Whether income from offshore supplies should be attributed to the Indian PE in case, the buyer holds the right to reject the product?
M/s Huawei Technologies Co. Ltd Vs. The ADIT [TS-638-ITAT-2020(Del)]
The appellant is a company incorporated in China and is primarily engaged in the business of supplying non-terminal products. The products include advanced telecommunication network equipment, namely, core and access network equipment, mobile network equipment and data communications equipment, etc., for use in fixed and mobile phone networks and terminal products, that is, mobile phone handsets to various customers (including customers in India).
The appellant company (Huawei China) has a subsidiary in India, namely Huawei Telecommunications India Company Private Ltd. (Huawei India). During the year under consideration, Huawei China provided services to Huawei India under the terms of the Technical Service Agreement (TSA). Huawei India is involved in the provision of integration, installation, and commissioning services in relation to telecom network equipment supplied from outside India by Huawei China.
The appellant offered revenues accrued from the provision of technical services but did not offer the revenue on account of the sale of telecom network equipment and terminal equipment/ mobile handsets.
Survey operation u/s 133A of the Income-tax Act was conducted in the office premises of Huawei India. After examining the documents impounded during survey proceedings and considering them in the light of the statements of the key employees, the Assessing Officer (AO) proceeded to decide that the taxpayer has a business connection in India u/s 9(1)(i) of the Act as well as the ‘Service Permanent Establishment (PE)’ and ‘Installation PE’ in India.
After considering the arguments laid down by both the parties, the Delhi tribunal had held that the evidence on record clearly shows that Indian resource was involved in deal negotiations on behalf of the taxpayers. The facts on record show that a real and intimate relationship exists between both the companies, as the sale of telecommunication network equipment would serve no purpose for a buyer unless the telecommunication network equipment is installed and commissioned in India by Huawei India.
Further, the contract clearly states that the owner shall have the right to reject the entire shipment/goods or part thereof. Hence, the taxpayer continued to undertake the risk of rejection for the supplies to India, and therefore, the activities of Huawei China continue till the telecommunication network equipment are installed and commissioned in India. This entire sequence contributes directly to the earning of income of Huawei China in its business even if the sale transaction has been concluded outside India and hence sale consideration should be taxed in India.
Facts on record show that the foreign expat experts in the technology behind the equipment were present in India onsite in order to supervise the installation and commissioning process. In taxpayer’s own contention, Huawei India was not technically equipped for the installation and commissioning on its own and thus requisitioned the expats to supervise the installation process on-site in India. Therefore, considering the facts on record, it is a wrong claim that the Indian entity was independent to carry out the installation and commissioning of the equipment.
Considering the facts in totality, in light of the various judicial decisions, the Delhi tribunal held that Huawei India constitutes not only dependent agent PE of Huawei China but also Service PE and fixed place PE within Article 5 of Indo China DTAA.
The taxability of the offshore supply of goods has been a topic of debate for ages. Determination of taxability is very case-specific. A similar judgment was also pronounced recently by the Delhi Tribunal in the case of Voith Paper GmbH.
Whether income derived by professionals shall be taxed under Article 12 or Article 14 of India- Japanese DTAA? And whether it would impact the Foreign Tax Credit (FTC) claim?
Amarchand & Mangaldas & Suresh A Shroff & Co. Vs. ACIT
The taxpayer is a renowned law firm in India. In its return of income for the year under consideration, it had claimed a foreign tax credit of INR 8.055 million in respect of taxes withheld by its clients in Japan. The taxes so withheld were at the rate of 10% on gross billing amounts, by treating the professional fees earned by the taxpayer in Japan as taxable in Japan, i.e., the source country, under article 12 of the Indo-Japanese tax treaty.
The tax officer, however, was of the view that credit for such taxes withheld in Japan was not admissible to the taxpayer, as the income so earned could only have been taxable under Article 14 for the ‘independent personnel services’ but then since taxpayer admittedly did not have any fixed place in Japan, the condition precedent for taxability even under Article 14 was not at all satisfied. Accordingly, taxes are wrongly withheld in Japan and the credit for the same should not be available in India. Aggrieved by the order, the appellant is in appeal before the Mumbai tribunal.
On perusal of the material on record and provision of Article 12 and 14 of Indo Japan DTAA, the Mumbai tribunal was of the opinion that undoubtedly, there are overlapping areas in the definition of fees for technical services under article 12(4), which covers technical, management and consultancy services vis-à-vis the definition of professional services income which can be taxed under article 14 as ‘income from independent personnel services.’
The treaty approach is in consonance with the well-settled principle of law contained in the latin maxim generalia specialibus non derogant, i.e., general provisions do not override the specific provisions. Quite clearly, therefore, when a particular type of income is specifically covered by a treaty provision, the taxability of that type of income is governed by the specific provisions so contained in the treaty. However, it is an equally well settled legal position that a treaty is to be read as a whole and, therefore, different articles cannot be read on a standalone basis dehors the scheme of the tax treaty. There is a valid school of thought that in the scheme of the Indo Japanese tax treaty, article 14 for independent personal services holds the field for the individuals only- particularly in the light of the exclusion clause under article 12(4) being restricted to payment of fees for professional services to individuals alone. Sufficient to say, judging by the facts of this case, the conclusions arrived at by the Japanese tax authorities, directing tax withholdings from the payments made to the taxpayer by its Japanese clients, cannot be said to be unreasonable or incorrect.
The judgment has highlighted the principle that although a specific article will override a general article in a tax treaty but at the same time, one needs to understand that each article cannot be read in isolation; rather, the treaty must be read as a whole. Also, it further confirms the position that Article 14 is for an individual taxpayer, and the firm of an individual would not be covered under the same.
Whether borrowing funds from related parties through debentures can be the sole reason for determining it as a ‘shareholder activity?’
Kolte Patil Developers Ltd. –ITA No. 2111/PUN/2017 – AY 2013-14
The taxpayer is engaged in the business of development of real estate. Amongst the international transactions reported, transaction pertaining to ‘interest on debentures’ and specified domestic transaction of ‘interest on debentures’ is under appeal which had been benchmarked using the CUP method. During the year, the taxpayer issued Compulsory Convertible Debentures (CCDs) and Optionally Convertible Debentures (OCDs) to its AE, in respect to which interest was claimed as a deduction.
The TPO relying on the definition of ‘shareholder activity’ as per OECD Guidelines, contended that transaction of funding through issue of debentures should be considered as issue of shares., TPO held that a group company held the taxpayer’s 50% share capital and it was in dire need of funds in respect to its large ongoing project. Thus, the taxpayer was funded by the AEs through hybrid instruments, which were convertible into shares. The capital to borrowing ratio of the taxpayer was 1:23 as compared to 1:4 debt-equity ratio stipulated in the RBI Master Circular, and thus, no independent party would have invested in convertible debentures. Basis the above understanding, the TPO re-characterized the transaction as an issue of shares and determined the ALP as Nil on the basis that the economic substance of the transaction differed from its form. CIT(A) reversed the finding of the TPO and proposed a TP adjustment of 1.25% of the value of the transaction by applying CUP and determining the ALP at 13.75% as against the payment by the taxpayer at 15%.
ITAT held as under
- Based on the facts, it was observed that debentures issued to the AEs were redeemed and never converted into equity shares. Thus, the intention of the taxpayer was never to issue debentures in order to claim interest deduction and erode the tax base;
- Though the TPO relied on the thin capitalization rule basis the RBI circular, it is pertinent to note that after the insertion of Section 94B, it does not prescribe any debt-equity ratio as a thin capitalization rule;
- In order to avoid thin capitalization, the government introduced a limit of 30% of earnings before interest, tax and depreciation as a cap for deductible interest wherein interest exceeds INR 10 million. Further, ITAT pointed that as per the Impermissible Avoidance Agreement (IAA), defined in Section 96(1), wherein the main purpose of the arrangement is to obtain a tax benefit, and the form differs from a substance, it can be declared as IAA. However, the TPO cannot just characterize the transaction into equity but has to abide by the strict procedure under IAA;
- ITAT noted that the TP provisions are an anti-avoidance tax measure requiring computing income from transactions with related parties at arm’s length. It does not require a re-characterization of the nature of the transactions from which it was actually entered;
- Though the TPO emphasized the nature of the transaction to be a ‘shareholder activity’ reflecting the act done to perform activity solely for the ownership activity as per the OECD Guidelines, this was not the scenario for the taxpayer.
Under the Transfer Pricing Regulations, the purpose is to compute income from the transactions with the related party at arm’s length. The businessman has the full right to choose either way of financing. However, the form and substance of the transaction should not differ, and the intention should not be to avoid tax. Provision of reconstruction of a transaction should be applied by the tax authorities only after the exceptions outlined in the law are reasonably and appropriately satisfied.
Whether determining the ALP of the ‘availing of regional management services’ at NIL is justifiable basis insufficient documentary evidence?
Henkel Chembond Surface Technologies Limited – ITA No. 1049/Mum/2016 – AY 2011-12
The taxpayer is engaged in the business of manufacturing/trading chemicals. During the year into consideration, the taxpayer had entered into an international transaction pertaining to ‘availing of regional management services’ amounting to INR 26.1 million. The TPO made a TP adjustment of INR 26.1 million by determining the ALP of the transaction pertaining to ‘availing of regional management services’ at NIL on the basis of inadequate documentation.
ITAT held as under
- The taxpayer had submitted various documentary evidence such as the copy of the regional management services ‘agreement’ dated 23 November 2010, details of regional management charges, and copies of ‘debit notes’ raised on the taxpayer by the AE. Apart from that, the cost benefit analysis along with the details of the requirements to avail regional management services, description of services, the information in relation to visits by overseas employees for rendering services, and back up documentation substantiating the benefits received by the taxpayer were also submitted by the taxpayer;
- Further, it was quite evident from the documents submitted by the taxpayer that availing of regional management services had resulted into a better market position for the taxpayer and an ultimate increase in sales. Thus, the contention of the TPO was not regarded as a valid basis that the taxpayer had actually received the services and reaped benefits out of the same, for which enough documentation was on the record;
- As these services are intangible in nature, reliance is required to be placed on demonstrations by narrations, descriptions and documentary evidence and the way the business is being conducted;
- ITAT further contended that the TPO had divested of his jurisdiction and assessed ALP at Nil instead of following any one of the prescribed methods.
Thus, TP adjustment was deleted by the ITAT
Availing of regional management services from the group companies is a highly contentious transfer pricing issue. The said ruling has laid down the importance of robust documentary evidence to support the cost benefit analysis for availing of management services and determining the ALP of transaction. The ruling has reiterated that the role of the TPO is to determine the ALP by applying the correct transfer pricing method instead of challenging the commercial rationale of the decisions taken by the taxpayer.
[Background: As per Section 66E of the Finance Act, 1994, ‘Declared services’ include service by way of agreeing to the obligation to refrain from an act, or to tolerate an act or
The GST law has an identical provision under Schedule II to the CGST Act.]
Southern Eastern Coalfields Ltd. v/s Commissioner of Central Excise and Service Tax, Raipur - CESTAT, New Delhi [2020 (12) TMI 912]
- Appellant entered into several commercial contracts, containing certain clauses that provide for penalty for non-observance/ breach of terms of the contract;
- The appellant pointed out that penalty is charged from the vendors only if there was a delay in supply of goods ordered by the appellant, and the contractor also does not execute the terms of the contract in time;
- The penal clauses are in the nature of providing a safeguard to the commercial interest of the appellant.
Based on the above, the CESTAT ruled as follows:
- ‘Consideration’ must flow from the service recipient to the service provider and should accrue to the benefit of the service provider and that the amount charged has to be necessarily a consideration for the taxable service;
- Any amount charged which has no nexus with the taxable service and is not a consideration for the service provided does not become part of the value which is taxable;
- It should also be remembered that there is a distinction between ‘conditions to a contract’ and ‘considerations for the contract;’
- The consideration contemplated under the agreements was for the supply of coal, materials, or for availing various types of services. The intention of the parties certainly was not for flouting the terms of the agreement so that the penal clauses get attracted;
- The activities that are contemplated under Section 66E(e) are activities where the agreement specifically refers to such an activity, and there is a flow of consideration for this activity;
- Therefore, penalty amount, forfeiture of an earnest money deposit, and liquidated damages received by the appellant cannot be said to be ‘consideration’ for ‘tolerating an act’ and therefore are not leviable to service tax.
The taxability of liquidated damages and forfeiture of deposits under indirect tax laws has been a subject of various litigations. Under the GST regime, various AARs have consistently held that such payments are chargeable to GST.
However, this CESTAT ruling, which discusses the issue comprehensively in the context of various judgments of Indian and foreign courts, should help taxpayers to substantiate their case before GST authorities and obtain favorable rulings.
Whether services of a foreign holding company in relation to providing credit cards to employees of the applicant can be treated as intermediary services?
ICU Medical LLP - AAR, Tamil Nadu [2020 (10) TMI 764]
- The ultimate holding company of the applicant has entered into a contract with Wells Fargo Bank (located in the USA) through which certain employees of the applicant are extended with the credit card issued by the said bank;
- The credit card is used by the employees of the applicant for incurring various expenses towards tickets, food, and accommodation, etc. during their official travel;
- The holding company settles these transactions with the bank and in turn, raises an invoice for ‘credit card expenses’ on the applicant and collects the charges.
Based on the above facts, the AAR observed as follows:
- For the privilege of using the cards, the applicant has to pay ICU Medical Inc. all the relevant expenses and charges made by its employees;
- It is evident that this is a separate transaction between the applicant and ICU Medical Inc. for the services of providing the credit cards to the employees of the applicant, which are to be used only for business-related activities;
- ICU Medical Inc. is making the supply of the credit cards to the applicant, for the use of its employees, on its own account and not as an ‘intermediary;’
- Therefore, the applicant is liable to pay IGST under the reverse charge mechanism on account of the import of services from the ultimate holding company.
The transaction model in the present case is common in the case of MNCs, and therefore this ruling should be a guide on the GST implications to taxpayers entering into similar arrangements with their foreign associate entities.