From The Judiciary

Whether human resource and leadership training service would qualify as Fees for Technical Services (FTS)?

M/s Sandvik AB Vs. DCIT ITA No. 2524/PUN/2017

Facts

The taxpayer is a resident company in Sweden. During the year under consideration, the taxpayer received a certain amount from Sandvik Asia Private Limited (SAPL) towards training charges. In the return of income, the taxpayer designated such receipt as non-technical and accordingly not chargeable to tax as FTS in India under the India-Sweden DTAA read with the Protocol and India Portuguese DTAA.

The taxpayer emphasized that the leadership training services imparted by it enabled the recipients to manage its Indian affiliate's affairs more effectively. The same would qualify to be managerial services and by virtue of the Protocol in the India-Sweden DTAA, the restrictive definition of FTS under India Portuguese DTAA can be imported. Under the India-Portuguese DTAA, fees for managerial services do not fall under FTS.

The Assessing Officer (AO) did not accept the taxpayer's contention. The AO relying on the Authority for Advance Ruling (AAR) in Perfetti Van Melle Holding B.V., in Re [2012] 342 ITR 200 held that the benefit of IndiaPortuguese DTAA cannot be extended. Further, even if India-Portuguese DTAA has to be referred, the receipt is in the nature of technical or consultancy service, that makes technical knowledge available. The DRP upheld the contentions of the AO.

Aggrieved by the order passed pursuant to the directions of the AO, the taxpayer is in appeal before the tribunal.

Held

On hearing the facts and contentions of the parties involved, the tribunal has held that once two sovereigns have added Protocol to the DTAA between India and Sweden, which contains the Most Favoured Nation (MFN) clause, inter alia, qua Article 12, the sequitur is that the beneficial provisions contained in the India and Portuguese DTAA is to be read in the India and Sweden DTAA. Further, the Ruling in Perfetti has been overruled by the Hon'ble Delhi High Court.

After a thorough analysis of the service rendered and documents on record, the tribunal was of the opinion that the contention of the assessee that the training was leadership training that would help recipients to manage the affairs of its Indian affiliate, and thus it should be considered as managerial service do not hold any merit. Thus, it is to be analyzed whether such training service qualifies to be a technical or consultancy service under the DTAA.

Under India-Portuguese DTAA, technical and consultancy services would be taxable as FTS only when it makes available technical knowledge, skill, know-how, etc., to the recipient.

The tribunal held that the leadership training provided by the assessee did not result in imparting any technical knowledge, experience or skill, etc., to the employees of SAPL, which could enable them to use it later on. In that view of the matter, it is held that the Revenue authorities were not justified in considering training fees for rendering Consultancy or Technical services within the meaning of Article 12(4) (b) of the DTAA between India and Portuguese.

Our Comments

The precedent once again re-iterated the principle that where a treaty with any contracting state includes Protocol, the benefit from the Protocol has to be read in conjunction with the treaty.

Whether perquisite value arising on the Employee Stock Ownership Plans (ESOPs) exercised by a nonresident, granted for employment exercised in India should be taxable in India?

Unnikrishnan V S Vs. ITO ITA Nos 1200 and 1201/ mum/2018

Facts

The taxpayer is an employee of HDFC Bank Limited, Mumbai, currently deputed to Dubai. While exercising the employment in India, the employee was granted ESOPs. However, these options were exercised while being on deputation in the UAE. At the time of exercising the options, the employee had become a UAE resident.

The taxpayer claimed a refund on the taxes withheld on the perquisite amount on account of exercising the options. He was of the view that the ESOP benefits are received on account of services rendered in Dubai. Thus, the same does not accrue in India. Further, as per Article 15 of India-UAE DTAA, salary, wages and any other similar remuneration would be taxable in the country where such employment is exercised, i.e., UAE in the current scenario.

However, the AO noted that the options were granted to the taxpayer in consideration were services rendered in India, back in 2007, when the taxpayer was a resident of India. The claim of the assessee that the income reflected by the ESOP benefit did not accrue or arise in India, was, thus, rejected. The AO's order was upheld by the CIT(A).

Aggrieved by the order, the taxpayer filed an appeal with the Mumbai tribunal.

Held

First and foremost, the tribunal overlooked the terms 'Accrue' and 'Arise.' Referring to certain judicial precedents, the tribunal concluded that accrual or arising of an income cannot be equated with receipt of an income. The common thread in the connotations of these expressions is that both represent a state anterior to the point of time when the income becomes receivable and connote a character of income that is more or less inchoate.

In light of the above, so far as the ESOP benefit is concerned, although the income has arisen to the assessee in the current year, the rights were granted in consideration for the services which were rendered by the assessee prior to the rights being granted. Thus, the ESOP benefits relate back to the point of time, and even periods prior thereto, when the benefit is granted. It cannot, therefore, be viewed as accruing or arising at the point of time when the ESOP benefits are exercised. The taxpayer is a nonresident in the current assessment year, but quite clearly, the benefit, in respect of which the income is bring sought to be taxed now, had arisen at an earlier point of time in India.

Further, the tribunal observed that even under the India-UAE DTAA, such benefit is to be taxed in the country where the employment has been exercised. Since, the taxpayer has been granted ESOP for his services in India, Article 15 cannot be of any rescue to the assessee. Thus, the taxpayer's claim was dismissed.

Our Comments

The case law has clarified the notion that ESOP is granted to an employee for his past performance and cannot be termed as a benefit for service rendered during the vesting period.

Determinants of 'Associated Enterprise' - Whether Section 92A(1) and 92A(2) are interlinked?

M/s. Page Industries Ltd – Karnataka High Court ITA No. 285 of 2017 – AY 2010-11

Facts

Taxpayer is engaged in the manufacture and sale of readymade garments and is a licensee of the brand name 'Jockey' for exclusive marketing of branded garments. The taxpayer paid royalty at 5% of sales and reported the payment to 'Jockey International Inc.' in Form 3CEB.

The Transfer Pricing Officer (TPO) considered the taxpayer's expenditure incurred on the advertisement, marketing, and product promotion as an international transaction for brand promotion and determined the Arm's Length Price (ALP) using the Bright Line Test to make a TP adjustment. The Dispute Resolution Panel (DRP) also upheld the order of the TPO. Aggrieved by the DRP's order taxpayer filed an appeal before Income Tax Appellate Tribunal (ITAT).

ITAT partly allowed the appeal of the taxpayer merely on the ground that taxpayer cannot be considered as an AE and therefore requirements of Sec 92A(1) have not been complied with, and thus the provisions of Sec 92A are not attracted. To this, the Revenue filed an appeal contending that provisions of section 92A(1) and (2) have to be read independently and the transactions in the current case were under the purview of 92A(2)(g).

The High Court (HC) held as under

• Relying on the memorandum to Finance Bill, 2002, the HC observed that sub-section (2) of section 92A was amended w.e.f 1 April 2002 to clarify that mere fact of participation in the management, control or capital shall not qualify to be AEs unless the criteria specified in sub-section (2) are also fulfilled.
• On perusal of sub-section (1) and (2) of Section 92A, it is clear that the same are interlinked and have to be read together.

Further, noting the ITAT's view that taxpayer does not meet the condition u/s. 92A(1) was not assailed by the Revenue, accordingly, HC dismissed the Revenue's appeal.

Our Comments

If the provisions of sub-section (1) and (2) of Section 92A are read independently, one of the provisions would be rendered otiose, which is impermissible in law in view of the well-settled rule of statutory limitation. Therefore, the requirement contained in sub-sections (1) and (2) of Sec. 92A are interlinked and have to be read together.

Whether RBI approval is a relevant factor for determining arm's length rate of interest for External Commercial Borrowing (ECB) loan?

GE India Technology – Karnataka High Court ITA No. 282 of 2013 – AY 2006-07

Facts

The taxpayer had obtained two loans at the interest rates of 7.5% and 8.49%. However, the TPO recomputed and scaled down the interest rate to 5.67%. The DRP also upheld the TPO's order, after which the taxpayer filed an appeal before the ITAT.

The ITAT noted that the interest was paid at the same rate on the basis of the loan agreements entered by the taxpayer during AY 2000-01 and the TPO accepted the same for AY 2002-03 to AY 2005-06 and AY 2008-09. Hence, the ITAT deleted the addition on account of interest while reaffirming that the interest rate depended upon the credit rating of the borrowings at the time of advancing the loan. Accordingly, the ITAT held that in view of uniformity and consistency rules, the same approach was to be adopted for AY 2006-07 too. Aggrieved by the ITAT's order, the Revenue filed an appeal before the HC.

HC held as under

• RBI has given the approval regarding the rate of interest on the loan, which is a relevant factor and must be taken into consideration.
• It is equally well settled that the rate of interest should be determined on the basis of conditions prevailing at the time of availing the loan.
• Relying on the Hon'ble SC ruling in the case of Radhasoami Satsang wherein it was held that "even though principles of res judicata do not apply to income tax proceedings, but where fundamental aspect permeating through different AYs has been found as the fact one way or the other and the parties have allowed the position to be sustained by not challenging the order, it would not at all be appropriate to allow the position to be changed in subsequent years." Accordingly, as the issue has been accepted in the prior years, the Revenue cannot be allowed to take a departure in case of the rate of interest for AY 2006-07. Thus, the HC dismissed Revenue's appeal against the taxpayer.

Our Comments

RBI approval regarding the rate of interest is a relevant factor for determining the rate of interest. The Revenue should also follow uniformity and consistency rules while determining the ALP of the international transaction.

Can the selection of foreign AEs as the tested party be in consonance with OECD and UN Manual?

Majesco Software and Solutions India Pvt Ltd ITA No. 7070/Mum/2019

Facts

The taxpayer was engaged in the development of software solutions for the insurance sector. Formerly the taxpayer's insurance product and service business was held by Mastek Ltd. that was transferred to Majesco Ltd. through a slump sale that was thereafter transferred to the taxpayer. The taxpayer had entered into distribution agreements with its AEs for appointing advertising agencies, negotiating contracts with overseas customers, etc., where the taxpayer borne the service liability risk. The taxpayer benchmarked the transactions using Transactional Net Margin Method (TNMM), considering AEs as a tested party.

The TPO rejected AEs as a tested party, asserting them to be entrepreneurial entities rather than minimal risk distributors as AEs performed varied functions viz. marketing, customer relationship as well as entrepreneurial functions, etc. Aggrieved by the TPO's order, the taxpayer filed objections with DRP which were dismissed and impugned while the TPO's order was upheld.

ITAT held as under

• Although the taxpayer has acquired new business, a similar distribution transaction undertaken earlier by the parent and ultimate parent was benchmarked using foreign AEs as a tested party.
• There were no changes in the functional profile of foreign AEs for distribution activity relying on agreement pre and post slump sale.
• The term 'Tested Party' has not been defined under the provisions of the Income Tax Act or the Rules. The meaning can be interpreted from OECD and UN guidelines as follows: The one to which a transfer pricing method can be applied in the most reliable manner and for which the most reliable comparable can be found, i.e., it will most often be the one that has the less complex functional analysis and that necessary relevant information and sufficient data on comparables is furnished to the tax administration.
• Further, reliance was placed on Indian judicial precedents¹ , which accepted foreign AEs as a tested party, subject to conditions of the least complex entity and availability of data for comparison.

Basis above, ITAT ruled in favor of taxpayer as conditions for selecting foreign AE as a tested party was satisfied.

Our Comments

The ruling emphasizes the essence of the selection of tested party:

1. Availability of reliable and accurate data for comparison;
2. Least complex (amongst the parties to the transaction);
3. Data available can be used with minimal adjustments.

Further, the importance of a thorough fact finding and submission of relevant evidence to substantiate the complexity of parties involved and the historical trend is reaffirmed.

Whether the Show Cause Notice (SCN) is valid if the same is not issued as per the procedure laid down in Rule 142 of the CGST Rules, 2017?

Akash Garg versus State of MP – Madhya Pradesh High Court [2020 (11) TMI 786]

Facts

• The authorities issued a SCN and subsequently an order dated 10 June 2020 under Section 74 of the CGST Act, 2017;
• The said SCN and order were communicated on the registered email id of the petitioner;
• Further, against the said order, authorities issued a demand in GST DRC - 07.

Based on the above facts, the High Court ruled as follows:

• A bare perusal of Rule 142 reveals that the only mode prescribed for communicating the SCN/order is by way of uploading the same on the Revenue's website;
• It is a trite principle of law that when a particular procedure is prescribed to perform a particular act, then all other procedures/modes except the one prescribed are excluded;
• This principle becomes all the more stringent when statutorily prescribed, as is the case herein;
• In view of the above discussion, this Court had no manner of doubt that the Revenue had not followed the statutory procedure prescribed for communicating SCN/order under Rule 142(1), and hence the impugned demand was struck down.

Our Comments

This is an important judgment wherein the High Court has once again emphasized the importance of Revenue authorities following the due procedure of law vis-à-vis tax demands.

Whether promotional products/ materials and marketing items used by the applicant can be considered as 'inputs' as defined under Section 2(59) of the CGST Act, 2017?

Whether GST paid on the same can be availed as an input tax credit in terms of Section 16 of the CGST Act, 2017?

M/s Page Industries Limited - AAR, Karnataka [2020 (12) TMI 902]

Facts

• The applicant is engaged in the manufacture, distribution, and marketing of knitted and woven garments and swimwear;
• The applicant disposes of/issues the distributable goods free of cost to franchisees and other shops/retailers, where all brands are sold (Retailers/ All brands stores);
• The applicant sends these items to promote their brand.

Based on the above facts, the AAR ruled as follows:

For distributable goods

• The distributor/franchisees and the applicant are 'associates in the business of one another' and hence, are 'related persons' under the Explanation (c) to Section 15 of the CGST Act, 2017.
• Therefore, in accordance with Schedule I to the CGST Act, 2017, GST is applicable on free of cost transfer of distributable goods;
• Thus, the applicant needs to discharge GST on such supplies, and thereby is entitled to avail ITC on the said supply of goods;
• However, in the case of retailers, they are unrelated to the applicant and accordingly, the provisions of Schedule I do not apply;
• Consequently, GST paid by the applicant on purchase of (distributable) products which are distributed to the retailers (i.e., unrelated parties) free of cost, will not be allowed in accordance with Section 17(5)(h) of the CGST Act, 2017.

For non-distributable goods

• The GST paid by the applicant on purchase of (non-distributable) products that qualify as 'capital goods', should be available as eligible ITC;
• However, in case if they are disposed of or destroyed or lost, then the same needs to be reversed under Rule 43 of the CGST Rules, 2017.

Our Comments

As per Explanation (c) to Section 15, 'persons who are associated in the business of one another in that one is the sole agent or sole distributor or sole concessionaire' are deemed to be related persons. However, in the present case, whether the distributors/ franchisees qualify as 'sole distributor' as held by the AAR can be a subject matter of dispute.