WHAT'S INSIDE...

Direct Tax

Transfer Pricing

Indirect Tax

March 16-31

What’s inside… DIRECT TAX

1. Tribunal allows set-off of business loss to UK Company

under section 71 of the Income-tax Act, 1961 (‘the Act’) 2. License fee payments for non-customized dataset not

'royalty’ 3. Income from container services not taxable under section

44BB 4. Sub-arranger fee paid to Non-Resident for offshore services

not taxable 5. Furnishing of information in respect of payments to Non-

Residents

TRANSFER PRICING 6. The ITAT set aside the taxpayer’s plea for granting

adjustment, to be made in relation to the variation in raw material cost, by considering it as normal industry event; However, granted the economic adjustment on account of under utilization of capacity

7. The Tribunal deleted the adjustment made by TPO on ad-hoc basis; Also confirms that consideration due from AE is the result of a commercial transaction and not be viewed as extending loan or placing deposits

8. Tribunal refers back the case to AO/TPO to be taken afresh in case of disallowance of management fee that was made taxable in the subsequent year; TPO’s contention for computation of ALP was upheld

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9. The “quotations” could be used as valid input under the

residuary method set out in Rule 10AB of the Income-tax Rules and consequently, the hypothetical price under uncontrolled comparable conditions can be used as comparable for benchmarking analysis

10. Tribunal approves internal CUP of 5% interest-rate for benchmarking overseas AE-loan considering higher rates on domestic loans vis-à-vis application of external CUP by the Revenue.

11. Transfer Pricing regulations do not apply to capital account transactions.

INDIRECT TAX 12. Invoice date to be point of taxation in case there is a change

in service tax liability by the service recipient. 13. Central Government prescribes maximum limit for the credit

reversible under Rule 6(3)(i) of the Credit Rules

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Before the ITAT, the assessee contended that the losses arose out of the earlier business activities of the assessee and thus the provisions of Section 71(2) of the Act would apply. The taxpayer placed reliance on the judgment in the case of Sumitomo Mitsui Banking Corporation and claimed benefit of the provisions of Section 90 and argued that the losses should be set-off as per the provisions of Section 71(2), being the beneficial provisions. Placing reliance on the ruling of Sumitomo Mitsui Banking Corporation (136 ITD 66), ITAT held that the AO was not justified in denying the setting off of losses and held that as per the provisions pf section 90, the assessee could avail the benefit of provisions of the Act over the provisions of the DTAA for setting off of losses. Nangia ‘s Take This is an important ruling wherein the ITAT has reiterated the fact that where the assessee finds that the provisions of the Act are more beneficial than the provisions contained in DTAA, he can avail that benefit lawfully. [Source: ITA No. 3138/Mum/2011 and ITA No. 6746/Mum/2011 dated March 18, 2016]

DIRECT TAX 1. Tribunal allows set-off of business loss to UK Company under section 71 of the Income-tax Act, 1961 (‘the Act’)

Lloyds Register UK [‘the assessee’] had a Branch Office in India, which was closed during its world-wide corporate restructuring and the Reserve Bank of India [‘RBI’] granted approval for closure on Dec 2, 2005. However, the assessee continued to file its return of income for AY 2005-06, declaring its royalty income and claiming set-off of business loss amounting to 38.57 lakhs against long term capital gain and income from other sources.

In the assessment proceedings, the Assessing Officer [‘AO’] denied the set-off of losses, contending that since the taxpayer had discontinued its business, the business profits could not be taxed in India in the absence of Permanent Establishment (‘PE’) in view of Article 7 of India- UK DTAA, hence the set-off of loss would also not be allowed. The Commissioner of Income Tax (Appeals) upheld AO’s order, aggrieved, the assessee preferred an appeal before the Mumbai Income Tax Appellate Tribunal (‘ITAT’).

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regional framework in depth domain”, for a period of 40 years from the US entity. Licence obtained from GSS was also similar in nature. ITAT analyzed the definition of ‘royalty’ under the Act, Article 12(3)

of India-US DTAA and Article 13 of India-UK DTAA and noted that the scope of definition of royalty under Act was more as compared to definition under the tax treaties since under the Act, consideration for granting of license for use of property also meant royalty, however there was no such provision under the tax treaties.

Accepting the assessee’s reliance on Bangalore ITAT ruling in Wipro Ltd. [(2005) 94 ITD (Bang)], wherein it was held that provisions of DTAA where beneficial to the assessee shall prevail over Act, ITAT examined the taxability of subject payments under the DTAAs. ITAT observed and held that since only the data available with the licensor which they have acquired using their expertise have been made available to the assessee as it is, without customization, the licensor is not making available any technology. ITAT also stated that unless and until the license was given to use the copyrighted property itself, consideration paid would not be treated as ‘royalty’.

Nangia ‘s Take The Tribunal has reiterated the principle laid in various earlier rulings, that where only data is provided without customization, it cannot be treated as “making available” any technology and the payment for the same shall not qualify as ‘royalty’. [Source: ITA No. 317 & 318/Hyd/2012 dated March 9, 2016]

2. License fee payments for non-customized dataset not 'royalty’

GVK Oil & Gas Ltd. [‘the assessee’] is a company engaged in the business of oil and gas exploration. The assessee entered into agreements with GX Technology Corporation, US (‘GXT’) and GGS Spectrum Ltd., UK (‘GGS’), for purchase of a comprehensive range of advanced seismic data and derivatives. By virtue of agreements with both these companies, the taxpayer acquired a “non-exclusive” license to use information embedded in the product in consideration for an agreed license-fee. During assessment proceedings, the Assessing Officer [‘AO’] held that

payment made by the taxpayer by way of “license-fee" constituted ‘royalty’ both under the Act and respective DTAAs. Since the assessee had failed to deduct TDS under section 195, the AO treated the assessee as “assessee in default” u/s 201(1)/(1A). The Commissioner of Income Tax (Appeals) upheld the AO’s order, aggrieved, the assessee filed an appeal before the Income Tax Appellate Tribunal (‘ITAT’) which ruled as under – Assessee acquired a non-exclusive license from GXT to use the

product “IndiaSPAN” - “regional 2d seismic data programme and geological and geophysical study providing the fundamental basis for evaluation of India’s vast offshore margins as well as the

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3. Income from container services not taxable under section 44BB

Forbes Container Line Pte. Limited [‘the assessee’], a company incorporated in Singapore, engaged in the business of operating ships in international traffic across Asia and the Middle East, a wholly owned subsidiary of Forbes and Co. Ltd. [‘FCL’], an Indian Company. FCL had entered into an agency agreement with Volkart Flemming Co. and Services Ltd. [‘VFSSL’] another wholly owned subsidiary of FCL and VFSSL had demerged its shipping agency division into FCL.

During assessment proceedings, the Assessing Officer [‘AO’] held that income of the assessee was arising out of the operation of ships in international traffic, and it was taxable in India as per the provisions of Section 5(2) of the Act read with the provisions of Section 44B of the Act. The assessee had business connections in India because FCL secured the business from India for the assessee, the principal and agent had common control mechanism, the promoters of FCL, created the assessee a wholly owned subsidiary in Singapore, one of the directors of the assessee was also a director of FCL, who was permanently residing in India and was looking after the policy matters of the assessee and control mechanism of both the entities were in India. Further, the assessee had agency and fixed place PE in India under Article 5 of the India- Singapore tax treaty (tax treaty), and hence assessee’s income was taxable under Article 7 of the tax treaty.

The Commissioner of Income-tax (Appeals) concurred with the AO. ITAT observed that since the taxpayer had received a substantial portion of its income from the operation carried out in the Middle East and other countries, it was handling its business from Singapore. Further, factors like permanent residence of one of the directors in India or holding of only one meeting during the year under consideration or the location of the parent company in India in itself would not decide the residential status of the assessee. It was held that the assessee had not claimed exemption under Article 8 of the tax treaty as it was not engaged in the shipping business and therefore provisions of Section 44B of the Act were not applicable. Income of the assessee had to be assessed under the provisions of Article 7 of the tax treaty which dealt with business income and in absence of a PE, income of the assessee is not taxable in India. Nangia ‘s Take Amidst the chaos on POEM, this ruling is a relief for the foreign subsidiaries of Indian companies earning substantial income outside India. Also, the ITAT has rightly looked deeper into the facts of the case before adjudicating on taxability of income, which shows the Indian Judiciary is following a non-adversarial approach. [Source: Forbes Container Line Pte. Ltd. v. ADIT (ITA No.1607/Mum/2014)]

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As per Sec 9(1)(vii), FTS include any consideration for rendering of managerial, technical or consultancy services including the provisions of services of technical or other personnel but does not include consideration for any construction, assembly etc. Circular No.786 dated February 7, 2000 states that commission paid to non-resident agents is not chargeable to tax in India as they operate outside the country and no part of income arises in India. Thus, where such an amount would not be chargeable to tax in the hands of non-resident, the question of the same liable to tax u/s 195, and disallowance u/s 40(a)(i) would not arise. The ITAT concluded that the services rendered in obtaining deposits of IMDS could not be considered to be management services. Thus, there could be no application of provisions of section 40(a)(i) read with section 195 of the Act. Aggrieved Revenue filed an appeal before Bombay High Court which observed and ruled as under – The services were rendered by non-resident sub-arrangers outside

India. There was no occasion for any income accruing or arising to the non-resident in India. The services of the non-resident sub-arrangers of attracting deposit to the IMDS Scheme were carried out entirely outside India.

Reliance was placed on the Supreme Court ruling in the case of Toshoku Ltd. [TS-4-SC-1980] wherein it was held that no income can be said to accrue or arise in India where payment is made for service by non-resident outside India. The High Court also referred to CBDT Circular No.786 of 2000 dated February 7, 2000 wherein the view expressed by SC in Toshoku Ltd. case was reiterated.

4. Sub-arranger fee paid to Non-Resident for offshore services not taxable

Credit Lyonnais [‘the taxpayer’], was appointed by the State Bank of India [‘SBI’] as an arranger for mobilizing the deposits under the India Millennium Deposit Scheme [‘IMDS’]. In turn, the taxpayer was entitled to appoint sub-arrangers for mobilizing IMDS both inside and outside India.

The Assessing Officer [‘AO’] observed that the taxpayer paid a sum of INR 26.75 crore to non-residents sub-arrangers without deducting TDS u/s 195. The AO thus invoked Sec 40(a)(i) and disallowed expenditure to the extent of INR 26.75 crores, contending that the payment is in the nature of fees for technical services [‘FTS’] u/s 9(1)(vii). The Commissioner of Income Tax (Appeals) held that the sub arranger fee was in the nature of brokerage and commission and not FTS. The taxpayer had also amortized the same over a period of five years and for the subject AY had debited INR 99.16 lakhs to its P&L account. The AO held that since the expenditure was amortized over a period of five years in the books of account, deduction ought to be restricted to INR 99.16 lakhs. On appeal, CIT(A) upheld the AO’s order whereas the ITAT ruled in favour of the taxpayer. On further appeal by the Revenue, the ITAT held that sub-arranger fees could not to be construed as FTS liable to TDS, since sub-arrangers were simply acting as commission agent/ broker for which it was entitled to a particular rate of commission.

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With regards to the amortization of expenses, the High Court relied on the Supreme Court ruling in the case of Taparia Tools Ltd. [TS-134-SC-2015] to rule in assessee’s favour. The High Court thus held that the amount of INR 14.87 crores was deductible in its entirety in the year of expenditure.

[Source: ITA No. 2120 of 2013 dated February 22, 2016]

5. Furnishing of information in respect of payments to Non-Residents

The Central Board of Direct Taxes vide circular1 amended Rule 37BB of the Income Tax Rules to strike a balance between reducing the burden of compliance and collection of information under section 195 of the Income Tax Act, 1961 [‘the Act’].

The significant changes under the amended Rules are: No Form 15CA and 15CB would be required to be furnished by an

individual for remittances which do not requiring the Reserve Bank of India’s [‘RBI’] approval under its Liberalised Remittance Scheme [‘LRS’];

Further the list of payments of specified nature mentioned in Rule 37 BB which do not require submission of Forms 15CA and 15CB had been expanded from 28 to 33 including payments for imports.

A CA certificate in Form No. 15CB would be required to be furnished only in respect of such payments made to non-residents which are chargeable to tax and the amount of payment during the year exceeds INR 500,000.

The amended rules come into force from April 1, 2016. _________________________ 1Notification No. G. S. R. 978(E) dated December 16, 2015

6. The ITAT set aside the taxpayer’s plea for granting adjustment, to be made in relation to the variation in raw material cost, by considering it as normal industry event; However, granted the economic adjustment on account of under utilization of capacity

Transfer pricing

Background

Momentive Performance Materials (India) Private Limited [“the taxpayer’] is engaged in manufacture and distribution of silicon and silicon based products. During the assessment year under review, the taxpayer entered international transactions in the nature of purchase of raw materials, traded goods, provision of IT enabled services with its Associate Enterprises [“AEs”]. The Transfer Pricing Officer (“TPO”) while making assessment concurs with taxpayer’s ALP calculation in relation to trading segment. However, the TPO proceeded to make an adjustment of INR 1.47 crore in the taxpayer’s manufacturing and ITeS segment by

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considering the taxpayer as tested party [as against AE which was taken as tested party by the taxpayer in its TP documentation]. Aggrieved by the same, the taxpayer preferred to move to the Dispute Resolution Panel (“DRP”). In the submission filed before DRP the taxpayer bought in light the following additional points in support of high cost incurred during the year under consideration: There was replacement of low priced raw material [B-Stream] with

the costlier one [Virgin]; and Lower capacity utilization due to relocation of manufacturing plant.

The DRP, while agreeing over taxpayer contention directed TPO to revised operating margins on account of lower capacity utilization. Aggrieved Revenue decided to move to the Income Tax Appellant Tribunal [“the ITAT”/ the Tribunal”] against DRP directions and the taxpayer on the other hand, also filed an appeal before ITAT over inclusion/ exclusion of certain comparables in its ITeS segment. Tribunal’s Ruling 1. On the Appeal filed by the Department

A. DRP powers vested u/s 144C of Income Tax Act 1956.

The ITAT while quoting sub section 8 of Section 144C of Income-tax Act, 1961 (“the Act”) [i.e. “The Dispute Resolution Panel may confirm, reduce or enhance the variations proposed in the draft order so, however, that it shall not set aside any proposed variation or issue any direction under sub-section (5) for further enquiry and passing of the assessment order.”] stand with Revenue to confirm that the DRP has no power to set aside proposed variation in draft order.

B. Raw Material Composition The ITAT is of opinion that taxpayer was unable to clarify its stand in relation to the following: Raw material used by the comparables is of lower or cheap quality;

and

Variation in raw material is an extra-ordinary event in the industry in which taxpayer operate

By taking change in raw material composition as a typical activity in any industry, the Tribunal ruled out against the DRP directions to reject adjustment in profit level indicator to accommodate any change in cost of raw material used by the taxpayer, thereby delete the direction of the DRP. C. Adjustment with respect to under-utilization of capacity

The Tribunal while deciding over adjustment in respect of under utilization of capacity is of view that adjustment in this respect can only be given to the tested party only when it is possible for the taxpayer to establish that comparables are working with utilization significantly above its own. Facts apropos in the instant case are that actual production was only 1,700 mts. as against installed capacity of 3,400 mts. which is only 52.26%, which is lower than average capacity utilization of comparables of 65.21%. Difference in capacity is claimed for adjustment by the taxpayer.

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The ITAT while calling for analysis for veracity of figures used by taxpayer to show comparables capacity utilization more than its own, set aside the order of the lower authority and remit the case back to the file of AO/ TPO for afresh consideration in accordance with law. 2. On the Appeal filed by the taxpayer

A. Exclusion/Inclusion of Comparables

The taxpayer sought exclusion of Infosys BPO Ltd. and inclusion of Microland Ltd. in the list of comparables. a) Infosys BPO Limited: Though this entity was the part of

taxpayer’s own list of comparables; the taxpayer now sought its exclusion due to its huge brand value and substantial ownership of intangibles.

The ITAT pronounce the exclusion of the aforesaid entity by placing reliance on the decision of Delhi High Court in the case of CIT vs Agnity India Technology Pvt. Ltd. [(2013) 93 DTR 0375] wherein it was held that “risk profile, ownership of proprietary products and expenditure on R&D took Infosys Technologies Ltd. out of the list of comparables companies in case of software development service segment” b) Microland Limited: The taxpayer proposed to include Microland

Ltd. in the list of comparables though initially not included in the same. Passing all the filters applied by the TPO and availability of information in public domain are the basis on which the taxpayer proposed Microland Ltd. in comparables list. To provide impetus to his view the taxpayer placed reliance on following case laws:

Mindtek India Ltd v. DCIT [IT(TP)A.70/Bang/2014] DCIT v. Quark Systems Pvt. Ltd.

The Tribunal, by virtue of the aforesaid decisions, stood with taxpayer point to undertake the fresh analysis of Microland Ltd. on the basis of submissions to be filed by the taxpayer. Nangia’s Take The Indian TP regulations provides that that the margins of the comparable companies need to be adjusted to take into account the functional and other differences which could materially affect such margins in the open market. In the light of above, the ITAT, duly emphasized that the normal Industry standard/ practice while deciding over adjustment (for high cost of raw material taking such increment as a part and parcel of normal business activity along with under utilization of capacity) and thereby putting the onus on taxpayer to confirm the existence any extra-ordinary circumstances for claiming any economic adjustment. Source: Momentive Performance Materials (India) P. Ltd. Vs. ACIT [TS-92-ITAT-2016(Bang)-TP]

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7. The Tribunal deleted the adjustment made by TPO on ad-hoc basis; Also confirms that consideration due from AE is the result of a commercial transaction and not be viewed as extending loan or placing deposits

Facts of the Case Det Norske Veritas A/S (“the taxpayer”) is a non- resident company, incorporated in Norway carrying on its business in India through a branch office. The taxpayer is engaged in the business of classification, certification, verification and advisory services relating to offshore activities, and inspection and certification of non- marine products and services.

made by the TPO. Aggrieved, the taxpayer filed an appeal before Mumbai Income Tax Appellant Tribunal (“the ITAT”/ “the Tribunal”). The ITAT’s Adjudication 1. On Amount paid to Head Office

The ITAT noted that the TPO did reject the TP methodology adopted by the taxpayer to benchmark its international transactions. Also, the TPO did not raise any question on the selection of comparables. Based thereon, the ITAT held that it was not open to the TPO to even reject the benchmarking done by the taxpayer. Such a course of action is not permissible under the scheme of TP regulations. Even when the method of ascertaining the ALP is rejected by the TPO, he has to select the best suited method out of the six methods recognized under Rule 10AB and 10B of the Income-tax Rules, 1962 and applies the same. But such a procedure had not been followed by the TPO. The TPO had only made ad-hoc adjustments, which is not permissible. He had not only wrongly rejected the ALP determined by the taxpayer, but also determined the ALP under a method which is not recognized. Therefore, the ITAT deletes TP additions of INR 95.04 lakhs and INR 16.31 lakhs made by the TPO on ad-hoc basis. 2. On delayed realization of trade receivables

In this relation, the taxpayer’s stand was that it was the policy of the taxpayer, to not to charge the interest in respect of such delays, neither from its AE nor from unrelated entities. But the TPO was of the view that non recovery led to blockage of funds, thereby resulting in loss of revenue, which, if had been realized, would have improved the profitability of the taxpayer. With this contention, the TPO called for an adjustment of Rs. 7.20 lakhs.

During the Assessment Year (“AY”) 2008-09, the Transfer Pricing Officer (“TPO”) had ordered for ad-hoc adjustments in respect of sharing of expenses of regional office expenses, for services received from Associate Enterprise (“AE”) and payment of interest in respect of delay in realization of receivables from AE. The TPO did not point out any fault in ascertaining the Arm’s Length Price (“ALP”) based on using Transactional Net Margin Method (“TNMM”). Yet, the TPO proceeded to make adjustments of 20% amounting to INR 95.04 lakhs for services received from AE in respect of Services Level Agreement. He also made ad-hoc adjustments of 20% amounting to Rs. 16.31 lakhs in respect of sharing of regional office expenses. Aggrieved with the actions of TPO, the taxpayer filed an appeal before Commissioner of Income Tax (Appeals) who confirmed the additions

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In this regard, the Tribunal stated that while deciding the ALP, the main issue is to consider as to what would have been the situation in respect of a non AE. Since the taxpayer claims that no such interest is charged from anyone, including non-AE and the contention is not disputed to be factually incorrect, it cannot be open to the TPO to make adjustments for delay in realization of amounts from AE. The Tribunal also held that the treatment for AE and non-AE has to be the same. Relying on the ruling of Micro Ink Vs. ACIT, the Tribunal held that when transactions are benchmarked using TNMM, interest on delay in realization of amount is incidental to such transaction; therefore, such an adjustment cannot be made independently. Accordingly, ITAT deleted the TP addition in respect of such transaction. Nangia’s Take Another ruling which clearly provides that the delay in realization from AE is not subject to levy of any interest when the taxpayer, under its business commercial realities, does not follow such policy while dealing with AEs or unrelated parties. It is high time when the lower tax authorities should understand and respect the business policies of the taxpayer in the instances where the taxpayer does not make any discrimination while doing businesses with its AEs or unrelated entities. Source: Det Norske Veritas A/S V/S ADIT [ITA No. 200/Mum/2014].

8. Tribunal refers back the case to AO/TPO to be taken afresh in case of disallowance of management fee that was made taxable in the subsequent year; TPO’s contention for computation of ALP was upheld

Facts of the Case DRI India Relays P Ltd., (“the taxpayer”) is engaged in manufacture and assembly of hermitically sealed relays, connectors, contacts and sockets. During the year under consideration, it had entered into international transactions. The Transfer Pricing Officer (“TPO”), during the course of proceedings, accepted the Arm’s Length Price (“ALP”) of all international transactions of the taxpayer other than the transaction pertaining to payment of management fee and made an upward adjustment of INR 78.82 lakhs by determining the ALP of the same at NIL.

The TPO was of the view that since the taxpayer had reversed provision of the entry of payment of management fee in the subsequent assessment year which means that no services had actually been received by the taxpayer from its associated enterprise (“AE”). The taxpayer appealed before the Commissioner of Income Tax (Appeals) [“CIT(A)”] stating that the debit balance of management fee was only a provision and tax was deducted at source. The taxpayer also

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highlighted that its AE had engaged a specialist for rendering consultancy services and advises to the group companies. On the contrary, the CIT(A) believed that there was a waiver of management fee by the AE that led to reversal of entry in subsequent year. Also, he believed that the taxpayer did not use any services from the AE. The CIT(A) further stated that if a provision is made in a year only because it was reversed in the subsequent year does not mean that the provision made is at arm’s length. Further to this, he opined that tax deducted at source could not be used as a ground for claiming an allowance which was not otherwise according to law and based thereon, confirmed the additions made. Aggrieved taxpayer appealed before the Income Tax Appellate Tribunal (“The Tribunal”/ “the ITAT”). The Tribunal’s Ruling 1. Amount already disallowed in the computation of income

should not be disallowed again

During the course of proceedings before the ITAT, the taxpayer submitted that allowance of the amount was never claimed and hence, no disallowance or addition could be made. It was also, submitted that no plea reckoning disallowance was made before the lower authorities. The Tribunal called for the statement of taxable income that was filed by the taxpayer which distinctly stated disallowance of INR 89.73 lakhs including the management fees. The taxpayer claimed that suo-moto disallowance was made by the taxpayer since the tax was not deducted at source thereon. Thus, the taxpayer claimed that further addition of Rs. 78.82 lakhs would result in double disallowance.

The Tribunal reprimanded that the taxpayer claimed that it had deducted tax at source but not paid it to the credit of Central Government of INR 78.82 lakhs and thus, made a suo-moto disallowance through its computation. Apparently, such claim was wayward to the submission presented before the CIT(A) by the taxpayer. 2. On the benefits extended by the AE to the taxpayer by

rendering management services

In addition to the above, the ITAT further mentioned that the taxpayer never furnished the details of the services rendered by the AE and the benefits obtained from such services to the lower authorities. After taking into consideration the submissions made by the taxpayer before the TPO, CIT(A) and now the Tribunal, the Tribunal was of the notion that the matter required a fresh look by the lower authorities. The Tribunal also ruled out that the TPO was justified in looking at the ALP concerning the claim of the taxpayer irrespective of whether the amount was suo-moto added by the taxpayer, for a reason other than non-rendering of services by the AE. Nangia’s Take The Tribunal’s recognition of the fact that despite disallowing suo-moto, the management fee paid by the taxpayer, it is necessary for tax authorities to look into the evidence to prove rendering of services and benefits received, as they may not be tangible in nature. Accordingly, needless to say, taxpayers in general, are required to maintain documentation specific to their own set of facts.

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9. The “quotations” could be used as valid input under the residuary method set out in Rule 10AB of the Income-tax Rules and consequently, the hypothetical price under uncontrolled comparable conditions can be used as comparable for benchmarking analysis

Facts of the Case Gulf Energy Maritime Services Private Limited [“the taxpayer”] is engaged in the business of providing ship management services to its parent company viz. Gulf Energy Maritime PJSC, United Arab Emirates. During assessment year 2011-12, the taxpayer, for providing aforesaid services, received USD 40,000 per month from its parent company.

For determining the arm’s length price [“ALP”] of the same, the taxpayer had applied Comparable Uncontrolled Price Method (“CUP Method”) using quotations from Orient Express and Herald Maritime Services Pvt. Ltd. as comparable uncontrolled price. The taxpayer, concluded that since it has charged higher price for the services rendered to the AE in comparison with the rates offered in the above mentioned quotations, accordingly the international transaction entered by the Assessee meets the arm’s length criteria as per Indian TP transfer pricing [“TP”] regulations. During the course of the assessment proceedings, the Assessing Officer [“AO”] determined the ALP considering the comparables used by the Assessee as merely quotations wherein no real transactions have taken place.

Further, the AO also noted that the taxpayer had been paid a lump sum amount for the aforesaid services while the number of crew members have not remained same during the year under consideration. Hence, the AO recalculated the revenue of the taxpayer by taking the actual receivables and applying minimum rate per crew. Based thereon, the AO made an upward adjustment of INR 12.71 lacs. The taxpayer filed appeal before the Commissioner of Income Tax (Appeals) [“CIT(A)”]. The CIT(A) rejected the same and upheld the adjustment made by the AO. Aggrieved by the above stated addition the taxpayer filed an appeal before the Income Tax Appellate Tribunal [“the ITAT”/”the tribunal”]. ITAT Ruling The ITAT observed that the AO was not justified in re-computing the ALP of the said international transaction merely on the grounds that the quotations used by the Assessee as comparable uncontrolled price are not actual transactions. Further, the ITAT also stated that the AO cannot decide that for each variation in the number of crew members on the job, the charges must vary. The ITAT further noted that the AO did not dispute the bonafide of quotations provided by the taxpayer but merely rejected them on the basis that no real transactions have actually taken place. For this purpose, the ITAT referred to Rule 10B(1)(a) of Income-tax Rules, 1962 (“the Rules”) which states that the valid inputs for CUP method can only be the “price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions”. However, the rigidity of the aforesaid Rule has been considerably relaxed when Rule 10AB of the Rules is taken into account which allows hypothetical price of a transaction being considered as comparable uncontrolled price as well. Subsequently, when Rule 10AB read with Rule 10B(1)(a);

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such an expression not only covers the actual price but also the hypothetical price that would have been paid if the same transaction was entered into with an independent enterprise. The ITAT also threw light on the fact that even though Rule 10AB is effective from 1st April 2012 in the Income Tax Rules, is retrospective in effect. In relation to the aforesaid, the ITAT also referred to co-ordinate bench decision in M/s. Toll Global India Forwarding Pvt Ltd Vs DCIT in ITA No.[(2014) 37 ITR (Trib) 391 (Del)] which supports the retrospective effect of Rule 10AB of the Rules. The ITAT further opined that the AO can decide the ALP of the given transaction but the same should be done on the basis of a legally recognized method. Therefore, the re-computation of ALP by the AO on the basis of number of crew members was devoid of any legally sustainable basis. In the light of the same, the Tribunal ruled that lower authorities were not justified in making the upward TP adjustment, and thus, allowed taxpayer’s appeal. Nangia’s Take It is clear that the tax authorities are not empowered to re-compute the ALP of an international transaction on an ad-hoc basis. Further, the ITAT in the instant case, while discussing introduction of Rule 10AB read with Rule 10B(1)(a) of the Rules threw light on the widened scope in relation to the valid quotes that can be used while applying CUP Method. Having said that, the ITAT, however, clarified that the proposition, bonafide quotations can be accepted as valid inputs for benchmarking analysis is a subjective matter and has to be verified accurately in all circumstances. Source: Gulf Energy Maritime Services (P) Ltd Vs ITO Ward 8(1)(4) [I.T.A. No. 3812/Mum/2015]

10. Tribunal approves internal CUP of 5% interest-rate for benchmarking overseas AE-loan considering higher rates on domestic loans vis-à-vis application of external CUP by the Revenue.

Background of the case

Intergarden (India) Private Limited [“the Taxpayer”], had availed an External Commercial Borrowing [“ECB”] of INR 81 million [approx. USD 1.35 mn] from its associated enterprise [“AE”]

Facts of the case During AY 2006-07, the taxpayer had availed an ECB and paid 5%

as rate of interest to its AE. The Transfer pricing officer [“TPO”] opined that 5% was

excessive and by applying comparables ECB rates, considered 3.87% as arm’s length rate of interest.

Aggrieved by the findings, taxpayer further contested before the Dispute Resolution Panel [“DRP”], contending inter-alia that the effective rate of interest paid by the taxpayer on lanes taken in India is 6.62% and accordingly, the rate of 5% was lower than and ought to be considered as being at arm’s length. DRP refused to interfere with the approach of the TPO.

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Subsequently, the taxpayer approached the Tribunal to adjudicate the matter. Contentions of the Taxpayer before the Tribunal: The taxpayer contended that an internal CUP existed at 6.62%

which is undisputed. This internal CUP should take precedence over external CUP.

Contentions of the Revenue before the Tribunal: The departmental representative [“DR”] reiterated and

supported the position taken by the lower authorities.

Tribunal’s conclusions: The Tribunal duly considered the facts of the case and arrived at

the following conclusion: The Tribunal held that when internal CUP of 6.62% is available

and the interest paid by the taxpayer to the AE is @ 5% which is lower, it takes precedence over external CUP.

Accordingly, no adjustment ought to be made. [Source: Intergarden (India) Private Limited; ITA No. 1292/Bang/2010] Nangia Take: It is heartening to see that the Tribunal does appreciate the

intricacies of taxpayer’s business profile and accepts that an internal CUP is more appropriate to benchmark the transaction vis-à-vis external CUP.

The importance of appreciating functional profile and methodology of arriving at an arm’s length price by adopting an appropriate method has gained importance in recent times as the appellate authorities as amenable and non-adversarial regime. There are other direct tax grounds dealt with by the Tribunal in the present case.

11. Transfer Pricing regulations do not apply to capital account transactions.

Background of the case Topsgrup Electronic Systems Limited [“the Taxpayer”], a wholly owned subsidiary of Tops Securities Limited [“TSL”] is engaged in the business of manufacturing security equipment, however, since this business stopped, it is carrying on the activity of an investment / holding company.

Facts of the case During AY 2009-10, in order to expand the security business on a

global scale, the Topsgrup proposed to invest in Shield Guarding Company Ltd, UK [“Shield”], a company engaged in the business of providing security services.

The holding company i.e. TSL subscribed to shares of the taxpayer at a premium of 990/- per share, resulting in investment of INR 1.25 billion [approx. USD 20.77 mn.]

This money received by the taxpayer was invested in acquiring the shares of Tops BV Netherlands, a wholly owned subsidiary, which was to be an intermediate holding company of Shield @ euros 2,663.38 per share. This money was further invested in Shield.

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The taxpayer claimed that this subscription to equity capital did not have any bearing on profitability and TP regulations were not applicable.

During the course of the assessment proceedings the transfer pricing officer [“TPO”], observed that the AE (viz. Tops BV) got the huge premium due to its special relation with the assessee and the assessee had failed to establish that the AE was capable of raising funds, either by way of loan or share capital, on a standalone basis by itself. In the absence of this share premium, the AE would have had to take loans from the assessee or on open market which would entail it to pay huge interest costs. The AE thus got the funds by way of the above transfer by the assessee without being charged any interest thereon. Thus, according to the TPO, the premium was nothing but a loan given by the assessee to its AE (vis. Tops BV) in the garb of share premium.

The TPO then proceeded to compute the book value per share and accordingly made an addition of INR 1.24 billion.

TPO also re-characterised the said investment as loan and charged notional interest @ 15 per cent.

Aggrieved by the findings, taxpayer further contested before the Commissioner of Income-tax Appeals [“CIT(A)”], contending inter-alia that transaction was capital in nature and did not attract transfer pricing provisions due to absence of the income element therein. However, the CIT(A) upheld the order of the TPO.

Subsequently, the taxpayer approached the Tribunal to adjudicate the matter.

Contentions of the Taxpayer before the Tribunal: The subject matter of dispute is with regard to the investment by

the assessee in acquiring the shares in Tops VB, Netherlands.

The taxpayer contended that since the alleged transaction is capital in nature, TP provisions are not triggered as it did not result in any income nor was there any scope of earning any potential income arising out of this transaction.

Reference was made to the decision of the Bombay High Court in the case of Vodafone India Services Private Limited, wherein it has been held that the ALP in transaction between the taxpayer and the AE is to be determined under TP provisions only in the event of occurrence of income. It does not warrant re-computation of a consideration received/given on capital account.

It was also argued that a transaction of investment in share capital cannot be re-characterised as a loan. The Act does not permit re-characterisation of equity into loan or for that matter loan to equity.

Contentions of the Revenue before the Tribunal: The Departmental representative [“DR”] contented that the term

“income” includes “potential income” that could arise/be affected by the investment made by the taxpayer in the share capital of Tops BV and reiterated the findings of the TPO.

The DR also contended that the assessee may sell the shares it holds in Tops BV, at a future date for a price lower than the cost at which they had been acquired resulting in long term/short

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capital loss, thereby impacting the income of the assessee in subsequent years. On the issue of re-characterisation of investment in equity shares

as a loan the learned DR raised additional refuted by the taxpayer as being the DR is not permitted to raise any points different from those considered by the AO/CIT(A).

Tribunal’s conclusions: The Tribunal duly considered the facts of the case and arrived at the following conclusion: Income arising from the international transaction is a condition

precedent for computing the ALP and such income should be chargeable to tax under the Act. In the absence of such income, benchmarking of an international transaction and computing ALP thereof would not be in order. Consequently, if an international transaction is on capital account and does not result in income as defined under section 2(24) of the Act, the provisions of Chapter X of the Act would not be applicable to such transaction.

The learned D.R. was not able to establish that any income arose out of the assessee's transaction, i.e. of investment in the shares of its wholly owned subsidiary, Tops BV.

A plain reading of section 92(1) of the Act which specifies that 'any income arising from an international transaction shall be computed having regard to the Arm's Length Price' implies that the potential income, if any, should arise from the impugned international transaction for consideration and not out of a hypothetical international transaction which may or may not take place in future.

Since the transaction is capital in nature, the addition on the part of the equity capital being re-characterized as loan would not be possible, as the said loan cannot, by any stretch of imagination, be considered income of the assessee.

Based on the documentary evidence, there is no reason to hold that the impugned transaction was in fact in the nature of a loan advanced and not an investment in share capital.

Accordingly, the addition of notional interest on the share capital re-characterized as loan is not tenable. Further, there is no income/potential income arising to the assessee out of the impugned international transaction of investment in acquiring shares in its subsidiary TOPs BV, Netherlands, the same would not fall within the purview of Indian Transfer Pricing provisions.

[Source: Topsgrup Electronic Systems Limited; ITA No. 2115/Mum/15] Nangia Take: The issue of applicability of transfer pricing provisions to the

capital account transactions is well settled by the jurisdictional High Court.

Re-characterisation of investment as loan is also common phenomenon seen before the lower authorities.

These aspects are not appreciated at lower levels but it is heartening to see that the Tribunal appreciates the merits and grants corresponding reliefs.

There are plethora of cases to support the taxpayer on the subject matter and robust documentation to support the position and the transactions undertaken by the taxpayer is a key aspect in defending the position of the taxpayer.

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12. Invoice date to be point of taxation in case there is a change in service tax liability by the service recipient.

INDIRECT TAX

In terms of Rule 7 of the Point of Taxation Rules, 2011 (‘POT Rules’), point of taxation for payment of service tax, under reverse charge mechanism, shall be the date on which payment is made. In case payment is not made within 3 months from the date of invoice, point of taxation shall be the date immediately following the said period of 3 months.

Nangia’s take This is a much awaited amendment on point of taxation for services covered under reverse charge mechanism. In our view, change in the liability would include changes on account of change in rate of tax, introduction/ omission of new tax /cess, change in rate of abatement etc. [Source: Notification No. 21/2016-Service Tax dated 30 March 2016]

Vide Notification No. 21/2016-ST dated 30 March 2016, rule 7 of POT Rules has been amended to provide for point of taxation in case there is a change in the service tax liability under reverse charge mechanism. In terms of the amendment, point of taxation for payment of service tax, under reverse charge mechanism, would be the date of invoice in case following condition is fulfilled cumulatively: There must be change in service tax liability, under reverse charge mechanism; Service has been provided before the date of the change; Invoice has been issued before the date of the change; and Payment has not been made as on the date of the change.

13. Central Government prescribes maximum limit for the credit reversible under Rule 6(3)(i) of the Credit Rules

In terms of Rule 6(3)(i) of the Cenvat Credit Rules, 2004 (‘Credit Rules’), an option is given to a manufacturer/ service provider to pay an amount equal to 6% of value of the exempted goods and 7% of the value of the exempted service in case the manufacturer or service provider is engaged in manufacture/ provision of exempted goods/ services.

Vide Notification No. 23/2016-CE (NT) dated 1 April 2016, the amount of reversal under Rule 6(3)(i) of the Credit Rules has been restrict to sum of total of opening balance of input and input services credit available at the beginning of the period to which payment relates and credit of input and input services taken during the said period.

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Nangia’s take In view of the amendment, manufacturer and service provider would not be liable pay any excess amount in case amount reversible, under Rule 6(3)(i) of the Credit Rules, is more than the sum of opening balance of credit and credit availed during the relevant period. [Source: Notification No. 23/2016-Central Excise (NT) dated 1 April 2016]