Whether payment for benchmarking services can qualify as Fees for Technical Services (FTS)?
M/s Reliance Industries Ltd. Vs ACIT ITA No.5688/Mum/2019
The taxpayer is an Indian company engaged in the business of oil exploration, refining crude oil, manufacturing and trading of petrochemicals. During the year under consideration, the taxpayer entered into an agreement with a company based in the US to receive benchmarking services. The taxpayer filed an application with Indian tax authorities seeking authorization for making the payment for said services with NIL withholding taxes. The taxpayer adopted a view that such income is non-taxable business income under the India-USA Double Tax Avoidance Agreement (DTAA) in the absence of its Permanent Establishment (PE) in India.
The Assessing Officer (AO) concluded that payments made by the taxpayer to the US entity should be considered as FTS, and hence taxpayer was liable for withholding tax on the said amount.
On appeal by the taxpayer, the Commissioner of Income-tax (Appeals) [CIT(A)] held that the taxpayer was not liable to deduct tax at source on the payments made as it did not qualify as FTS. Aggrieved by the order, the Revenue had raised the aforesaid grounds before the Mumbai Tribunal.
After considering the data on record, the Bangalore Tribunal observed that for those payments to fall under FTS as per India-USA DTAA, the service providers should have made the technical knowledge, experience, skill, and knowhow available, etc. to the taxpayer. The Tribunal specified that benchmarking services only enable the taxpayer to take further action to improve its qualitative capacity. However, such services did not provide any know-how or technical knowledge. The Tribunal also noted that the US vendor was not a domain expert in the area where the taxpayer operated; hence, the make available conditions of Article 12(4)(b) under India-USA DTAA are not satisfied.
Thus the Tribunal stated that these payments constitute business income and in the absence of a PE of the vendor in India, these payments are not chargeable to tax in India.
It has always been a contentious issue whether a particular service is covered under FTS. The Mumbai Tribunal has re-iterated that the "make available test" is a pre-requisite for qualification of a transaction to be FTS where the definition of FTS is restrictive.
Whether reimbursement of bandwidth charges services can be Royalty or Fees for Technical Services (FTS)?
M/s Madura coats Pvt Ltd. Vs DCIT IT(IT)A Nos. 1344 & 1345/ Bang/2019
The taxpayer is an Indian Company engaged in the business of manufacturing and sewing threads and other goods. During the year under consideration, the taxpayer paid bandwidth charges to a company based in the UK. The taxpayer made such payments without deducting any withholding taxes on the footing that the UK company did not have a PE in India and the payment was neither in the nature of Royalty nor FTS.
The AO was of the view that these payments were ‘use’ or ‘right to use’ towards dedicated bandwidth, the process, and equipment associated with the network and thus qualified as Royalty both under Indian domestic tax law (IDTL) and under India-UK DTAA. Hence taxpayer was liable for withholding tax on the said payment. Furthermore, the AO held that income from bandwidth services was in the nature of FTS under IDTL as well as under India-UK DTAA.
The CIT(A) confirmed the AO’s order. Aggrieved by the order, the taxpayer filed an appeal before the Bangalore Tribunal.
The Tribunal emphasized the fact that there was neither transfer of any intellectual property nor any exclusive right has been granted to the taxpayer for the use of intellectual property in the network. The Tribunal also observed that the taxpayer does not have any ownership, control, possession or rights in respect of any process in the network owned by the UK company or equipment associated with it. Thus, the Tribunal stated that said payment does not constitute Royalty.
On the issue of classification of reimbursement of bandwidth charges as FTS, the Tribunal held that no technical knowledge, know-how, skill, etc., is made available to the taxpayer enabling the taxpayer to use it independently. The Tribunal stated that since the make available condition of Article 13(4)(c) under India-UK DTAA is not satisfied, the amount received will not be treated as FTS.
The Tribunal has accepted that bandwidth fees cannot be considered as payments for the 'use of the process' or ‘use of equipment’ and thus does not qualify as Royalty under DTAA.
Rate of interest on loan transactions cannot be equated with delayed outstanding receipts
Zeta Interactive Systems (India) Pvt Ltd7
The taxpayer is engaged in rendering software development and information technology-enabled services to its Associated Enterprise (AE) and benchmarked the international transactions using the external Transactional Net Margin Method (TNMM). The taxpayer did not report the interest on outstanding receivables as an international transaction.
In addition to the issue relating to the choice of comparables for the software development segment, the Transfer Pricing Officer (TPO) made an upward adjustment by levying interest at 12% on outstanding receivables and held that details regarding raising of invoices and subsequent receipts along with the transfer pricing study (for the said arrangement) were not filed by the taxpayer even pursuant to the show cause notice issued by the TPO.
The CIT(A) observed that 60% of the total receivables were from the AE and considered 8% as a reasonable rate of interest on outstanding receivables as against 12% computed by the TPO.
The transactions of the taxpayer are required to be examined from the perspective of a prudent businessman and analyzed whether the taxpayer would extend similar benefits to unrelated parties. Citing reference to Section 92B of the Act8, the ITAT held that outstanding receivables are is required to be benchmarked to ensure that there should not be any shifting of profit from taxpayer to the AE.
Delay in receiving its dues, the taxpayer has faced economic consequences as it is required to bear the cost of trade receivables without any carrying cost. In case of outstanding receivables for a longer period, the taxpayer would be required to deploy more resources either in the form of debt/equity to meet the cash flow/working capital requirements.
The Income-tax Appellate Tribunal (ITAT) outlined that adopting LIBOR+200 points would defeat the purpose of benchmarking trade receivables and tantamount to shifting the profits. The ITAT further held that the rate of interest on loan transaction (LIBOR + points) could not be equated with delayed receipt of the outstanding amount by the taxpayer from its AE as both stand on different premises having different purposes and natures.
The ITAT concluded that in a strict sense, the application of 8% interest rate would be contrary to the principles of TP analysis as the interest rate is ideally required to be backed up by internal or external comparables and applying Comparable Uncontrolled Price (CUP) method to fix the rate of interest. However, to give a quietus to the issue, the rate of interest was reduced to 6% on the outstanding receivables at the year-end.
In the above ruling, the ITAT has emphasized that overdue outstanding receivables and loan arrangement stands on different premises having different purpose and nature. The mechanism used to benchmark the arrangement relating to a loan transaction may not hold relevance for benchmarking overdue outstanding receivables. Furthermore, while concluding the interest rate at 6%, the ITAT itself applied an Adhoc rate instead of following TP principles and a scientific approach.
Reference to TPO to be made within the course of normal assessment under Section 153
Virtusa Consulting Services Private Limited9
The taxpayer is engaged in the business of software development services globally. For AY 2006-07, the AO sought permission from the CIT to make reference to the TPO, which was approved and granted on 18 November 2008. Thereafter, notice under Section 92CA of the Act, the TPO notice to the taxpayer on 17 February 2009 (i.e., post expiry of a time limit of 21 months, i.e., 31 December 2008 from the end of the AY – time limit for regular assessment, without TP reference).
The taxpayer participated in the proceedings before the TPO and no objection was raised regarding the limitation during TP assessment proceedings. It was only before the Dispute Resolution Panel (DRP) that the taxpayer raised the objection regarding the limitation for the first time.
The time limit specified for completing regular assessments under the first proviso to erstwhile S. 153 of Act altered the original time limit from 24 months to 21 months vide amendment with effect from 1 June 200610. The second proviso11 extended the time limit for assessments for transfer pricing cases from 24 months to 33 months.12
The taxpayer contended that the non-obstante clause under the 2nd proviso to Section 153(1) of the Act extending the period from 21 months to 33 months is circumscribed by two jurisdictional pre-conditions, and they need to be satisfied by the respondents, namely, (i) reference under Section 92CA (1) is made by the AO to the TPO and (ii) reference must be made during the course of assessment proceedings. In the present case, the limitation to finalizing the assessment expired on 31 December 2008 and the reference made on 17 February 2009 is legally not sustainable.
The DRP dismissed the objection of the taxpayer with regard to the limitation. Challenging the order passed, the taxpayer filed a writ petition before Madras High Court, invoking Article 226 of the Constitution of India.
The single-judge bench of the Madras High dismissed the taxpayer’s writ. Aggrieved, the taxpayer filed an intra-court appeal13 before the division bench. The bench held that:
- Though the taxpayer participated in draft scrutiny proceedings, a legal plea can be raised at any stage and there cannot be any waiver of a statutory right.
- The language used in 2nd proviso to Section 153 is “reference” and not “approval”. “Reference” is used in the context of reference to TPO, and “approval” is from the CIT. The extended time limit for TP cases under Section 153 comes into operation only on a “Reference to TPO” and not on “concurrence by the CIT.”
- When one proviso provides a time limit, and when another proviso extends such time under certain circumstances, it cannot be held that both the provisos are independent. Even if there is any conflict between the two provisions, they must be read harmoniously to make both provisions workable. Accordingly, Section 153 and the first two provisos lay down that the time limit to pass the original period of assessment is 21 months, and when a reference to TPO is made during the course of such proceedings, the time limit would be 33 months.
- If the TPO reference is bad, then as a sequitur, all further proceedings in furtherance of the same are also bad. In the present case, because of a reference after the permissible period, the department has missed the timeline at every stage.
- The period of limitation of 33 months provided under Section 153 would apply to the final assessment order after the directions from the DRP and not the draft assessment order. The bench thereby held that even the directions of the DRP (issued on 24 September 2010) were beyond the permissible limit.
Section 153 limitation prescribes the time limit for passing assessment orders under different scenarios. It is pertinent to note that Section 153 does not explicitly prescribe the time limit for making a reference to TPO. However, unless a reference to the TPO is not made within the course of normal assessment, i.e., expiry of 21 months from the end of the relevant assessment year, the extended time limit of 12 months would fail to be attracted for TP assessments.
The single-judge bench ruling has also harped on the relevance of bringing out the plea of limitations during the proceedings with the lower authorities though the division bench has held that the legal plea can be raised at any stage and there cannot be any waiver of a statutory right.
8. Income Tax Act, 1961
9. The High Court of Judicature at Madras; Writ Appeal No. 1903 of 2021
10. In Finance Act, 2006
11. Inserted by Finance Act 2007
12. S. 153 was repealed and substituted with effect from 01.06.2016. Under the present S. 153(1) it is clearly mentioned that the period of assessment is 21 months and under S. 153(4), it is clearly mentioned that in case of reference under S. 92CA (1) i.e. transfer pricing provisions apply, the period of assessment would be extended by 12 months.
13. Intra-court appeal means internal or same court appeal but in front of different bench.
Whether transfer of excess Input Tax Credit (ITC) from one unit to an ISD unit, by means of issuing tax invoice for outward supply of services, is valid in the eyes of the law?
JSW Steel Ltd. vs. Union of India & Others [2022 (5) TMI 1238 – Odisha High Court]
- JSW Steel Ltd. was awarded the lease for undertaking mining operations for iron ore blocks in the State of Odisha.
- To undertake the mining process, the company obtained GST registration in the State of Odisha and paid GST under the Reverse Charge Mechanism (RCM) on the bid premium, Royalty, etc., vis-à-vis the licensing services for the right to use minerals, including exploration and evaluation in respect of four mines located inside the State.
- The iron ore extracted from the mining blocks would either be supplied by JSW Steel Ltd (Odisha) to JSW Steel plants by way of stock transfer or to the extent permissible, supplied to third parties.
- Having utilized a portion of the tax paid under RCM to discharge output GST on aforesaid supplies, JSW Steel Ltd (Odisha) raised tax invoices in favor of JSW Steel Ltd.’s HO in Mumbai, which is registered as Input Service Distributor (ISD), towards the supply of facilitation services.
- However, the GST authorities objected to such a modality of adjusting unutilized ITC on the premise that such a device to facilitate units located in other States to claim ITC arising in the State of Odisha was contrary to the statutory mandate.
- Having not been allotted an ISD registration with the State Code of Odisha, the transactions in question were adjudicated as sham by invoking the provisions of Section 74 of the OGST / CGST Act, 2017.
- Hence, the company filed a writ petition before the Odisha High Court seeking a prohibition on the recovery of demand.
- The Court observed that there was no specific clarity regarding the nature of the support service provided by JSW Steel Ltd (Odisha) to ISD in Mumbai, much less any common services which could be utilized by other units located in other parts of the country.
- It emerges that JSW Steel Ltd (Odisha), has utilized ISD as a wrongful conduit and facilitated the utilization of ITC by other units of JSW Steel Ltd., which in this manner have availed ITC twice, i.e., once on the strength of the purchase invoices of supply of iron ore and the other on the strength of the tax invoices for alleged services, issued by ISD.
- The argument of the company that it is the ISD that has been awarded the contract and, therefore, whatever tax has been deposited in the State of Odisha is actually paid on behalf of the ISD in Maharashtra is not supported by documentary evidence, nor has the statutory backing.
- As per the definition of “Input Service Distributor” under Section 2(61) of the CGST Act, it is necessary that the ISD as an office receives tax invoices towards inward supply. Since no such supply has been made by JSW Steel Ltd. (Odisha) to JSW Steel Ltd. of Maharashtra, no prima facie case is made by the petitioner-company.
- Thus, the transactions in question prima facie amount to siphoning of tax amounts and, therefore, apparently warrant invocation of proceeding under Section 74 of the CGST Act.
- As regards the challenge to the jurisdiction of GST authorities in the State of Odisha, the Court has ordered to file counter-affidavits and objections while listing the matter for hearing in August 2022.
This order could result in similar investigations/scrutiny being initiated with regards to cross State adjustments as compared to ISD against similarly placed taxpayers who have obtained GST registration in other States in adherence to the GST provisions, along with ISD registrations.
Wherever applicable, companies will need to accordingly evaluate if the transfer vide the ISD registration is appropriate.
Whether the appellant is liable to service tax on the penalty (liquidated damages) collected from their contractor?
M.P. Audyogik Kendra Vikas Nigam (Indore) Limited vs. Commissioner, CGST & C. Ex., Indore [2022 (6) TMI 381 CESTAT NEW DELHI]
- Service tax demand was confirmed against the appellant on the ground that the penalty levied and collected from their contractor(s) during FY 2016-17 and April 2017 to June 2017 was liable to tax in terms of Section 66E(e) of the Finance Act.
- Section 66E(e) inter alia provided that declared services include agreeing to the obligation to refrain from an act or to tolerate an act or situation or to do an act.
It was held that there was no contract between the appellant and their contractor – to refrain from an act or a situation or to do an act in favor of their contractor, or to tolerate any act or situation.
Furthermore, there was no remuneration prescribed in the contract for such an alleged act or tolerance.
Liquidated damages collected by the appellant from their contractor were in the nature of a penalty and not by way of any consideration for any service as defined in Section 66E(e).
In this regard, CESTAT relied on its ruling in the case of Lemon Tree Hotel vs. Commissioner, GST, CE & Customs, Indore [2020 (34) GSTL 220 (Tri. Del.)], wherein it was held that the amount retained/forfeited by the hotel upon cancellation of a booking by the customer was in the nature of penalty, and not a consideration as defined under Section 66E(e) of the Finance Act.
Accordingly, the appeal was allowed with consequential benefits to the appellant.
Since the Service Tax regime, the taxation of liquidated damages has been a subject matter of dispute between the taxpayers and the Revenue. This judgment is a welcome move to consider recovery of liquidated damages against forfeiture of contracts as a 'penalty,’ not being subject to tax.
The judgment could also assist the taxpayers to substantiate their stand/ defend their position under the GST regime by considering liquidated damages (vis-à-vis agreeing to do an act/tolerance in terms of Entry 5(e) of Schedule II to the CGST Act.) in the nature of penalty, not exigible to tax.
Merger & Acquisition Tax
Chennai ITAT dismisses taxpayer’s claim that letter to AO regarding merger is a valid communication and upholds revision of assessment order passed on amalgamating entity
IRIS Engineering Industries Pvt. Ltd. [TS-401-ITAT-2022(CHNY)] (Chennai ITAT)
Chennai ITAT has recently dismissed the taxpayer’s appeal and upheld the revision of the assessment order passed on the amalgamating company IRIS Engineering Industries Pvt. Ltd. The ITAT noted that a letter was submitted with the Assessing Officer (AO) stating that the taxpayer was planning a merger with Ravilla Aerospace. However, no specific details about the amalgamation were filed with the tax authority. On the date of the assessment order, the AO had not received any concrete evidence that the entity had merged with Ravilla Aerospace, as the High court orders sanctioning the merger scheme were submitted with the Registrar of Companies (ROC), but not the AO.
Chennai ITAT distinguished the Maruti Suzuki14 judgment of the Supreme Court from the current case, as in Maruti Suzuki’s case, the AO was informed about the cessation of the company’s existence. Chennai ITAT also considered the Supreme court case of Mahagun Realtors15, where a similar issue was considered. It was held that the corporate death of an entity upon amalgamation per se shall invalidate an assessment order, but the same cannot be ordinarily determined on a bare application of provisions of the Companies Act and would depend on the terms of the amalgamation and facts of each case.
Following the decision of Mahagun Realtors, this is the second decision in line, highlighting the relevance of intimating the tax authority about the merger taking place. It is pertinent that due disclosures are made in the communications to the tax authorities, return forms, other income tax filings, etc., about the merger.
Bangalore ITAT remits appeal over AO's 'colorable device' finding on valuation report & goodwill in business acquisition
TE Connectivity Services India Private Ltd [TS-436-ITAT- 2022(Bang)]
The taxpayer had acquired the shared service business of TE Connectivity Global Shared Services Ltd under slump sale and paid purchase consideration of INR 685.5 million. This consideration was based on an independent valuer’s report prepared by using the weighted average of two internationally accepted methods, i.e., the Discounted Cash Flow method (DCF) and the Comparable Market Multiple methods.
The AO rejected the valuation report stating that the valuation using the DCF method is not acceptable. It concluded that the purchase consideration was a colorable device since it was fixed at an abnormally higher value than the net assets taken over (INR 76.4 million). It rejected the depreciation on the amortized cost of goodwill claimed.
The taxpayer’s representative argued that AO failed to demonstrate and record any reasons for considering it as a colorable device. A colorable device is an instrument or a transaction designed to camouflage an underlying transaction. Also, a comparison of the projections with the actual revenues cannot be a basis for rejecting any valuation.
Agreeing with these contentions, specifically in the context of valuation, Banglore ITAT also observed a similar issue was addressed by Delhi ITAT in the case of Rockland Diagnostics15, wherein it was decided that the AO cannot reject the valuation report merely on the ground that the projected results did not match the actual results. In the context of Section 56(2)(viib) of the Income Tax Act, 1961, read with Rule 11UA of the Income tax Rules, 1962, every taxpayer has an option to do a valuation of shares and determine their Fair Market Value either by DCF method or Net Asset Value (NAV) method and that the AO cannot examine or substitute his own value in place of the value so determined.
Post the amendment vide Finance Act 2021, while goodwill is no longer eligible for depreciation for tax purposes, this decision would be of relevance in the context of valuation of other intangible assets, which are valued using varied methods.
While it is a settled position that valuation cannot be questioned merely because of variation of projections with actuals, it is pertinent to ensure that strong documentation is in place for the basis for projections made and where there is a variation of the actuals with the projections made, the reasoning for the variation is identified and suitably documented for ease of substantiation.
14.  107 taxmann.com 375 (SC)
15. Civil Appeal No. 2716 of 2022 [arising out of Special Leave Petition (C) No. 4063 of 2020]
16. ITA No.316/Del/2019