Author Archives: Amit

No re-assessment to probe share premium : Bombay HC

The High Court of Bombay has held that a re-assessment notice which was issued to examine the Share Premium received by a Taxpayer was not valid in law. The Revenue’s contention that it was entitled to examine if the premium received was justified and corresponds to the intrinsic value of the shares of the Taxpayer company was not accepted by the Court. The ruling was rendered in the case of Khubchandani Health Parks.

The Revenue had also made a rather sweeping assertion that since the Taxpayer’s case was not subjected earlier to an assessment (audit) process, it was entitled to issue the notice and it was not necessary that the notice should be supported by reasons. The Revenue sought to rely on the ruling of Supreme Court in the case of Zuari Estate Development [DCIT Vs Zuari Estate Development and Investment Co. Ltd. (373 ITR 661)] .The Bombay High Court instead relied on observation in an earlier ruling of the Supreme Court in the case of ACIT Vs. Rajesh Jhaveri Stock Brokers P Ltd. (291 ITR 500) wherein the Apex court had observed that a re-assessment proceeding has to be in accordance with law and supported by valid reasons [ Interestingly though, in the aforesaid case, the issuance of the re-assessment notice was upheld as valid].

The Bombay High Court also relied on its earlier ruling in the case of Vodafone [Vodafone India Service Ltd Vs CIT 368 ITR 1] wherein it was held that Share Premium was a capital receipt and did not constitute income of an assessee, to decide the petition in favor of the Taxpayer. Attempts by the counsel for the Revenue to differentiate the issue involved in the instant case was not appreciated by the Court.

 

Units enjoying Tax holiday not immune to TP Adjustments: Delhi Tax Tribunal

The Tax Tribunal Bench in Delhi has held in the case of Headstrong Services Private Limited that even units which enjoy Tax holiday can be subjected to Transfer Pricing (‘TP’) adjustments, rejecting ‘no base erosion’ argument put forward on behalf of the Taxpayer.

The Delhi bench refused to follow the ruling of the co-ordinate Mumbai Bench  rendered in the case of Tata Consultancy services, wherein it was held that the TP provisions are not applicable to Tax holiday units. The Delhi bench ruled that it was bound to follow the earlier ruling given by the Special Tribunal Bench in Aztec’s case, which upheld applicability of TP provisions even to Tax payers enjoying a Tax holiday.

Certain other issues decided by the Tribunal are briefly re-capitulated below:

Use of Past year’s data and future projection

The Tribunal also rejected the use of past years’ data as well as future projections for computation of the Transaction Net Margin (‘TNM’) of the Tax payer.

Alternate TP defense using revenue distribution ratio as a ‘CUP’

An interesting alternate defense was raised on behalf of the Taxpayer – that of using revenue distribution ratio as a Comparable Uncontrolled Price (CUP). It was contended that 80% of the revenues which were earned by the Associate Enterprise was shared with the Taxpayer, as against Tax Payer sharing only 77.50% of its Revenues with other third parties, in respect of certain other service contracts.  The Tribunal held that such a comparison was not valid and further  the distribution ratio did not constitute a CUP.

Exclusion of foreign exchange fluctuations in margin computation

The Tribunal ruled that forex fluctuation impacts both the Taxpayer as well as the comparable companies selected for TNM analysis and therefore there was no reason to make any adjustment for the same.

Right of Taxpayer to challenge comparable companies for the first time before Tribunal

The Tribunal upheld the right of the Taxpayer to challenge certain comparable companies for the first time before the Tribunal. The earlier ruling of Special Bench in the case of Quark Systems was followed. However, instead of deciding on the comparability or otherwise of these companies, the issue was restored to lower authorities for their consideration.

On Comparables’ selection

The Tribunal accepted Taxpayer’s argument that companies like Wipro, Infosys which own IPRs and have significant R&D expenses are not comparable to that of Taxpayer. Further, companies which are engaged in software product development were also held non-comparable to the Taxpayer, which was a service provider.

Project office not a PE : Delhi High Court

The Delhi High court has ruled that a Project office set-up by a foreign company in relation to a contract for design and fabrication of petroleum platform is not a Permanent Establishment. The said ruling was given in the case of National Petroleum construction company, a resident of U.A.E.

The High Court accepted the argument advanced on behalf of the foreign company that the role of the project office was limited to performance of co-ordination activities. The fact that the contract which the foreign company entered into with the Indian party (ONGC) required it to set-up a Project office in India was also not considered relevant. The argument by the counsel of the foreign company that the employees at the project office had a low-profile and the team which was engaged in critical contractual discussions were not employees of the project office, as alleged by Revenue, found favor with the Court.

The Court further opined that the existence or otherwise of the Installation PE would have be tested from the time the activities are actually commenced at the site by the foreign company itself and time spent at the site by the sub-contractor for carrying our survey activities would not be reckoned for the purpose of determination of existence or otherwise of the PE.

Interesting, the company itself admitted to its project office as being a PE in its return of income filed and offered to tax that portion of income which related to activities in India. The company revised its position at the time of scrutiny, which was not accepted by the lower authorities – the Assessing Officer, the first level Dispute Resolution Panel as well as the Tax Tribunal – all of which  came to the uniform conclusion that there was a PE in India.

Bright Line, Now blurred : Delhi High Court rejects TP adjustment for AMP

 

After reversal of the Tribunal (famously referred as LG electronic’s case) on the Transfer Pricing Adjustment made towards alleged “excessive” expenses incurred by the Taxpayers , the Revenue once again found itself on the losing side of the battle on the issue of TP adjustment in relation to the Advertising, Marketing and Promotion (‘AMP’) expenses, before the Delhi High Court.

Further Set-Back to Revenue in Maruti Suzuki’s case

After its ruling to the effect that Bright Line Test cannot be applied to deduce an international transaction [Sony ericsson’s case], the Delhi High Court moved one more step closer to the Taxpayer’s position on the issue of Transfer Pricing Adjustment in relation to alleged brand promotion services by an Indian company by virtue of incurring excessive Advertising spends.

The Delhi High Court  negatived the Revenue stand that excessive brand promotion expenses incurred by Maruti Suzuki could be analysed as an “International Transaction”  under the Indian Transfer Pricing provisions.

The Revenue’s case was that companies which use a foreign brand and incur aggressive Advertising and Marketing expenses are helping their parent / associate group company to improve the value of the Brand owned by the foreign associate, at the expense of the Indian entity of the group. The Revenue alleged that there exists an unwritten arrangement between the Indian entity and its foreign associated enterprise as a result of which the Indian company is incurring these expenses. By incurring such abnormal AMP expenses, the Indian company is effectively undertaking brand promotion / brand building for its foreign associated enterprise and therefore it must be compensated at arm’s length for such services, the Revenue contended.

The Court has taken the view that the provisions of the Indian Transfer Pricing law do not permit  an exercise of deducing the existence of an international transaction in the nature of brand promotion assistance / services being rendered by the Indian company, when such expenses have admittedly been incurred by the Indian company for its own business. Any incidental benefit of such expenses to the foreign company by way of improving its brand value cannot be deemed as an International Transaction without there being an express  provision  under the law, the Court ruled.

 

 

CBDT’s New Year Gift to Taxpayers: File Appeals electronically

In a move aimed at greater use of technology interface in Tax administration, the CBDT has issued a press release on Dec 30 announcing that electronic filing of appeals before the first appellate level authority –  namely, the Commissioner of Income-tax (Appeals) – is being introduced.

The electronic filing will be mandatory for all Taxpayers who are required to file their Tax returns electronically. Currently, a large section of the Tax payer population [barring low-end tax payers with income less than INR 500,000] are required to file their Tax returns electronically. Given that most assessments which are challenged in Appeal are filed by non-individual Taxpayers and individuals in the higher tax brackets, the move is likely to usher in near-complete digitization of the appeal filing process at the first level.

The existing form 35 is also being substituted by a new form which the press releases promises to be more “structured, objective, systematic and aligned with the current provisions of the Income-tax Act”.  The electronic filing will also facilitate fixation of hearings of appeals electronically, adds the Press release.

Our comment

The introduction of electronic filing of appeals before the Commissioner of Income-tax (Appeals) is a very welcome move and one hopes that this would be the precursor to introducing e-filing of objections before the Dispute Resolution Panel and appeals before the Tax Tribunal.

 

 

 

No TP adjustment sans base erosion: ITAT Mumbai

In a recent decision rendered in the case of Tata Consultancy Services, the Tax Tribunal has held that a Transfer Pricing adjustment was not warranted in situations where Tax avoidance / Profit shifting is not possible, such as in cases where the Indian company is enjoying Tax holiday or the foreign associated enterprise is located in a high-tax jurisdiction.

The Tribunal also held that a mechanical reference to the Transfer Pricing Officer was improper and the Assessing Officer ought to have applied his mind to the Transfer Pricing report filed by the Taxpayer and given an opportunity of hearing to the Taxpayer, before referring the case to Transfer Pricing Officer.

The other issues that were decided in the aforesaid appeal in favor of Taxpayer were allowing the deduction for State Taxes paid in US, allowing capitalization of software expenses to escape dis-allowance under section 40(a) for non-deduction of Taxes and allowing deduction under section 10A, even though 80HHE relief was claimed in earlier years.

Our Comment

The Tribunal has dealt with two forms of base erosion arguments on the same footing:

(a) That there cannot be any motive to shift profits where the Indian Taxpayer is enjoying a Tax holiday and

(b) Where the Tax rate in the foreign country is higher, again, there cannot be any motive for shifting profits

In cases where the Taxpayer in India is enjoying an undisputed Tax holiday  benefit, the logic that there is no motive to avoid Tax is quite unexceptionable. As regards the argument relating to the foreign associated enterprise being located in a ‘high-tax’ jurisdiction is concerned, in our view, the head-line tax rate per se cannot be a factor to determine if there exists a motive or incentive to shift profits, as what would be relevant is the effective tax rate of the foreign enterprise.  In this context, the other aspect of the ruling on providing an opportunity for hearing to the assessee before a reference to the TPO becomes relevant, as the said opportunity could be used by the Taxpayer to demonstrate the effective tax impact of the Transaction in both jurisdictions.

 

 

 

Revised Transfer Pricing Process under the new TP Rules

The Government has finally notified the new set of rules for determination of Arm’s length price  (‘ALP’) under the Transfer pricing provisions. The new set of rules would also apply in relation to the international transaction entered during the fiscal 2014-15, for which Transfer pricing and filing compliance fall due by end of next month (30 November 2015)

The revised process of determination of ALP under the rules is summarized below:

(1) Arm’s Length Range concept introduced

Where the application of Most Appropriate method results in more than one price, then the Tax payer would have to construct a ‘data set’ for determination of arm’s length mean or range, as  applicable.

(2) The mean concept will apply for smaller data sets

Arm’s length range would apply if there are six or more entries in the data set and the mean would apply if the number is less than six.

(3) Multi-year data (current year+ 2 previous years) to be used for margin-based methods

Where the margin-based methods (i.e. Transaction Net margin method, cost plus method or Resale price method) are used for determination of ALP, then the weighted average margin for the current year (i.e. the year under analysis) and two prior years would have to be considered for determination of the arm’s length price (margin).

(4) Previous year data can be used for comparable selection

While applying the margin-based methods, if current year data is not available for a company, then its comparability would be analysed based on the previous year’s data, and if a company meets the comparability criteria, then two prior years’ data would be considered for constructing the data set.

(5) Comparable companies selected on Previous year data to be re-validated upon availability of current year data

While applying the margin-based methods, if a company is selected as a comparable based NOT on current year data, but instead on previous year data (as discussed under point 4 above),  and subsequently current year data for such a ‘comparable’  is available at the time of assessment, then the suitability for inclusion as a comparable would be re-determined based on current year data. If the current year data reveals that a selected company was not really a comparable, then such a company would have to be excluded from the analysis. Should the current year data however validate the selection, there is no provision to ‘update’ the weighted average margin of such a comparable with the current year’s result, as is the practice normally adopted by the Transfer Pricing officers currently.

(6) Range defined

Where the data set consists of six or more ‘entries’, then the values in data set lying between the 35th and 65th percentile would be regarded as the arm’s length range.

Practically, on account of the way the 35th and 65th percentile have been defined, the actual range would be slightly higher at both the lower and the higher bounds of the range, than the actual / ‘pure statistical’ values.

(7) Mean ALP to apply for smaller data sets

Where the number of the ‘entries’ in the data set is less than six, then the ALP would be determined at the mean of the values or a permitted deviation (not exceeding 3%) from such a mean, which may be notified.  This is the same as the method which was in use till now.

(8) No impact on Profit Split Method / Residual Method

The revised process would not impact the application of the Profit Split method and the ‘residual method’ – both rarely used in practice in the Indian context.

Our Comments

The introduction of the Arm’s length range concept and use of earlier years data are steps which are in line with the Taxpayers expectation, although the use of multi-year data can prove to be a double-edge sword and can result in unrealistically higher ALP in a period of secular decline in margins in an industry.

The new rules however would have little impact on the core of the Transfer Pricing problem being faced by Taxpayers, which revolve around the selection of comparables per se, with both Taxpayers and the Taxman seldom agreeing on comparables which are fit for inclusion / exclusion in the data set to be used for determining the ALP.

 

Section 68 shocker for foreign Investments from ‘suspect sources’- Economic Times report

The Economic Times, a leading business daily has reported that the Indian Tax authorities have now set their sights on in-bound investments to track unaccounted / suspect  investment sources. The report can be accessed in the following link:

“Inbound M&A deals on I-T department’s radar; total tax demand may exceed Rs 4,000 crore

 

Our Comment

As the report states, only those investments which are from “suspicious” sources have been targeted for action. While cracking down on suspicious investment sources is welcome and in line with the stated intent of the Government to cleanse the economic ecosystem, the reported action under Section 68 seems to be beyond the mandate of law.

Prima facie, it appears to be a mis-application of a proviso which was introduced in the taxing statute from fiscal 2013-14 by Finance Act, 2012. As per the said proviso, monies received by privately held and closely held companies, in the form of Share capital , Share application and Share premium is “presumed” to be its  “unexplained income”, unless the “residents” contributing such monies can explain the source of funding.

The above amendment was introduced to plug the loop-hold of white washing unaccounted sums by introducing the same as share capital, and is clearly intended to operate only where such monies have been received from resident persons.It appears that the Taxman has mis-construed the provision to be applicable even for share capital contributions received from foreign sources. Thus, while the intent behind the action appears to be above board, the means adopted to secure the intent looks questionable, and may not stand judicial scrutiny.

Interestingly, the window for voluntary disclosure of unaccounted monies held abroad under the Black Money legislation introduced by the Government came to a close recently [on September 30, 2015] which was soon followed by stern statements by the Finance Minister suggesting that those who are hoarding monies and have not come forward with disclosure would have to pay the price. It is not apparent whether the reported actions have any link to the ‘harsh action’ that the Honorable Finance Minister warned of.

 

Supreme Court Ponders over Ponds

“Things are not what they appear to be…” – Zen Quote

A natural pond specially designed to raise prawns is a ‘Plant’ ruled the Supreme Court, in a brief ruling in the case of Victory Acqua Farm Ltd, relying upon its earlier ruling in the case of Karnataka Power Corporation. In Karnataka Power Corporation’s case, specially designed Power generating stations were held to be ‘Plant’ on the basis that they were integrated with and formed an inseparable part of the Power generating equipment.

The Revenue had rested its hopes on an even earlier ruling by the Apex Court in the case of Anand Theaters, wherein the Apex Court had ruled that merely because a building is specially designed for use as a movie theater, it would not assume the character of a ‘Plant’.

In Victory Aqua’s case, the Apex Court approved the application of the ‘functional test’ and effectively upheld the Taxpayers contention that the Ponds were tools of its business. The attempt by Revenue authorities to challenge the finding that the Ponds were specially designed was not entertained on the ground that it was too late in the day to dwell into factual findings which were on record.

The classification as ‘Plant’ is more advantageous to Taxpayer as ‘Plant & Machinery’ is entitled to higher depreciation allowance than Buildings.

 

 

 

 

Expert Committee report on MAT levy: A case of closing the lid or opening up a Pandora’s box..

The Direct Taxes expert committee constituted by the Government of India under the Chairmanship of Justice A.P.Shah, on the controversial issue of applicability of Minimum Alternate Tax (‘MAT’) to Foreign Investors, submitted its report in last week of August [MAT is levied on the profit as appearing in the books of accounts, as opposed to a normal Tax levy, which is based on the ‘income’ as determined under the Tax laws].  As  widely expected, the report has concluded that MAT levy does not apply to Foreign Investors, which do not have a presence in India.

The Government has been quick to accept the recommendations of the committee and a Circular to this effect has also been issued by the CBDT. As of now, one could safely conclude that only certain last rites remain to be performed – in the form of legislative changes – to bury the controversy for good – atleast insofar as the same relates to the levy on a foreign Investor. But in the process of putting a lid to one controversy, one wonders if the ground has been laid for another one – that relating to levy of MAT on foreign companies per se.

Tracing the legislative history of MAT levy, the committee has noted quite unequivocally that this piece of legislation was introduced only to target domestic companies. So where does that leave foreign companies which have a physical presence –  a Permanent Establishment (Branch / Project office) in India? Logically, the finding of the committee based on ‘past history’ of the legislation would lead to a rather straight forward conclusion  that all foreign companies ought to be out of the MAT net. However, perhaps mindful of the far reaching implication of such a situation, the committee has refrained from expressing a view on such companies.

The committee has also implicitly sought to create a distinction between the two sets of foreign companies – one which are under the regulatory radar of the Registrar of companies (Branch/Project offices) and the other that aren’t (Investors) – and concluded that there is no case for levy of MAT on the latter. But that surely does not mean as a corollary that the former are under the MAT net – if anything, the committee leaves a lot of fodder for the former set too.

A key piece of analysis relied by the committee to support its final conclusion revolves around the interpretation to be applied to the MAT code. The committee has expressed the view that the procedure laid for MAT levy is also a key determinant of the constituency to which the code should apply. A raft of judicial pronouncement, including the ever-famous Apex Court ruling in B.C.Srinivasa Setty’s case has been quoted in this context. Since the foreign investors are not required to prepare accounts in India, the committee concludes that it is reasonable to infer on that basis, that they are not liable to MAT levy.

Now, another piece of the procedural requirement for MAT levy is that the annual accounts for the purpose of the levy should be prepared on a fiscal-year basis; and the company (the Taxpayer)  should follow the same key parameters (accounting policies, standards, depreciation basis) for these accounts, as that adopted in the accounts “which are laid before the Company at its Annual General Meeting”. A foreign branch or project office, does not have to convene a General meeting in India. Does that lead to the argument that such companies are also not contemplated to be brought under MAT ?  Watch out for the odds on this one.