APRIL 01-15

Direct Tax

Transfer Pricing

Indirect Tax

WHAT'S INSIDE...

What’s inside… DIRECT TAX

1. Cost to be substantiated for claiming deductions under cost

allocation agreements 2. Karnataka High Court grants Foreign Tax Credit to tax holiday

entities 3. Debenture interest paid upfront is deductible in the year of

payment irrespective of the treatment in books of accounts 4. Tribunal ruling on Gift transactions by companies 5. The salient features of the Undisclosed Foreign Income and

Assets (Imposition of Tax) Bill, 2015 TRANSFER PRICING 6. Tribunal sets ALP for guarantee commission fee at 0.5% and

interest at the rate of LIBOR+2% for loans to associated enterprises

7. Delhi High Court landmark ruling on marketing intangibles 8. Rollback of Advance Pricing Agreements INDIRECT TAX

9. Taxability of Services under ‘works contract’ pre 2007 upheld by CESTAT

02

1. Cost to be substantiated for claiming deductions under cost allocation agreements

The taxpayer, a tax resident of the United Kingdom, was engaged in the business of exploration and production activities in the oil and gas sector. The taxpayer provided support services to its group entities and expenditure incurred in this regard was charged to such group entities without any mark-up.

BG Exploration and Production India Limited [‘BGEPIL’], an Associated Enterprise [‘AE’] of the taxpayer entered into a production sharing contract [‘PSC’] with the Government of India along with Oil and Natural Gas Commission and Reliance Industries Limited, for exploration and production of oil and gas hydrocarbons in India. BGIL had rendered various services to BGEIPL on a cost-to-cost basis, and had received reimbursement of an amount of INR 972,898,465. In the return of income, the income element in the receipts of INR 972,898,465 was considered to be at NIL as an amount equal to INR 972,898,465 was claimed as deduction towards expenditure incurred. The Assessing Officer disallowed the expenses in the hands of BGIL on the grounds that the taxpayer failed to provide any worthwhile evidence to substantiate expenses incurred; there was no evidence of actual rendering of services; and the taxpayer did not give any explanation as to how BGEIPL was charging the amount of accrual overhead to the taxpayer, as BGEIPL was supposed to charge this to its parent and not to the taxpayer.

DIRECT TAX

05 05

Aggrieved, the taxpayer approached the Dispute Resolution Panel [‘DRP’] which agreed with the AO’s view, though it allowed the deduction for few expenses in respect of which third party evidence was submitted. Aggrieved with the DRP’s decision, the taxpayer filed an appeal before the Income Tax Appellate Tribunal. Before the Income Tax Appellate Tribunal, the taxpayer contended that – The Principle of res-judicata did not operate in income tax proceedings.

Accordingly, the fact that during earlier years, the income was assessed under section 44BB of the Act should not be considered as precedent for all the years. The taxpayer drew reference the ITAT’s order for AY 2006-07 on the same issue where the issue had been decided in the taxpayer’s favor;

The taxpayer referred to the global allocation policy of the taxpayer, which iterated the allocation policy of the overhead costs (cost-to-cost basis). It was mentioned that the cost allocation policy was quite reasonable, and that the policy had been validated by two independent consultants;

Reliance was placed on the decision of High Court in the case of Enron Oil and Gas Limited [305 ITR 68], wherein it had been held that the taxability of income of each member of PSC had to be determined in terms of section 42, which overrode other provisions of the Act. As per section 42, in addition to the allowances admissible under the Act, allowances specified in the agreement with the Central Government also had to be allowed.

The Revenue, on the other hand, contended that the evidence produced by the taxpayer was insufficient to prove that the expenses had been incurred for rendering the services in the arrangement. With regard to the Tribunal earlier decision in the assessee’s own case, the Revenue pointed that the taxpayer had produced invoices, and therefore its appeal had been

dismissed. Regarding the taxpayer’s without prejudice contention that the assessment should be made under section 44BB, the Revenue argued that the taxpayer’s profits were taxable under Article 7 of the India-UK tax treaty on a net basis. With regards to the BGIL’s global cost allocation policy as certified by independent consultants, the Revenue argued that the report of independent consultants only mentioned that the overhead cost allocation and time writing policy of the group has been adhered to and did not certify cost allocation to businesses and benefits. The Income Tax Appellate Tribunal observed and ruled as under – The taxpayer’s reliance on the Tribunal’s earlier judgment could not be

accepted, as the decision was in light of the finding that the taxpayer had provided invoices and supporting to substantiate the expenditure which was not the case in the present case.

It was a well-established principle that unless the taxpayer was able to substantiate its claim, deduction could not be allowed. The taxpayer had failed to substantiate its claim regarding the allocation of expenses incurred by it for the services rendered to BGEIPL. The taxpayer has not been able to substantiate the common expenditure incurred, the basis of allocation of the same, and why those had to be allowed as deduction from its Indian operations. The matter would not be restored to the TO for re-examination, as the taxpayer had clearly stated that it would not be possible to have a one-to-one nexus of the expenses with the services rendered;

In the light of the facts, and the limitation that the taxpayer was not in a position to substantiate expenses incurred, taxing the income under section 44BB of the Act was the only possible recourse, as done in previous years.

[Source: BG International Ltd v. ADIT [TS-120-ITAT-2015(Delhi-Tribunal)] 03

2. Karnataka High Court grants Foreign Tax Credit to tax holiday entities

The Karnataka High Court [‘HC’] delivered an important verdict in the case of Wipro on foreign tax credits to Indian IT company in tax holiday situations, allowing foreign tax credit [‘FTC’] u/s 90 to Wipro (enjoying Sec 10A tax holiday) on taxes paid abroad. HC holds that Sec 90(1)(a)(i) and (ii)

cannot be interpreted to mean as obligating an actual payment of tax in both taxing jurisdictions for grant of foreign tax credit and also observes that credit u/s 91 shall be allowed for State taxes paid abroad. HC concluded the following in its judgment:

Sec 90(1)(a)(i) and (ii) cannot be read or interpreted to mean the same obligating an actual payment of tax in both taxing jurisdiction for grant of foreign tax credit.

DTAA are entered with countries by India in both ways i.e. treaties falling u/s 90(1)(a)(i) and 90(1)(a)(ii). For such treaties falling u/s 90(1)(a)(i), the income should be subjected to tax or tax should be paid in both the jurisdictions, and tax credit is allowed only to the extent of tax paid in India. For the DTAA falling u/s 90(1)(a)(ii), HC has ruled that as long as income is chargeable to tax, even if the same is not subjected to tax, full credit of tax paid in the foreign jurisdiction should be allowed in India as long as the income is liable to taxation under the Income-tax Act, 1961 [‘the Act’]. The judgment has contracted the expression “subjected to tax” meaning tax to be actually paid and “chargeable to tax” meaning liable to tax, following Apex Court ratio in Azadi Bachao. Whether section 90(1)(a)(ii) which came into the Statute w.e.f. April 1, 2004 is retrospective or clarificatory?

05 05

HC did not go into the issue and held that by virtue of Sec 90(2), a beneficial provision of DTAA would override the provisions of the Act and consequently held that full tax credit under Indo-US DTAA would be available even for periods prior to April 1, 2004. Decision rendered by Coordinate Bench in Yokogawa would not stand in the way in concluding as above and the said judgment has uttered a caution that the definition of total income has different variants and its interpretation in that judgment is confined only to Chapter III and hence the same would have no bearing while interpreting Section 4, 5 and 90 of the Act. Section 91 of the Act was also examined and HC held that tax credit is allowable even on taxes paid to the State Government. Since DTAAs do not cover State taxes, they would fall u/s 91 and by virtue of Explanation IV, taxes paid to State Government would also be available for credit. [The information contained in this alert is source-based. A copy of the ruling is awaited]

3. Debenture interest paid upfront is deductible in the year of payment irrespective of the treatment in books of accounts

In the case of Taparia Tools Ltd. [‘the assessee’], the Supreme Court has held that an assessee can be permitted full deduction under the provisions of the Income-tax Act, 1961 [‘the Act’] for upfront payment of debenture interest, even if such payment has been amortized

04

03 0

over the tenure of the debenture in the books of account. The apex court, based on the facts, held that since the assessee had claimed deduction for the full amount of upfront interest payment, the same should be allowed in the year of payment and should not be spread over the term of the debentures. The Supreme Court reiterated that there is no concept of deferred revenue expenditure under the Act. Furthermore, the Supreme Court also ruled that the treatment given in the books of account is not an estoppel against the statute to claim deduction. The assessee issued non-convertible debentures which provided for two options as regards payment of interest:

Half-yearly payment of interest @ 18% p.a. for five years.

One-time upfront payment of INR55 per debenture. Few debenture holders opted for upfront payment of interest and the same was, accordingly, paid by the assessee. The assessee accounted the upfront interest as deferred revenue expenditure in its books of account and the same was written off over a period of five years i.e., the tenure of the debentures issued. However, for tax purposes, the entire upfront interest payment was claimed as a deductible expenditure in the year of payment. The Assessing Officer [‘AO’], treated the upfront interest amount as “deferred revenue expenditure” and allowed deduction proportionately over the tenure of the debentures (1/5th of the total interest amount each year) i.e., in line with the treatment provided in the books of account of the assessee. AO based his argument on the decision of SC in the case of Madras Industrial Investment Corporation Ltd. [(1997) 4 SCC 666]. The Appellate Authorities and the Bombay High Court ruled in favor of the Tax Authority. Bombay High Court held that the assessee itself had, in its books of account, spread the interest expenditure over a period of five years. Further, as per “matching concept” under the

The Supreme Court ruled as under –

The Apex Court held that the assessee is entitled to claim deduction of upfront interest in the year of payment and the deduction should not be spread over the term of the debentures in the absence of the concept of deferred revenue expenditure under the Act. As per the provisions of the Act, interest “paid” on borrowed capital for the purposes of business or profession is deductible. In the present case, the debenture proceeds were used for business purpose. The borrowing was genuine and not an illusory or colorable transaction. The clause permitting the option of upfront payment of interest was genuine and upfront interest expenditure was genuinely incurred. Hence, the AO is not justified in disallowing the deduction either on the ground that the rate of interest is unreasonably high or that the assessee had it-self charged a lower rate of interest on the monies which it lent.

Reliance was placed on the Supreme Court decision in the case of Bharat Earth Movers [(2000) 6 SCC 645] wherein it was ruled that if a

Mercantile system of accounting, the income shown for the year has to match with the expenditure incurred for the purpose of such income. In the facts, interest paid In the first year actually pertained to five years, being the term of the debentures And accordingly, deduction in respect of the same shall be spread over a period of five years. For this propostion, reliance was placed on the SC ruling in the case of Madras Industrial Investment Corporation Ltd. (supra) in which the SC allowed deduction for discount on the debentures on amortized basis over the tenure of the debentures. Aggrieved, the assessee appealed before the Apex Court.

05

04

particular year has to be allowed in the same year. Hence, if an assessee claims such expenditure in that year, the Tax Authority cannot deny the same, however, where an assessee itself wants to spread the expenditure over a period of ensuing years, it can be allowed only if the principle of “matching concept” is satisfied.

Just because a different treatment is given in the books of account, it would not deprive the assessee from claiming the entire expenditure as deduction. It is well-settled that entries in the books of account are not determinative or conclusive and the matter is to be examined on the touchstone of the provisions contained in the Act [Kedarnath Jute Manufacturing Co. Ltd. [(1972) 3 SCC 252], Tuticorin Alkali Chemicals and Fertilizers Ltd. [(1997) 6 SCC 117], Sutlej Cotton Mills Ltd. [(1978) 4 SCC 358], United Commercial Bank [(1999) 8 SCC 338]. The apex court has reiterated the well-settled principle that entries in the books of account are not determinative or conclusive and the matter is to be examined on the touchstone of statutory provisions. An assessee is free to claim deduction as per its option in the return of income and the Tax Authority is bound to allow the same if it is otherwise allowable under the law.

business liability has arisen in the accounting year, the deduction should be allowed even if such a liability may have to be quantified and discharged at a future date. In the present facts, liability had not only arisen but was also discharged in the relevant tax year.

It was further observed by the Apex Court that in the case of Madras Industrial Investment Corporation Ltd (supra), the assessee itself had opted for amortized deduction of discount on the debentures over the tenure of the debentures, though the liability for discount was actually incurred in the year of issue of the debentures itself. The apex court found that the assessee could still be allowed to spread the expenditure since the assessee could utilize the monies collected under the said debentures and secure benefit over a number of years. From the above it can be inferred that revenue expenditure incurred in a

4. Tribunal ruling on Gift transactions by companies

KDA Enterprises Private Limited [‘the taxpayer’] was a company engaged in the business of investments. During the relevant year, the Donors (shareholders in Reliance India Limited [‘RIL’]) gave irrevocable instruction to RIL to pay dividend directly to the taxpayer. No consideration was given to the Donors by the taxpayers for the same.

The dividends received from RIL were credited to capital reserve account in the books of the taxpayer, since such a gift was in the nature of capital receipt. The gift transaction was authorised by the Memorandum of Association [‘MoA’] and Articles of Association [‘AoA’] of the taxpayer, as well as the Donors, and both the parties passed board resolutions for making/receiving such a gift. This gift was considered as not taxable by the taxpayer, being in the nature of a capital receipt. The taxpayer submitted that the gift transaction was a capital receipt which was made and received in accordance with the governing provisions of the Companies Act. Hence, no addition can be made in computing the total income of the taxpayer on account of this receipt, either under the normal tax provisions or for arriving at the book profit for the purpose of Minimum Alternate Tax [‘MAT’]. Further, a transfer of property made voluntarily and without consideration is a valid gift as per the Transfer of Property Act [‘TPA’], even though the gift was between corporate entities. Additionally,

[Source: Taparia Tools Limited Vs JCIT (Civil Appeal No. 6366-6368 & 6946- 6948)]

06

Since the parties were corporate entities, there was no requirement to satisfy the condition of natural love and affection amongst the parties. The Assessing Officer [‘AO’] did not concur with the taxpayer and included the amount of gift in the taxpayer’s total income and taxed the same as “income from other sources”. The AO also contended that the whole scheme was a camouflage to evade tax and to devoid the Government of its funds. Even if the alleged transaction was not taxed as “income from other sources”, it should be considered as unexplained cash credit and taxed accordingly. The CIT(A), upon appeal, ruled in favor of the taxpayer. Aggrieved, the Revenue preferred an appeal before the Income Tax Appellate Tribunal. The Income Tax Appellate Tribunal observed and ruled as under - The transaction of the gift was valid under the TPA as there was

voluntary transfer of a moveable property without consideration. The provisions of the TPA allowed corporates to transfer any property under a gift. The three essentials of a valid gift transaction i.e., delivery of the gift, donative intent of the Donors to gift and acceptance by the taxpayer were duly fulfilled.

Furthermore, corporate are competent to make and receive gifts and natural love and affection are not necessary requirements. The only requirement for a company to make gifts is to have the requisite authorization in the MoA/AoA, which was satisfied in the present case. Additionally, the specific provisions present under the Income Tax Act, the TPA and the erstwhile Gift Tax Act did recognize the possibility of the gift transaction between corporate entities.

For a receipt to be taxable under the Act, it must necessarily be in the nature of “income” or its taxation specifically provided for in the statute. Any other receipt that is not in the nature of income is not taxable under the Act.

05 05 07

Additionally, this income is taxable only if it falls under any of the specified heads of income. Only revenue receipts that are in the nature of income can be taxed under the residuary head of “income from other. Though, presently, there is a provision for taxing gifts received by

corporates, this provision is restricted to receipt of shares of an unlisted company for no or inadequate consideration. It does not cover the receipt under consideration in the present fact pattern, being capital receipt in nature. The Tribunal relied on the Supreme Court’s decision in the cases of Padmaraje R. Kadambande [195 ITR 877 (SC)] and Groz-Beckert Saboo Ltd. [116 ITR 125], in arriving at this conclusion.

The provisions under the Act for taxing unexplained cash credits are applicable only where a taxpayer either offers no explanation or its explanation is unsatisfactory as to the identity of the donors, the donor’s capacity/source of payment and the genuineness of the transaction. In the facts of the present case, there was no doubt on the identity of the Donors, their capacity to make a gift or explain the source of dividends. The Tax Authority’s suspicion as to the dubious nature of transaction was contrary to the facts of the case, since the transaction was backed by the resolution of the boards of directors of the corporate entities involved, affidavits for making/receipt of gifts and authorization by the respective MoA/AoA of the parties to the transaction. Further, as there was no common shareholding between the taxpayer and the Donors, provisions to tax the receipt as deemed dividend could not be invoked.

With regard to MAT provisions, the Tribunal relied on the SC’s decision in the case of Apollo Tyres Ltd. [255 ITR 273], where the SC held that the Revenue has to accept the authenticity of the books of account of a company, prepared as per the provisions of the Companies Act, scrutinized and certified by the statutory auditors, approved by the shareholders and filed before the Registrar of Companies. The Tax Authority has limited power to make adjustments to the book profit so computed.

05 05 08

Since the gift was not credited to the P&L account, no adjustment was required while determining book profits for the purpose of MAT computation. Since the books of account of the Taxpayer were in conformity with the provisions of the Companies Act, the amount received as gifts cannot be added to the book profits computed for the purpose of MAT. [Source: ITA No. 2662/M/2013] 5 . The salient features of the Undisclosed

Foreign Income and Assets (Imposition of Tax) Bill, 2015 The Finance Minister, in his budget

speech, while acknowledging the limitations under the existing law, had conveyed the considered decision of the Government to enact a comprehensive new law on black money to specifically deal with black money stashed away abroad and the Undisclosed Foreign Income and Assets (Imposition of Tax) Bill, 2015 has been introduced in the Parliament on March 20, 2015.

Scope - The Act will apply to all persons resident in India. Provisions of the Act will apply to both undisclosed foreign income and assets (including financial interest in any entity). Rate of tax – Undisclosed foreign income or assets shall be taxed - 30 percent. No exemption or deduction or set off of any carried forward losses

shall be allowed. Penalties – Violation of the provisions of the proposed new legislation will entail stringent penalties. Non-disclosure of income or an asset located outside India - three times

the amount of tax payable thereon, i.e., 90 percent of the undisclosed income or the value of the undisclosed asset.

Failure to furnish a return or non-disclosure of foreign assets and bank accounts or income - Rs.10 lakh.

Prosecutions - The Bill proposes enhanced punishment for various types of violations. Willful attempt to evade tax in relation to a foreign income or an asset

located outside India - rigorous imprisonment from three years to ten years.

Failure to furnish a return or non-disclosure of foreign assets and bank accounts or income - rigorous imprisonment for a term of six months to seven years.

Abetment or inducement of another person to make a false return or a false account or statement or declaration under the Act - rigorous imprisonment from six months to seven years. This provision will also apply to banks and financial institutions aiding in concealment of foreign income or assets of resident Indians or falsification of documents.

Safeguards Mandatory issue of notices to the person against whom proceedings

are being initiated, grant of opportunity of being heard, necessity of taking the evidence produced by him into account, recording of

reasons, passing of orders in writing, limitation of time for various actions of the tax authority, etc. The right of appeal has been protected by providing for appeals to

the Income-tax Appellate Tribunal, and to the jurisdictional High Court and the Supreme Court on substantial questions of law.

To protect persons holding foreign accounts with minor balances which may not have been reported out of oversight or ignorance, it has been provided that failure to report bank accounts with a maximum balance of upto Rs.5 lakh at any time during the year will not entail penalty or prosecution.

Persons who have any undisclosed foreign assets which have hitherto not been disclosed for the purposes of Income-tax, may file a declaration before the specified tax authority within a specified period, followed by payment of tax at the rate of 30 percent and an equal amount by way of penalty. Such persons will not be prosecuted under the stringent provisions of the new Act.

Amendment of PMLA – The Bill also proposes to amend Prevention of Money Laundering Act (PMLA), 2002 to include offence of tax evasion under the proposed legislation as a scheduled offence under PMLA.

05 05 09

TRANSFER PRICING

6. Tribunal sets ALP for guarantee commission fee at 0.5% and interest at the rate of LIBOR+2% for loans to associated enterprises

Everest Kanto Cylinder Ltd. [‘the taxpayer’] is engaged in the business of manufacturing high pressure seamless gas cylinders and CNG cylinders. During the year under consideration, the taxpayer had provided guarantee to its associated enterprises [‘AEs’] viz. EKC Dubai and EKC China, for taking term loans from banks. It charged guarantee commission @ 0.5% from EKC

Dubai. No guarantee commission is charged from EKC China on account of regulatory prohibitions in China. The taxpayer benchmarked the receipt of guarantee commission by applying Comparable Uncontrolled Price [‘CUP’] Method and stated that YES bank had provided similar financial arrangement to the taxpayer and charged 0.5% for the same. Also, the taxpayer had provided corporate guarantee to another AE i.e. CP Industries [‘CPI’] towards borrowings. Nothing could be recovered towards guarantee given to CPI on the ground that the loan taken by CPI was in the nature of ‘quasi equity’ which is for making acquisitions of business in other countries which is akin to shareholders’ funds. For its international transactions pertaining to receipt of interest on loan advanced to EKC Dubai and EKC China, the taxpayer determined the arm’s length price [‘ALP’] thereof using

CUP Method wherein rates based on LIBOR+50 basis points for loan to Dubai and a range of 5.58% to 6.84% for the loan provided to EKC China was considered as comparable uncontrolled interest rates. The taxpayer received interest at the rate of LIBOR+100 BP and 7% from EKC Dubai and EKC China respectively. The Transfer Pricing Officer [‘TPO’] did not agree with taxpayer’s way of determining the ALP of payment of guarantee fee and corporate guarantee and re-determined the arm’s length guarantee commission rate at 1% and 4% in case of EKC Dubai and EKC China. In case of CPI, the guarantee rate for the corporate guarantee was determined by TPO at 4.5%. Consequently, the TPO made an adjustment of INR 105.74mn. For its receipt of interest loan transaction, the TPO re-determined the arm’s length interest rate at 10.25% and accordingly, made an addition of INR 103.67mn. Discontented with TPO’s adjustment, the taxpayer appealed before the Dispute Resolution Panel [‘DRP’]. The DRP re-determined the guarantee fee at 1% for EKC Dubai and 3% for EKC China and CPI USA, whereby the amount of adjustments was reduced to INR 73.08mn. For the taxpayer’s international transaction pertaining to receipt of interest on loan advanced to AEs, the DRP upheld the adjustments proposed by the TPO. Aggrieved, the taxpayer as well as revenue appealed before the Tribunal. The proceedings before the Tribunal have been summarized below: In this relation, the Hon’ble Tribunal referred and relied upon the Taxpayer’s own identical issue decided by the Tribunal for previous assessment years. Based thereon, the Hon’ble Tribunal held the following: For Guarantee Commission Even though no commission is received by EKC China and CPI USA, the guarantee commission still has to be assessed in the hands of the Taxpayer at arm’s length as per the Indian Transfer Pricing regulations. It was held that Taxpayer had entered into a similar transaction with Bank wherein the

05 05 10

Taxpayer was charged 0.6% towards the guarantee fee by the bank and the Taxpayer charged guarantee fee commission @ 0.5% from its AE. Accordingly, 0.5% shall be taken to be at arm’s length rate of the guarantee fee for all the three transactions of guarantee undertaken by the Taxpayers with its AEs. Interest on Loan The arm’s length rate of interest in respect of loan provided to the AE should be LIBOR+200 BP. Accordingly, the ITAT directed the AO to recomputed the arm’s length rate in respect of the loan transaction to each AE of the Taxpayer, “by clubbing all the loan transactions of each AE and then compare the interest charged by the assessee with arm’s length rate at LIBOR +2%.” Further, ITAT observed that as regards the transactions of loan to its EKC China, the same was at arm’s length since the Taxpayer had charged the interest at 7%, and held that only with respect to the transaction of loan to EKC Dubai is required to be re-computed for the purpose of TP adjustment. [Source: Everest Kanto Cylinders Limited Vs. ACIT [ITA No. 550/Mum/2014]]

7. Delhi High Court landmark ruling on marketing intangibles

Recently, Delhi High Court [‘High Court’] in the case of Sony Ericsson Mobile computing India Pvt. Ltd. and several other connected matters upheld the tax

to department’s jurisdiction advertisement, marketing and sales promotion [‘AMP’] expenditure as an international transaction subject to Transfer Pricing [‘TP’]. Among its several findings in the case, the High Court held that distribution and marketing are intertwined functions and can be analyzed together as a bundled transaction. And that segregation of non-routine AMP expenditure using the Bright line approach is not appropriate.

In 2013, in the case of LG Electronics India Pvt. Ltd, the Delhi Special Bench of the Tribunal [‘SB’] delivered a ruling on the complex issue of marketing intangibles anIndian d held that TP adjustment in relation to AMP expenditure incurred by Indian taxpayer is permissible as the same is in the nature of provision of brand building service to its AE. The SB also held that the taxpayer’s use of Brand/ Logo of its foreign AE coupled with proportionately higher AMP spend indicated an oral or tacit understanding between the taxpayer and its foreign AEs of building and promoting the foreign brand. The same can be construed as provision of service by taxpayer to its AE. Subsequently, Delhi Tribunal in the case of Casio India Company Ltd.[ ACIT v. Casio India Company Ltd. (ITA No. 6135 & 5611/Del/2011)] and in number of other cases followed the SB Ruling and proposed transfer pricing adjustments.

05 05 11

The issue thereafter travelled to the Delhi High Court, which ruled in a bunch of petitions concerning the matters arising from the SB ruling. Issue before the High Court

The High Court admitted another question of law specifically for one of the connected matters before the court (ITA 231/2014). The same pertains to the tax department’s appeal against setting aside/ deleting transfer pricing adjustment on payment of royalty to an AE. The same was answered by the High Court against the tax department in favor of the taxpayer. However, the same is not discussed in detail in this flash news.

Whether the additions suggested by the Transfer Pricing Officer (TPO) were bad in law since there was no specific reference by the AO?

Whether AMP expense incurred by the taxpayer can be considered as an international transaction?

Whether TOP adjustment can be made by TPO in respect of excessive AMP expenditure?

Whether Cost Plus Method is the appropriate method for making TP adjustment in respect of AMP expense?

Whether fresh bench marking/ comparability analysis is required to be undertaken by the TPO by applying comparability parameters, as laid down by tribunal?

Whether exclusion of trade/ volume discounts, rebates and commission paid to retailers/ dealers, etc. from the AMP expenses was justified?

High Court’s Ruling

The High Court has pronounced a landmark ruling on the issue of marketing intangibles. The HC held first two questions in the favor of the tax department, and upheld that AMP expense constitute an international transaction subject to TP. While the High Court upheld the tax department’s jurisdiction to such transactions, it overturned various other aspects of the SB ruling holding the application of such ratios is erroneous and unacceptable. The findings of the High Court have been discussed in detail below:

05 0512

Transfer Pricing Officer has jurisdiction over non-reported transaction

The High Court held that in light of the retrospective amendmentintroduced by Finance Act 20121, the TPO is empowered to adjudicateon the transactions which have not been reported by the taxpayer inthe Form of 3CEB. No specific reference by the Assessing Officer (AO) isrequired for the same.

AMP Expenses constitutes an international transaction

The High Court, ruling in favor of the revenue, upheld the decision ofthe SB and observed that AMP expense is an international transaction.Differentiating the provision of Chapter X from section 37(1) of theIncome Tax Act, 1961 (the Act), the High Court observed that thequestion under consideration is whether the taxpayer is adequatelyreimbursed for performing marketing and distribution functions, ratherthan the amount of AMP expenses incurred by the taxpayer. By virtueof application of TP provisions, the TPO seeks to determine an arm’slength compensation for the marketing and distribution functionsperformed by the taxpayer towards related parties.

Section 92CA (2B) inserted by the finance Act, 2012 with retrospective effect from 1 June 2002, empowering the TPO to examine the arm’s length pricing of such international transactions that were not reported by the taxpayer and comes to the TPO notice during the course of proceedings before him.

Aggregation of transactions and application of transactional Net Margin Method

The High Court held that distribution and marketing are intertwinedand may be examined as bundled/inter-connected transactions.Clubbing of closely linked transactions, which includes continuoustransactions is permissible under law. However, close linkage oftransactions is a pre- condition for aggregation. The High Court heldthat it would be inappropriate to proceed with Arm’s Length Pricedetermination with a pre-conceived supposition that each transactionmust be analyzed separately.

The high Court was of the view, that there is no prohibition onapplying Transactional Net Margin Method (TNMM) on an entity widebasis, provided the tested party is into single line of business.

Further, the High Court objected to manner of application of TNMM bythe TPO and held that AMP expense cannot be segregated andbenchmarked separately as the same would lead to inappropriateresults. The High Court even provided that when margins of thecomparables finalized on the basis of functional analysis are compared,AMP expenses automatically get factored into it, and as such horizontallevel analysis is not required.

The High Court however also noted that when appropriate comparablesare not available or suitable adjustments cannot be made to ensurefunctional comparability, it is open for the revenue to adopt and applyother methods.

Segregating Non-routine AMP expenses using bright line approach lacks acceptability

The High Court ruled that while applying the bright line test, the taxauthorities have measured all the taxpayers by similar yardstick withoutfocusing on the facts of the case. In the SB ruling, AMP expense wasclassified into routine and non-routine expense, with the latterattributed towards brand building services. One of the most importantobservations of the High Court was rejection of the Bright Line Test, as ameans to bifurcate AMP expense into routine and non-routine for thepurpose of application of bright line test.

In this context the High Court ruled that value of a brand depends onthe nature and quality of goods and services sold or dealt with and notnecessarily AMP expense which only contribute to a part of it. Incommercial parlance, the taxpayers do not undertake advertisementwith a purpose to increase the value of brand but to increase sale andthereby earn higher profits.

05 0513

An APA is, by definition, a future looking agreement, i.e., it is to be applied for controlled transactions over a future period of time. However, the negotiated position under an executed APA can be applied to prior years as

Focusing on the importance of the functional profile andcharacterization of entities, the High Court observed that in case of anormal distributor, undertaking marketing and distribution functions, ifthe distributor has been adequately remunerated by way of lowerpurchase price, reduce payment of royalty or payment in some otherform, then additional remuneration for AMP expenditure may not berequired.

Section 92(3) of the Act does not prohibit set off in case of bundled transaction

The High Court held that Section 92(3) of the Act does not incorporate abar or prohibit a set off or adjustments. The concept of set off hasbeen internationally well accepted and the legislative intent of Section92(3) of the Act is not to deny set of in case of closely linkedtransactions. The High Court has given due importance to theinternational guidance (OECD TP Guidelines, UN TP Manual) whileinterpreting the legislative intent of the Act.

Economic Ownership

Contrary to the SB Ruling, the High Court has accepted the concept ofeconomic ownership of intangibles. The High Court observed thatunder a long term contact, economic ownership of marketingintangibles would arise due to advertisement and marketing functionsperformed by a taxpayer. The High Court also observed that only in theevent of the termination of long-term distribution-cum-marketingagreement the need for a transfer pricing valuation would arise in orderto determine an exit charge for compensation of transfer of economicownership.

Selling expenses to be excluded from AMP expenses

In line with the SB ruling, the High Court has ruled that direct marketingand selling expenses have a direct connect with the increasing volumeof sales and should be excluded from constituents of AMP expense.

On an overall basis, the ruling can be considered as one of the mostsignificant and landmark rulings in context of marketing intangibles. Thisruling delves deep into fundamentals of TP and places reliance oninternational available in the OECD and ATO guidelines. The Ruling can beconsidered as a mixed bag of positives / negatives for the taxpayer. Fromthe positive side, the ruling has clarified important concepts like usage ofaggregated TNMM for benchmarking AMP transactions, concept ofeconomic ownership being clarified and the principles of Bright Linetests, being done away with. On the negative side, the ruling has decided infavor of the revenue with regard to the TPO jurisdiction over non-reported transaction and stating the fact that AMP constitutes anInternational Transaction for the purpose of TP.

[Source: http://www.itatonline.org]

8. Rollback of Advance Pricing AgreementsThe Finance Act, 2012 saw the introduction of the Advanced Pricing Agreement [‘APA’] Program effective from July 1, 2012 providing for its validity for a maximum of consecutive 5 years (unless there is a change in the provisions of the Act having a

international APA program of the most

bearing on the transaction). The was seen as one positive amendments that shall assist taxpayers to obtain certainty on their crucial transfer pricing matters, if so desired.

05 0514

well also known as ‘roll-back’ of an APA. The Government added impetus to the program by extending the benefits of APA to the prior years for eligible taxpayers by introducing the rollback provisions vide Finance (No. 2) Act, 2014. The taxpayer community awaited detailed guidelines providing the mechanism for its implementation. In line with the global best practices, almost after six months from its introduction, the CBDT has notified APA rollback guidelines. These guidelines seek to enhance certainty to the eligible taxpayers for prior four years immediately preceding the year for which APA has either been filed or signed but pertaining to the “same” international transaction (“covered transactions”), thereby providing certainty for a total period of 9 years.

Criteria for its applicability of Rollback

Rollback to be applied only for the “same” international transactioncovered under the main APA application and also undertaken in theprior years. The use of the word “same” and not “similar” severelyrestricts the possibilities of rollback. In today’s dynamic businessenvironment and inexorable changes in the operations of the taxpayer,scenarios change in couple of years, let alone transactions remaining“same” over past four years. Even a slight change in the underlyingbusiness operations or functions could veto rollback benefits.Furthermore, the guidelines state that rollback provisions ought to berequested for “all” the prior eligible years. Whether the taxpayer has anoption not to opt for a rollback in one of the four years block period isnot clear.

Second pre-condition is that the taxpayer ought to have filed theAccountant’s Report under section 92E i.e. Form 3CEB and its return ofincome within the due dates for each of the years proposed to becovered in the rollback. Belated or revised returns filed by the taxpayercould easily throw the possibility of rollback of APA out of the windowfor any multinational. In case of non-filing or belated return, would itlead to non-applicability for rollback option in its entity i.e. for theentire block of four years or only for that particular year is also unclear.

It would be heartening to see CBDT addressing these issues at the earliest since the taxpayers are given a short window of merely a fortnight i.e. ending on 31 March 2015 to evaluate and opt for the rollback.

Third, in case an appeal is disposed of by the Appellate Tribunal for anyof the preceding years prior to the date of signing of the APA or wherethe rollback provisions result in reduction of the income offered to tax /increase in the loss, such a scenario would render therollback provisions inapplicable.

One can understand the intent of inserting the latter as a factor fornon-eligibility, since similar provision for non- applicability of thetransfer pricing regulations in case of reduction of income orincrease in loss per-se was always a part of the statute books.Current trend shows Tribunal decisions pertaining to AY 2009-10 beingadjudicated. Keeping the former aspect in mind, the taxpayers whoopted for APA in March 2013 the earliest year they can request arollback till fiscal year 2009-10.

Procedural aspect of the rollback provisions

Additional fees for INR 500,000 (approx. USD 8,000) is payable for thetaxpayers opting for rollback irrespective of the value of “coveredtransaction” unlike the APA filing fees which are dependent on thevalue of the “covered transactions”

Any appeals filed by the taxpayer and pending adjudication before therevenue authorities ought to be withdrawn. As a taxpayer, one wouldthen worry about the immunity from the authorities taking coerciveaction towards recovery of the alleged outstanding tax demand as therollback provisions do not provide protection in this regard unlike theclear direction of “suspension of collection of demand” in cases underthe Mutual Agreement Procedure (“MAP”). CBDT needs to look intothis crucial aspect to curtail undue hardship on the taxpayer and advice

the jurisdictional officers to refrain from taking any coercive actions. Separate application in Form 3CEDA is to be filed on or before 31 March

2015 in case of APA applications filed / agreement entered into before 01 January 2015. In cases where application is to be filed, the APA application is suitably amended to include the details pertaining to the rollback option.

It is therefore in light of the above, imperative that the CBDT looks into the missing blanks and takes a more pragmatic approach before rushing to legislate the same, for the proposed guidelines in its current form to achieve more effective results and curtail litigation.

[Source:www.incometaxindia.gov.in]

INDIRECT TAX

9. Taxability of Services under ‘works contract’ pre 2007 upheld by CESTAT

The issue for consideration before the Larger Bench of the Central Excise and Service tax Appellate Tribunal [‘CESTAT’] was whether components of a composite transaction amounting to supply of labour/ rendition of service(s) under a works contract ought to be classified only under Section 65(105)(zzzza) of the Finance Act 1994 [‘Act’] i.e. works contract service), w.e.f. June 1, 2007 or would the same be covered within the ambit of the existing (pre June 2007) taxable service

categories of ‘Commercial or Industrial Construction service [‘CICS’], Construction of Complex Service [‘COCS’] or Erection, Commissioning or Installation service [‘ECIS’]. Previously a three member Bench of the CESTAT in M/s. Jyoti Ltd. v CCE [2008 (9) STR 373] and CCE v Indian Oil Tanking Ltd. [2010 (18) STR 57] had ruled that works contracts were taxable only w.e.f. June 1, 2007 on introduction of sub-clause (zzzza) in Section 65 (105) but not prior thereto, by classification under other and pre-existing taxable services. An earlier two member Bench decision in Daelim Industrial Co. Ltd. vs. CCE [2003 (155) ELT 457] which assumed the same position was doubted and referred to a three member Bench. The reference was answered in CCE vs. BSBK Pvt. Ltd.[ 2010 (253) ELT 522], which ruled that turnkey contracts could be vivisected and discernible elements therein abstracted and classified for levy of service tax, provided such services are taxable services defined under the Act. Therefore pursuant to conflict of opinion between the Larger Bench decisions of CESTAT in Jyoti Ltd., Indian Oil Tanking Ltd., and BSBK Ltd., the issue whether a composite contract, involving transfer of property in goods and services is taxable only from June 1, 2007 onwards and not earlier thereto, in view of the provisions of Section 65(105)(zzzza) of the Act, could be vivisected and service components of such composite contracts be subjected to tax by classification of such service components under other taxable services such as CICS, COCS or ECIS for the period prior to June 1, 2007, was referred to a Larger Bench of 5 members. Majority judgment of CESTAT: A composite contract, involving transfer of property in goods and rendition of services, could be vivisected and service components thereof subject to levy of service tax, on classification of services under the taxable service categories of ‘CICS’, ‘COCS’ or ‘EICS’ prior to June 1, 2007. The Majority judgment observed that the Delhi High Court had considered the same issue in G.D. Builders and Others v Union of India [(2013) 32 STR 673 (Del.)] and YFC Projects (P) Ltd.[ [TS-8-HC-2014(DEL)-ST]] and had taken a view that a

05 05 15

works contract can be vivisected and discernible taxable service elements could be subjected to service tax pre-June 2007. CESTAT being sub-ordinate to both the Supreme Court and the High Court would be bound by these decisions. Minority judgment of CESTAT: While ruling that components of a composite transaction amounting to supply of labor/ rendition of service(s) under a works contract were taxable under the Act w.e.f June 1, 2007 and could not be classified under CICS, COCS or ECIS prior to 2007, the Minority judgment, inter-alia observed, as under:

Neither CICS, COCS nor ECIS authorize a charge of Service Tax on a

works contract (which is a distinct contractual arrangement inhering integrated elements of accretion sale of goods and of exertion of labour/rendition of services);

Taxable services defined and enumerated as CICS, COCS & ECIS cover only such contracts/ transactions which involve pure supply of labour or rendition of service(s), falling within the ambit of the respective definitions;

Only with insertion of sub-clause (zzzza) in Section 65(105), w.e.f June 1, 2007, complemented by introduction of the amended Service tax (Determination of Value) Rules 2006 (‘Valuation Rules’) (inserting Rule 2A therein) and the Works Contract (Composition Scheme for Payment of Service tax) Rules 2007 (‘Composition Rules’), that the requisite and appropriate statutory framework, for charging, levy, collection and assessment of Service Tax, supported by appropriate computation/valuation machinery on a works contract stands incorporated. This framework defines ‘works contract’ (in the Act) by clearly enacting the legislative recognition that this distinct species of contractual arrangements inheres components of sale of goods which fall within the (exclusive) taxation domain of States, for levy of sales tax;

Rule 2A of the Valuation Rules [applied exclusively to ‘works contract’

referred to in sub-clause (zzzza)] inserted w.e.f June 1, 2007, mandates specified exclusions/deductions from the gross amount received on execution of a works contract;

The Composition Rules, also introduced w.e.f June 1, 2007 (and made explicitly applicable only to Works Contract service), provide an optional composition protocol which enables availment of calibrated deductions, particularly appropriate to situations where proof of the value of sale of goods by accretion/incorporation cannot be furnished or the nature of the transaction is such as to render the necessary accounting process cumbersome, impractical or inadequate;

The enactment of a specific legislative provision – sub-clause (zzzza) of Section 65(105) and the simultaneously introduced supportive and reinforcing provisions of the Valuation Rules and the Composition Rules (all w.e.f. June 1, 2007) signal (1) the enactment of a charge of Service Tax on a works contract; and (2)incorporation of the requisite computation, valuation and machinery provisions, which facilitate a coherent, fair, rational, stable and legitimate exaction of tax, confined to such components/elements of this composite, facially indivisible transaction as fall within the taxation domain of the Union, under Entry 97, List I of the Seventh Schedule of the Constitution of India. Only upon introduction of such integrated statutory architecture, w.e.f. June 1, 2007, has uncanalized executive/quasi-judicial discretion been, substantially eliminated; and assessment of service components and associate components/elements involved in the execution of a works contract, by lawful and intra vires valuation, levy and collection of Service Tax, ensured to be non-discriminatory and rational. Consequently, the CESTAT larger Bench decision in B.S.B.K. Pvt. Ltd., to the extent it rules that a works contract is a taxable service prior to 1 June 2007 is overruled. However, the fact is majority bench of CESTAT has uphold the taxability of services under works contract, prior to June, 2007 under the aforesaid category of CICS, COCS and ECIS under the Act.

[Source: M/s. Larsen and Tubro Limited v CST, Delhi (S.Tax Stay No. 59278 of 2013 in ST Appeal no. 58658 of 2013, ST Appeal no. 550 of 2007)]

05 05 16

The Information provided in this document is provided for information purpose only, and should not be construed as legal advice on any subject matter. No recipients of content from this document, client or otherwise, should act or refrain from acting on the basis of any content included in the document without seeking the appropriate legal or professional advice on the particular facts and circumstances at issue. The Firm expressly disclaims all liability in respect to actions taken or not taken based on any or all the contents of this document.

OUR OFFICES

www.nangia.com nangia@nangia.com

DELHI Suite - 4A, Plaza M-6, Jasola, New Delhi–110 025

Ph: +91-11-4737 1000, Fax: +91-11-4737 1010

MUMBAI 11th Floor, B Wing, Peninsula Business Park,

Ganpatrao Kadam Marg, Lower Parel, Mumbai–400 013, India

Ph: +91-22-6173 7000 Fax: +91-22-6173 7060

DEHRADUN 3rd Floor, NCR Plaza,

New Cantt. Road, Dehradun–248 001 Ph: +91-135-274 7081, +91-135-274 7082

Fax: +91-135-2747080

SINGAPORE 24 Raffles Place, #25-04A

Clifford Centre Singapore- 048621