From The Judiciary

Can an individual with dual residency is treated as a resident for India tax purposes under Article 4 of the India-US tax treaty, based on his economic ties?

Ashok Kumar Pandey [TS-736-ITAT-2024(Mum)]

Facts

The Assessee, filed his return of income, declaring an income of INR 9500. The Assessee was a dual resident of India as well as USA and he claimed that his ‘center of vital interest’ was in the USA under Article 4(2)(a) of the India-US tax treaty and thus, he was a US resident for tax purposes. Assessee is a US passport holder, and his family primarily resides in the USA. However, he actively manages a company in India with a substantial financial involvement.

The key issue was whether the Assessee, who claimed dual residency in India and the U.S., should be treated as a U.S. resident for tax purposes under the India-U.S. Double Taxation Avoidance Agreement (DTAA).

The AO argued that based on the Assessee’s presence in India for over 183 days, the AO classified him as a resident of India under Indian tax law and assessee’s active business involvement in India.

The case was brought before the Mumbai Tribunal or Mumbai Income Tax Appellate Tribunal (Mumbai ITAT), which examined the ‘tie-breaker’ rule of the DTAA.

Held

After applying tie-breaker rule, the Mumbai ITAT held the following:

• It determined that, based on his active role in the Indian company, substantial time spent in India, and primary residence with his family in India, the Assessee's center of vital interest was closer to India.
• It emphasized that personal and economic relationships, including active business management, took precedence over passive investments in establishing residency.
• Concluding that the Assessee was an Indian resident under Article 4(2)(a) of the India-US DTAA, the Mumbai ITAT dismissed the appeal, confirming that his global income, including income sourced from the USA, is taxable in India under Indian tax laws.

Our Comments

The decision highlights the application of the ‘tie-breaker’ rule under the India-U.S. DTAA, focusing on the importance of clear and substantial connections to a country for residency claims and how both personal and economic relationships can influence tax residency under international treaties.

Can sales and marketing services provided by a foreign subsidiary be considered FTS under Section 9(1) (vii) or the India-US DTAA, thereby triggering Tax Collection at Source (TDS) under Section 195?

Algonomy Software Pvt. Ltd [TS-773-ITAT-2024(Bang)]

Facts

The Assessee, Algonomy Software Pvt. Ltd. is a domestic software and IT-enabled services (ITeS) company. The Assessee had made payments of sales commission to its US subsidiary (Manthan Systems Inc.) and other associated enterprises (AEs) for marketing services. The Assessee did not deduct TDS on these payments.

During the assessment, the AO argued that these payments are classified as Fees for Technical Services (FTS) under the Act and Article 12 of the India-US tax treaty.

The Assessee argued that the services rendered by the US subsidiary did not meet the ‘make available’ conditions under Article 12 of the India-US DTAA, which would require transfer of technical knowledge or skills for classification of FTS. Assessee submitted that the issue is squarely covered by the decision of the coordinate bench in Assessee’s own case¹ for AY 2012-13 to 2015-16, where similar payments were held outside the scope of FTS, supporting the position that no TDS was required.

The Revenue took the matter before the Bangalore Income Tax Appellate Tribunal (Bangalore ITAT).

Held

It deleted the disallowance under Section 40(a)(ia) of the Act on payments made by an Indian company to its US subsidiary as sales commission.

It held that the sales and marketing services rendered to Assessee by its US based subsidiary does not fall within the ambit of FTS as defined under Section 9(1)(vii) or Article 12 of India-US DTAA, thus, liability to deduct tax at source u/s 195 does not arise.

It was held that income received towards sales commission is not in the nature of managerial, technical, and consultancy services.

Our Comments

This case addresses a common dilemma on the payments of sales commission for sales and marketing services to foreign subsidiaries. Like many other similar precedents on this aspect, the Bangalore Tribunal has continued to uphold the position that payment of commission will not be FTS in the absence of any technical, managerial or consultancy services.

Delhi High Court Dismisses Revenue's Appeal: 'Other Method' can be considered as most appropriate method only after appropriately rejecting other methods

Sabic India Pvt Ltd²

Facts

The taxpayer merely provides marketing support services to its associated enterprises (AEs) to facilitate sale of fertilizers, chemicals and polymers and does not enter into any contract with the customer. The taxpayer used Transactional Net Margin Method (TNMM) as the most appropriate method with OP/VAE (Operating Profit/ Value Added Expenses) as the profit level indicator for benchmarking its international transactions. The taxpayer furnished that the fees received from its AE were a percentage of sales of various products. However, the Transfer Pricing Officer (TPO) rejected this approach and instead applied the "other method" under Rule 10B(1)(f), claiming it was more appropriate due to the nature of taxpayers operations as a commission agent without title to inventory. This adjustment resulted in a significant upward revision of INR 3.61 billion to the taxpayer income leading to an appeal that was ultimately resolved in the High Court (HC). The taxpayer contended that TNMM was the most appropriate method as it had been consistently used for prior assessment years (2009-10 to 2014-15) without challenge from the TPO. Taxpayer further argued that the TPO did not justify the shift to the ‘other method’ and that the comparables selected were not suitable due to differing business models.

Held by ITAT

The ITAT was in favor of the taxpayer contentions, ruling that the TPO's rejection lacked sufficient justification and also that the selection of comparables could not be a ground for rejecting the method. ITAT emphasized that the principle of consistency should prevail, as TNMM had been accepted in prior years. The ITAT was of the view that the use of the “other method” under Rule 10AB is permissible only if none of the primary five methods are applicable, which, in the taxpayers case, was not established by the TPO.

Held by High Court

The Delhi High Court upheld the ITAT’s ruling, agreeing that the TPO had unjustifiably rejected the TNMM method. The Court highlighted the principle from the Supreme Court’s ruling in Radhasoami Satsang v. CIT, which stresses the need for consistency in tax treatment unless there are substantial reasons for change. The High Court observed that the TPO provided no specific reasons for dismissing TNMM, which had been applied in previous years. The Court also clarified that the "other method" under Rule 10AB should only be applied if none of the five prescribed methods are suitable, a criterion the TPO failed to establish. Given these observations and the inconsistencies in the comparables chosen by the TPO, the High Court dismissed the Revenue’s appeal and ruled in favour of the taxpayer, reaffirming that the international transactions were at arm’s length.

Our Comments

The High Court’s decision underscores the importance of consistency in transfer pricing methods and reinforces the need for thorough justification and appropriate rejection of other methods before shifting to the ‘other method.’ The case also highlights that comparables must reflect similar functional and transactional profiles to maintain the reliability of the transfer pricing analysis.

ITAT Rejects notional interest on sum advanced to AE for subscription of shares, as the delay in allotment of shares was due to delay in granting of statutory approvals and the same was not attributable on taxpayer or its AE

Aries Agro Limited

Facts

The taxpayer had, prior to 2010, remitted funds for subscription of shares to its AE registered in UAE. Until the year under consideration no shares were allotted to the taxpayer due to inordinate delay in granting of approval by the statutory authority of the AE i.e. the Sharjah Airport International Free Zone (SAIF) for increasing the share capital and allotment of the shares. The TPO made an addition for notional interest on share application money overdue and the same was upheld by Dispute Resolution Panel (DRP). The DRP disregarded the application made in the year 2017 by the Appellant and its AE seeking status request from SAIF as the same was not acknowledged. Aggrieved by the final order passed pursuant to the directions of the DRP, the Appellant preferred an appeal before the ITAT.

Held by ITAT

The ITAT observed that similar additions were made in the case of Appellant for earlier years and ITAT ruled in favor of Appellant as the delay in allotment of shares was attributed solely due to delay in granting the approval from SAIF. Further on the status application filed before SAIF by the Appellant and AE, the ITAT didn’t consider the same as the same was not acknowledged. However, the delay in allotment of shares can’t be attributed to the Appellant or its AE as the same was due to operation of the law. Thus, ITAT accepted Appellant’s contention that share application money can’t be re-characterized as loan advanced to its AE, merely due to inordinate delay in allotment of shares.

Our Comments

The ITAT’s decision signifies that circumstantial evidence and facts needs to be weighed in for the purpose of making any addition to income. Further, statutory and operational issues needs to be taken into consideration by the tax authorities. It can also be observed that the acknowledged copy of communication with relevant authorities may have helped taxpayer in avoiding further litigation.

Whether clauses (c) and (d) of Section 17(5) of the CGST Act restricting the eligibility of ITC in respect of works contract services, and goods, and/or services used for construction of immovable property, were constitutionally valid?

Whether the time limit to avail ITC prescribed under Section 16(4) is arbitrary and discriminatory in nature?

Chief Commissioner of Central Goods and Services Tax & Ors. vs. Safari Retreats Private Limited & Ors. [TS-622-SCC-2024-GST]

Note

Section 17(5)(c) reads as follows:

‘(c) works contract services when supplied for construction of an immovable property (other than plant and machinery) except where it is an input service for further supply of works contract service’

Section 17(5)(d) reads as follows:

‘(d) goods or services or both received by a taxable person for construction of an immovable property (other than plant or machinery) on his own account including when such goods or services or both are used in the course or furtherance of business.’

Further, the Explanation to Section 17 states:

“For the purposes of this Chapter and Chapter VI, the expression "plant and machinery" means apparatus, equipment, and machinery fixed to earth by foundation or structural support that are used for making outward supply of goods or services or both and includes such foundation and structural supports but excludes:

1. land, building or any other civil structures;
2. telecommunication towers; and
3. pipelines laid outside the factory premises.”

Facts

• In 2019, Orissa HC read down the provisions of Section 17(5)(d) while concluding that if the Assessee was required to pay GST on the rental income from the mall, it would be entitled to ITC of the GST paid on the construction of such mall.
• It was held that the narrow interpretation given by the Department to Section 17(5)(d) would frustrate the very object of the Act.
• Consequently, the Revenue approached the Supreme Court challenging the aforesaid HC judgement.

Ruling

Discussion on Section 17(5)(c) and (d)

• SC noted that Section 17(5)(d) is different from clause (c) in various aspects. There are two exceptions in clause (d):
  • First, where goods and/or services are received to construct an immovable property consisting of a “plant or machinery”;
  • Second, where the construction of immovable property is not on the taxable person’s own account.
  • Construction is said to be on a taxable person’s “own account” when (i) it is made for his personal use and not for service, or (ii) it is used by the person constructing as a setting in which business is carried out. However, construction cannot be said to be “on own account” if it is intended to be sold or given on lease or license.
• On the other hand, clause (c) operates in a completely different field. It applies only to works contract services supplied for the construction of immovable property.
• It further observed that the expression ‘plant or machinery’ used in Section 17(5)(d) cannot be given the same restricted meaning as the expression ‘plant and machinery’ defined by the Explanation to Section 17, which excludes land, buildings or any other civil structures. The legislature has made the distinction consciously.
• Therefore, in a given case, a building can also be treated as a plant, which is excluded from the purview of the exception carved out by Section 17(5)(d), held the Court.
• Whether a mall, warehouse or any building other than a hotel or a cinema theatre can be classified as a plant within the meaning of the expression ‘plant or machinery’ is a factual question, which should be determined by applying the functionality test.
• Consequently, the Apex Court dismissed the challenge to the Constitutional validity observing that the provisions involved intelligible classification with a rational nexus to the legislative objective.

Discussion on Section 16(4)

• As per the Court, the Assessee had failed to show how the provision, which restricts ITC after 30 November following the end of FY, was arbitrary and discriminatory. It remarked, ‘The fact that the provisions could have been drafted in a better manner or more articulately is not sufficient to attract arbitrariness.’

Our Comments

The judgement is expected to ease the financial burden on industries involved in property development and leasing, marking a crucial shift in how ITC regulations are applied in these cases. However, the application of functionality test has been left open for interpretation by the GST authorities.

Given this, it would be imperative that the GST Council issues clear clarifications/guidelines on this matter, including on applicability of this ratio to other sectors such as ports, airports, factories, warehouses, data centers, etc., as well as treatment of ITC in relation to works contract services availed for construction of immovable property for leasing purposes.

Further, it would be interesting to see whether any retrospective or prospective amendment is made to the legislation to mitigate the implications of this judgement.