(43.6 KiB, 505 DLs)

For s. 5(2), income receivable in kind, received at place where goods delivered

The assessee, a fishing company, obtained two fishing vessels on charter from a foreign company based in Hong-Kong. The charter fee of $ 600,000 was payable from the earning from the sale of fish and for that purpose 85% of the gross earnings from the sale of fish was to be paid to the foreign company. The trawlers were delivered to the assessee at Chennai Port. Actual fishing operations were done outside the territorial waters of India but within the EEZ. The voyage commenced and concluded at Chennai Port. The catch made at high seas were brought to Chennai where its value for assessed for local taxes. The assessee thereafter arranged Customs clearance for the export of the fish and the Trawlers carried the fish to the destination chosen by non-resident company. The Trawlers reported back to Chennai Port after delivering fishes to the destination and commenced another voyage. The AO took the view that the assessee ought to have deducted tax at source u/s 195 whilst making payment to the foreign company. He treated the assessee as in-default u/s 201. The CIT (A), ITAT & High Court decided against the assessee. On appeal to the Supreme Court, HELD dismissing the appeal:

(i) The argument that the income of the non-resident had not been received in India is not acceptable. The agreement provided that the charter fee of $600,000 was “payable by way of 85% of gross earning from the fish-sales“. The chartered vessels with the entire catch were brought to the Indian Port, the catch was certified for human consumption, valued, and after customs and port clearance and the non-resident received 85% of the catch. So long the catch was not apportioned the entire catch was the property of the assessee and not of non-resident company as the latter did not have any control over the catch. It is after the non-resident company was given share of its 85% of the catch it did come within its control. It is trite to say that to constitute income the recipient must have control over it. As the apportionment was in India, the non-resident effectively received the charter-fee in India. This being the first receipt in the eye of law and being in India was chargeable to tax u/s 5(2).

(iii) The said catch was in sum and substance, the receipt of value of money. Had it not been so, the value of the catch ought to have been the price for which the non-resident sold at the destination chosen by it. (Toshoku 125 ITR 525 (SC) distinguished on the ground that there mere entries had been made in India and that was held not to be a receipt in India; Ishikawajima 288 ITR 408 (SC) distinguished on the ground that the entire transaction was completed on high seas);

(iii) Accordingly, the assessee was liable to deduct tax u/s 195 and was rightly held to be in default u/s 201.

(52.1 KiB, 1,601 DLs)

Profits from supply of ‘shrink-wrapped’ software is not ‘royalty’

The assessee, a Mauritius company, was engaged in supply of software. It supplied “off-the-shelf” “shrink-wrapped” software to Infosys Technologies and took the view that the profits there from was not taxable in India as it did not have a Permanent Establishment in India. The AO assessed the profits as royalty u/s 9(1)(vi) of the Act and this was confirmed by the CIT (A). On appeal by the assessee, HELD allowing the appeal:

(i) In CIT vs. Samsung Electronics 227 CTR 335 the Karnataka High Court has confined its decision to the issue of responsibility of the assessee u/s 195 in deducting tax at source before making remittances to non-residents. Even though the court held in favour of the Revenue on the application of the TDS provisions, the court made it clear in paragraph 78 that it has not examined the question of tax liability of the non-resident assessees in respect of the payments received from assesses in India.

(ii) On the question whether income from supply of software can be assessed as royalty, in Motorola Inc vs. DCIT 95 ITD 269, the Delhi Special Bench held that the crux of the issue was whether the payment was for a copyright or for a copyrighted article. If it was for a copyright, it had to be classified as ‘Royalty’ under the Act and the DTAA. If it was for a copyrighted article, then it only represented the purchase price of an article and could not be considered as Royalty either under the Act or under the DTAA. This principle was upheld by the AAR in Airports Authority of India and the ITAT in Sonata Software 6 SOT 700 and it was held that the payments partook the character of purchase and sale of goods; and as there is no PE in India, no income accrued or deemed to accrue or arise in India. Immense support can be drawn from Tata Consultancy Services v. State of AP 271 ITR 401 (SC) where it was held that though copyright in a software programme may remain with the originator of the programme, the moment copies are made and marketed, it becomes goods which are assessable to sales-tax. It was held that even intellectual property become “goods” once put to a media whether in the form of books or computer disks or cassettes. Accordingly, profits on sale of software cannot be assessed as royalty either under the Act or under the DTAA.

(180.3 KiB, 1,849 DLs)

Pre S. 94(7) dividend stripping loss cannot be disallowed. Transaction cannot be ignored on ground that it is for tax-planning

In respect of AY 2000-01, the assessee bought units of a mutual fund on 24.3.2000 (the record date) for Rs. 17.23 each and immediately became entitled to receive dividend of Rs. 4 per unit. After the dividend payout, the NAV of the unit fell by Rs. 4 to Rs. 13.23. The assessee redeemed the units on 27.3.2000 at Rs. 13.23 per unit and claimed a loss of Rs. 4. The dividend of Rs. 4 was claimed exempt u/s 10(33). The AO & CIT (A) rejected the claim of loss on the ground that the loss was “artificial” and could not be allowed. On appeal by the assessee, a Five Member Special Bench of the Tribunal 96 ITD 1 (Mum) (SB) upheld the claim and this was confirmed by the Bombay High Court 310 ITR 421 (Bom). On appeal to the Supreme Court, HELD, dismissing the appeal:

(i) The argument of the department that the loss (the difference between the purchase and sale price of the units) constitutes “expenditure incurred” for earning tax-free income and was liable to be disallowed u/s 14A is not acceptable. The difference arose as a result of the dividend payout. The said “pay-out” is not “expenditure” to fall within s. 14A. For attracting s. 14A, there has to be a proximate cause for disallowance, which is its relationship with the tax exempt income, which is absent in the present case.

(ii) The argument of the department that the transaction was entered into in a pre-meditated manner and that the loss is not genuine is not acceptable because the transaction was a “sale”, the sale-price and dividend was received by the assessee. The assessee made use of the provisions of s. 10(33), which cannot be called an “abuse of law”. Even assuming that the transaction was pre-planned, there is nothing to impeach the genuineness of the transaction. With regard to McDowell & Co 154 ITR 148(SC), in the later decision in Azadi Bachao Andolan 263 ITR 706(SC) it has been held that a citizen is free to carry on its business within the four corners of the law. Mere tax planning, without any motive to evade taxes through colourable devices is not frowned upon even in McDowell & Co. Accordingly, the losses pertaining to exempted income cannot be disallowed prior to s. 94(7).

(iii) S. 94(7) was inserted w.e.f. 1.4.2002 to curb claim of such loss. However, the effect of s. 94(7) is that only losses to extent of dividend have to be ignored by the AO and not the entire loss. Losses over and above the dividend are still allowable even after s. 94(7). This shows that Parliament has not treated the dividend stripping transaction as sham or bogus or the entire loss as a fictitious or fiscal loss. If the argument of the Department is to be accepted, it would mean that before 1.4.2002 the entire loss would be disallowed as not genuine but, after 1.4.2002, a part of it would be allowable u/s 94(7) which can never be the object of s. 94(7).

(iv) As regards the reconciliation of ss. 14A and 94(7), the two operate in different fields. S. 14A deals with disallowance of expenditure incurred in earning tax-free income while S. 94(7) refers to disallowance of loss on acquisition of an asset. S. 14A applies to cases where an assessee incurs expenditure to earn tax free income but where there is no acquisition of an asset. In cases falling u/s 94(7), there is acquisition of an asset and existence of the loss which arises at a point of time subsequent to the purchase of units and receipt of exempt income. It occurs only when the sale takes place. S. 14A comes in when there is claim for deduction of an expenditure whereas s. 94(7) comes in when there is claim for allowance for the business loss. One must keep in mind the conceptual difference between loss, expenditure, cost of acquisition, etc. while interpreting the scheme of the Act. Also, though ss. 14A and 94(7) were inserted by the Finance Act, 2001, s. 14A was inserted w.r.e.f. 1.4.1962 while s. 94(7) was inserted w.e.f. 1.4.2002.

(v) The argument of the department that by virtue of Para 12 of AS 13, the dividend should be regarded as a “return of investment” and go to reduce the cost of the unit is not acceptable. As 13 provides that interest/ dividends received on investments are generally regarded as return on investment and not return of investment and it is only in certain circumstances where the purchase price includes the right to receive crystallized and accrued dividends/ interest, that have already accrued and become due for payment before the date of purchase of the units, that the same has got to be reduced from the purchase cost of the investment. A mere receipt of dividend subsequent to purchase of units, on the basis of a person holding units at the time of declaration of dividend on the record date, cannot go to offset the cost of acquisition of the units. (Reference made to Vijaya Bank 187 ITR 541 (SC) where it was held that where the assessee buys securities at a price determined with reference to their actual value as well as interest accrued thereon till the date of purchase the entire price paid would be in the nature of capital outlay and no part of it can be set off as expenditure against income accruing on those securities).

(590.0 KiB, 1,146 DLs)

Transfer Pricing Law for user of foreign trademarks & advertisement expenditure laid down

The assessee manufactured cars using the brand name “Maruti”. It entered into an agreement with Suzuki, Japan, pursuant to which it began manufacturing cars using the brand name “Suzuki”. The TPO issued a show-cause notice in which he alleged that the substitution of the brand name “Maruti” for the name “Suzuki” meant that the assessee had sold the “Maruti” brand to Suzuki. On that basis, he determined the “arms length” sale proceeds at Rs. 4,420 crores. The assessee filed a writ in which the TPO was allowed to pass an order subject to the outcome of the Petition. In the order, the TPO abandoned the theory of “sale” to Suzuki but instead held (without giving the assessee a show-cause notice in this behalf) that as the assessee was using the trademark “Maruti-Suzuki”, the “Suzuki” trademark had “piggybacked” on the “Maruti” trademark without payment of any compensation by Suzuki to the assessee. He alleged that “Maruti” was a “super-brand” while “Suzuki” was a “weak-brand”. He held that the assessee was not liable to pay Suzuki for the trademark “Suzuki” but instead Suzuki was liable to pay the assessee for “piggybacking” on the trademark “Maruti”. He also held that the advertisement expenses incurred by the assessee had gone to benefit Suzuki. He accordingly directed that an adjustment of Rs. 206 crores be made in the hands of the assessee. HELD remanding the matter to the TPO:

(i) While the onus is on the assessee to satisfy the AO/TPO that the arm‘s length price computed by it is in consonance with s.92, the AO/TPO can reject the price computed by the assessee only if he finds that the data used by the assessee is unreliable, incorrect or inappropriate or he finds evidence, which discredits the data used and/or the methodology applied by the assessee;

(ii) The TPO/AO is obliged to give the assessee an opportunity to produce evidence in support of the arm‘s length price and before making adjustments, he is obliged to convey to the assessee the grounds on which the adjustment is proposed to be made and give the assessee an opportunity to controvert the grounds on which the adjustment is proposed;

(iii) Re user of trademark by the domestic entity on discretionary / mandatory basis: If a domestic Associate Enterprise uses a foreign trademark, no payment to the foreign entity on account of such user is necessary in case the user of the trademark is discretionary. However, the “income” arising from such transaction is required to be determined at arm‘s length price;

(iv) If a domestic Associate Enterprise is mandatorily required to use the foreign trademark on its products, the foreign entity should make payment to the domestic entity on account of the benefit the foreign entity derives in the form of marketing intangibles from such mandatory use of the trademark. Even where payment is made by the foreign entity, the arm‘s length price in respect of the international transaction needs to be determined taking into consideration all the rights obtained and obligations incurred by the parties under the international transaction including the value of marketing intangibles obtained by the foreign entity on account of compulsory use of its trademark by the domestic entity. Suitable adjustments in this regards will have to be made considering the individual profiles of these entities and other facts and circumstances justifying such adjustments.

(v) Re advertisement expenditure incurred for the trademark: The expenditure incurred by a domestic Associate Enterprise on advertising of its products using a foreign trademark does not require any payment or compensation by the owner of the foreign trademark/logo to the domestic entity on account of use of the foreign trademark/logo in the advertising undertaken by it, so long as the expenses incurred by the domestic entity do not exceed the expenses which a similarly situated and comparable independent domestic entity would have incurred.

(vi) If the expenses incurred by the domestic Associate Enterprise are more than what a comparable independent domestic entity would have incurred, the foreign entity needs to suitably compensate the domestic entity in respect of the advantage obtained by it in the form of brand building and increased awareness of its brand in the domestic market. The said “arms length price” should be determined by taking into consideration all the rights obtained and obligations incurred by the two entities, including the advantage obtained by the foreign entity.

(vii) In determining whether the advertisement expenses incurred by the domestic Associate Enterprise on advertising the brand trademark/logo of the foreign entity are more than what an independent domestic entity would have incurred, the TPO has to identify appropriate comparables and make suitable adjustments considering the individual profiles of these entities and other facts and circumstances justifying such adjustments.