(241.1 KiB, 2,090 DLs)

Transfer Pricing: Important Principles on comparability & +/-5% adjustment stated

The Tribunal had to consider the following transfer pricing issues: (i) whether the use of multi-year data for determining ALP is permissible? (ii) Whether +/-5% adjustment is a “standard deduction”? (iii) Whether companies with minor differences can be treated as non-comparable? (iv) Whether a company with turnover 20 times that of the assessee can be said to be comparable? (v) Whether as the assessee was operating in a “risk-free environment”, adjustment for valuable intangibles and entrepreneurial risk borne by the comparables has to be made? (vi) Whether the TPO/AO need to demonstrate the assessee’s motive to shift profits outside India by manipulating prices charged in international transactions? HELD:

(i) The expression “shall” in Rule 10B(4) makes it clear that it is mandatory to use the current year data first and if any circumstances reveal an influence on the determination of ALP in relation to the transaction being compared than other data for period not more than two years prior to such financial year may be used. If the current year’s data of comparables is not available at the time of filing the ROI a fresh search of comparables during the transfer pricing proceedings is permissible;

(ii) The +/-5% tolerance band in s. 92C is not a standard deduction. If the arithmetic mean falls within the tolerance band, then there should not be any ALP adjustment. If it exceeds the said tolerance band, ALP adjustment is not required to be computed after allowing the deduction at 5%. That means, actual working is to be taken for determining the ALP without giving deduction of 5%;

(iii) The argument that a company with employee-cost of 1.38% of its revenue and with intangible property is not comparable because the assessee has an employee-cost of 52.12% and has no intangible property is not acceptable because the differences do not materially affect the price or profit earning. No two comparable companies can be replicas of each other. Rule 10B has to be applied not with technical rigor, but on a broader prospective;

(iv) A company with 20 times turnover (Wipro BPO) more than the assessee is not at all comparable because the assessee is a pygmy compared to a giant. Accordingly Wipro BPO has to be excluded from the list of comparable companies;

(v) There are several factors such as market risks, environmental risk, entrepreneurial risk and functional risk etc., which affect this matter and which ultimately affect the results of the company. These factors make it impracticable to find out exact duplicate of the assessee as comparable. Some variation is bound to exist. The TPO had identified comparables whose functions were similar to the assessee by applying quantitative and qualitative filters to eliminate differences between the assessee and the comparable to neutralize the risk factors. The assessee’s argument that it is a “low end performer” operating in “risk-free environment” and that suitable adjustment should be made is not acceptable;

(vi) The transfer pricing rules apply when one of the parties to the transaction is a non-resident, even if the transaction takes place within India. There is no need to find out the legislative intent behind the transfer pricing provision when the provisions were unambiguous. The existence of actual cross border transactions or motive to shift profits outside India or to evade taxes is not a pre-condition for transfer pricing provisions to apply.

(233.5 KiB, 1,165 DLs)

Non-Resident, even with “business connection”, can be taxed only in respect of business operations carried out in India. While canvassing agent is not “business connection”, fair fee extinguishes non-resident’s liability to tax

Star Isle of Man was engaged in providing promotional services for the cruise vessels operated by the Star Cruise Group. It appointed the assessee as its agent in India to canvass business for marketing its cruise packages and shore excursions. The assessee received 3% of the net cruise charges as retainer fees. The AO took the view that the relationship between the assessee and Star Isle of Man was a “business connection” and that 5% of the net cruise charges was chargeable to tax in the hands of Star Isle of Man u/s 9(1)(i) and that the assessee ought to have deducted tax at source u/s 195 r.w.s. 201. This was reversed by the CIT(A). On appeal by the department to the Tribunal, HELD dismissing the appeal:

(i) The expression ‘business connection’ does not cover mere canvassing for business by an agent in India. It postulates a real and intimate relation between business activity carried on outside India and business activity within India, the relation between the two contributing to the earning of income by the non-resident in his business activity. The business operations carried out outside India and inside India must have such a relationship as to contribute to business operations as a whole. On facts, as Star Isle of Man was merely engaged in providing promotional services, which did not contribute to core business operations as a whole, there was no “business connection” (R D Aggarwal & Co 56 ITR 20 (SC) and Anglo French Textile Co 23 ITR 101 (SC) followed. Rajiv Malhotra 284 ITR 564 (AAR) dissented from);

(ii) The scope of deeming fiction u/s 9 (1)(i) which prima facie appears to be an extension of the classical source rule of taxation is in fact confined to the simpliciter taxability of an income earned in a tax jurisdiction because ‘while the main provision of the deeming fiction seems to be taking a rather aggressive view of the source rule, the Explanations to the deeming fiction considerably narrow down the scope of the same’ and to that extent there is overlapping of s. 9(1)(i) and s.5(2)(b). Further, while s. 9(1)(i) provides that an income with ‘business connection’ in India is chargeable to tax no matter in which part of the world it accrues or arises, the income which can be subjected to tax in India can never exceed the income attributable to operations carried out in India – by the non-resident or by the agent. This is made clear by clause (a) of Explanation 1 to s. 9(1)(i) and Explanation 3. The result is that if the agent (“the business connection”) has been compensated with fair remuneration, there cannot be further income of the non- resident which can be brought to tax u/s 9(1)(i) r.w.s. 5(2)(b).

(192.3 KiB, 547 DLs)

Bonus shares eligible for s. 115F relief if original shares acquired in foreign currency

The assessee, a NRI, purchased shares in foreign currency. On the sale of bonus shares, the assessee claimed relief u/s 115F. The AO & CIT (A) rejected the claim on the ground that s. 115F applied only to shares “acquired or purchased with, or subscribed to in, convertible foreign exchange” and not to bonus shares. On appeal by the assessee, HELD allowing the appeal:

The department’s objection that the assessee has received bonus shares without investing any convertible foreign exchange is not correct because as the original shares were acquired by investing convertible foreign exchange, it cannot be said that the bonus shares were acquired without taking into consideration the original shares. In accordance with Dalmia Investment 52 ITR 567 (SC) the cost of acquisition of the original shares is closely interlinked with the bonus shares. Once bonus shares are issued, the averaging out formula has to be followed with regard to all shares. Accordingly, bonus shares are covered by s. 115C(b) and eligible for benefit u/s 115F.

(36.2 KiB, 1,014 DLs)

To decide whether s. 148 notice is “issued” in time, date of handing over by AO to post office to be seen

In respect of AY 2003-04, the AO issued a notice u/s 148 dated 31.3.2010. However, the notice was given by the AO to the post office for dispatch to the assessee on 7.4.2010 and it was delivered to the assessee on 8.4.2010. The assessee filed a Writ Petition contending that though the notice was dated 31.3.2010, it was not “issued” till it was delivered to the post office on 7.4.2010 by which time the limitation period of 6 years from the end of the assessment year prescribed in s. 149 had expired. HELD upholding the plea:

For purposes of s. 149, the expression “notice shall be issued” means that the notice should go out of the hands of the AO. On facts, though the notice was signed on 31.3.2010, it was sent to the speed post center for booking only on 7.4.2010. Considering the definition of the word “issue”, merely signing the notices on 31.3.2010 cannot be equated with “issuance of notice” as contemplated u/s 149. The date of issue would be the date on which the same was handed over for service to the proper officer, which in the present case would be the date on which the notices was actually handed over to the post office for the purpose of booking for the purpose of effecting service on the assessee. Till the point of time the envelopes are properly stamped with adequate value of postal stamps, it cannot be stated that the process of issue is complete. As the notice was sent for booking to the Speed Post Center on 7.4.2010, the date of “issue” of the notice would be 7.4.2010 and not 31.3.2010, which is beyond the limitation period. Consequently, the reassessment cannot be sustained.

(143.9 KiB, 1,040 DLs)

Jurisdictional CIT should not be part of DRP to avoid likelihood of bias

Pursuant to s. 147 reopening and a draft assessment order u/s 144C, the assessee filed objections before the Dispute Resolution Panel (DRP). As the Director of Income Tax (International Taxation)-II (DIT-IT) who had granted approval to the reopening and had supervised the passing of the draft assessment order was a member of the DRP, the assessee requested him to recuse himself from the panel on the ground that there was a “conflict of interest”. As the DIT-IT declined to do so and participated in the proceedings and finalized the draft assessment order, the assessee filed a Writ Petition contending that the jurisdictional CIT should not be a part of the DRP. The constitutional validity of s. 144C and Rule 3 (2) of the Rules was also challenged. HELD disposing of the Petition:

(i) The doctrine of nemo judex in causa sua (no man shall be a judge of his own cause) is subject to the doctrine of necessity. Bias cannot be established merely because one of the members of the DRP is also a jurisdictional CIT if he was not interested in his personal capacity in the outcome of the assessment order and the directions issued to the AO were not based on extraneous considerations. As the CIT was only discharging statutory functions provided under the Act, bias stood excluded on principles of the doctrine of necessity. Consequently, s. 144C & Rule 3 (2) are not ultra vires;

(ii) However, as the DIT-II was exercising supervisory functions over the AO, the real likelihood of “official bias” cannot be ruled out. Even if the officer is impartial and there is no personal bias or malice, nonetheless, a right minded person would think that in the circumstances, there could be a likelihood of bias on his part. In that event, the officer should not sit and adjudicate upon the matter. He should recuse himself. This follows from the principle that justice must not only be done but seen to be done. In order to ensure that no person should think that there is a real likelihood of bias on the part of the officer concerned, the CBDT is directed to ensure that a jurisdictional Commissioner is not nominated as a member of the DRP under Rule 3 (2) of the Rules. By doing this, the principle that justice must not only be done but seen to be done would be ensured.

(90.1 KiB, 1,110 DLs)

AO reprimanded for harassing the assessee by wrongly levying penalty

The AO levied penalty u/s 271(1)(c) which was deleted by the CIT(A). The AO filed an appeal before the Tribunal. The assessee filed a CO in which it was inter alia argued that in the assessment order which had been supplied to the assessee, there was no direction for initiating penalty though in the assessment order filed by the department with the memo of the appeal, there was a reference to the issue of notice u/s 271(1)(c). The assessee demanded costs u/s 254(2B). HELD by the Tribunal upholding the assessee’s plea:

“… we are surprised to note that contents of assessment orders meant for the same A.Y. 2004-05 in the case of the same assessee, are different. Both the assessment orders are stated to have been passed by the A.O on 25.11.2006 …… The copy of assessment order filed by the assessee with its cross objection is a certified true copy by the ITO and further certified as true copy by the assessee. The above stated facts and circumstances suggest that the A.O has tried to cover up its lapses in not mentioning his satisfaction that it is a fit case for levy of penalty u/s. 271(1)(c) and recording of the initiation of penalty proceedings in the assessment order, which cannot in any way be appreciated. Under these circumstances, there is no reason to doubt the allegation of the assessee that the A.O was adamant to harass the assessee. Thus, in our view, it is a fit case of awarding cost u/s. 254(2B) of the Act, but at the same time, we appreciate the approach of the assessee as discussed hereinabove that they are not interested in the awarding of the cost but their whole purpose in making such request in awarding the cost is only to bring the high handedness of the A.O against the assessee to the notice of the Tribunal. Under the circumstances, we though restrain ourselves from awarding the cost as wished by the assessee, but at the same time, we are inclined to record over here before parting with the order that A.O should have confined himself in making just and proper assessment only, as per the provisions of the law and harassment of the assessee which is not permitted under the Statute should have been avoided at all cost.”

(394.9 KiB, 1,072 DLs)

Despite Tax Avoidance, 100% Depreciation on Sale & Lease Back Allowable

The assessee purchased equipment from the Haryana State Electricity Board (“HSEB”) which was already installed at the Board’s Thermal Power Station at Faridabad and immediately leased the equipment back to the HSEB. The assessee claimed 100% depreciation on the said equipment. The AO relied on McDowell 154 ITR 148 (SC) and disallowed depreciation on the ground that the transaction was not one of purchase and lease but was a pure financial and loan transaction. However, the CIT(A) & Tribunal upheld the claim on the ground that it was a genuine transaction of purchase and lease back. The department filed an appeal before the High Court where it relied on Asea Brown Boveri Ltd v. Industrial Finance Corporation of India AIR 2005 SC 17 and claimed that as risks and rewards incident to the ownership of an asset were transferred to the lessee, the transaction was a loan. HELD dismissing the appeal:

(i) The real intention of the parties in entering into the sale and lease agreement has to be gathered from the words in the agreement in a tangible and in an objective manner and not upon a hypothetical assessment of the supposed motive of the assessee to avoid tax.The lease agreement and invoice show that the ownership of the equipment was that of the assessee. There was a transfer of title. The fact that the transaction was entered into by HSEB in order to raise finance for its day-to-day needs and that HSEB decided to go in for tapping the system of sale and lease back assets as a mode of raising finance at a lower cost does not bind the assessee. HSEB’s intention in going in for the transaction cannot be transposed onto the assessee (Industrial Development Corporation of Orissa 268 ITR 130 (Ori), Rajasthan State Electricity Board 204 CTR 415 (Raj) and Gujarat Gas Company 308 ITR 243 (Guj) followed);

(ii) In order to deny the claim of depreciation, it would have to be held that the transaction was not genuine and that the same was a subterfuge. Merely because an assessee gets a commercial advantage because of the factoring in of a tax benefit, it cannot be said that the transaction is not genuine. There is no finding or evidence to indicate that the transaction was not genuine. The observations of Chinappa Reddy, J in McDowell is not good law in view of UOI vs. Azadi Bachao Andolan 263 ITR 706 (SC) where it was held that “tax planning may be legitimate provided it is within the framework of law”;

(iii) The observations in Asea Brown Boveri Ltd with regard to the nature of a financial lease are not of much use to the revenue in view of the factual backdrop that the transaction has been found to be genuine. Once it is established that the ownership of the equipment is that of the assessee, it is clear that the assessee is entitled to claim depreciation.

(268.4 KiB, 746 DLs)

CBDT directed to formulate uniform policy with strict parameters on appeal filing

A Central Excise appeal was allowed in favour of the assessee by the High Court inter alia on the ground that the department had not challenged similar orders passed by the Tribunal in cases of other assessees. On appeal by the department, HELD reversing the High Court (on merits as well):

As regards the argument of learned counsel for the respondents that having not assailed the correctness of some of the orders passed by the Tribunal and a decision of the High Court of Karnataka, the revenue cannot be permitted to adopt the policy of pick and choose and challenge the orders passed in the cases before us, it would suffice to observe that such a proposition cannot be accepted as an absolute principle of law, although we find some substance in the stated grievance of the assessees before us, because such situations tend to give rise to allegations of malafides etc. Having said so, we are unable to hold that merely because in some cases revenue has not questioned the correctness of an order on the same issue, it would operate as a bar for the revenue to challenge the order in another case. There can be host of factors, like the amount of revenue involved, divergent views of the Tribunals/High Courts on the issue, public interest etc. which may be a just cause, impelling the revenue to prefer an appeal on the same view point of the Tribunal which had been accepted in the past. We, may however, hasten to add that it is high time when the Central Board of Direct and Indirect Taxes comes out with a uniform policy, laying down strict parameters for the guidance of the field staff for deciding whether or not an appeal in a particular case is to be filed. We are constrained to observe that the existing guidelines are followed more in breach, resulting in avoidable allegations of malafides etc on the part of the officers concerned.

(177.7 KiB, 819 DLs)

General Anti Avoidance Rule (GAAR) Law Explained

The assessee, a Canadian Co controlled by its sole director Peter Cohen, earned capital gain of $7.7M from the transfer of property. Another company named “Rcongold Systems Inc” which was controlled by the assessee issued 8,000 voting “common shares” for a consideration of $8M to the assessee. Thereafter, Rcongold issued 80,000 Class “E” non-voting preferred shares with a redemption price of $100 each to the shareholders (the assessee) by way of dividend. The redemption price of the Class “E” non-voting preferred shares was identical to the fair market value (“FMV”) of the common shares. The said 8,000 “common shares” of Rcongold were sold by the assessee to “the Peter Cohen Trust” for an amount of $65, which resulted in the assessee reporting a capital loss of $7.9 M. The assessee’s claim to set-off the said capital loss of $7.9M against the capital gain of $7.9M was denied by the AO on the ground that the scheme was one for “tax avoidance” and hit by the “General Anti Avoidance Rule” (“GAAR”) in s. 245 of the Canadian Income-tax Act. HELD upholding the stand of the AO:

(i) For the GAAR in s. 245 to apply, three aspects have to be satisfied

(a) the assessee must obtain a “tax benefit” from a “transaction” or “series of transactions”,

 

(b) the transaction(s) must be an “avoidance transaction” in the sense of not having been “arranged primarily for bona fide purposes other than to obtain the tax benefit” and

 

(c) the avoidance transaction(s) must be abusive of the provisions of the Act, the burden being on the AO to establish the abuse;

(ii) On facts, all three requirements were satisfied because

(1) there were a “series of transactions” comprising of (a) the incorporation of Rcongold, (b) the subscription for shares of Rcongold by the assessee, (c) the declaration of a stock dividend by Rcongold, (d) the creation of the trust and (d) the sale by the assessee of shares of Rcongold to the trust and there was a “tax benefit” as a result of the transactions;

 

(2) the primary purpose of each transaction in the series was the avoidance of tax. While the incorporation of Rcongold and the issuance by it of common shares were not avoidance transactions in and of themselves, they were necessary steps taken in furtherance of the scheme. The primary purpose of the entire series of transactions was to obtain a tax benefit and so the entire series of transactions is an avoidance transaction;

 

(3) The transactions amounted to “abusive tax avoidance” because they sought to defeat the underlying rationale of the capital loss provisions in the Act. The assessee sought to create an “artificial capital loss” without incurring any “real economic loss”.

(485.2 KiB, 2,407 DLs)

Sale of shares by Mauritius Co can be treated as sale by 100% USA parent. Sale of shares of foreign company taxable if object is to acquire the Indian assets

Idea Cellular Ltd, an Indian company, was set up as a joint venture company pursuant to a JV agreement between AT&T Corp, USA, and the Birla Group. As provided by the agreement 49% of Idea Cellular’s equity was allotted to AT&T Mauritius, being 100% subsidiary & “permitted transferee” of AT&T, USA. Though the shares were allotted to AT&T Mauritius, all rights of voting, management, right to sell etc were vested in AT&T USA (subsequently known as “New Cingular Wireless Services Inc, USA” (“NCWS”). Subsequently, Tata Industries was inducted as a joint venture partner in Idea Cellular. Thereafter, 50% of the shares of Idea Cellular held by AT&T Mauritius were sold by AT&T Mauritius to Aditya Birla Nuvo (nominee of the Birla group) and 100% of the shares of AT&T Mauritius (which held the balance 50% of the shares of Idea Cellular) were sold by NCWS to Tata Industries. Aditya Birla Nuvo obtained a NOC u/s 195(2) permitting it to remit the sale consideration to AT&T Mauritius without TDS. The Court had to consider the validity of three proceedings initiated by the AO (i) Order u/s 163 treating Aditya Birla Nuvo as agent of NCWS USA on the ground that though the transferor was AT&T Mauritius, the gains from sale of the Idea Cellular shares was taxable in the hands of NCWS USA, (ii) Order u/s 163 treating Tata Industries as agent of NCWS USA on the ground that though the shares of AT&T Mauritius were purchased, effectively the underlying shares of Idea Cellular were purchased and (iii) Notice u/s 148 asking NCWS to file a return in respect of the gains arising from (indirect) transfer of the Idea Cellular shares. HELD deciding in favour of the department:

(i) Aditya Birla Nuvo’s argument that the shares of Idea Cellular were beneficially owned by AT&T Mauritius and that the gains would not be taxable in India under the India-Mauritius DTAA is not acceptable because under the JV agreement, AT&T Mauritius was merely the “permitted transferee” and acted “for and on behalf” of NCWS, USA. It was NCWS, USA which was the “beneficial owner” of the shares of idea Cellular and not AT&T Mauritius. Accordingly, Azadi Bachao Andolan 263 ITR 706 (SC) has no application;

(ii) The argument that s. 163 applies only with respect to income “deemed to accrue or arise” in India u/s 9 and not to income “accruing or arising” is not acceptable. Pursuant to Eli Lily 312 ITR 225 (SC), the income accruing or arising in India to NCWS, USA on transfer of a capital asset situate in India, (shares of Idea Cellular) is deemed to accrue or arise in India to NCWS and can be assessed either in the hands of NCWS or in the hands of the payer as agent of the non-resident u/s 163;

(iii) The argument that the AO having issued a NOC u/s 195(2) permitting Aditya Birla Nuvo to remit the sale proceeds without TDS could not recover the tax from the payer by treating it as agent is not acceptable because the said order was obtained by “suppressing material facts” relating to the circumstances in which the shares of Idea Cellular were issued in the name of AT&T Mauritius. As the payer had obtained the s. 195(2) Certificate by making a representation which was incorrect to its knowledge, it could not claim that the s. 195(2) Certificate was validly issued. Further, the proceedings u/s 163 & 195 operate in different fields;

(iv) The argument that once the AO exercises his option u/s 166 to assess the non-resident NCWS USA directly by issuing notice u/s 148, the proceedings initiated against the payer must come to an end is not acceptable because there is nothing in the Act to suggest that the option to assess either in the hands of the representative assessee or in the hands of the non-resident must be exercised at the threshold itself and not at the end of the assessment proceedings. While ordinarily, the AO must not proceed against the representative assessee once proceedings are initiated against the non-resident, in exceptional cases like the present one where complex issues are involved and the AO is unable to make up his mind on account of suppression of material facts, it is open to the AO to continue with the assessment proceedings against the representative assessee and the non-resident simultaneously till he decides to assess either of them;

(v) NCWS’ argument that the s. 148 notice is without jurisdiction is not acceptable because the prima facie belief of the AO that the transaction was in fact a transaction for transfer of a capital asset situate in India (shares of Idea Cellular) was with substance. It is open to NCWS to prove to the contrary by placing all material facts in the assessment proceedings;

(vi) Tata Industries’ argument that no gains are taxable in India as the subject matter of sale were shares of AT&T Mauritius and not the shares of Idea Cellular is not acceptable because prima facie it appears that the transaction for sale of shares of AT&T Mauritius was a “colourable transaction” and was in fact for sale of the shares of Idea Cellular.