAT-2021(Kol)-TP]

Facts

The taxpayer is engaged in the business of manufacturing and sale of sugar, molasses and generation and distribution of power in the form of steam and electricity. The taxpayer claimed deduction u/s 80IA for the generation and distribution of power. It had considered the rate of electricity at INR 8.30 per Kwh, which was as per tariff orders issued by the Uttar Pradesh Electricity Regulatory Commission for the sale of electricity in that area. The taxpayer considered the said rate as a benchmark for selling electricity to other manufacturing units of the taxpayer company.

The Transfer Pricing Officer (TPO) alleged that the rate of electricity for claiming deduction shall be at INR 4.90 per Kwh, which was the ‘average rate’ at which the companies can sell electricity to the distribution licensees as governed by Electricity Act 2003 and the rate at which the taxpayer had sold electricity to other distributing third parties under the Power Purchase Agreement (PPA). The TPO disregarded the use of ‘market rate,’ which was considered by the taxpayer to benchmark its said inter-company transaction.

The Commissioner of Income-Tax Appeals [CIT(A)] agreed with the taxpayer's contention and granted relief to it.

Aggrieved, the Revenue contended before the ITAT (Income-tax Appellate Tribunal) that the TPO was right in adopting the ‘average rate.’

In addition to the above, the Revenue also submitted that there is no concept of the tested party when the CUP method is the MAM for determining the ALP.

The taxpayer further referred to the Electricity Act of Uttar Pradesh and submitted that it was legally eligible to sell power in the open market. The Revenue was factually and legally incorrect in stating that the taxpayer should not supply power in the open market.

Furthermore, the taxpayer contended that the sale of electricity under the PPA to the distribution companies could not be considered an uncontrolled transaction. Hence the ‘market rate’ as determined by the taxpayer was the correct comparable data that ought to be considered.

Ruling by (ITAT)

The ITAT placed its reliance on various judicial precedents wherein it was held that the ‘market value’ should be the rate at which the State Electricity Boards supply electricity to its industrial customers.

In relation to the selection of the tested party, the ITAT observed that since the ALP is the ‘market value’, there is no dispute that the MAM is CUP. In addition to the above, the ITAT held that the Revenue’s contention that since CUP was the MAM, there was no need to select a tested party is erroneous by placing reliance on the ICAI Guidance note.

In view of the above, the ITAT held that while determining the ALP under the Transfer Pricing provisions, the taxpayer had correctly identified the manufacturing unit as the tested party and CUP as the MAM and the purchase price of electricity in the open market from the State Electricity Board (SEB) to the manufacturing units in uncontrolled conditions as the ALP.

Our Comments

It is rightly adjudicated by the ITAT that the selection of the tested party is mandatory and the same has to be identified even when the CUP is the MAM. The ITAT in the present case has relied on the ICAI Guidance Note. Also, to conclude, the benchmarking analysis selection of a tested party becomes pivotal.

Resale Price Method (RPM) as MAM for benchmarking import of dental products and reselling to third party customers

Dentsply India Pvt Ltd [TS-205-ITAT-2021(DEL)-TP]

Facts

The taxpayer is engaged in the manufacturing and trading of dental products. The trading activities of the taxpayer constitute 95% of its business activities, and the remaining 5% is from manufacturing activities.

The taxpayer has imported dental products from its Associated Enterprises (AE) for the purpose of resale, which is the internal transaction under discussion.

In its transfer pricing study report, the taxpayer benchmarked the said transaction (purchase) by adopting the Transactional Net Margin Method (TNMM) as the MAM and the same was followed in the subsequent years as well. Subsequently, during the audit proceedings, the taxpayer submitted to the TPO that RPM is the most appropriate method with Gross Margin on sale as the appropriate Profit Level Indicator (PLI) to benchmark the said transaction.

The TPO argued that TNMM should be adopted as the MAM with net operating margin as the PLI. The TPO concluded that since the net operating margin of the taxpayer is less than that of the comparable companies, the transaction is not at arm’s length.

The taxpayer challenged the said action of the TPO before CIT(A). The taxpayer submitted that it had incurred a significant administrative cost due to the initial year of business, which had impacted the profit at the net level. The CIT(A) disregarded the contentions of the taxpayer by citing the following:

1. taxpayer was in its first year of operations and it thus incurred significant administrative costs
2. gross profit margin in the year under consideration is lower than the prioryear which disregards the taxpayer’s contention that it was in the initial year of its business
3. taxpayer has given a detailed explanation in its Transfer Pricing Study Report as to why RPM should not be considered as the MAM and accepted TNMM as the MAM.
4. taxpayer did not make the required adjustment to its profit (i.e., on account of the advertisement expenses) and left it to the TPO to make the same.

The Authorized Representative (AR) of the taxpayer, during the proceedings before the ITAT, submitted that the reasons as to why RPM should be considered as the MAM over TNMM. The AR held that the taxpayer was a distributor of goods and in the case of distribution, RPM should be considered as the MAM. In support of his contention, he referred to the Guidance Note issued by ICAI and relied on various judicial precedents.

In addition to the above, the taxpayer’s AR held that what is important while considering RPM as the MAM is the ‘functional comparability’ and not ‘product comparability.’ He relied upon the contents of the Organisation for Economic Co-operation and Development (OECD) guidelines and the guidelines issued by the ICAI.

Ruling by ITAT

The ITAT observed that considering the facts of the case and the functional profile of the taxpayer with respect to the transaction under litigation held that RPM was the MAM to benchmark the said transaction. The ITAT emphasized that while selecting RPM as the MAM, the focus should be on the same or similar nature of properties or services rather than the similarity of products.

The ITAT held that if it’s found that a particular method will not result in a correct determination of the ALP, then the taxpayer can adopt an alternate method to determine the ALP. The matter was remanded back to the TPO for fresh analysis considering RPM.

Our Comments

The said ruling has re-iterated the use of RPM as the MAM when a taxpayer procures goods/services from its AE and resells the same to an independent third party without physically altering them and adding and intangible assets to add substantial value.

Also, an important factor while considering RPM as the MAM would be ‘functional similarity’ and not ‘product similarity.’

Further, acceptance of a revised method to determine the ALP should be considered if the adoption of the revised method helps in the correct determination of the ALP.

Bright Line Test (BLT) not sustainable for Advertising, Marketing and Promotional (AMP) expenses. RPM as the MAM for import transaction

Luxottica India Eyewear Pvt Ltd [TS-193-ITAT-2021(DEL)-TP] AY (2013-14)

Facts

The taxpayer is primarily engaged in the business of trading sunglasses and spectacles frames in India. The taxpayer had incurred AMP expenses during the year under consideration.

The TPO, during the course of the assessment proceeding, made an adjustment on account of the AMP expenses incurred by the taxpayer in the regular course of its business on the ground that the said expenses were excessive and should be compensated by the respective AE.

The TPO held that the intensity of AMP expenses expressed as an ‘AMP/Sales’ ratio is much higher than that of the comparables, but the taxpayer is not suitably compensated for this additional function.

Further, the TPO considered TNMM as the MAM to benchmark the transaction pertaining to the import and ignored the ITAT’s ruling in the case of the taxpayer in one of the prior years wherein the said transaction was benchmarked by considering RPM as the MAM.

The DRP upheld the order of the TPO.

Ruling by ITAT

The ITAT accepted the RPM as the MAM, relying on the Tribunal’s judgment in taxpayer’s own case in the prior year.

Regarding the AMP adjustment, the ITAT held that the TPO instead of making any AMP intensity adjustment in the profit rate of comparables considered AMP expenses as a separate international transaction and determined its ALP independent of the purchase transaction.

Since the facts of the case for the year under consideration were covered by the previous judicial precedents in case of the taxpayer itself, the ITAT directed the adjustment to be made considering RPM as MAM.

In relation to the application of the BLT approach proposed by the Revenue (on a protective basis) for computing the transfer pricing adjustment towards AMP, the ITAT relied upon the various judicial precedents wherein the application of BLT was rejected.

Our Comments

The Revenue’s attempts to bring in AMP expenses within the ambit of transfer pricing stems from an understanding that incurring such expenses necessarily entails a benefit to the foreign AE in terms of enhancement of brand value. The need for making a transfer pricing adjustment arises because of the absence of an adequate compensation in exchange for the benefit.

However, the said issue of marketing intangible/brand development has been subjected to intense litigation. Therefore, it is only a matter of time when the Revenue in this case would again challenge the order of the ITAT before the High Court.

(i) Whether books supplied by the applicant from a warehouse located in the USA to the customers located in USA, UK and Canada without such books entering in India constitute as ‘supply’ under GST?

(ii) Can GST be levied on shipping charges collected by the applicant from the customers located outside India for delivering the books?

(iii) Whether printing charges collected by the printer located in the USA, where only content is supplied by the applicant, taxable under Reverse Charge Mechanism (RCM)?

(iv) Whether warehousing services provided by the foreign service provider to the applicant taxable under RCM? and

(v) Can Input Tax Credit (ITC) be availed to the extent of input and input services on the transactions covered under Question 1?

M/s. Guitar Head Publishing LLP [2021 (4) TMI 929- AAR, Karnataka]

Facts

• The applicant is engaged in selling guitar training books to customers located in USA, UK and Canada.
• The applicant would send a soft copy of the books to the printer in USA, which would in turn print and ship the paper books to the customers in USA, UK and Canada without bringing the same to India.

Based on the above, the AAR ruled as follows:

Question (i)

The supply of books from the warehouse to the customers will not be treated as a supply under GST in view of Clause 7 of Schedule III, i.e., “Supply of goods from a place in the non-taxable territory to another place in the non-taxable territory without such goods entering into India.”

Question (ii)

• The applicant, though collects the shipping charges from the customers, actual shipping of the books happens outside India, a non-taxable territory, by the agent of the applicant.
• Thus, the shipping charges collected by the applicant from the customers located outside India for delivery of books from the warehouse located outside India are not exigible to GST.
• The charges paid by the applicant for receiving shipping services from the warehouse agent in the non-taxable territory should be treated as ‘import of services’ and would be liable to GST under RCM.

Question (iii)

• The supplier of printing services is located outside India, the recipient, i.e., the applicant, is in India and the place of supply of service is India.
• Consequently, printing charges collected by the printer from the applicant are taxable under RCM.

Question (iv)

• Though the supplier is located outside India and the recipient is located in India, the place of supply of service is outside India, in terms of Section 13 of IGST Act 2017.
• Therefore, the warehousing services of printed books would not constitute as ‘import of services’ and hence, would not be exigible to GST on a reverse charge basis.

Question (v)

Lastly, as the supply of books from the warehouse to the customer is not chargeable under GST, the applicant is not entitled to avail ITC on inputs and inputs services on the said transactions.

Our Comments

The ruling in respect of Question nos. (i) to (iv) is in line with the prevalent understanding in the industry.

However, Section 17, while restricting the ITC in respect of effecting exempt supplies specifically excludes transactions covered under Schedule III from the expression ‘value of exempt supply’. Therefore, the ruling in respect of question no. (v) restricting the claim of ITC may not stand scrutiny by appellate authorities.

Whether the issue and supply of own closed Pre-Paid Instrument’s (PPIs) by the appellant to its customers will be treated as supply of goods or supply of services?

M/S. Kalyan Jewellers India Limited [2021 (4) TMI 885- AAAR, Tamil Nadu]

Facts

• The appellant is engaged in the manufacturing and trading of jewelry.
• The appellant provides PPIs to their customers as a part of sales promotion activity. These PPIs are called ‘gift vouchers/cards.’
• According to the appellant, the vouchers are not marketable as they have a redeemable value and have no intrinsic value.
• The vouchers are issued to the customers in cards and in digital formats; they are not sold to them.

Based on the above, the AAAR ruled as follows:

• Both, Sections 12 and 13 of the CGST Act, 2017, which deal with determining the time of supply for goods and services, respectively, use the term ‘voucher.’ This indicates that the voucher relates to both goods as well as services.
• A voucher is a means for advance payment of consideration for the future supply of goods or services.
• When a voucher is issued, though it is just a means of advance payment of consideration for a future supply, Sections 12 and 13 determine the time of supply of the underlying goods or services.
• Voucher per se is neither goods nor service.
• It, therefore, follows that where a voucher identifies the goods or service that can be received on redeeming, the supply of the underlying goods or service takes place at the time of issue of the voucher.
• Therefore, the gold voucher (representing the underlying future supply of gold jewelry) would be taxable at the time of issue of the voucher.
• It must be emphasized that this interpretation does not result in double taxation as transfer of gold subsequently will not be subject to tax at the time of redeeming the voucher for gold, as the supply is deemed to have been done at the time of issue of the voucher itself.

Our Comments

On one end, the GST law defines a voucher as an instrument creating an obligation to accept it as consideration for the supply of goods or services, while the time of supply provisions refer to ‘supply of vouchers by a supplier’ thereby equating it with goods/services. This has created complexities in the taxability of vouchers.

The question of whether ‘voucher’ can be treated as an ‘actionable claim’ creates an additional layer of complexity.

The present ruling by the AAAR clearly states that a ‘voucher’ itself is neither goods nor service but simply a form of consideration for the actual supply of goods or services. The ruling brings in much-needed clarity to taxpayers with a similar business model.

However, the question of taxability in scenarios such as where a voucher is sold by a different party and ultimate goods/services are supplied by a different party remains unanswered.