Tag Archives: Delhi High Court

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.

 

 

Tribunal can stay recovery of Tax demand beyond the statutory time-limit of 365 days: Delhi HC

The Delhi High Court has struck down as “unconstitutional” a provision under the Income-tax Act which restricts the power of the Tax Tribunal to grant a stay on recovery of the Tax demand beyond a 365-day period.  The decision was taken in response to a batch of petitions filed before the Court by Petitioners Pepsi foods, Ericsson Ab and Aspect Software Inc.

The Issue Involved

Under the Income-tax Act, where an appeal is pending before the Tax Tribunal, the related Tax demand can be stayed by the Tribunal for a period of 180 days and the Tribunal has to decide the case within that time. If the Appeal is not decided within the 180-day period, the stay can further be extended to 365 days if the delay is not on account of the Taxpayer and the Appeal would then have to be decided within the extended period of 365-days.

Practically, in quite a few instances involving complex issues, the Appeal process before the Tribunal can stretch even beyond the 365-day period. In all such cases, the law provided that the Tribunal cannot extend the stay beyond the 365-day time-limit even if the delay in disposal of the Appeal is not on account of the Taxpayer [Third proviso to section 254(2A) is the relevant provision]. This provision under the law was challenged by a batch of Petitioners before the Delhi High Court as “unconstitutional” and it was also argued that the provision restricting the time-limit for Stay of demand to 365-days rendered the Appeal mechanism an “illusory remedy” and rendered it nugatory. 

The Decision of the Court

Under Article 14, a provision of law can be struck down as unconstitutional if the same is found to be “discriminatory”. The High Court was of the view that the provision restricting the stay to 365 days, even where the delay in deciding the appeal was not attributable to the Taxpayer, is discriminatory. The Court ruled that a “well-behaved” Taxpayer (i.e.one who does not adopt dilatory tactics) cannot be clubbed with another who resorted to dilatory tactics, and both the classes of the Taxpayer cannot be made to face the same consequences.

Impact of the Ruling

This ruling would clear the air on an issue where different practices were being followed by various benches of the Tax Tribunal.  The ruling would of course would be of no consequence where the delay in deciding the appeal is on account of the Taxpayer and would benefit only those Taxpayers who have been co-operative in the appellate process before the Tribunal.

Our View – A fallacy in appreciating the “discrimination” angle

In general, a Court would be slow to strike down a provision of law as unconstitutional – challenges to various pieces of legislation as “unconstitutional” under Article 14 on the grounds of “discrimination” have been turned down more often by the Courts than upheld.

In the above ruling, the Court has taken a view that the provision to deny the stay beyond 365, even if the Taxpayer was not at fault,  was discriminatory since such a Taxpayer would be placed on the same footing as another who was indeed at fault, say, by having adopted dilatory tactic.

However, it is noteworthy that the stay on demand is granted on a staggered basis – initially for a 180-day period which is further extended to 365 days ONLY in those cases where the Taxpayer has co-operated in the proceedings and delay is not on his account. A recalcitrant Taxpayer who adopts dilatory tactics would not even be granted a stay beyond the initial time-limit of 180-days, and the extension of stay to 365-days itself is reserved only for “well-behaved” Taxpayers. It is only at the end of the 365-day period, that the “well-behaved” would be relegated to the same position as the not so well-behaved. As the ruling itself notes, even after the 365-day period, the “well-behaved” would have the liberty to approach the High Court for extension of stay, which option would not be available to a recalcitrant. This would no doubt make the appeal process more onerous, but whether that would warrant  a provision of law being construed as “discriminatory” and struck down as “unconstitutional” is a moot question, which probably the Supreme Court would be called upon to answer.

 

234B Interest levy not to apply when tax was “deductible” at source : Delhi HC

The De-Brief

234B interest – what’s that

234B interest is levied when there is short-fall in payment of Advance Tax by a Taxpayer.

The controversy

The controversy has a connection with Section 209 – which lays down how advance tax liability is to be computed. As per Section 209, a Taxpayer can take into account the amount of tax which is “deductible” at source from his income while determining the quantum of Advance Tax payable.

(Note – the law has since changed with the amendment to Section 209 by the Finance Act, 2012. Currently, the Advance Tax liability has to be determined with reference to the  taxes actually deducted)

Quite often, there is a mis-match between the amount of tax which is “deductible” from the income of the Taxpayer and the amount which is actually deducted by the payers of such income. In all such cases, the Taxpayer contends that interest under section 234B should not be applied in case of short-fall in payment of Advance Tax on account of non-deduction or short-deduction of taxes by the payers of the income.

The non-residents’ angle to the controversy

In the case of a non-resident, the entire income is liable to tax deduction at source under section 195. Thus, a non-resident would, in theory, never have any Advance Tax payment obligation since the payer of the income would have to deduct the entire tax amount while making the payment.

However, in practice, on account of different views being taken by the Taxpayer and the Revenue authorities on the issue relating to taxability in India of income of a non-resident, the dispute on taxability led to an incidental dispute on the Advance Tax obligations and consequent applicability of Section 234B interest levy.

The defense of non-resident taxpayers was similar to that taken by resident taxpayers – that since tax was “deductible” from their income, they cannot be held to be in default of payment of Advance Tax. This defense was taken even while contending that the income was per se not liable to tax. By and large, the above defense for non-levy of interest was accepted by various Courts.

The ‘Bombshell’ ruling in case of Alcatel Lucent

However, the division bench of Delhi High Court in the case of Alcatel Lucent had upheld the levy of Section 234B interest on the Taxpayer. The Court had reasoned that since the Taxpayer was denying tax liability, it is quite conceivable that the Taxpayer had influenced its customers (the payers of the income) not to deduct the tax at source. Accordingly, the Court upheld the levy of interest under section 234B on the Taxpayer.

The Present ruling in GE packaged power- Anti-dote to Alcatel Ruling

In a more recent ruling involving various overseas GE group companies that were charged to tax in India on the ground that they had a Permanent Establishment (‘PE’)  in India, the Delhi High Court has held the ruling in case of Alcatel Lucent was rendered in the context of its own “peculiar facts” and did not lay down any general proposition of law.

Similar to the case of Alcatel Lucent, the GE entities were denying the charge from Revenue authorities that their operations resulted in a PE exposure, and consequently denying any tax liability in India. The entities also raised the defense that in any event, interest should not have been levied on the basis that the income was liable to tax deduction at source ( as explained in detail above).

The Revenue relied on the earlier Division Bench ruling of the Delhi High Court in the case of Lucent Alcatel to contend that the 234B interest was applicable.

The court did not accept the Revenue’s contention and reiterated the principle which was widely applied earlier (i.e. before the Alacatel ruling) – that the Taxpayer was entitled to consider the tax that was “deductible” from its income – and since in the case of a non-resident, the entire tax was “deductible” at source by the payer of income under section 195, the payee Taxpayers (GE entities involved in the case) cannot be charged with Section 234B interest levy.

The Court also noted that in Alcatel ruling, the stand of Taxpayer was “vacillating” and after denying PE-related tax liability, the Taxpayer had admitted to tax liabilities in India, and it is only in consideration of those peculiar set of facts and on grounds of equity, that the earlier ruling was rendered.

Lessons from the Ruling

A natural, and perhaps unintended, consequence of the above ruling would be that Taxpayers who are facing similar tax liabilities in India, who might have been considering admitting some tax liability to ‘close-out’ on open disputes would now think twice, since the Revenue authorities are sure to pounce on them and cite their “vacillating” stand and contend that the ratio of Alcatel Lucent ruling should apply to them and Section 234B interest would be applicable. Sticking to the ‘not taxable’ stand now would seem to be an added compulsion to avail 234B interest reprieve!

 

 

 

 

 

 

Delhi High court ‘looks at’ Compulsorily Convertible Debenture (‘CCD’) instruments with put option; allows capital gains tax relief

In a significant ruling, the Delhi Court upheld the bona fides of investment into a Realty SPV by a Mauritius based company through the route of Compulsorily Convertible Debentures with call/put options, thereby allowing Capital Gains tax relief to the investor under the India-Mauritius Treaty. Here’s a low-down on the ruling.

What was the Transaction?

The Taxpayer, a Mauritius based company (Zaheer Mauritius) had invested in a real estate JV along with an Indian promoter. The investments were made by subscribing to the Compulsorily Convertible Debentures (‘CCD’)  issued by the JV company.

What was the Tax issue?

This time not with the Mauritius Treaty per se. The controversy was on the ‘true character’ of CCD instruments – more specifically, whether they were merely loans camouflaged as equity instruments.

What was the Taxpayer’s stand?

The taxpayer contended that the gains from sale of CCDs resulted in “capital gains” in its hands since CCD constituted a “capital asset”. Invoking the India-Mauritius Tax Treaty, the Taxpayer contended that such gains were not taxable in India

What was Revenue’s position?

The Revenue’s argument was that the gain from sale of CCDs should be taxed as ‘interest’ income since the Transaction was effectively in the nature of loan. Revenue alleged that the clauses relating to call/put option in the Shareholders agreement guaranteed a fixed return to the investor.

How did the matter reach the Delhi High Court?

The Taxpayer had approached the Authority for Advance Rulings (‘AAR’) for a ruling on the Taxability of the transaction. The AAR disregarded the arrangement between the parties by ‘lifting the corporate veil’, held the transaction by way of CCD as a sham transaction intended for tax avoidance and upheld the Revenue’s position on the taxability of gain from CCDs as ‘interest’.

Since there are no appeal provisions under the Indian Tax law against the order of AAR, the Tax payer filed a writ petition before the Delhi High Court, assailing the order of the AAR.

What did the Delhi High Court decide?

The Honourable High Court ruled in favor of the Taxpayer based on the following:

(a)  The clauses relating to call/put options cannot be interpreted to mean that the Taxpayer was only entitled to a fixed return – the Taxpayer also stood to gain an equity value of the project.

(b)Upon a perusal of the terms of the share holder agreements, the Court ruled that the terms as negotiated between the parties evidenced that there was genuine commercial substance behind those agreements

(c)  The Court also noted that CCD’s were permitted mode for investing in India under the Foreign  Direct Investment policy

(d)Based on the above, and relying on the ‘look at’ principle as enunciated by the Apex Court, the Court upheld the validity of arrangements between the parties and struck down the ruling of the AAR.

Consequently, the Taxpayer’s stand met with Court’s approval.

Our Comments

The Ruling was not so much on the issue of the tax impacts arising to CCD instruments. As the Court itself observed, the tax position is very clear that the CCD were capital assets and therefore gains arising from sale of CCDs would clearly be taxable as Capital Gains.

The dispute in the instant case was really on the aspect of “Substance Vs. Form” in the context of use of CCD instruments, given that the terms of the agreement between the parties contained call/put options which, the Revenue alleged, provided for a Fixed rate of return.

The Court returned a favorable verdict upon being satisfied that the agreements between the parties had commercial substance and the FDI policy permitted investments by way of CCD.

However, a key contention of the Revenue – to the effect that call/put options guaranteed a fixed rate of return – seems to have been overcome by adverting to the terms which stated that the investor (Taxpayer) was not only entitled to a fixed return, but also an ‘equity value’ of the project. There does not seem to be any specific observation or finding on legality of the said option arrangement in light of the RBI Circular which was issued earlier this year. As per the aforesaid Circular [AP (DIR Series) Circular No.86 dated January 9, 2014] while clause relating to buyback by way of exercise of options has been permitted, there is a specific bar that the investor cannot be guaranteed any assured return. It appears that Revenue has not specifically brought the Circular to the notice of the Court and the Court has adverted only to the FDI policy document, while deciding the matter.