Direct Tax

Whether services are required to be rendered in India to qualify as FTS?

M/s. Infosys Limited. Vs ACIT IT(IT)A No.4,1182/Bang/2014

Facts

The taxpayer is an Indian company engaged in the business of the development and export of software and related services. The taxpayer subcontracted certain overseas work in China to its wholly-owned subsidiary and made payment for subcontracting charges to the subsidiary without any Tax Deducted at Source (TDS). It has adopted a view that since services were rendered completely from outside India, the same would not be taxable in India under Indian tax laws, relying on the Supreme Court (SC) ruling Ishikawajima Harima Heavy Industries Ltd.1

Out of the total payment, a major amount was paid after the enactment of the Finance Act, 2010, where the retrospective explanation was added to Section 9(1)(vii), which clarified that Fees for Technical Services (FTS) provided to Indian resident shall be taxable in India, irrespective of location for providing such services and indirectly overruled the SC ruling of Ishikawajima Harima Heavy Industries Ltd.

The Assessing Officer (AO) concluded that the payment made to the Chinese subsidiary was liable for TDS U/s 9(1)(vii) of the Income-tax Act as FTS at 20% in the absence of PAN of subsidiary. The Commissioner of Income-tax (Appeals) [CIT(A)] confirmed the AO’s order. Aggrieved by the order, the taxpayer filed an appeal before the Bangalore Tribunal.

Held

The Tribunal has remanded the matter to file of AO for payment made before the enactment of the Finance Act, 2010 for fresh adjudication in line with law prevalent at that point in time.

For the payments made after the enactment of the Finance Act, 2010, the Tribunal rejected the taxpayer’s plea about the non-taxability of the payment. The Tribunal noted that the taxpayer’s reliance on Ishikawajima Harima was not correct in view of the retrospective amendment to Section 9(1)(vii) read with the Explanation. In view of the amendment, rendering services in India is no longer necessary. The Tribunal held that merely because the clients were outside India did not mean that the taxpayer was conducting business outside India. The said subcontracting services were held to be taxable under India-China Double Taxation Avoidance Agreement (DTAA) as well since the services will be deemed to have been accrued in the tax jurisdiction in which the person making the payment is located.

Our Comments

The Bangalore Tribunal observed that subsequent to the amendment to Section 9(1)(vii), it is no longer necessary that the services must be rendered in India.

Whether subscription income, an activity of mutual concern, can be taxable as FTS?

M/s. Deloitte Touche Tohmastu Vs DCIT ITA No. 6703, 5760, 5759, 530/ Delhi/2015

Facts

The taxpayer is a non-profit association (Swiss Verein) and a tax resident of Switzerland. The taxpayer received subscription income from its member firms during the year under consideration. The taxpayer claimed that it is an association of members owned and managed by its members and did not offer the income to tax based on principles of mutuality.

The AO did not accept the taxpayer’s contention of the principle of mutuality. The AO held that the activity of mutual concern of the taxpayer was in the nature of trade with its members in lieu of which it was receiving income from its members and accordingly treated the subscription fees as FTS. The CIT(A) held that the payments made to the taxpayer were in the nature of reimbursement and covered by the principle of mutuality. Aggrieved by the order, the AO filed an appeal before the Delhi Tribunal.

Held

The Tribunal emphasized that the key conditions required to be satisfied for achieving the principle of mutuality are common and completeness of identity, non-profiteering and obedience to mandate. The doctrine of mutuality refers to the principle that a man cannot engage in business with himself. If the identity of both parties is marked by oneness, then a profit motive cannot be attached to such a venture. The Tribunal noted that the only source of generating funds for the taxpayer was the subscription amount from its members determined on the basis of proposed annual expenditures, which member firms paid in mutual concern to evolve better professional practices. The Tribunal also stated that the taxpayer’s articles of association indicate that it was not working as a commercial venture on a quid pro quo basis and hence the subscription income should be exempt based on the principle of mutuality.

Our Comments

The Delhi Tribunal has re-affirmed that where contributions are not with an idea to trade but with an idea of rendering mutual help, the same can be covered under principles of mutuality. However, it is pertinent to note that the determination of mutuality is a factual exercise.

1. [2007]288 ITR 408(SC)

Transfer Pricing

Auditor’s disclaimer cannot be grounds for rejection of the segmental accounts without any specific concern raised by the TPO

V2 Tech Ventures Pvt Ltd [ITA No. 777/Mum/2016] - AY 2011-12

Facts

The taxpayer provided software support services to its US-based Associated Enterprise (AE) and benchmarked the same by adopting an internal comparison of profit margins earned from the AE segment and Non-AE Segment. The Transfer Pricing Officer (TPO) observed that the segmental profit and loss furnished by the taxpayer contained a disclaimer that read as “...the information and explanation provided to us...” Thus, basis this disclaimer, the TPO opined that it raised doubts about its authenticity as it was signed based on the information disclosed by the management and claimed that allocation of expenses was arbitrarily done between the two segments to skew the results in favor of the AE segment. Accordingly, the TPO disapproved taxpayer’s justification of the Arm’s Length Price (ALP) and proposed an adjustment by comparing taxpayer’s margins with external comparable companies. Aggrieved, the taxpayer raised objections before the Dispute Resolution Panel (DRP), which concurred with the TPO’s stand.

ITAT Held

The Income Tax Appellate Tribunal (ITAT) disagreed with the TPO’s rejection of the AE/non-AE segmental on the basis of disclaimer by the auditor and noted that such disclaimer was a standard practice and there was no specific information that was sought to be disclaimed vis-a-vis the authenticity of the segmental. The ITAT also highlighted TPO’s failure to pinpoint the specific issues or seek response through raising questions on issues whilst rejecting the segmental. Whilst the ITAT remitted the verification of the segmental basis TPO’s claim on the arbitrary allocation of expenses; it was done with a direction that if no defects were found in the segmental so drawn, then the justification of the ALP should be accepted.

Our Comments

The decision also lays down an onus on the TPO to pinpoint specific flaws in any data produced by the taxpayer or the need for requisition of further details to resolve specific doubts before the adhoc rejection of the data produced by the taxpayer. The common practices like disclaimer while signing segmental accounts should not be the ground for outright rejection of data relied on by the taxpayer. However, this also emphasizes maintaining an appropriate basis for applying allocation keys and documentary evidence, which can make the segmental profit and loss more robust.

ITAT distinguishes trade credit from a loan and opines that while there may be implied interest for opportunity cost and notional financial costs for the credit period agreed – however, extended trade credit may also require an interest charge

Tech Mahindra Limited [ITA Nos.1034 & 1035/MUM/2010] - AY 2004-05 & AY 2005-06

Facts

The taxpayer was engaged in the development of computer software and other related services. The taxpayer had provided a trade credit to its AE, citing that the AE had incurred losses and was not able to raise funds externally. The taxpayer had not charged any interest from the AE for the extended trade credit provided by stating that trade credit was very different from a loan considering the differences in geographies, timing, nature and purpose of funds. However, the TPO had proposed to levy an interest rate of 10%, relying on the interest rate applied to German AE on a Euro-denominated loan extended by the taxpayer. At the Appeal stage, the CIT(A), allowed partial relief by adopting an interest rate using USD LIBOR (1.22%) + 80 basis points. Aggrieved, the taxpayer appealed before the ITAT.

ITAT Held

The ITAT took cognizance of the fact that it was the taxpayer’s business decision to extend trade credit to AE to tide over its temporary liquidity situation and also the fact that the average debtor days relating to AE was 124 days whilst the same was 150 days in case of third parties with no interest being charged in the case of latter for delayed payments. The ITAT further observed that for a similar transaction, no Transfer Pricing (TP) adjustment was proposed for prior years,i.e., for AY 2002-03 and AY2003-04. While these are only observations pointers, the ITAT went on to opine that “..Transfer Pricing regime normally judges the transfer pricing of the taxpayer based on the results rather than on the intent to shift income from one side to another. In the normal ALP, an element of implied interest would always have been there so as to compensate for the opportunity cost and notional financial cost associated with account receivable/ adjustments so called for.

Hence, the ITAT seems to be affirming the charging of interest even on extended trade credit. However, it has remitted the case for computation of the correct period of charge as well as the correct interest rate to be applied, which would be available at that particular point of time in the open market and as per the practice on (trade credit).

Our Comments

The decision brings out relevant distinguishing factors in the nature of trade credit vis-a-vis loans and consequent different approaches to be adopted in benchmarking. However, it also seems to indicate that even a trade credit contains an implied interest cost imbibed in the pricing of the underlying transaction, from which they emanate) as against a loan transaction. Furthermore, it also delves into the fact that regard should be had to comparable instances/ practices followed by the taxpayers while undertaking similar transactions with third parties while deciding the appropriate benchmark for a particular transaction.

Closing balances of loans cannot be considered as a basis for the charge, instead, the actual outstanding period of loans should be looked at

OPTO Circuits (India) Ltd [IT(TP)A No.2323/Bang/2016] – AY 2007-08

Facts

The taxpayer was a manufacturer of electronic medical equipment and had extended a loan to its AE without charging any interest. The TPO proposed interest to be charged based on the average prime lending rate prescribed by the State Bank of India (i.e.11.375%) prevailing during the said financial year on the closing balance (for the full year), which was affirmed by the DRP as well.

ITAT Held

ITAT observed that there was an opening debit balance as well as amounts advanced during the year, and opined that interest should have been computed based on the time for which the loan amount was outstanding (rather than on the closing balance and for the full year) and hence remitted the recomputation of interest on a time basis.

Our Comments

The taxpayers should be vigilant to ensure that when submissions are made, they provide such details of the loan period during the year on which only the interest should be charged, in the absence of which the TPO may be forced to levy adjustment on the closing balance.

Indirect Tax

Whether the DFIA licenses were obtained by the exporters on the basis of fake export documents, thereby warranting denial of import benefits?

Neev Trading Co. and Vids Overseas vs. Commissioner of Customs, ICD, Delhi [2022 (3) TMI 1005 - CESTAT NEW DELHI]

Facts

  • The appellants were accused of purchasing Duty Free Import Authorization(DFIA) licenses from the open market through the middleman/brokers rather than directly from the exporters. They neither tried to ascertain the existence of the subject exporter nor verify the genuineness of the licenses through any other source.
  • The licenses were allegedly obtained fraudulently by some unscrupulous persons in collusion with the exporters.
  • According to the Department, the goods imported under these DFIA licenses, which were procured on the basis of forged and fabricated documents, were liable to be treated as non-duty paid, and appropriate customs duty was liable to be demanded under Section 28(4) of the Customs Act, by invoking the extended period of limitation.

Contentions

  • The appellants contended that at the time of import of goods, the licenses were checked on the Directorate General of Foreign Trade (DGFT) website, and undisputedly, the same was valid and duly registered with the Customs.
  • Just because the exporters obtained the licenses fraudulently, as alleged by the Department, imports made by the appellants could not be treated as non-duty paid, as the DGFT duly issued the licenses.
  • Reliance was inter alia placed on Customs, Excise and Service Tax Appellate Tribunal's (CESTAT) Larger Bench judgment in the case of Hico Enterprises vs. Commissioner of Customs, Mumbai2, wherein a similar case, the Bench had referred to Section 29 of the Sale of Goods Act, 1930 to reiterate that the transferee-importer would attain good title to the license and the endorsement of transferability could not be held to be not valid in the hands of bona fide purchaser of the license.

Ruling

  • Nowhere is it the case of the Department that the appellants colluded with any of the persons concerned for alleged fraud/forgery/ manipulation of the documents on the basis of which the licenses were obtained.
  • The only observation was that the appellants did not exercise due diligence in checking the correctness of exports.
  • Once the DGFT makes the licenses transferrable and negotiable on fulfillment of the export obligation, the same are traded by the parties through brokers, which are permitted under the DGFT Policy and Foreign Trade Policy. There was no reason to disbelieve the licenses issued by the Competent Authority/DGFT, as they duly reflected on the website.
  • The Adjudicating Authority had erred in not appreciating that the appellants were bona fide purchasers of DFIA licenses that were registered with Customs on the date of purchase and utilization by these appellants
  • In the facts and circumstances, the Tribunal concluded that the extended period of limitation was not invokable, as admittedly, there was no case of fraud, misstatement, or contumacious conduct on the part of the appellants.
  • Tribunal observed that a similar issue had come for consideration before the Punjab and Haryana High Court in the case of Commissioner of Customs vs. Leader Valves Limited3 in respect of the Duty Entitlement Pass Book Scheme (DEPB) license purchased from the open market under the bona fide belief of being genuine.

Our Comments

The case law reiterates the principle that bona fide purchasers of licenses/ scrips cannot be held accountable for any fraud/forgery by the preceding party.

However, to mitigate any plausible risks, it may be worthwhile to do a preliminary check on the authenticity of the license as well as the seller, given the rise in trading of different types of scrips/ licenses.

Whether GST, Central Excise Duty and National Calamity Contingency Duty (NCCD) could be levied simultaneously on tobacco and tobacco products?

V. S. Products vs. Union of India [TS-178-HC(KAR)-2022-GST]

Note: Vide order dated 4 January 2022, the Single Judge Bench of Karnataka HC [TS-4-HC(KAR)-2022-GST] had dismissed a batch of writ petitions filed by manufacturers of tobacco and tobacco products challenging the constitutional validity of section 174 of the CGST Act 2017, which allows the continuation of basic excise duty along with GST, and section 136 of the Finance Act which enables the levy of NCCD.

Facts

  • The petitioner-assessee is a proprietary firm engaged in the manufacture of tobacco and tobacco products.
  • The petitioner-assessee challenged the levy and collection of excise duty and NCD before the Division Bench in intra Court appeal.

Judgment

  • Affirming the Single Judge Bench’s order, High Court (HC) held that there could be a simultaneous levy of GST and excise duty and NCCD on tobacco or tobacco products.
  • After coming into force of Constitutional 101st Amendment w.e.f. 1 July 2017, the levy of excise duty on tobacco or tobacco products is constitutionally valid.
  • Tracing the interpretation of statutory provisions (Article 246(1) and (2) as well as Article 246A(1), which begins with the non-obstante clause) and taking note of the Apex Court decision in VKC Footsteps4, HC observed, “non-obstante clause is appended to a provision at the beginning with a view to give the enacting part of the Section…an overriding effect over the provision or Act mentioned… the enactment, following it, shall have its full operation or that the provisions embraced in the non-obstante clause will not impede the operation of the enactment.”
  • Articles 246 and 246A do not overlap each other and co-exist in the constitutional scheme. Article 246A is “unique” and “independent power” as it contains the source of power as well as the field of legislation, thus having simultaneous power of taxation.
  • Article 246A neither overrides nor restricts the operation of Article 246 r/w Entry 84 of List I of Schedule VII, and accordingly, the central excise duty and GST are levied under different sources of power.
  • Activities of manufacture and supply remain two independent activities in the goods chain. The Section 7 of the CGST Act, 2017 indicates that the definition of ‘supply’ does not subsume manufacturing activity.
  • The petitioner-assessee had failed to demonstrate that the levy of excise duty either suffers from manifest arbitrariness or is discriminatory. Accordingly, such levy is not violative of Article 14 of the Constitution.
  • The HC relied on the Apex Court decision in Federation of Hotel and Restaurant Association of India vs. Union of India5.

Our Comments

The judgment affirms the legislative wisdom to impose simultaneous levies on the same goods/transactions with an aim to generate more revenue.

Taking a cue from this decision, the government could simultaneously introduce GST on petroleum products after a corresponding reduction in the Excise duty and VAT rates imposed by the States.

2. 2005 (189) ELT 135 (Tri-LB)
3. 2007 (218) ELT 349 (P & H)
4. Civil Appeal No. 4809 of 2021 – Supreme Court of India
5. (1989) 3 SCC 634

Merger & Acquisition Tax

Mumbai ITAT: Rounding off of shares’ issue price attracts addition under Section 56(2)(viib)

Royal Accord Realtors Pvt. Ltd. [TS- 281-ITAT-2022(Mum)]

  • A company (assessee) allotted equity shares to a resident company at a premium. The assessee applied round off on the FMV determined at INR 3,560.77 and allotted the shares at INR 3,600 per share. During the assessment proceedings, the AO invoked the provisions of Section 56(2)(viib) and made an addition for the differential value in the hands of the assessee.
  • The assessee relied on the decision in the case of Jain Housing6 and submitted that the marginal difference in valuation should be ignored. It also relied on other specific sections which provide for round-off. The tax authorities held that Section 56(2)(viib) does not explicitly provide for rounding off, unlike other provisions. The CIT(A) confirmed the addition made by AO.
  • Mumbai ITAT upheld such addition placing reliance on the ruling of Kolkata Tribunal7 of Shresth Dealers Pvt. Ltd. by observing that there is no ambiguity on a plain reading of Section 56(2)(viib) and the other provisions cannot be applied. The sections do not lay down the general principle of rounding off for other sections of Act. The tax statute and tax law don’t have a concept of equity, and nothing is to be implied by together reading of sections. The departure of literal interpretation will lead to interpreting sections in exceptional cases.

Our Comments

The rounding off of the valuation number arrived at for share issuance/ transfer is a common practice followed in valuation exercises. The observations of this decision based on a literal reading of the provision would impact such cases, and thus the implications need to be assessed accordingly.

Mumbai High Court: Sum withdrawn from escrow account deductible while working out the capital gains

Dinesh Vazirani [TS-274-HC- 2022(BOM)]

A resident individual (assessee) along with other promoters held equity shares collectively in a company. They executed a Share Purchase Agreement (SPA) to transfer shares for a base consideration of INR 1.25 billion and further consideration of INR 300 million to be kept in an escrow account subsequently realizable on the satisfaction of future conditions. Certain statutory dues and liabilities amounting to INR 91.7 million pertaining to the period before sale arose subsequent to the sale of shares. This amount was extracted from the escrow account for the discharge of the liability.

The assessee offered the entire consideration of INR 1.55 billion to tax in its income tax return. However, the assessee filed a revision petition with CIT under Section 264 of the Act for a reduction of the consideration to the extent of the liability discharged amount of INR 9.17 crores. The petition was rejected by the CIT.

The High Court relied on the landmark judgment of the Supreme Court in the case of Shoorji Vallabhdas and Co8 and applied the real income principle to hold that consideration that has neither accrued nor received cannot be brought to tax. As the same was neither received nor accrued by promoters, the same should not form part of the consideration accruing or arising from the transfer.

Our Comments

The ruling has applied the concept of real income theory and has held taxability only for the income which has accrued to the assessee. This is certainly a relevant and welcome decision from the perspective of M&A deals where due to prevailing circumstances, contingency is inbuilt in the overall consideration agreed for a transaction.

6. 109 taxamann.com 428(Chennai)
7. ITA No.2517/Kol/2018

Regulatory Updates

Ministry of Corporate Affairs (MCA)

Companies (Accounts) Second Amendment Rules, 2022 (31 March 2022)

The Ministry of Corporate Affairs has recently notified the Companies (Accounts) Second Amendment Rules, 2022 vide a Notification dated 31 March 2022. With this amendment, the MCA has extended the implementation of Audit Trail software to a financial year commencing on or after 1 April 2023, earlier such provision was applicable from 1 April 2022. Also, the timeline for filing web Form CSR-2 has been extended to 31 May 2022, earlier, such form was to be filed by 31 March 2022.

Extension of Applicability of Provisions of Audit Trail

The MCA vide its notification dated 24 March 2021, introduced the concept of audit trails by inserting a proviso to rule 3(1) of the Companies (Accounts) Rules, 2014.

An audit trail is a step-by-step sequential record that provides evidence of the documented history of financial transactions to its source. An auditor can trace every step of the financial data of a particular transaction right from the general ledger to its source document with the help of the audit trail.

The objective of mandating the requirement of an audit trail feature in accounting software was to mitigate the chances of fraudulent transactions or manipulation in the company’s books of accounts and to bring in more transparency.

The applicability of maintaining an Audit Trail was deferred by one year by amending the same vide Companies (Accounts) Second Amendment Rules, 2021. The new date of applicability was 1 April 2022. Yet again, the MCA has amended the proviso vide Companies (Accounts) Second Amendment Rules, 2022, and has deferred the applicability by one more year. Hence the provision of audit trail is now applicable with effect from 1 April 2023.

Extension of the Timeline for filing Web Form CSR-2

MCA had introduced the requirement for filing Form CSR-2 for each company which is covered under Section 135(1) and required to conduct CSR activities as per Company law. The due date for filing such a form was set as 31 March 2022. However, on account of certain technical difficulties being faced by the Companies in filing such form, MCA, vide its notification dated 31 March 2022, announced that Form CSR-2 shall be filed separately on or before 31 May 2022 for the preceding financial year (2020-2021) after filing Form AOC-4 or AOC-4 XBRL or AOC-4 NBFC (Ind AS).

From the above, we can interpret that the due date of filing Form CSR- 2 is as below:

  1. For the financial year 2020-21, the Form CSR-2 is to be filed separately on or before 31 May 2022.
  2. For the financial year 2021-22 onwards, the Form CSR-2 is to be filed as an addendum to form AOC-4 (due date of AOC-4).

Our Comments

An audit trail encourages the user for better accountability and compliance, protects against fraud, improves security, and above all, the right information reaches the public domain. However, many companies were facing practical difficulties in inducting this new feature into their existing accounting software or in migrating to altogether new accounting software and this amendment has come as a respite for such Companies struggling to procure and install such software.

Similarly, an extension of the due date for filing Form CSR-2 provides more time to Companies who were struggling to complete the filing on the MCA portal on account of certain technical glitches and lack of clarity on the interpretation of certain requirements under Form CSR-2.

Securities and Exchange Board of India (SEBI) Regulations

SEBI issues clarification on validity of Omnibus approval given by the Audit Committee in cases where the transactions were material and shareholders’ approval was also required

Regulation 23(3)(e) of the SEBI LODR Regulations specifies that omnibus approval granted by the audit committee shall be valid for a period not exceeding one year and shall require fresh approvals after the expiry of one year. Furthermore, Regulation 23(4) of the SEBI LODR Regulations requires shareholder approval for material Related Party Transactions (RPTs). Also, Section 96(1) of the Companies Act, 2013 specifies that the time gap between two Annual General Meetings (AGMs) cannot be more than fifteen months.

Hence, representations were made to SEBI seeking clarity on the period of validity of the omnibus approval granted by the Audit Committee in such instances.

In order to facilitate listed entities to align their processes with conducting AGMs and obtaining omnibus shareholders’ approval for material RPTs, SEBI, vide its notification dated 8 April 2022, clarified that the shareholders’ approval of omnibus RPTs approved in an AGM shall be valid upto the date of the next AGM for a period not exceeding fifteen months.

In the case of Omnibus approvals for material RPTs, obtained from shareholders in general meetings other than AGMs, the validity of such omnibus approvals shall not exceed one year.

Our Comments

This clarification comes as a welcome move for Companies struggling to comply with Regulation 23(3)(e) of the SEBI LODR Regulations in cases where the transactions were material and shareholders’ approval was also required, in spite of the fact that Companies Act 2013 allowed a time gap of up to 15 months between two AGM’s. Increasing the validity of shareholders’ approval of omnibus RPTs approved in an AGM upto the date of the next AGM will ease the procedural formalities. However, it is pertinent to note that the validity of approvals for material RPTs, obtained from shareholders in general meetings other than AGMs, has not been enhanced and is still only one year.

SEBI issues documentation guidelines in case of transmission of securities

SEBI has notified the SEBI (Listing Obligations and Disclosure Requirements) (Fourth Amendment) Regulations, 2022, which came into force w.e.f. 25 April 2022. SEBI vide this notification has provided that the listed entity shall comply with all documentation requirements as specified in Schedule VII of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 with respect to the transmission of securities.

Our Comments

Earlier to this notification, no specific documentation guidelines were listed regarding the transmission of shares which led to different internal standards being followed by different listed entities.

Notification of uniform documentation requirements will help to streamline the procedural formalities in the case of transmission of securities.

8. (1962) (46 ITR 144) (1962) (46 ITR 144)