From The Judiciary

Whether ancillary services linked to equipment-purchase qualify as 'Fees for Included Services'?

Electronics Corporation of India Ltd Vs ACIT ITA No.228/HYD/2017

Facts

The taxpayer is a Central public sector undertaking company engaged in manufacturing and selling electronic goods and components. During the year under consideration, the taxpayer paid a sum of INR 23.1 million to BAE systems, an entity incorporated in the USA, towards site testing charges. The taxpayer adopted a view that the equipment's installation, testing and supply are integral parts of a single purchase order and the sum paid for supplementary and subsidiary services cannot be considered as "Fees for Included Services". In view of above the taxpayer did not withhold any taxes on the above payments for site testing.

The Assessing Officer (AO) opined that the site testing charges paid by the taxpayer should be considered as Fees for Technical Services (FTS) as separate invoices were raised by the USA entity for the completion of the site acceptance. Thus the AO held that the above charges shall be liable for withholding of taxes.

This was upheld by the first Appellate Authority. Aggrieved by the order, the taxpayer filed an appeal before the Hyderabad Tribunal.

Held

On perusal of the sales invoice, the Tribunal stated that the main focus of the agreement is only on the purchase and installation of the radar system and the fees paid for completing the site acceptance test and finalizing the on-site training in India are essentially ancillary and subsidiary services. The Tribunal noted that the USA entity's incidental services mentioned in a sales invoice cannot be independently or solely offered to the taxpayer since the equipment must first be purchased and installed. Furthermore, Article 12(5) (a) of the India-USA Double Taxation Avoidance Agreement (DTAA) excludes the services which are ancillary and subsidiary and are inextricable and essentially linked to the sale of property from the purview of 'Fees for Included Services.' Accordingly, the Tribunal held that services inextricably linked with the purchase of equipment and forming an integral part of the said supplies would not be amenable to tax under India-USA DTAA.

Our Comments

The Hyderabad Tribunal held that where services are delivered in conjunction with the acquisition of equipment, there is no obligation to withhold tax as India- USA DTAA provides a specific exclusion for the same.

Whether payment made for clinical trial and testing services would qualify as Royalty or FTS?

M/s. Cadila Healthcare Ltd.Vs ACIT ITA Nos. 711 & 1140/AHD/2019

Facts

The taxpayer is a global pharmaceutical company based out of India. During the year under consideration, the taxpayer made several payments to several nonresidents in USA and Canada for Clinical trials. The taxpayer adopted a view that such income is non-taxable business income under the India-USA and India- Canada DTAA in the absence of its Permanent Establishment (PE) in India.

The AO concluded that payments made by the taxpayer to USA and Canada entities should be considered as FTS/ Royalty and hence taxpayer was liable for withholding tax on the said amount.

On appeal by taxpayer, the Commissioner of Income-tax(Appeals) CIT(A) held that taxpayer was not liable to deduct tax at source on the payments made as it did not qualify as FTS/Royalty. Aggrieved by the order, the revenue has raised the aforesaid grounds before the Ahmedabad Tribunal.

Held

After considering the data on record, the Tribunal stated that for those payments to fall under fees for technical services as per respective DTAA, the service providers should have made the technical knowledge, experience, skill, know-how, etc., available to the taxpayer. The Tribunal specified that clinical trials only provided final results to their taxpayer by using highly sophisticated bio-analytical procedures. However, the service provider did not provide any access whatsoever to the taxpayer to such know-how for conducting trials. Hence the make available condition of the respective DTAA are not satisfied. Furthermore, Tribunal also held that by nature, such payments cannot fall within the ambit of Royalty.

Thus the Tribunal stated that these payments constitute business income and in the absence of the Indian vendor’s PE, these payments are not chargeable to tax in India.

Our Comments

The Ahmedabad Tribunal has reestablished the principle that "make available test" is a pre-requisite for qualification of a transaction to be FTS where the definition of FTS is restrictive.

Whether premium on redemption of preference shares can be treated as deemed dividends?

M/s. Information Technology Park Ltd TS-563-ITAT-2022(BANG)-TP

Facts

In 2003, the taxpayer issued 0.5% redeemable non-cumulative preference shares to its Associated Enterprise (AE) at face value of INR 100 per share. In AY 2009-10 and AY 2010-11, the taxpayer redeemed the preference shares at a premium based on the valuation done by the expert valuer by adopting the Net Asset Value (NAV) method.

TPO’s Contentions

Under the NAV method, the Transfer Pricing Officer (TPO) reworked the redemption value based on the book value of assets instead of the fair value (guidance value) of assets, viz., land and building adopted by the taxpayer. Thus, the AO made an addition of INR 370 million under Section 93¹ of the Incometax Act, arising out of the difference between the redemption value adopted by the taxpayer (INR 900) and the TPO (INR 270).

CIT(A)’s Contentions

Rejecting the applicability of Section 93, CIT(A) retained the addition by stating that excess premium paid by the taxpayer on redemption of preference shares would constitute deemed dividend u/s 2(22). Furthermore, the consideration paid by the taxpayer on redemption of preference shares is artificially inflated and is a colorable device for transferring funds to the AE by avoiding payment of Dividend Distribution Tax (DDT).

Held by the ITAT

Whether valuation of preference shares should be based on the book value of fair value of assets?

On reading of Rule 11UA of Income Tax Rules, the Income Tax Appellate Tribunal (ITAT) opined that while calculating the valuation of preference shares, the immovable properties are to be considered at guideline value² and not book value. Thus, the TPO’s approach of computing the differential premium basis the book value of assets is not sustainable.

Can the premium on redemption of preference shares be treated as deemed dividends?

Under the Companies Act, payment of premium on redemption of shares is allowed while payment of the dividend is prohibited from “securities premium” being a specific (and not free) reserve. Furthermore, a preference shareholder is entitled to a fixed rate of dividend and cannot participate in the surplus assets on liquidation. The payment made by the taxpayer towards the premium of redemption of preference shares is neither towards reduction of share capital nor towards advance or loan. Thus, the excess premium (if any) paid to the AE by the taxpayer on redemption of preference shares cannot be taxed u/s 2(22) (d) or 2(22) (e) of the Act.

Our Comments

Companies often issue quasi-equity instruments carrying a nominal interest or dividend as an alternative funding option. The valuation of such instruments, especially where they are unlisted (as prescribed under Rule 11UA), is based on the litigious “open market value.” The above ruling clarified the use of guideline value for an immovable property while computing the open market value of such instruments. Furthermore, it has also upheld that the premium on redemption of preference shares cannot be treated as deemed dividends.

Whether equating compulsorily convertible debentures (CCDs) issued with equity - a valid ground for denying deduction of interest payment?

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Whether GST is liable on renting of residential dwelling in terms of Notification No. 4/2022-Central Tax (Rate) dated 13 July 2022, where such a dwelling is rented on a personal capacity and not in the course or furtherance of business?

Seema Gupta vs. Union of India & Ors. 2022 (9) TMI 1387 – Delhi High Court

Note: By virtue of Notification No. 4/2022-Central Tax (Rate), the exemption granted for residential accommodation is no longer available to tenants who are registered under GST.

Facts

• Writ petition was filed before the Delhi HC by a proprietor of a proprietorship firm, challenging clause (A)(b) of Notification No. 4/2022-Central Tax (Rate) as being ultra vires Article 14 of the Constitution and also beyond the powers conferred under the GST law.
• According to the petitioner, denial of exemption solely on the basis that the tenant is registered under GST is not based on any intelligible differentia and the said differentia has no rational relation to the object sought to be achieved.
• The Department filed a counteraffidavit before the Court, wherein it was averred inter alia that “…where the residential dwelling is rented by a person who is the proprietor of a proprietorship firm in his personal capacity for use as his own residential dwelling, and such renting is not on account of its business, i.e., not accounted for in the firms account but is on a personal account, the exemption shall continue to be available to him… The same would be the position in case of partnership firms or other forms of businesses.”
• In the supplementary affidavit, the Department also stated that a proposal to amend the impugned Notification to bring in greater clarity regarding the taxability of registered persons is being examined to be placed before the GST Council, as the same does not specify that GST would be charged only where the registered person has rented (taken on rent) residential dwelling in the course or furtherance of business.

Ruling

• The Court accepted the clarification from the Department that renting of residential dwelling in a personal capacity and not for use in the course or furtherance of business and such renting being on his/her own account and not that of proprietorship firm shall be exempt from GST, and held all the Respondents bound by the same.
• Accordingly, the Court disposed of the writ petition along with the application with no further orders.

Our Comments

The ruling attains significance in light of the ambiguity surrounding the taxability of renting of residential dwellings on a reverse charge basis in the hands of registered persons.

While the Department sought to clarify the issue through a series of tweets, a Circular or a clarificatory amendment to Notification No. 12/2017-Central Tax (Rate) r/w Notification No. 13/2017-Central Tax (Rate) in line with the clarification accorded to the High Court should settle the dust and plug any potential litigation on this issue.

Whether the appellant-assessee is entitled to make the pre-deposit of duty, payable as per the requirement of Section 35F of the Central Excise Act, by debiting the Electronic Cash Ledger and Electronic Credit Ledger under the GST regime?

Johnson Matthey Chemical India Pvt. Ltd. vs Asst. Commissioner CGST and Central Excise, Kanpur TS-387-CESTAT-2022-EXC

Note: Recently, the Bombay HC in the case of Oasis Realty vs. Union of India & Ors. [TS-493-HC(BOM)-2022-GST] observed that subsequent to Orissa HC order in Jyoti Construction, the CBIC Circular dated 6 July 2022 has clarified that any amount towards output tax payable, as a consequence of any proceeding instituted under the provisions of GST laws, can be paid by utilization of the amount available in the Electronic Credit Ledger. Accordingly, HC interpreted the provisions of Section 49 of the MGST Act r/w Section 107(6) of the MGST Act and held that a party could pay 10% of the disputed tax either using the amount available in the Electronic Cash Ledger or in Electronic Credit Ledger.

Facts

• The Commissioner (Appeals) had not accepted the mandatory pre-deposit of 7.5% under Section 35F of the Central Excise Act by way of reversal of CGST credit in GSTR-3B, and had accordingly rejected the appeal.
• Hence, the assessee-appellant approached the CESTAT. However, the Registry of the Tribunal also pointed out the defect vis-à-vis pre-deposit of 10%, given that the additional amount of 2.5% was deposited vide DRC-03 challan.
• As per the assessee-appellant, such a mode of pre-deposit was permissible in view of the Circular No. 15/CESTAT/General/2013-14 dated 28 August 2014 issued by the Tribunal, decisions of Tribunal and Courts and looking to the fact that credit balance under old regime had been subsumed in the new credit under the GST regime. Reliance was placed on the decision of the Tribunal in Dell International Services India Pvt. Ltd. vs. Commissioner of Central Tax [2019-TIOL-286-CESTAT-BANG] and it was claimed that the Tribunal Registry had accepted a similar deposit by Cargill Business Service India Pvt. Ltd.
• On the other hand, the Department argued that Section 41 of the CGST Act does not permit such payment, as was held by Orissa HC in Jyoti Construction vs. Deputy Commissioner of CT & GST [2021 (10) TMI 254 – Orrisa High Court] and that the said decision needs to be followed over the decision of Tribunal as per judicial discipline.
• According to the Department, Section 174(2)(f) of CGST Act envisages the continuation of proceedings of past cases of erstwhile repealed Central Excise Act as if such Act had not been repealed; hence, pre-deposit should be made under Section 35F and not under CGST Act.

Ruling

• In Dell International Services India Pvt. Ltd, the Tribunal accepted the appellant’s contention as the Department did not dispute that mandatory pre-deposit can be made through the CGST credit. However, the same was an interim consent order, as pointed out by the Department in the instant case.
• Moreover, the judgment of Orissa HC in Jyoti Construction considered the provisions of Section 41 and held that CGST Act has no provision for the utilization of credit other than for payment of self-assessed output tax.
• The decision of HC is binding on the Tribunal and the assesse-appellant did not produce any judgment of any other HC which supports its contention.
• In view of the above, Tribunal held that the mandatory pre-deposit under Section 35F cannot be made by way of debit in the Electronic Credit Ledger maintained under the CGST Act and to that extent, granted four weeks time to cure the defect.

Our Comments

The mode of pre-deposit in appeals relating to the erstwhile Central Excise/ Service Tax regime has become a subject matter of dispute between the taxpayers and the Department. A clarification or procedural guidelines from the CBIC to this extent is the need of the hour.

Rejecting re-characterization of preference shares as debt Tribunal denies notional taxation of redemption premium before redemption

Enzen Global Solutions Pvt. Ltd TS-739-ITAT-2022(BANG)

The assessee had invested in preference shares of an investee company at face value. The preference shares were redeemable at the end of 20 years at a premium. While in the original return of income filed, the assessee considered the premium to be taxable as income from other sources and offered a proportionate amount to tax, in the revised filing, the assessee considered it to be a taxable in the year of redemption as capital gains. However, noting that preference share has features of both equity and debt as dividend payments are fixed at the beginning and mercantile basis of accounting, the tax department considered the preference shares to be in the nature of debt and taxed the premium component as income from other sources.

At the appellate level, The Bangalore ITAT bench upheld the submission of the assessee that the payment of redemption premium can be only out of profits of the company or reserves and even if one were to regard the premium as akin to a dividend, the assessee cannot claim dividend as a matter of right and it is for the directors of the company to declare dividend which needs to be approved by the shareholders in an AGM. It held that the preference shares issued to the assessee cannot be considered to be in the nature of equity. It further explained that inference of accrual of premium akin to the accrual of interest in case of a loan cannot be drawn and the repayment of the face value of the preference shares as well as the premium on redemption is uncertain. Placing reliance on the decisions distinguishing a bond or a debenture from a preference share, it held that the revenue authorities cannot disregard the legal effect of the issue of cumulative preference shares and say that the same is akin to debt.

Our Comments

This decision has duly taken the legal effect and related aspects of the shares into consideration while deciding on the taxation of the redemption premium component.

While this decision deals with the taxability of the premium element, the observations emanating from the decision would also be relevant from the perspective of valuation provisions where ambiguity may arise on categorization to be considered for security, especially the convertible instruments.

Notification of modified return form to be filed by the successor in cases of business reorganization or restructuring and extension for its filing

Section 170A was introduced to the Income-tax Act, 1961 vide Act Finance Act 2022 to enable the entities going through business reorganization to file modified returns for the period between the date of effectivity of the order and the date of issuance of the final order of the Tribunal or Court. The modified return is to be furnished within six months from the end of the month in which the said order has been issued.

In pursuance thereof, Rule 12AD has been inserted to provide for procedural aspects in relation to such filing. Notably, the modified return has to be furnished under a digital signature in Form ITR-A. However, this has reduced the time available for furnishing modified returns for successor companies in cases where the business reorganization order was issued between 1 April 2022 and 30 September 2022.

In order to address this genuine hardship and provide adequate time for furnishing of return under Section 170A of the Act, the timeline shall stand extended to 31 March 2023.

Our Comments

This decision has duly taken the legal effect and related aspects of the shares into consideration while deciding on the taxation of the redemption premium component.

While this decision deals with the taxability of the premium element, the observations emanating from the decision would also be relevant from the perspective of valuation provisions where ambiguity may arise on categorization to be considered for security, especially the convertible instruments.

MCA modifies the definition of a “Small Company” under the Companies Act 2013

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