WHAT'S INSIDE...
Direct Tax
Transfer Pricing
Indirect Tax
July 16-31, 2015
What’s inside…
DIRECT TAX
1. Offshore supply of equipment, designs and drawings not
taxable in India
2. Telecommunication ...
0505
03
Aggrieved, the taxpayer preferred an appeal before the Income Tax
Appellate Tribunal which observed and ruled as u...
0505
04
 The basic engineering packages sold by the taxpayer to the Indian
customers have been largely designed on the ba...
0505
05
Further during the year under consideration the taxpayer had
entered into an arrangement with certain telecom cabl...
0505
human endeavor in providing technical service or advice or make
available such a technical skills or services. But if...
0505
07
3. Service income held not taxable as Fee for
Technical Services and also not attributable to
a Dependent Agency P...
0505
08
consideration for such services could not be taxed under Article
12(4)(b) of DTAA as these services did not involv...
0505
09
During FY 2007-08 (i.e. the year under review), the Appellant
exported software developed by it to its Associated ...
0505
10
i.e. 50 percent is not reasonable. The Tribunal placed its reliance on
the ITAT ruling in case of Tweezmen India P...
0505
11
ITAT Ruling
A. Regarding the nature of income/ expenses to be considered as
operating or non operating
The ITAT ob...
0505
12
B. Selection/ Rejection of Comparable Companies:
The taxpayer objected to inclusion of five companies and exclusio...
0505
C. Computation of the arm’s length price [“ALP”] of international
transaction of ‘debt arising during the course of b...
0505
During AY 2007-08, the taxpayer entered into international
transactions pertaining to subscription of share capital o...
0505
The order also talks about with other non-transfer pricing related
grounds which are not dealt with herein.
[Source: ...
The Information provided in this document is provided for information purpose only, and should not be construed as legal a...
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Nangia & Co : TAX & REGULATORY Newsletter for July 16-31, 2015

Nangia & Co : TAX & REGULATORY Newsletter for July 16-31, 2015
Published on: Mar 3, 2016
Published in: Economy & Finance      
Source: www.slideshare.net


Transcripts - Nangia & Co : TAX & REGULATORY Newsletter for July 16-31, 2015

  • 1. WHAT'S INSIDE... Direct Tax Transfer Pricing Indirect Tax July 16-31, 2015
  • 2. What’s inside… DIRECT TAX 1. Offshore supply of equipment, designs and drawings not taxable in India 2. Telecommunication traffic and restoration services are not taxable as Fee for Technical Services 3. Service income held not taxable as Fee for Technical Services and also not attributable to a Dependent Agency Permanent Establishment TRANSFER PRICING 4. ITAT deleted the additions made on account of disallowance of deduction under Section 10A of the Income-tax Act, 1961: Held that mere placing reliance on transfer pricing documentation is not sufficient to conclude that the Appellant is earning excessive profits 5. The Tribunal did not consider the Safe Harbour Rules for determining the nature of expenses/ income to be operating/ non operating; Held that the computation of arm’s length price for non-charging or under-charging of interest on non realization of debt outstanding beyond allowed credit period 6. A quasi-capital loan or advance is not a routine loan transaction; nevertheless, the arm’s length price for the same could not be NIL. 7. CBEC issues circular on manual scrutiny of service tax returns 02 DIRECT TAX INDIRECT TAX 1. Offshore supply of equipment, designs and drawings not taxable in India Outotec GmbH [‘the taxpayer’] is a tax resident of Germany, engaged in the business of providing innovative and environmentally sound solutions for a variety of customers in the metals and minerals processing industry. The taxpayer earned revenue from offshore supply of equipment to seven Indian companies (relating to the steel industry) during the relevant assessment year. The Assessing Officer [‘AO’], in his draft order, held that the income earned by the taxpayer from offshore sale of equipment accrued or arose in India and was taxable under the Act and the tax treaty and calculated a taxable profit at 10 per cent of consideration from offshore sale of equipment. Further, the income earned from supply of designs and drawings was considered as taxable as royalty. In relation to income from supervisory services, the attribution percentage was enhanced to 27.5% of the gross revenue, from the 17.93% offered by the taxpayer. The Dispute Resolution Panel [‘DRP’] concurred with the AO and confirmed all the additions made by the AO.
  • 3. 0505 03 Aggrieved, the taxpayer preferred an appeal before the Income Tax Appellate Tribunal which observed and ruled as under – Sale of Equipment  All activities relating to design, fabrication and manufacturing of equipment took place outside India. The sale of Equipment to unrelated Indian customers was done from outside India on a principal-to-principal basis at arm’s length, and consideration was also received outside India. The fact was also confirmed by the documents and clauses of the agreement which clearly stated that the equipment was sold directly by the taxpayer on an export sale basis, and the title/ ownership of equipment was transferred outside India.  With regard to the acceptance tests, the Tribunal held that if the test failed, it could result only in payment of liquidated damages by the taxpayer, which were hence nothing but warranty provisions and remedial measures. These could not be construed to mean that all contracts could be clubbed together.  Reliance was placed on the decisions in the case of LG Cable [237 CTR 438], Motorola Inc. [95 ITD 269] and of the AAR in Hyosung Corp [314 ITR 343]. Deferred payment relating to an acceptance test did not have any impact on sale of goods, which was supported by the definition of “sale” mentioned under section 2(g) of the Central Sales-tax Act, 1956.  Revenue’s contention that the contract was a composite contract, and taxability could not be split into separate parts, was not accepted by the Tribunal based on the SC decision in Ishikawajma-Harima Heavy Industries Limited [288 ITR 408]. Revenue’s reliance on the AAR decision in Alstom Transport SA [349 ITR 292] was no longer valid as it had been overruled by the Delhi HC in Linde AG, Linde Engineering Division [365 ITR 1].  The Tribunal concluded that the sale of equipment took place outside India, and hence no portion of the receipts from the sale could be taxed in India. Income from Supply of Design and Drawings  It was clear that the entire work relating to designs and drawings was done outside the territory of India. Sale was affected outside India and the consideration was also received outside India in foreign currency. Since the taxpayer supplied the designs and drawings for setting up plants in India, in light of the decision of the Supreme Court in the case of Scientific Engineering House P. Ltd. [157 ITR 86], such designs and drawings partook the character of a product and accordingly, the income arising from supply of such designs and drawings was in the nature of business income.  The designs and drawings sold by the taxpayer amounted to the use of a ‘copyrighted article’ rather than use of a ‘copyright’ and was therefore in the nature of business income. Reliance was placed on Commentary on Double Tax Conventions by Klaus Vogel and various observations made in the OECD Model convention of 2010 on Article 12 dealing with Royalties and Fee for Technical Services as well as the ruling in the case of Geoquest Systems B.V. [327 ITR 1] and Dassault Systems K.K. [322 ITR 325]. It was clear that the restriction on intellectual property would not make any difference since the designs and drawings sold by the taxpayer were used by the Indian customers for their internal purpose of setting up plants and not for commercial exploitation.
  • 4. 0505 04  The basic engineering packages sold by the taxpayer to the Indian customers have been largely designed on the basis of standard technologies available with them. Since the work was done outside India and sale took place outside India, such income was not taxable either under the provisions of the Act or under the tax treaty. Retaining intellectual property in designs and drawings is similar in nature to retaining of patented rights in any goods/machinery. Restriction on intellectual property in designs and drawings sold by the taxpayer for the purpose of setting up a plant in India does not change the character of the transaction from sale of the product to the use of a licence/know-how.  Accordingly, the designs and drawings sold by the taxpayer tantamount to the use of copyrighted article rather than use of a copyright and therefore it was in the nature of business income. Income from Supervisory Activities  The Settlement Commission, in the taxpayer’s own case for earlier years, had held a profit rate of 27.5% applicable for attributing income from supervisory services. As no reason was provided by the taxpayer to deviate from this decision, the Tribunal had confirmed the rate of 27.5%. [Source: TS-349-ITAT-2015] 2. Telecommunication traffic and restoration services are not taxable as Fee for Technical Services Flag Telecom Group Limited [‘the taxpayer’], a company incorporated in Bermuda, had built a submarine fiber optic telecommunication cable to link telecom traffic amongst Western Europe, Middle East, South Asia, South East Asia and Far East. The capacity in the said cable system had been sold to various landing parties, which are mostly national telecommunication companies belonging to different nations. In India, Videsh Sanchar Nigam Limited [‘VSNL’] was one of the original landing parties in the FLAG cable system. For the purpose of selling the capacity in the cable system to various landing parties, including VSNL, a Capacity Sales Agreement (CSA) and a Construction and Maintenance Agreement (C&MA) which provided the entire procedure for the ownership of capacity in the cable system and also for providing standby maintenance activities contained in the separately entered between the parties. Under the terms of the C&MA, the FLAG cable system is to be jointly operated and maintained for an efficient working condition along with the taxpayer and landing parties signatories. During the year under consideration, the taxpayer had received the payment from VSNL on account of provision of standby maintenance activities, as in the earlier years.
  • 5. 0505 05 Further during the year under consideration the taxpayer had entered into an arrangement with certain telecom cable operator [‘SMW3’] to provide restoration of traffic to their customers in the event of disruption in the traffic on their cable system. Under these arrangements, if there is disruption in the traffic on a particular segment of the cable operator, the taxpayer provides the alternative telecommunication link route through its own capacity in the cable. For this purpose, the taxpayer had entered into a ‘Restoration Agreement’ with SMW3 Cable Network. During the year under consideration, the taxpayer received payment for restoration services. The Assessing Officer [‘AO’] held that receipts from standby maintenance services/charges and restoration services were in the nature of Fee for Technical Services [‘FTS’] within the meaning of Section 9(1)(vii) and hence it was to be taxed in India. The Commissioner of Income-tax (Appeals) [‘CIT(A)’] held that payment for restoration activities was to be assessed as business income and was taxable in India under Section 9(1)(i) of the Act and estimated the Indian income from restoration activity at 10 per cent of the global receipts. The Income Tax Appellate Tribunal, in due course of appeal, observed and ruled as under – Taxability of standby maintenance services/charges  It was not in dispute that the standby charges is a fixed annual charge, which is payable not for providing or rendering services albeit for arranging standby maintenance arrangement, which is required for a situation whenever some repair work on the under-sea cable or terrestrial cable is actually required to be performed or rendered. It was a facility or infrastructure maintained for ready to use for rendering technical services or for repairing services, if required. There was no actual rendering of the services qua the standby maintenance charges. Accordingly, following the earlier years’ precedence, it was held that the receipt on account of standby maintenance charges was not chargeable as FTS within the scope of Section 9(1)(vii) of the Act. Taxability of restoration services  In the present case restoration activity did not fall within the nature of ‘managerial’ or ‘consultancy services’, because there was no rendering or managing by direction, regulation, administration or supervision of activities by the taxpayer to VSNL. The taxpayer does not provide any advisory services for arranging of restoration activities to VSNL. The taxpayer already had a cable system network in which it had spare capacity, which was provided to VSNL on behalf of SMW3 in case of disruption in SMW3 cable network. There was no transfer of technology is involved nor have any technical services been rendered. VSNL only received end to end connectivity for a temporary period till the cable of SMW3 was restored for the traffic.  In the present case, the existing cable with its spare capacity with the taxpayer was being allowed to be used for transmitting data. Simple use of sophisticated technical equipment for providing the capacity in the cable to VSNL ipso facto did not lead to any inference that any technical service was being provided by the taxpayer to VSNL. Therefore, it cannot be held that for providing such a standard facility through its cable system, the taxpayer is rendering any kind of technical services to VSNL, so as to fall within the ambit of FTS under Section 9(1)(vii) of the Act.  For rendering of technical services there had to be delivery of technical skills through human element or there was a constant
  • 6. 0505 human endeavor in providing technical service or advice or make available such a technical skills or services. But if any technical equipment developed by a human has been put to operation automatically, then usage of such technology per se could not be held as rendering of technical services. Reliance was placed on the Madras High Court ruling in the case of Skycell Communications Ltd. [119 Taxmann 496]. On perusal of the restoration agreement, it could not be inferred that there was any actual rendering of technical services by the taxpayer. Nothing was suggestive of the fact that under the restoration agreement some kind of technical skill, technical services are being provided, except for the kinds of restorations which can be undertaken and terms thereof for the connectivity and payment.  Accordingly, such a standard facility for transmission of data and telecommunication traffic by cable operators cannot be termed as rendering of technical services and therefore it was held that consideration received from restoration activities was not taxable as FTS under Section 9(1)(vii) of the Act. Taxability as business income  A portion of the cable length fell within the territorial waters of India from where it connected to Mumbai and from there it again went to other countries. In case of sale of the capacity, the landing parties become the complete owner of the capacity to the exclusion of the taxpayer as held in earlier years. However, the spare capacity which lied in the cable belongs to the taxpayer, through which it had provided the restoration network to VSNL. The portion of the asset i.e. cable, through which restoration activity was provided also had connection in India in as much as it lied within the territorial waters of India. Accordingly, it can be held that income had accrued to the taxpayer from an asset in India and hence it was deemed to be 06 business income arising in India.  However, all the business operations of the taxpayer were not carried out in India, therefore reasonable attribution of income from such operations has to be done. In such a situation, Explanation 1A to Section 9(1)(i) provides that, in case of a business of which all operations are not carried out in India, then the income of the business shall be deemed to accrue or arise in India only such part of the income, which can be reasonably attributable to the operations carried out in India.  In the present case the most appropriate basis for identifying the income, which could be reasonably attributable to India would be on the basis of fraction of the length of the entire cable system in the cases where restoration services have been provided in respect of the cable segments connected to India in its territorial waters. The territorial waters extend upto 12 nautical miles in India and hence only 12 nautical miles of the cable system ought to be considered for attributing the income to India.  The taxpayer had provided the chart of segments on which the restoration activities have been undertaken by way of connection to the cable landing station in the territorial waters in India, which was from Fujairah to Mumbai, Miura to Mumbai and Mumbai to Singapore. The taxpayer had also filed a statement showing the details of restoration charges over the years giving the details of segments on which the restoration had been provided; length of the segment, length of the cable in territorial waters of India and apportionment of revenue to India.  In principle, the Tribunal upheld the method of attribution of revenue as given in the said statement, however the AO was directed to determine the income of the taxpayer which was to be
  • 7. 0505 07 3. Service income held not taxable as Fee for Technical Services and also not attributable to a Dependent Agency Permanent Establishment ABB Inc. [‘the assessee’] is a company incorporated and fiscally domiciled in the USA and is engaged, inter alia, in providing business development, market services and other support services to its Indian associated enterprises [‘AE’s] i.e. ABB Limited and ABB Global Industries & Services Limited. During the taxable as FTS under DTAA. However, the AO rejected the assessee’s contentions and as regards to assessee’s contentions on "make available" clause observed that a person without technical knowledge cannot provide these services on the reasoning that once Indian AEs have withheld taxes on the payments made to the assessee, then the assessee could not take a different view in its tax return. On appeal, the DRP confirmed the AO’s stand and also held, without prejudice to the taxability of FTS, that the Indian AE was a dependent agency permanent establishment [‘DAPE’] of the assessee on account of purchase and sale of certain products. The DRP also noted that the continuing commercial relationship between the assessee and the Indian company established business connection for the assessee in India and thus, profits attributable to the assessee’s operations in India had to be brought to tax. Further, the DRP held that the licensing fee paid by the Indian company to the assessee had to be attributed to the assessee and taxed as business income. Consequently, AO proceeded to bring to tax the income in question as FTS and business profits respectively. Aggrieved the assessee filed an appeal before the Income Tax Appellate Tribunal [‘ITAT”]. The Income Tax Appellate Tribunal observed and ruled as under -  The law in relation to the connotation of 'make available' clause in the definition of FTS was settled and a condition precedent for invoking this clause was that the services should enable the recipient of services to apply technology contained therein. Reliance was placed on the Karnataka HC judgment in CIT vs. De Beers India (P.) Ltd. [TS-312-HC-2012(KAR)] .  The ITAT thus held that unless there was a transfer of technology involved in technical services extended by the assessee, the 'make available' clause was not satisfied and, accordingly, the taxed in India after apportioning the revenue on the basis of length of the cable in the territorial waters in India on the segments on which restoration has been provided. [Source: ITA No. 2255/Mum/2006 and others] relevant tax year, the assessee earned fees towards support services provided to its AEs which was claimed to be taxable exclusively in the USA in view of Article 12(4)(b) of the Indo-US Double Taxation Avoidance Agreement [‘DTAA’]. During the course of assessment proceedings, the assessee was called upon to explain why the said fees was not taxable in India to which the assessee submitted that the said services did not “make available” any technical knowledge, experience,skill etc to ABB India and hence, not
  • 8. 0505 08 consideration for such services could not be taxed under Article 12(4)(b) of DTAA as these services did not involve enabling the recipient of the services to utilize the knowledge or know-how on his own in future without the aid of the service provider.  With regards to DRP’s order of regarding assessee’s Indian AE as its DAPE, the ITAT observed that it was difficult to understand, much less approve, such logic. The DAPE has been justified on the ground that its Indian affiliates, to which the services were rendered, were involved in purchase and sale of 'Harmony' products of the assessee company but the taxability was held to be in respect of the fees for technical services rendered to these very entities. It was only elementary even if a permanent establishment existed and the assessee carried on business through the PE, under Article 7(1) of the Indo US tax treaty, the profits of the assessee may be taxed in the source jurisdiction but only so much of them as were attributable to (a) that permanent establishment; (b) sales in the other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in the other State of the same or similar kind as those effected through that permanent establishment.  Based on the facts of the case, when the PE is in respect of trading transactions only, no part of the earning from rendering of services to the AEs could be related to the nature of PE’s activities and be brought to tax in the source jurisdiction i.e. India.  On the question of taxability DAPE’s profit in the hands of the assessee, ITAT ruled that even if there was a DAPE on the facts of the case, it would have no taxable profits in the hands of the assessee in the absence of the finding that the DAPE has been paid a remuneration less than arm's length remuneration. Reliance was placed on the legal position in the case of SET Satellite (Singapore) Pte Ltd vs DOlT [(2009) 307 ITR 205 (Bom)]. The ITAT thus declined the need to examine the aspect regarding existence of the DAPE and ruled for the deletion of additions in respect of income under Article 12(4)(a) as FTS and also in respect of income under Article 7(1) as business income. [Source: TS-386-ITAT-2015(Bang)] 4. ITAT deleted the additions made on account of disallowance of deduction under Section 10A of the Income-tax Act, 1961: Held that mere placing reliance on transfer pricing documentation is not sufficient to conclude that the Appellant is earning excessive profits Facts of the case Aquila Software Services Hyderabad Private Limited (“Aquila” or “the Appellant”) is engaged in the business of software development and related services. Transfer Pricing
  • 9. 0505 09 During FY 2007-08 (i.e. the year under review), the Appellant exported software developed by it to its Associated Enterprise (“AE”) i.e. M/s Login Soft Inc., USA. During the course of assessment proceedings, following were the findings of the Assessing Officer (“the AO”):  AO observed that Appellant, in its transfer pricing (“TP”) documentation, had adopted Transactional Net Margin Method (“TNMM”) to benchmark the aforesaid international transaction and determined the average profit margin earned by the comparable companies to be 15 percent. Whereas, the Appellant earned a profit margin of 50 percent on export of software to its AE;  The AO further noticed that as per Section 92C(2) of the Income Tax Act, 1961 (“the Act”), the deviation up to 5 percent from the arithmetic mean can be allowed. The AO, therefore, considered 20 percent to be the Arm’s Length Price (“ALP”) and disallowed the 30 percent of the profits of the Appellant on account of being excess profit claimed by under Section 10A of the Act. Aggrieved the Appellant filed an appeal before the Commissioner of Income Tax (Appeals) [“CIT(A)”]. CIT(A) observed that as per proviso to Section 92C(4), deduction under section 10A of the Act can be denied only to the extent of enhanced income computed after TP adjustment u/s 92C(4). Since, there is no enhancement of income; no disallowance can be made u/s 10A of the Act. Consequently, the addition made by the AO was deleted. Aggrieved by the order of CIT(A), revenue preferred an appeal before Income Tax Appellate Tribunal (“ITAT”/ “the Tribunal”). The ITAT observed that CIT(A) did not considered the provisions of section 10A(7) of the Act [that in-turn also refers to section 80IA(10) and 80IA(8) of the Act] which are applicable to the facts of the case and therefore, directed CIT(A) to look at the same and pass a speaking order. CIT(A) noticed that the provisions 80IA(10) are clearly applicable as there is close connection between Appellant and its AE and the Appellant is earning profits higher than the average profit margin of the comparables. Accordingly, he confirmed the disallowance of deduction made by AO. Appellant’s Contention before ITAT  The Appellant contended that even if provisions of sections 10A(7) are applicable, still AO is bound to satisfy the conditions of section 80IA(1) which stipulates that there has to be an arrangement between the Appellant and the AE in respect of business transacted between them, which has produced more than ordinary profits to the Appellant. The AO cannot compute the deduction under section 10A of the Act without fulfilling such conditions laid therein. In support of its contention, it relied on the various adjudications viz. AT Kearney India Pvt. Ltd. vs. Add. CIT (Delhi ITAT1 ; CIT Vs. Schmetz India Pvt. Ltd. (Bombay High Court)2 ; and Javata India Pvt. Ltd., Vs. ITO3 . Revenue’s Contention before ITAT  The department representative contended that since the Appellant and its AE are related parties and facts and materials on record indicate that profit earned by the Appellant is much more than the average profit earned by comparable companies, the disallowance u/s 10A(7) of the Act is justified and reasonable. __________________ 1 [(2014) 41 CCH 418] 2 254 CTR 504 3 141 ITD 456
  • 10. 0505 10 i.e. 50 percent is not reasonable. The Tribunal placed its reliance on the ITAT ruling in case of Tweezmen India Pvt. Ltd. Vs ACIT4 wherein the Chennai bench held that provisions of section of 80IA(10) do not give arbitrary power to AO to fix the profits of the Appellant. Based thereon, the ITAT held that addition made by the AO is unwarranted and hence should be deleted. Source: Aquila Software Services Hyderabad Private Limited Vs DCIT [ITA No. 423/Mum/2014] __________ 4 133 TTJ 308 The Tribunal’s Ruling  The ITAT observed that section 10A(7) of the Act is applicable to the Appellant as accepted by both the parties. Further, section 10A(7) of the Act refers to section 80IA(8) and 80IA(10) of the Act. Section 80IA(10) of the Act provides for two conditions to be fulfilled which are as follows:  There must be close connection between the Appellant carrying on the eligible business and the other person; and  The business between the two should be so arranged that such business produces more than ordinary profits to Appellant carrying on eligible business.  The Tribunal further noticed that the first condition is met as both the parties to the transactions are related to each other. With regard to second condition, it is evident from the assessment order that AO has merely relied on the TP document wherein it is stated that average profit margin of comparables is 15 percent as against 50 percent earned by the Appellant and has concluded that the profit so earned by the Appellant is not at arm’s length.  The ITAT further ruled out that the AO should have demonstrated that whether the earning of excess profit is as a result of business arrangement between the parties. Even the CIT(A) could not provide place any factual finding on records in this relation.  The Tribunal also held that excess profits can be generated on account of various factors and without analyzing such factors, it cannot be said that only because average profit earned by comparables is 15 percent, the profit earned by the Appellant 5. The Tribunal did not consider the Safe Harbour Rules for determining the nature of expenses/ income to be operating/ non operating; Held that the computation of arm’s length price for non-charging or under-charging of interest on non realization of debt outstanding beyond allowed credit period Facts of the Case Techbooks International Pvt. Ltd., [“the taxpayer”], is engaged in the development of customized electronic data. It converts data from hard copy or files into electronic form, i.e. XML/SGML/HTML for CD-ROM delivery.
  • 11. 0505 11 ITAT Ruling A. Regarding the nature of income/ expenses to be considered as operating or non operating The ITAT observed the following: During Assessment Year [“AY”] 2010-11, the taxpayer entered into international transactions pertaining to ‘Provision of IT enabled data conversion services’ with its Associated Enterprise [“AE”]. The taxpayer benchmarked its international transaction using Transactional Net Margin Method [“TNMM”] as the most appropriate method. During the course of the assessment proceedings the Transfer Pricing Officer [“TPO”] accepted TNMM but rejected use of multiple year data as considered by the taxpayer in its detailed TP report. After considering the TP report, the TPO shortlisted nine comparables with their arithmetic mean of the Profit Level Indicator [“PLI”] of Operating Profit/Operating Cost [“OP/OC”] at 33.71% and accordingly, made an addition of INR 20.48 crore. While doing so, the TPO treated For-ex Fluctuation Gain/Loss, Bank Charges and Provision for Doubtful Advances of the taxpayer as operating in nature. In addition to the above, the TPO credit period of 150 days allowed by the taxpayer to its AE. In this relation, the TPO considered the credit period to be allowed to the AEs should have been 60 days. Based thereon, the TPO further held that an interest @ 15% per annum should be charged on the realization of receivables which were outstanding beyond 60 days. Thus, he worked out the total TP adjustment on account of imputed interest to be charged on non- realization of exports proceeds at INR 5.86 crore. Aggrieved with the actions of TPO, the taxpayer filed its objections before the Dispute Resolution Panel [“DRP”] wherein the DRP rejected the same and upheld the TP adjustments made by the TPO. Aggrieved with actions of DRP/ TPO, the taxpayer filed an appeal before the Income Tax Appellate Tribunal [“ITAT”]. International Transactions TPO’s actions ITAT’s ruling Foreign Exchange Fluctuation Gain Treated as operating in nature. ITAT held that when foreign exchange gain directly results from the consideration received for rendering services to AE, it should be considered as an operating item. Bank Charges Considered as operating in nature. ITAT observed that there has been no bifurcation of such expenses between “Bank Interest” and “Bank Charges” in case of the taxpayer. Accordingly the ITAT directed TPO to consider the same as non-operating item. Provision For Doubtful Advances The TPO considered the same as operating case of taxpayer and non operating in case of comparables ITAT noted that taxpayer had not created any excess provision for ‘doubtful debts’. It held that both provisions for doubtful debts as well as doubtful advances are in realm of the operations of the business. Thus, ITAT ruled in favour of taxpayer and directed TPO to treat Provision for debts/advances as operating. The ITAT also held to the same to consider as operating in case of comparables as well in to maintain consistency.
  • 12. 0505 12 B. Selection/ Rejection of Comparable Companies: The taxpayer objected to inclusion of five companies and exclusion of six companies selected by it in the list of comparables. ITAT analysed the functional profile of these companies and ruled the following decisions: Companies that were included by TPO: Companies that were excluded by TPO: Companies ITAT’s ruling Accentia Technologies LTD. Rejected – On account of extra- ordinary financial event (i.e. Merger with Asscent Infoserve Pvt. Ltd.) TCS E-SERVE INTERNATIONAL LTD. Rejected - ITAT emphasized on the distinction between a company providing software development services and non-development software services. ITAT observed that the taxpayer being a non -development software services company cannot be compared with this company as it is a software development services. TCS e-SERVE LTD. Accepted- Functionally similar to the profile of the taxpayer. I-GATE GLOBAL SOLUTIONS Rejected – On account of extra- ordinary financial event INFOSYS BPO Rejected – On account of extra- ordinary financial event (Acquisition of another company) Companies ITAT’s ruling R. SYSTEMS INTERNATIONAL LTD. (Seg); JINDAL INTELICOM PVT. LTD; and CALIBER POINT BUSINESS SOLUTION LTD. Rejected - Different financial year ending. CG-VAK SOFTWARE & EXPORTS LTD. (Seg.) Accepted - The company was rejected by TPO due to its turnover in its ITeS segment. The ITAT observed that quantum of turnover can be no reason for exclusion of a company. MICRO GENETICS SYSTEMS LTD. Accepted - Following the reasoning given for inclusion of CG-VAK Software & Exports Ltd., the TPO was directed to consider the same as comparable company. AXIS IT & LTD. Accepted - The company was excluded by TPO as it failed the export turnover filter. The ITAT remitted the matter back to TPO for examining the functional similarity of the company.
  • 13. 0505 C. Computation of the arm’s length price [“ALP”] of international transaction of ‘debt arising during the course of business’- Section 92B of Income-tax Act, 1961 [“the Act”] In this regard, the ITAT referred to Sec 92B of the Act inserted with retro effect from April 1, 2002 which gives meaning to the expression that “any debt arising during the course of business” has also been expressly recognized as an international transaction. Further, the ITAT held that non-charging or under-charging of interest on the realization of debt beyond the expiry of credit period amounts to an international transaction and the ALP of such transaction is required to be determined. The ITAT stated that computation of ALP of the “debt arising during the course of business” involves two ingredients viz. the amount on which the interest should be charged; and the arm’s length rate at which the interest should be charged. Discussing about the first ingredient, the ITAT noted that TPO had erred in making adjustment for a period in excess of 60 days as the taxpayer has allowed a credit period of 150 days to its AEs and the effect of imputed interest on non-realization of invoices up to 150 days was already factored in the price charged for the services rendered by the taxpayer. Accordingly, the interest should have been charged for the period in excess of 150 days. Regarding the determination of rate of interest to be considered in this regard, the ITAT relied on the findings in case of Cotton Naturals Private Limited5 and noted that the same is required to be determined on the basis of the currency in which the loan is to be repaid. The ITAT thus, remitted the matter to TPO for fresh determination of addition to be made in the instant case. ____________________ 5 ITA No. 233/ 2104 (Delhi High Court) 13 Our comments At the outset, it is pertinent to highlight that the ITAT did not give any weightage to the Safe Harbour Rules, 2013 in respect of deciding the nature of certain items of income/ expenses to be considered as operating or non-operating in the present case. Further the contentions of the taxpayer for considering the imputed interest cost in the price charged towards provision of services have also been given a due consideration by the ITAT. Further, there has been no specific discussion on the determination of interest to be charged on realization of debt beyond the allowed credit period. Source: Techbooks International Pvt. Ltd. Vs. DCIT [ITAT No. 240/Del/2015] 6. A quasi-capital loan or advance is not a routine loan transaction; nevertheless, the arm’s length price for the same could not be NIL. Facts of the Case Soma Textile & Industries Limited [“the Taxpayer”] is in the business of manufacturing of textile cotton fabrics. The taxpayer has established its wholly owned subsidiary, Soma Textiles FZE, in UAE.
  • 14. 0505 During AY 2007-08, the taxpayer entered into international transactions pertaining to subscription of share capital of INR 21.71 lakhs and also advanced INR 16.75cr [approx. USD 2.79mn] to its Associated Enterprise [“AE”] i.e. Soma Textiles FZE. The advance is out of the foreign exchange proceeds of taxpayer’s Global Depository Receipts (“GDRs”) in the nature of “contribution towards quasi capital of its AE”. Based on above, the taxpayer considered the arm’s length price (“ALP”) of the transaction at NIL. During the course of the assessment proceedings the Transfer Pricing Officer [“TPO”] rejected the claim of the taxpayer on the basis that commercial expediency of the transaction is not relevant and determination of the arm’s length price [“ALP”] is essential. TPO examined the agreement entered into between the taxpayer and its AE which categorized it as a loan and not otherwise. The TPO relied on plethora of judgments and proceeded to make an adjustment by applying LIBOR + 2%. Aggrieved by the findings of the TPO, taxpayer approached the Commissioner of Income Tax (Appeals) [“CIT(A)”] who upheld the findings of TPO and that no evidence was provided to show that the intention was to treat the same as capital contribution. Subsequently, the taxpayer approached the Tribunal to adjudicate the matter. Contentions of the Taxpayer before the Tribunal:  The taxpayer contended the transaction pertaining to advance given to its AE per se is not a loan transaction as it is in the nature of contribution towards quasi capital. 14  The taxpayer also contended that entire amount of INR 16.75cr is out of the foreign exchange proceeds of GDRs and the grant is intended to be a long term investment in the subsidiary which has a crucial role to play in its business plan. On the other hand, the departmental representative (“DR”) supported the TPOs stand. Tribunal’s conclusions: The Tribunal duly considered the facts of the case and arrived at the following conclusion:  The Tribunal analyzed Rule 10B(1)(a) of Income Tax Rules, 1962 (“the Rules”) and observed that loan transactions should be benchmarked on the basis of interest rate applicable and cannot be compared with a transaction which is something materially different like a non-refundable loan which is to be converted into equity.  Tribunal further observed that the advances in such cases are materially different than the loan transaction which is the decisive factor for determination of ALP. The underlying intention for which it is granted is irrelevant.  In addition, the fact that funds are out of GDR proceeds does not justify extending the reason behind extending it to the AE as interest free. Source of funds is immaterial.  Tribunal also noted that the taxpayer in subsequent assessment years, the taxpayer himself has accepted ALP at LIBOR + 2%. Tribunal confirmed the additions made by the lower authorities.
  • 15. 0505 The order also talks about with other non-transfer pricing related grounds which are not dealt with herein. [Source: Soma Textile & Industries Limited; ITA No. 262/Ahd./2012) 15 Scope of Scrutiny  Ensure correctness of the assessment made by the assessee which shall include checking the taxability of the service, valuation, tax rate, admissibility of an exemption, abatement, or exports, correct availment/ utilization of Credit etc. Selection of returns for detailed Scrutiny  Focus of detailed return scrutiny would be assessees whose total tax paid (Cash+ CENVAT) for the FY 2014-15 is below Rs 50 lakhs and not being audited.  The assessees who have been selected for audit or have been audited in the past three years would not be taken up for detailed 7. CBEC issues circular on manual scrutiny of Service Tax Returns Central Board of Excise and Customs (‘CBEC’) issues revised guidelines for detailed manual scrutiny of service tax returns (‘ST- 3 returns’) effective from 1 August 2015. scrutiny.  In certain cases, the Chief Commissioner may direct detailed manual scrutiny of an assessee's return who has paid service tax (Cash+ CENVAT) more than Rs 50 lakhs.  An assessee should not be subjected to both audit and detailed manual scrutiny Methodology  Before return scrutiny is initiated, the assessee must be given prior intimation of at least 15 days in the prescribed manner.  Information for scrutiny may be obtained from the ST-3 returns filed in ACES without making any reference to the assessee.  Post compiling the information, a validation exercise would be undertaken for reconciling the information furnished in the ST-3 return with ITR Forms/ 26AS and any third party information made available.  In case any additional details are required, the same may be obtained from the assessee through requisition rather than through a visit.  The scrutiny process must be completed in a period not exceeding 3 months. Documentation of findings  The scrutiny officer must record his findings in the prescribed Observation Sheet.  In case pertinent, issues may be referred to audit or anti-evasion authorities  In case where detailed scrutiny results into detection of service tax defaults, the ST-3 returns of past period should be verified. (Source: Circular 185/4/2015-Service Tax dated 30 June 2015) INDIRECT TAX
  • 16. The Information provided in this document is provided for information purpose only, and should not be construed as legal advice on any subject matter. No recipients of content from this document, client or otherwise, should act or refrain from acting on the basis of any content included in the document without seeking the appropriate legal or professional advice on the particular facts and circumstances at issue. The Firm expressly disclaims all liability in respect to actions taken or not taken based on any or all the contents of this document. OUR OFFICES www.nangia.com nangia@nangia.com DELHI Suite - 4A, Plaza M-6, Jasola, New Delhi–110 025 Ph: +91-11-4737 1000, Fax: +91-11-4737 1010 MUMBAI 11th Floor, B Wing, Peninsula Business Park, Ganpatrao Kadam Marg, Lower Parel, Mumbai–400 013, India Ph: +91-22-6173 7000 Fax: +91-22-6173 7060 DEHRADUN 3rd Floor, NCR Plaza, New Cantt. Road, Dehradun–248 001 Ph: +91-135-274 7081, Fax: +91-135-2747080 SINGAPORE 24 Raffles Place, #25-04A Clifford Centre, Singapore- 048621

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