WHAT'S INSIDE...
Direct Tax
Transfer Pricing
Indirect Tax
June 16-30
What’s inside…
DIRECT TAX
1. Aircraft maintenance services are in the nature of FTS
though not deemed to accrue of arise i...
0505
03
company i.e. Lufthansa Technik’s [‘Technik’] workshops in Germany.
The taxpayer had entered into an agreement with...
0505
04
UK. i.e. the Head Office which in turn paid to the Lloyd ‘s Register UK.
During the course of assessment proceedin...
0505
05
expenditure in the nature of head office expenditure as is
attributable to the business of the assessee in India, ...
0505
lender on behalf of the borrower. The Arranger was thus the third
party who had acted as the middleman between the bo...
0505
07
 The term arranger fees could not be termed as “managerial” to
fall under the category of technical services. The...
0505
08
 The claim is correct and genuine;
 There is a case of genuine hardship on merits;
 Income is not assessable in...
0505
09
manufacture the Novo products.
 Agreement 4: Facility Establishment agreement whereby TPL will
create facility ex...
0505
10
TPO applied TNMM as the most appropriate method (“MAM”),
undertook a fresh benchmarking analysis and introduced co...
0505
conditions of section 92B(1) of the Act.
 Referring to the various agreements DR contended that the
arrangement star...
0505
Even the TPOs extend their reach to external sources viz. articles
published in business magazines, as in the present...
0505
Key contentions of the taxpayer are:
Chronology of events in brief:
• 29 October 2007 = Return of income is filed
• 1...
0505
14
Further, the TPO treated the reimbursement of freight and insurance
to the taxpayer as income with respect to the ...
0505
. The ITAT also mentioned that the AE did not pass any financial entry
in its books of account while carrying out the...
0505
16
latter on the routes and as per schedule specified, qualifies as
transfer of right to use of goods so as to be lia...
assessee/owner. Undoubtedly, it is the obligation of the
registered owner to make the vehicles available, with
their respe...
of 17

Nangia & Co - Tax and Regulatory Newsletter - June 16-30, 2015

Nangia & Co - Tax and Regulatory Newsletter - June 16-30, 2015
Published on: Mar 3, 2016
Published in: Economy & Finance      
Source: www.slideshare.net


Transcripts - Nangia & Co - Tax and Regulatory Newsletter - June 16-30, 2015

  • 1. WHAT'S INSIDE... Direct Tax Transfer Pricing Indirect Tax June 16-30
  • 2. What’s inside… DIRECT TAX 1. Aircraft maintenance services are in the nature of FTS though not deemed to accrue of arise in India if payment is made to earn income from sources outside India 2. License fee and management charges not under the ambit of ‘Head Office Expenses’ under section 44C 3. Loan-arranger fee not ‘interest’ or ‘fee for technical services 4. CBDT issues circular on condonation of delay in filing claim for refund or carry forward of losses TRANSFER PRICING 5. Transactions arranged between an associated enterprise and third party domestic manufacturer through chain of agreements is “concerted arrangement”. Section 92B triggered. 6. Reference to TPO post issue of assessment order and subsequently initiating re-assessments is bad in law. Rulings in case of Sap Labs and Maximise Learning followed 7. The Tribunal grants relief, classifies the taxpayer as a ‘job worker’; held CUP as the most appropriate method and further deletes addition made by TPO with respect to the risk of carriage 02 DIRECT TAX INDIRECT TAX 8. Delhi High Court (‘HC’) rules on transfer of right to use goods 1. Aircraft maintenance services are in the nature of FTS though not deemed to accrue of arise in India if payment is made to earn income from sourcesoutsideIndia Lufthansa Cargo India [‘the taxpayer’] is an Indian company and engaged in the business of wet-leasing of aircrafts with a fleet of four aircrafts acquired from outside India. The taxpayer was granted a license by the DGCA to operate these aircrafts on international routes only. Further overhaul repairs were permissible only in workshops authorized by the manufacturer as well as duly approved by the DGCA and there were no such facilities in India. The taxpayer wet-leased the aircrafts to a foreign company, Lufthansa Cargo AG, Germany [‘LCAG’] under an agreement. The taxpayer's engineering department tracked the flying hours of every component and before the expiry of flying hours, the component needing overhaul/repairs or needing replacement would be dismantled by the taxpayer's engineers and sent to a German
  • 3. 0505 03 company i.e. Lufthansa Technik’s [‘Technik’] workshops in Germany. The taxpayer had entered into an agreement with Technik in terms of which Technik carried out maintenance repairs without providing technical assistance by way of advisory or managerial services. The repairs by way of component overhaul in the Technik workshops in Germany and other foreign workshops were in the nature of routine maintenance repairs. No Technik personnel were deputed to India for rendering any technical or advisory services to the taxpayer. Likewise, the taxpayer's technical personnel did not participate in the overhaul repairs carried out abroad by Technik or other foreign workshops. The taxpayer used to send components with a tag to the workshop abroad. Technik's workshops in Germany were duly authorized by the manufacturer, i.e. Boeing USA. Upon receipt, Technik overhauled the component in terms of the Manufacturer's Manual, as mandated by the DGCA. During the course of assessment proceedings the AO held that payments were in the nature of FTS defined in Explanation 2 to Section 9(1)(vii)(b) of the Act, and were, therefore, chargeable to tax on which tax should have been deducted at source under Section 195(1) of the Act. The taxpayer submitted that it was unaware of the kind of repairs that had been carried out, as none of its employees visited Technik's facilities in connection with the repair work. These repairs, therefore, do not constitute 'managerial', 'technical' and 'consultancy services’ as defined under Explanation 2 to Section 9(1)(vii)(b) of the Act. The matter came before the High Court in due course of appeal, which observed and ruled as under –  Unlike normal machinery repair, aircraft maintenance and repairs inherently are such that at no given point of time it could be compared with contracts such as cleaning. Component overhaul and maintenance by its very nature cannot be undertaken by all and sundry entities. The level of technical expertise and ability required in such cases is not only exacting but specific, in that, an aircraft supplied by a manufacturer has to be serviced and its components maintained, serviced or overhauled by designated centers. It is this specification which makes the aircraft safe and airworthy because international and national domestic regulatory authorities mandate that certification of such component safety is a condition precedent for their airworthiness. The exclusive nature of these services lead to the inference that they are technical services within the meaning of Section 9(1)(vii) of the Act.  The explanation to Section 9(2) of the Act is deemed to be clarificatory and also retrospective in nature but it does not override the exclusion of payments made under Section 9(1)(vii)(b) of the Act which was clarified by the Supreme Court in the case of G.V.K Industries [371 ITR 453]. The ‘source rule’, i.e. the purpose of the expenditure incurred for earning the income from a source in India, is applicable, as stated by the Supreme Court in the case of G.V.K Industries.  The Tribunal had held that the overwhelming or predominant nature of the taxpayer’s activity was to wet-lease the aircraft to LCAG, a foreign company. The operations were abroad, and the expenses towards maintenance and repairs payments were for the purpose of earning an income abroad. Accordingly, these payments are not taxable because they have been made for earning income from sources outside India and therefore fall within the exclusionary clause of Section 9(1) (vii)(b) of the Act. [Source: DIT v. Lufthansa Cargo India - ITA 95/2005]
  • 4. 0505 04 UK. i.e. the Head Office which in turn paid to the Lloyd ‘s Register UK. During the course of assessment proceedings the Assessing Officer [‘AO’] took the view that the expenses paid towards licence fees and management charges was “head office expenses” under section 44C of the Income Tax Act, 1961 [‘the Act’] despite the following contentions/submissionsby the taxpayer -  The transaction was not between the head office and the branch but between Lloyd’s Register UK and Lloyd’s Register Asia (India Branch office) and thus the payment was only routed through the head office.  Lloyd’s Register UK is filing separate income tax return in India for the said income and the transactions had also been verified by the TPO to be at arm’s length and, therefore, provisions of section 44C do not arise.  The license fees and management fees cannot be held to be covered with the definition of ‘head office expenses’ as defined in section 44C of the Act, as the said section is only applicable to general and administration expenditure as referred to in Explanation (iv) to section 44C and thus “management charges and licence fees do not fall under “head office expenditure” as it only includes executive an general administration expenditure of the nature enumerated in clause (a) to (d) and the payments do not fall in them.  Section 44C, was a non obstante clause stating that in the case of a non-resident, no allowance shall be made in respect of so much of expenditure in the nature of head office expenditure as is in excess of the amount computed as an amount equal to 5% of the adjusted total income or the amount of so much of the 2. License fee and management charges not under the ambit of ‘Head Office Expenses’ undersection44C Lloyd’s Register Asia [‘the taxpayer’], is an Indian Branch of the UK based head office, Lloyd’s Register Asia UK, which is a subsidiary of a holding company, Lloyd’s Register UK, which in turn is engaged in the business of survey and inspection of the ships. Lloyd’s Register UK had entered into license agreement in 2003 with all the subsidiaries, which included Lloyd’s Register Asia UK [‘the licensee’], whereby it granted the licence to use brand “Lloyd register”. Lloyd’s Register UK [‘the licensor’] thus provided general, technical and marketing support services to all its products, which were collectively referred agreement as “Intellectual Property Rights”. Also a “Management service agreement” was entered between the aforesaid parties them wherein various specialized services were agreed to be provided which included corporate communications, taxation and treasury services, corporate finance, group reporting services and group quality assurance etc. For using the intellectual property rights and the management services, license / royalty fees and management charges were paid by the licensor to the licensee. The fees, however was in turn collected by the Indian branch of Lloyd’s Register Asia UK which was then was paid to Lloyd’s Register
  • 5. 0505 05 expenditure in the nature of head office expenditure as is attributable to the business of the assessee in India, whichever is less. The Commissioner of Income Tax (Appeals) upon appeal held that “royalty fees” paid was not covered under section 44C but the “management charges “paid did attracted the disallowance under section 44C and thus disallowed 50% of the “management charges “ claimed. Aggrieved, assessee preferred an appeal before Mumbai ITAT which observed and ruled as under -  The “head office expenditure” enumerated in section 44C was in the nature of executive and general administration expenditure incurred by the assessee outside India. Further, the nature of expenditure as enumerated in sub clause (a) to sub clause (c) of the aforesaid Explanation if compared with the nature of expenditure incurred by the assessee branch, showed that none of the expenditure under the head “license fees” fell within this category, even remotely.  The payment of ‘license fee’ is purely for using of brand/trademark and other business intangibles, which are in the nature of intellectual property. Nowhere such types of expenditure fell within the scope of “head office expenditure” as illustratedin clause (iv).  There is no CBDT clarification explaining the scope of executive and general administration expenses and thus expenses under the head “license fees” and “management charges “ did not fall under the ambit of head office expenses.  With reference to the “management charges “, the ITAT held that none of these services were in the nature of head office expenditure as illustrated in sub clause (a) to (d). For computing the deduction of head office expenditure, it was sine-qua-non that the nature of head office expenses must fall within the illustration given in clause (iv) of the Explanation. If any expenditure itself was beyond the scope of head office expenditure then it could not be brought within ambit of section 44C. The Tribunal overturned the order of the Commissioner of Income Tax (Appeals) holding 50% of management fees hit by Sec 44C, and upheld its order that ‘license fee’ payment for use of brand/trademark and other business intangibles being in the nature of intellectual property, fells outside the ambit of Section 44C of the Act. [Source: TS-324-ITAT-2005(Mum)] 3. Loan-arrangerfee not ‘interest’or ‘fee for technicalservices’ Idea Cellular Limited [‘the taxpayer’], entered into a term loan agreement with the lender, Finnish Export Credit Limited. The Hongkong Banking Corporation Limited, Hongkong [‘HSBC’; ‘Arranger’], had arranged for the loan and HSBC Bank PLC has acted as Facility Agent . The role of the Arranger was to liaise with the lender and to procure the loan for the borrower as well as to negotiate the terms and conditions of the facility with the
  • 6. 0505 lender on behalf of the borrower. The Arranger was thus the third party who had acted as the middleman between the borrower (the taxpayer) and the lender (Finnish Export Credit Limited) to achieve/negotiate the terms and conditions agreeable to both the parties. The Arranger also could not create any binding obligation on the borrower or the lender. Following this, Arranger had facilitated the transaction credit facility between the lender and the taxpayer which was agreeable to both the parties. For its services, an “Arranger fee” was paid by the taxpayer to the Arranger. During the course of assessment proceedings for the relevant assessment year, the Assessing Officer [‘AO’] held the payment made as “arranger fees” was interest u/s 2(28A) and hence taxable as fees for technical services u/s 9(1)(vii) of the Act. The Commissioner of Income Tax (Appeals) also held that that the payment of ‘arranger fee’ was not only in the nature of ‘interest’ but also it is in the nature of ‘for technical services’ within the meaning of section 9(1)(vii). Aggrieved, the taxpayer preferred an appeal before the Income Tax Appellate Tribunal on the question whether the fees paid to arranger could be termed as “Interest” within the meaning of section 2(28A) or “fees for technical services for service” within the meaning of section 9(1)(vii). The Tribunal observed and ruled as under - Whether the payment for “Arranger fees falls under the ambit of “interest” u/s 2(28A)?  For a payment to classify as interest it should be in respect of the money borrowed or debt incurred. In other words, interest is payable by the borrower who had borrowed money from the lender or the debt has been incurred by him in favour of the lender who has given the money.  The Arranger was not the lender and any fee paid to him was not in respect of the borrowing, because no debt had been incurred 06 by the taxpayer in favour of the Arranger vis-a-vis the money borrowed. He was merely a facilitator who brought the lender and borrower together for facilitating the loan/credit facility.  The second limb of the definition of interest was also analyzed and it was observed that the definition was an inclusive definition whereby interest encompasses to include service fee or other charge and such fee is in respect of the money borrowed or any debt incurred or, for unutilized credit facility. Such fee or charge is in respect of money borrowed only i.e. given by the lender to the borrower. Thus, the service fee or other charge did not bring within its ambit any third party or intermediary who had not given any money.  The element of relationship between the borrower and lender is a key factor to bring the payment within the ambit of definition of interest u/s 2(28A). The Arranger fee may be inextricably linked with the loan or utilisation or loan facility but it was not a part of interest payable in respect of money borrowed or debt incurred, because the relationship of a borrower or a lender is missing.  Though, the fees of an Arranger may depend upon the quantum of loan or loan facility arranged but to be included within the meaning of term ‘interest’, it has to be directly in respect of money borrowed, i.e. directly flowing from the consideration paid for the use of money borrowed. It was a kind of a compensation paid by the borrower to the lender. Thus, Arranger was only an intermediary/third party and accordingly, any fee paid as Arranger fee could not be termed as “interest” under both the limbs of the definition given in section 2(28A. Whether “Arranger fees” could be treated as “fees for technical services”
  • 7. 0505 07  The term arranger fees could not be termed as “managerial” to fall under the category of technical services. The term ‘managerial’ essentially imply control, administration and guidance for business, day to day functioning. It includes the act of managing by direction or regulation or superintendence. In the present case arranging of a loan could not be equated with lending of managerial services at all.  It was also not in the nature of ‘consultancy services’ because the Arranger did not provide any advisory or counselling services. The Arranger was not involved in providing control, guidance or administration of the credit facility nor was it involved in day- today functioning of the taxpayer in overseeing the utilisation or administration of the credit facility. It was not in charge of entire or part of the transaction of arranging services, hence, it could not be termed as managerial or consultancy services within the meaning of section 9(1)(vii) of the Act.  “Arranger fees” could not be held to be taxable u/s 9(1)(vii) and also no TDS was deductible on such payment. Reliance was placed on the Mumbai tribunal rulings in Credit Lyonnais vs. ADIT [TS-205-ITAT-2013(Mum)] and DDIT (IT) vs. Abu Dhabi Commercial Bank Ltd wherein it was held that “Arranger’s fees” for arranging the funds does not amount to fees for managerial or consultancy services and thus does not fall under “fees for technical services” as defined in section 9(1)(vii). [Source: ITA NO. 1619/Mum/2011] 4. CBDT issues circular on condonation of delay in filing claim for refund or carry forward of losses The Ministry of Finance, Government of India has prescribed the criteria and issued guidelines for the condonation of a delay in filing claim for refund/ carry forward of losses. The Central Board of Direct Taxes [‘CBDT’] has issued a comprehensive circular that shall superseding all earlier circulars/ instructions/ orders in this regard. The key highlights of this Circular are set out below:  The power to condone a delay has been delegated to various authorities as follows:  Upto INR 10 Lacs – Principal CIT/CIT  More than INR 10 lacs and up to INR 50 lacs - Principal CCIT/CCIT  More than INR 50 lacs – CBDT The Application is to be made within six years from the end of the relevant assessment year.  Such an application will be examined for acceptance/ rejection by the authority, based on the following criteria:
  • 8. 0505 08  The claim is correct and genuine;  There is a case of genuine hardship on merits;  Income is not assessable in the hands of any other person under the Income-tax Act;  The refund has arisen as a result of excess tax deducted or tax collected at source, advance tax or self-assessmenttax.  Authorities have been empowered to direct the jurisdictional Tax Officer to make necessary inquiry or scrutiny to ascertain the correctness of the claim. Taxpayers can claim an additional refund even after completion of the assessment. No interest would be admissiblein case of belated claim of refunds.  The application should be ideally disposed of by the authorities within six months from the end of the month in which the application was received.  A guideline has been prescribed for cases involving refund claim pursuant to a Court Order. The time limit of six years to exclude the period for which the proceedings were pending before any Court of Law. In such a case, the condonation application should be filed within six months from the end of the month in which Court order was issued or the end of financial year, whichever being later. Time limit of six years does not apply in the case of tax deducted at source by banks on interest in relation to 8% Savings (Taxable) Bonds, 2003 at the time of maturity, resulting in mismatch between the year of recognition of income by the taxpayer (on mercantile basis, if any) and tax deducted at source. [Source: CBDT Circular No. 9/2015 dated June 9, 2015] 5. Transactions arranged between an associated enterprise and third party domestic manufacturer through chain of agreements is “concerted arrangement” Section 92B triggered. Facts of the case Novo Nordisk India Private Limited [“the Taxpayer”], is engaged in trading of high purity insulin formulation, insulin delivery system and other specified pharmaceutical products. A brief overview of facts is critical for the sake of better understanding. Facts of the case  Taxpayer is a subsidiary of Novo Investments Pte. Ltd., Singapore (“Novo Singapore”) and Novo Nordisk region International Operations A/S, Denmark (“Novo Denmark”). Novo Nordisk A/S (“Novo A/S”) is the ultimate holding company.  Several transactions viz. purchase of excipients, purchase of finished goods, quality testing fee, receipt for admin services, receipt of subvention fee are aggregated for the purpose of Transfer Pricing
  • 9. 0505 09 manufacture the Novo products.  Agreement 4: Facility Establishment agreement whereby TPL will create facility exclusively for insulin production in terms of the insulin formulation supply agreement. TPL to earn fixed margin as stated in the said agreement.  Agreement 5: Quality control testing whereby Novo A/S undertakes to perform quality control testing of insulin manufactured by TPL.  Agreement 6: Subvention agreement between Novo A/S and the taxpayer whereby the taxpayer is the distributor and marketer of insulin and pharmaceutical products in India. Novo A/S to extend financial support to the taxpayer with no specific services to be rendered by the taxpayer in return.  Agreement 7: Insulin crystals and excipients supply agreement between TPL and taxpayer whereby TPL will exclusively purchase raw materials from Novo A/S and finished formulations to be sold only to the taxpayer. During the course of the transfer pricing (“TP”) assessment proceedings, with the above background, the Transfer Pricing Officer (“TPO”) re-characterised the taxpayer as a “manufacturer” instead of a “distributor”. TPL is considered as “captive contract manufacturer” earning a fixed margin as per Agreement 4. Accordingly the transaction between the taxpayer and TPL is also considered as an “international transaction” by the TPO under the deeming provisions of section 92B(2)(i) of the Income-tax Act, 1961 (“the Act”). Considering the entirety of the agreements and chain of transactions dominated by the terms of Novo A/S the TPO concluded that introduction of TPL and treatment of the taxpayer as a trader, is merely to avoid the incidence of the provisions of Chapter X. benchmarking analysis. Collectively considered as “Distribution activity” by the taxpayer.  Apart from above transactions, taxpayer has also given advance to the third party domestic manufacturer viz. Torrent Pharmaceuticals Ltd. (“TPL”) to be adjusted against purchase of manufactured goods by the taxpayer.  Receipt of ITeS service fees and towards provision of administrative services are other international transactions benchmarked separately. Crux of the matter is with regards to the Distribution segment. The segment is further divided into two parts i) sale of products purchased locally; and 2) direct import and sale of products from Novo A/S and Novo Healthcare AG. It is imperative to highlight the chain of agreements entered into by the taxpayer with its AE and TPL with regards to the Distribution activity.  Agreement 1: Know-how license agreement between Novo A/S and taxpayer. Novo A/S grants the taxpayer the exclusive rights and license to use or sub-license the use of the Novo Nordisk know-how.  Agreement 2: Trade Mark Master License Agreement between Novo A/s and the taxpayer. Wherein taxpayer is given the Master License to exclusively use and sob-license the use of the Trade Marks of the Novo products.  Agreement 3: Insulin Formulation Supply agreement whereby the taxpayer and the third party domestic manufacturer i.e. TPL is given the license to use Novo Nordisk know- how and
  • 10. 0505 10 TPO applied TNMM as the most appropriate method (“MAM”), undertook a fresh benchmarking analysis and introduced comparable companies and considered the subvention fee received by the taxpayer as non-operating. Resultant an adjustment of 33.78 crores. Hence, the dispute arose as to whether the supply of raw materials by Novo A/S to TPL to manufacture and its subsequent sale to the taxpayer at prices controlled by Novo A/S be considered as an “international transaction” Aggrieved by the findings of the TPO, taxpayer approached the Dispute Resolution Panel (“DRP”). The DRP upheld the approach of the TPO of recognising TPL as merely a pass-through entity. DRP concluded that the transaction between taxpayer, TPL and Novo A/S is an international transaction. DRP went further to apply PSM as the MAM and eventually enhanced the adjustment by 3.14 crores after adopting an adhoc ratio of 50:40 profit split amongst Novo A/S and taxpayer respectively. Aggrieved by the decision of the DRP, Taxpayer approached the Tribunal to adjudicate the matter. Out of 47 grounds filed before the Tribunal, broadly they can be split as under: I. Whether transaction by which the taxpayer engages services of TPL to manufacture the raw material supplied by Novo A/S into finished goods ultimately sold to the taxpayer can be considered as “International transaction” between “AEs” attracting the provisions of section 92(1) of the Act? II. Whether the approach adopted by the transactions pertaining to supply of raw materials to taxpayer and direct import from Novo A/S towards purely distribution function can be aggregated? Contentions of the Taxpayer before the Tribunal:  Pre-requisites for considering a transaction as an “International transaction” are i) there should be a transaction between two or more AEs and ii) either or both of them should be non- residents.  In present case, the supply of raw material between Novo A/S and TPL is a case where though one of the entities is a non- resident however, they are not AEs. Subsequently, by virtue of provisions of section 92B(2)(i) TPL and taxpayer could be considered as AEs, however, both entities are “resident” and hence, does not satisfy the pre-requisites to be regarded as “International transaction”  Provisions of section 92B(1) of the Act does not dispense of the requirement to satisfy the conditions for a transaction to be termed as “international transaction”. Section 92B(2) only controls the definition of “Associated Enterprises”.  With regards to the pure distribution function, the taxpayer contended that the transactions were interconnected and ought to be benchmarked at entity level by considering the taxpayer as a “distributor” and not a “manufacturer”. Contentions of the revenue before the Tribunal:  The departmental representative (“DR”) contented that all the agreements have to be read together and accordingly, its clear that the arrangement between the taxpayer, TPL and Novo A/S depicts that the manufacture and sale of Novo products through TPL is an international transaction since taxpayer and Novo A/S are AEs whilst the latter is a non-resident which satisfies the
  • 11. 0505 conditions of section 92B(1) of the Act.  Referring to the various agreements DR contended that the arrangement starts with supply of raw materials and ends with manufacture of finished goods for the taxpayer to sell in Indian markets.  With regards to the distribution function the DR contended that purchase of raw material and its manufacture and sale are inter- connected. The distribution of products imported from Novo A/S are not closely linked transaction with the sale of manufactured products. Tribunal’s conclusions: The Tribunal duly considered the facts of the case and arrived at the following conclusion:  The sum and substance of all the agreements is the supply of raw material by Novo A/S to taxpayer to enable it to manufacture and sell in India. It is a concerted action apparently intended and framed so as to not attract the provisions of Section 92B of the Act but in substance is a transaction between Novo A/S, TPL and the taxpayer where Novo A/S is a non-resident. The said transaction is an “international transaction”.  If the cost of raw material supplied to TPL is not subjected to test of arm’s length price (“ALP”) then it could result in erosion of tax base in India.  The transaction between TPL and the taxpayer for manufacture of Novo products cannot fall within the ambit of provisions of section 92(1) of the Act since income of TPL and taxpayer, being residents, are subjected to tax in India. 11 The products sold by the taxpayer is also subjected to tax in India.  The tax base erosion can happen only at the point of time of supply of raw material by Novo A/S.  Tribunal adjudicated that the sale of imported products is a trading activity whilst the purchase of raw material would be part of manufacturing activity and ought to be benchmarked separately. Accordingly the approach of the TPO and the DRP of applying PSM as the MAM is erroneous.  The matter is remitted back to the TPO to determine the ALP of i) supply of raw materials; ii) import of products directly from Novo A/S and its sale; iii) Quality testing fee are to be tested independently.  Subvention fee received by the taxpayer not to be subjected to ALP test and will need to be set off against any transfer pricing adjustment to reduce the additions, if any. The decision also covers other grounds pertaining to ALP computation of ITeS services and Administrative support services provided by the taxpayer alongwith few direct tax disallowances which are not covered in detail herein. Comments: This is yet another case the importance of “substance” over “form” is seen forthcoming. Revenue department has frequently adopted this macro level approach to analyse a given chain of transactions which has led to humongous adjustments eventually.
  • 12. 0505 Even the TPOs extend their reach to external sources viz. articles published in business magazines, as in the present case, which highlighted that group was planning to make India a hub for manufacturing insulin in partnership with TPL in order to characterise the taxpayer. This evidence was sufficient enough for the TPO to consider the entire arrangement as an “eye wash” and treated the taxpayer as a manufacturer rather than a distributor. Maintenance of robust documentations and supporting are of paramount importance in order to portray true and correct functional profile. It is imperative for taxpayers to embark upon an appropriate course of action based on the current ruling and carve out a more robust transfer pricing policy to safeguard its international transactions from future litigation. [Source: Novo Nordisk India Private Limited] (ITA No. 122/Bang-2014); 12 6. Reference to TPO post issue of assessment order and subsequently initiating re- assessments is bad in law. Rulings in case of Sap Labs and Maximise Learningfollowed Lister Petter India Private Limited, (‘the taxpayer’), company incorporated in India, is engaged in the business of manufacture and trading of I C Engines, components and provides related services. During the year 2007-08 the taxpayer had filed its return of income and the assessment was concluded vide order dated 19 November 2009 Subsequently, the assessing officer referred the matter to the transfer pricing officer (“TPO”). TPO vide order dated 21 October 2010 proposing an adjustment of Rs. 1.05 crores (approx. USD 175,000). Based on the TPO’s order, the assessing officer initiated re-assessment proceedings and proposed the adjustment to the income of the taxpayer. Aggrieved by the impugned order, the taxpayer approached the Dispute Resolution Panel (‘DRP’). But DRP confirmed the action of the TPO. Taxpayer aggrieved, knocked the doors of the Hon’ble Tribunal to adjudicate the transfer pricing issue pertaining to the alleged re- opening of the assessment based on the invalid reference made to the TPO. The chronologies of the proceedings before the Tribunal are:
  • 13. 0505 Key contentions of the taxpayer are: Chronology of events in brief: • 29 October 2007 = Return of income is filed • 19 November 2009 = Assessment completed by the AO • 18 December 2010 = Reference made to the TPO • 21 October 2010 = Order passed by the TPO • 14 January 2011 = Re-assessment notice issued to the taxpayer • 22 November 2011 = Draft order issued by the AO.  The Taxpayer vehemently contended that the reference made to the TPO pursuant to the issuance of the assessment order was bad in law and out of jurisdiction.  When no return is pending for consideration before the AO, reference made to the TPO is invalid.  Accordingly, the resultant re-assessment initiated by the AO is also without jurisdiction. Even otherwise, no new incriminating material was found against the taxpayer. On the other hand the departmental representative (‘DR’) supported the AO’s order. The DR contended that the action of the AO is justified. Legislature does not lay the condition that reference can be made only during pendency of assessment proceedings. Tribunal’s findings: The Tribunal duly considered the facts of the case and arrived at the following conclusion:  Tribunal referred to the relevant section under the Act and observed that on bare reading of the clause, it shows that the 13 reference to the TPO can be made by the AO only when the assessmentis open before him.  Once the assessment is passed the AO cannot make a reference to the TPO.  Tribunal relied on the decisions of the Karnataka High Court in the case of Sap Labs (P.) Ltd. and another decision of the co- ordinate bench in the case of Maximise Learning (P.) Ltd. wherein similar issue arose and it was held that the once the assessment stood terminated, there was no occasion for the AO to make reference to the TPO for determination of arm’s length price of the international transactions. [Source: Lister Petter India Pvt. Ltd. (ITA 2171/PN/2012]
  • 14. 0505 14 Further, the TPO treated the reimbursement of freight and insurance to the taxpayer as income with respect to the risk of carriage of gold and made another TP adjustment of INR 1.76cr by assuming risk factor of 1%. The taxpayer contended that according to Dubai laws, insurance cannot be done for an overseas transaction; therefore the taxpayer on the behalf of the AE has taken insurance policies. The taxpayer filed its objections before the Dispute Resolution Panel [“DRP”]. The DRP rejected the objections of the taxpayer and upheld the TP adjustment of INR 11.26cr made by the TPO. Aggrieved by the above stated additions the taxpayer filed an appeal before the Income Tax Appellate Tribunal [“ITAT”]. The taxpayer is a ‘job worker’ and not a ‘manufacturer’ The ITAT observed that the taxpayer imports pure gold bars of .999 or .995 fineness on free of cost [“FOC”] basis from its AE and is required to convert the gold received into jewellery and send it back to AE such that the quantity of pure gold content in jewellery supplied including permissible wastage equals the quantity of pure gold received. ITAT also observed that the taxpayer exclusively works for its AE and no consideration has been passed by the taxpayer for the value of gold imported from its AE and is only entitled to making charges at the rate of $0.65 per gram of gold. ITAT referred to the judgement rendered by Bombay High Court in CIT Vs. Gopal Purohit 336 ITR 287 (Bom) wherein the Court held that the substance of the transaction has to be seen rather than form of transaction. Thus, ITAT held that just because the taxpayer has passed memorandum/ notional entries in its books of account, it cannot be said that the international transaction is of ‘purchase and sale’. ITAT also noted that the cost of raw materials was not passed between the parties to the transaction. 7. The Tribunalgrants relief,classifiesthe taxpayeras a ‘job worker’;held CUP as the most appropriatemethod and furtherdeletes additionmade by TPO with respectto the risk of carriage Kailash Jewels Pvt. Ltd., [“the taxpayer”], is engaged in the business of manufacturing and trading of Gold & Silver Jewellery etc. During AY 2010-11, the taxpayer entered into international transaction with Associated Enterprises [“AE”] viz. M/s AL-MOWAI-JI Jewellers LLC of Dubai (UAE). The taxpayer benchmarked its international transaction using Comparable Uncontrolled Price [“CUP”] method as the most appropriate method. During the course of the assessment proceedings, the Transfer Pricing Officer [“TPO”] considered the international transaction pertaining to the undertaking of job work done by the taxpayer for its AE to be the ‘purchase and sale’ of jewellery and while calculating Arm’s Length Price [“ALP”] added the cost of gold into the cost base. The TPO rejected the adoption of CUP method since some of the companies were located in different geographical locations and applied Transactional Net Margin Method [“TNMM”] by selecting 12 comparables with average margin of 8.88% and made TP adjustment of approximately INR 9.50cr.
  • 15. 0505 . The ITAT also mentioned that the AE did not pass any financial entry in its books of account while carrying out the subject transaction with the taxpayer and hence, the transaction cannot be classified as of ‘purchase and sale’. ITAT was of the view that the import and export invoices were on FOC basis which were duly verified by the custom authorities and also no custom duty was required to be paid by the taxpayer or by its AE for the value of gold imported and jewellery exported. In addition to the above, the ITAT held that the taxpayer was not the owner of the gold imported and jewellery exported and was not entitled to any profits on the same. ITAT referred to the judgement in the case of R.B. Jodha Mal Kuthiala Vs. CIT 1971 82 ITR 570 (SC) and held that gold sent cannot have two owners. A reference to the Sale of Goods Act, 1930 was also made by the ITAT in respect of which the ITAT mentioned that since no consideration was passed for the value of gold between the taxpayer and its AE and therefore, the transaction between both the parties cannot be termed as ‘sale’. ITAT relied on the ruling in the case of DCIT Circle 3(1), New Delhi Vs. M/s Cheil Communications India Pvt. Ltd. ITA No. 712/Del/2010 and held that the value of gold imported and exported is only a pass through cost and cannot be part of the operating cost while computing the margin. At last ITAT observed that the taxpayer also does not separately invoice the jewellery items exported to AE. TNMM can only be applied when direct methods are incapable of determining the ALP The ITAT referred to the comparable invoices provided by the taxpayer and observed that the nature of business of the comparables was similar to that of the taxpayer and prices charged by the taxpayer was at arm’s length. ITAT held that the taxpayer correctly applied CUP method and TNMM being an indirect method 15 cannot be applied in the case of the taxpayer. ITAT further held that in a situation where the taxpayer has followed one of the standard methods of determining ALP, such a method cannot be discarded in preference over transactional profit methods unless the revenue authorities are able to demonstrate the fallacies in application of direct standard methods. Further, ITAT held that the method adopted by the TPO was ex facie incorrect as all the comparables were engaged in retail business who sell directly to the consumer and on the other hand the taxpayer is engaged in a business to business model whose profitability cannot be compared to companies which are in business to consumer model. Based on above, the ITAT deleted the first TP addition of INR 9.5cr made on account of applicability of most appropriate method. Insurance and freight is only a reimbursement and is not a source of income to the taxpayer The ITAT ruled out that the taxpayer has placed on record the three insurance policies taken by the taxpayer on behalf of its AE. ITAT also noted that it was clear that in case on any loss, the same would be recovered from the insurance company and paid to the AE. The ITAT further observed that the taxpayer was only reimbursed by its AE of the freight and insurance charges at the rate of $350 consignment. ITAT further referred to the judgement in the case of Vodafone Vs. UOI W.P(c) 871/2014 and agreed with the contention of the taxpayer that reimbursements can never come with the scope of charging Section 4 of the Income Tax Act, 1961 [“the Act”] and therefore, income cannot be deemed under the TP provisions under Chapter X of the Act. ITAT thus, deleted the second TP adjustment of INR 1.76cr on account of provision of facility, freight and insurance. [Source: Kailash Jewels Pvt. Ltd. Vs. ITO [ITA No. 101/Del/2015]
  • 16. 0505 16 latter on the routes and as per schedule specified, qualifies as transfer of right to use of goods so as to be liable to VAT under Section 2(zc)(vi) of DVAT Act.” The Revenue contended that the effective control of the buses was transferred by the assessee to DTC. In support, the Revenue relied upon the various clauses in the agreement such as - exclusive use of the bus on DTC routes; exclusive right to collect advertisement revenue by the DTC; the entire revenue being collected by DTC employees (i.e. its conductor); maintenance or repairs not at the choice of the assessee/ owner but after approval of the DTC; restriction upon right to terminate the contract under pain of penalty. Ruling of the Delhi High Court The HC, while ruling in favour of the assesee, inter-aliaheld as under:  That DTC has control over ticket collections or absolutely collects all the revenues or that bus maintenance and repair is subject to its prior approval, are ipso facto, not decisive either by themselves or cumulatively in concluding that there was a transfer of the right to use the vehicles;  In the present case, the assessee/ owner bears responsibility for any mis-happening or accident. It commits to be the bus owner at all times; the registration and licenses are in its favour and most importantly, DTC has limited use for these buses, i.e. to ply them (of course through driver provided by the assessee/ owner) at the scheduled routes, in terms of the contract;  The various terms of the contract, summarized above, make it vividly clear that the possession has always remained with the 8. Delhi High Court (‘HC’) rules on transfer of rightto use goods The assessee is a partnership firm approved by the Government of India as a tourist operator engaged in the business of providing vehicles on rental basis. The assessee is registered under the Delhi Value Added Tax Act 2004 (‘DVAT Act’). The assessee had entered into agreements with the Delhi Transport Corporation (‘DTC’) for providing buses to it on the terms and conditions mutually agreed. For rental of the buses, the assessee received certain amount from DTC on account of hire charges for running its buses. The DVAT Authorities imposed VAT on the said receipts under the DVAT Act treating the transaction as a ‘deemed sale’ on account of transfer of right to use the goods from the assessee to DTC. The assessee challenged, the said order issued by the DVAT Authorities before the Adjudication and the Appellate Authority, however both failed. Aggrieved, the assessee filed an appeal before the HC. The issue before the HC was as follows: “Whether the agreement between the assessee and the DTC for giving on hire two Deluxe buses for being plied as per requirement of the INDIRECT TAX
  • 17. assessee/owner. Undoubtedly, it is the obligation of the registered owner to make the vehicles available, with their respective drivers, for being deployed on routes, and as per schedule, specified by DTC. The assessee/ owner cannot withdraw the buses unilaterally nor send them for repairs and nor can alienate their ownership in favour of a third party, except by incurring penalties. The goods are specified, the right to deploy them is conferred on the third party, but the custody of the goods is retained by the assessee/ owner who remains responsible for keeping them fit for use in terms of the contractual obligations. The registration certificate and the permits continue to be in the control and possession of the assessee/ owner. The assessee/ owner remains responsible for maintenance, repairs, etc. and also keeps the other party indemnified against any claim for loss or damage on account of operations. The rights conferred on DTC by such contract, therefore, do not result in the goods (vehicles) being "delivered" to DTC at any stage.  Thus, the contract in question does not pass the muster of Article 366(29A)(d) of the Constitution of India and cannot be treated as ‘transfer of a right to use the goods’ or a ‘deemed sale’. [Source: Hari Durga Travels v Commissioner of Trades and Taxes, Delhi (2015-TIOL-1300-HCDEL-VAT)] 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, GanpatraoKadam 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, +91-135-274 7082 Fax: +91-135-2747080 SINGAPORE 24 Raffles Place, #25-04A CliffordCentre Singapore-048621 11

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