From The Judiciary

Whether Poland LLP shall be eligible to claim the benefit of India- Poland Double Taxation Avoidance Agreement (DTAA)?

M/s Infosys BPO Ltd. Vs. The DCIT IT(IT)A No. 986/Bang/2017, 990/ Bang/2017

Facts

The taxpayer is an Indian company engaged in the business of providing business process outsourcing services. During the year under consideration, the taxpayer made payment to the non-resident in the USA towards a retainership and site license subscription fee and to the non-resident LLP in Poland for legal service rendered. The law firm is a fiscally transparent entity as per the tax law of Poland. The taxpayer grossed up the invoices and deposited tax under protest.

The issue under consideration was whether the partnership firm would be eligible for benefit under India Poland DTAA.

Held

The Bangalore Tribunal held that the India-Poland DTAA applies only to a ‘person’ who is a resident of one or both of the contracting states. Therefore, in view of the provisions of Article 4(1) read with Article (1) and Article 3(1) (e), unless the payee is taxable under domestic laws of Poland, treaty benefits cannot be extended. The Tribunal was of the view that the law firm is a nontaxable entity as per the domestic laws and therefore, treaty benefit cannot be extended to the firm. However, given that income of the partnership is taxable in the hands of the partners and such partners have provided valid TRC partners shall be eligible to India-Poland treaty benefit and no tax shall be levied under Article 15: Independent Personal Services (IPS).

The Tribunal followed the Mumbai Tribunal’s judgment in the case of Linklaters LLP.

Our Comments

After the judgment of Linklaters LLP, the India-UK DTAA was modified to provide a specific clause that the provision of the treaty in case of a partnership shall apply only to the tune of income taxable in the hands of a partner in the UK. India-Poland DTAA does not include such a specific clause.

Furthermore, Article 15 (IPS) of India- UK DTAA specifically covers individuals who are partners of a firm. However, IPS clause under the India-Poland DTAA covers only professional individuals. So, this decision could be a welcome decision for the fiscally transparent entities outside India, which are receiving payment from India.

Whether web-based database service and access to e-journals can be considered as Royalty?

American Chemical Society Vs. ACIT I.T.A. No.1030/Mum/2021

Facts

The taxpayer is a US-based non-resident entity engaged in the promotion and development of knowledge in the field of chemistry. The company is organized in two divisions as follows:

• Chemical Abstracts Service (CAS) Division: It identified, aggregated, and organized publicly disclosed scientific information and offered online, webbased access to its customers to databases with scientific content.
• Publications (PUBS) Division: It reviews research work submitted by scientists worldwide and offers a subscription of web-based and printed copies of research journals/ejournals.

The taxpayer earned revenue of INR 624.8 million as a fee for providing access by subscription to online chemistry databases (CAS division) and revenue of INR 401.8 million as subscription revenue from the sale of online journals (PUBS division).

The tax officer considered both payments as Royalty and taxed at the rate of 15% under India-USA DTAA.

Held

It was held that customers of the taxpayer only enjoy the benefits of using SciFinder and STN and do not acquire the right to exploit any copyright in this software. Thus, the income earned by the taxpayer from the Indian Customers with respect to the subscription fees for CAS cannot be taxed as Royalty as per Section 9(1)(vi) of the Act as well as Article 12(3) of the India-USA DTAA.

Furthermore, the journal provided by the PUBS division did not provide any information arising from taxpayer's previous experience. The taxpayer's experience lies in creating/maintaining such information online. By granting access to the journals, the taxpayer neither shares its experiences, techniques, or methodology employed in evolving databases with the users nor imparts any information related to them. The customers don’t get any rights to the journal or articles therein. Thus, no 'use or right to use' in any copyright or any other intellectual property of any kind is provided by the taxpayer to its customers.

Our Comments

This is a welcome decision, which clarifies that providing access to a database created by aggregating and organizing publicly available data would not be a Royalty unless the copyright of such database is provided to the subscriber.

Whether notional interest can be charged on overdue receivables when the taxpayer has received more advance than the overdue receivables?

McKinsey Knowledge Centre India (P) Ltd [TS-518-HC-2021(DEL)-TP]⁶

Facts

The taxpayer was engaged in research and information services and adopted the Transactional Net Margin Method (TNMM) as the most appropriate method. The Transfer Pricing Officer (TPO) observed that certain receivables were outstanding beyond 60 days and, thereon, made adjustments for notional interest. However, the TPO ignored the payments received in advance for other receivables. This position was upheld by the Dispute resolution Panel (DRP) as well. However, the Income Tax Appellate Tribunal (ITAT) placed reliance on Pegasystems Worldwide India Pvt. Ltd.⁷, wherein it stated that in the case of a debt-free company, there is no requirement for making adjustments on account of the interest on outstanding receivables. The ITAT also stated that the taxpayer had not borrowed any fund for its business activity and thus deleted the said TP adjustment.

Before the HC

The HC held that on a factual basis, there can be no notional computation of ‘delayed receivables’ by ignoring the receivables received in advance - as the amount received in advance far outweigh the amount received late. The appeal was upheld in favor of the taxpayer.

Our Comments

When the advances received outweigh the overdue receivables, notional interest cannot be charged as this would amount to a one-sided adjustment.

Whether data procured from external sources can be applied as a valid Comparable Uncontrolled Price for generic products?

TRL Riceland Pvt. Ltd (formerly known as M/s. Tilda Riceland P Ltd)⁸, [TS-521-ITAT-2021(DEL)-TP]

Facts

The taxpayer purchases paddy and exports rice after milling and had benchmarked its international transactions of sale of rice by relying on the daily export data procured from customs and compiled in TIPSS database (i.e., using the Comparable Uncontrolled Price (CUP) Method). The taxpayer stated that the database provides quantum, price, date, quantity, and the type of rice exported by parties in India to parties in the European Union, Middle East, and North America. Furthermore, the transfer pricing study has given due consideration for the product and geographic differences to ascertain comparability.

However, the TPO observed that the taxpayer was incurring losses. He rejected the CUP method adopted by the taxpayer and sought to adopt the Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM), thereby leading to an adjustment. The DRP upheld the said adjustment. The TPO and DRP were of the view that CUP requires a high degree of comparability between the controlled and uncontrolled transactions. Furthermore, the product data compiled in the TIPS database, even after making some adjustments, did not give reliable results, and therefore, it would not be appropriate to compare the adjusted CUP data with the controlled transaction.

Before the ITAT

The information so furnished by the database used by the taxpayer is comprehensive and went on to state that the product comparability does not require the comparables to be exactly the same. The product categorization has been done based on a reasonable generic description, and the product being generic in nature, such categorization is reasonable and sufficient. Generic goods, even under different brand names, do not cease to be comparable with each other unless the impact of brand or other intangibles is so substantial that it distorts the comparison altogether. In any event, even if there are minor variations in prices of generic goods, such factors are adequately taken care of by average in the case of large sizes of comparables.

In the prior year as well, the CUP was upheld as the MAM in the taxpayer’s own case, and hence the ITAT deleted the adjustment.

Our Comments

Under the CUP method, product comparability for generic goods does not require the products to be exactly same, comparability could be established even with minor variations.

Amendment in agreement does not validate if costs can be considered as pass-through

Parexel International Clinical Research Private Limited⁹, [TS-506- ITAT-2021(Bang)-TP]

Facts

The taxpayer is a subsidiary of the Netherlands entity and is engaged in providing clinical research services in India (that was outsourced by the Associated Enterprises (AE’s)). While acting as an intermediary, the taxpayer had made payments to investigators, which were subsequently reimbursed by the AEs on a cost-to-cost basis for the year under consideration.

The TPO observed that the taxpayer had considered these costs as part of its cost base in prior years and charged a mark-up of 15%. However, for this year, placing reliance on an addendum of an agreement, the taxpayer claimed that no mark-up was warranted. However, the TPO, considering the nature of the activities performed by the taxpayer, held that it was engaged in an agency function as an intermediary. Accordingly, a mark-up on the reimbursement of expenses was made, which was upheld by the DRP as well.

Before the ITAT

The ITAT observed that the agreement provided to state the payments to investigators were pass-through was a make-believe story and held that the AO has the right to go beyond this document to find out the real intention of the parties. ITAT upheld the TPO’s order and said that the costs incurred by the taxpayer for the AE cannot be considered as reimbursement of expenses or pass-through costs as it is a separate service for which the taxpayer needs to determine the Arm’s Length Pricing (ALP).

Our Comments

Where the AE is deriving economic or commercial benefits from the services offered by the taxpayer company, such services cannot be treated as passthrough costs and are to be treated as intra-group services that warrant a mark-up.

i. Whether the supply of sales promotion goods such as gold coins, refrigerator, split AC, etc., at a nominal price to retailers against the purchase of specified units of hosiery goods (main product) qualify as individual supplies or mixed supply?

ii. Whether Input Tax Credit (ITC) paid on the items being sales promotion items sold at nominal prices would be available to the applicant?

Kanahiya Realty Private Limited [2021-VIL-371-AAR, West Bengal]

Facts

• The applicant intends to manufacture and supply hosiery goods such as Vests, Briefs, etc.
• The applicant proposes to implement a sales promotion scheme whereby it would offer unconnected goods, such as gold coins, refrigerator, mixer grinder, cooler, split AC, etc. (hereinafter referred to as the said goods), for sale at a discounted price to such retailers who have bought a certain unit of hosiery product from it as would be prescribed in its retail scheme circular.
• However, the retailers will be at liberty not to purchase the goods offered under the said promotional schemes.

Ruling

• To qualify any supply as “Mixed supply” as per Section 2(74) of CGST Act, 2017, there has to be:
  • Two or more individual supplies or combination of such supplies made in conjunction to each other.
  • The said supplies must be made for a single price.
  • The said supplies must not qualify as a composite supply.
• In the present case, the supply of hosiery goods followed by the supply of the said goods would not be made 'in conjunction with' each other as a supply of the said goods would be contingent upon the supply of hosiery goods, and the retailer would have the option not to purchase the said goods.
• As the applicant would be raising separate invoices, the two supplies shall not take place for a single price.
• Furthermore, the supply shall also not fall under the category of 'composite supply' since the supply of hosiery goods and the said goods cannot be considered as naturally bundled and supplied in conjunction with each other in the ordinary course of business.
• Hence, they are separate supplies, and tax shall be charged at the rate of each such item as per Section 9 of the GST Act.
• Moreover, since 'gift' is something which is given completely out of one's volition and without being linked to any condition or any concomitant charge, the goods under the promotional scheme cannot be termed as the same.
• Hence, ITC paid on the items sold at nominal prices would be available to the applicant.
• Furthermore, on the valuation aspect, the ruling authorities pronounced that the value of the said goods shall be required to be determined as per provision of Section 15 read with Rule 27 of the CGST/ WBGST Rules, 2017 as authorities found that here price is not the sole consideration for the supply.

Our Comments

This ruling is peculiar as the same deals with the supply of goods for sales promotion on completion of a target which is an extensively followed practice in the industry.

Furthermore, the ruling has clarified the term “gift” which has been widely debated as it is not defined under the GST law. The ruling also throws light on the scope of eligibility of ITC on procurement of goods for sales promotion.

However, there are contrary rulings too on the similar matter wherein ITC has been disallowed on the grounds of personal use.

i. Whether GST is payable on management fee /administrative charges only or otherwise on the entire billing amount?

ii. Whether employer portion of EPF and ESI amount of the bill are exempted for paying GST?

Ex-servicemen Resettlement Society [2021-VIL-372-AAR, West Bengal]

Facts

• The applicant is a registered society providing security and scavenging services to different Medical Colleges, District Hospitals and West Bengal govenrment’s hospitals.
• As per labor laws of West Bengal, the applicant claims Minimum Wage + Employer Portion of EPF @13% + ESI @3.25% and charges GST @18% on gross bill amount every month from the government hospitals.
• However, the Audit Authority(Indian Audit and Accounts Department, West Bengal) has raised an objection of excess payment of GST upon the observation that GST is payable only on management fees/services charges.
• The applicant further submits that few hospitals have raised an objection that since the Employer portion of EPF and ESI are deposited to the respective authority, both the amounts should be exempted from GST.

Ruling

• The claim that only management fees/service charges should be the taxable value is merely a presumption and is not backed by any law.
• Furthermore, the objection of Audit also fails to refer to any legal provision to justify the same.
• The only point of the argument is the presence of a clause on management fees /administrative charges in the e-tender, which cannot be the basis of determining the assessable value under any Tax Law.
• Section 15 of the CGST Act, 2017, categorically clarifies that each and every component of the invoice, except GST taxes, must form a part of the taxable value.
• Additionally, the said section also clearly excludes the elements that are not to be included in the value of supply.
• Therefore, this leaves no room to deduct any amount like management fee, employer portion of EPF and ESI to determine the value of supply under the GST law.
• Thereby in the instant case, tax should be charged under Section 9 of the Act on the entire billing amount.

Our Comments

This ruling is not in favor of the applicant as it completely relied on the audit objection, and has failed to provide any legal provisions for excluding the ESI and EPF portion from the gross transaction value.

Instead, it can be explored whether a collection of such charges will qualify under the ambit of ‘pure agent’ under the GST law.

Mumbai ITAT: Holds that allotment of shares on the right issue shall fall outside the purview of Section 56(2)(vii)

Rajeev Ratanlal Tulshyan [TS-950- ITAT-2021(Mum)]

The assessee, a resident individual, is a director and major shareholder in Kennington Fabrics Pvt. Ltd. (KFPL). During the relevant year, KFPL offered the right issue, and the assessee was allotted INR 39.5 million shares of KFPL at face value of INR 1 per share. During the course of the assessment, the Assessing Officer (AO) alleged that the consideration was less than the Fair Market Value (FMV) and proposed addition u/s 56(2)(vii). While the assessee relied on the jurisdictional Tribunal decision in the case of Sudhir Menon HUF, wherein it was held that in the case of proportionate allotment of shares, there would be no taxability u/s. 56(2)(vii), the AO held that there was a disproportionate allotment of shares in the said case and hence, the decision would not apply. Accordingly, the AO worked out the intrinsic FMV at INR 11.85 per share and proceeded to make an addition of INR 428.7 million under Section 56(2)(vii) of the Act.

The Tribunal ruled in favor of the assessee, laying down the following:

• Tribunal’s decision in case of Sudhir Menon HUF is applicable wherein on similar facts, shares being allotted on pro-rata basis to the shareholders, based on existing shareholding there is no scope for any property being received by them on the said allotment of shares; there being only an apportionment of the value of their existing holding over a larger number of shares. In such a case, the provisions of Section 56(2)(vii) would not get attracted.
• Considering the intent of the introduction of provisions, the aforesaid transaction, since carried out in the normal course of business, would not attract rigors of provisions of Section 56(2)(vii).
• The provisions are a counter evasion mechanism to prevent the laundering of unaccounted income. Therefore, the same do not apply to the genuine issue of shares to existing shareholders.

Our Comments

The ITAT has reconfirmed the nonapplicability of Section 56 (gift tax provisions) on the rights issue offered to all shareholders. It will be interesting to wait and watch the ruling of the Bombay HC on the pending appeal in the case of Sudhir Menon HUF.

Delhi HC: Disregards internal arrangement with regards to income tax liability, holds director liable for dues of company u/s 179 of the Act

Rajeev Behl [TS-904-HC-2021(Del)]

The petitioner was a co-founder and promoter of the Realtech group of companies. In 2011, due to some disputes, the petitioner resigned as director and stopped participating in the management. He also entered into a Memorandum of Understanding (MoU) with the other two promoters that income tax liability for certain group companies shall be borne and paid by Mr. Pankaj, another co-founder. To implement the MoU, an arbitration proceeding was undertaken and an arbitration award dated 28 January 2018 upheld the terms of MoU. Meanwhile, the petitioner was served with the impugned order dated 29 January 2018 under Section 179 of the Act, wherein it was held that tax dues of a private limited company that cannot be recovered from the company.

However, the same can be recovered from a Director of the said company as the director is jointly and severely liable for payment of outstanding tax demands of the company. The petitioner’s revision petition under Section 246 of the Act was also dismissed vide order dated 1 April 2021.

The petitioner filed a writ application, and the HC has decided in favor of revenue, citing the following observations:

• While the AO has to give a finding that the tax dues could not be recovered from the company before proceeding against the director, the onus is on the director to prove that the non-recovery can not be attributed to his gross neglect, misfeasance, or breach of any duty on his part in relations to the affairs of a company.
• Considering various steps taken by the department,, including attachment of the company's bank account, the petitioner’s contention that no action is taken to recover the demand from the company is incorrect.
• Private parties can not apportion income tax liability by private agreements as the petitioner has sought to do in the present case. It is settled law that while rights in personam are arbitrable, rights in rem are unsuited for private arbitration and can only be adjudicated by the courts or tribunals.

Our Comments

This is a crucial decision that rejects private arrangements against the payment of taxes. This could have a major impact on M&A deal space, especially while agreeing on indemnity and warranties. Also, the decision reiterates that the onus to prove is on the directors.