(99.5 KiB, 475 DLs)

A composite contract for installation & commissioning cannot be split so as to exempt the profits from offshore supply of goods

The Applicant entered into a contract with ONGC for “services for supply, installation and commissioning of 36 manometer gauges”. The applicant claimed that the contract, though composite, had to be split into various components in line with Ishikawajima-Harima Heavy Industries 288 ITR 408 (SC), Hyundai Heavy Industries 291 ITR 482 (SC) & Hyosung Corporation 314 ITR 343 (AAR), and that the income attributable to the supply of manometer gauges was not taxable in India because the title to the goods had passed outside India & the payment was received outside India. HELD by the AAR rejecting the plea:

Though in Ishikawajima-Harima, a two judge bench of the Supreme Court had adopted a dissecting approach by dissecting a composite contract into two parts and holding one of the parts not amenable to taxation in India, this cannot be followed in view of the 3 Judge verdict in Vodafone International Holdings vs. UOI 345 ITR 1 (SC) where it was held that a transaction had to be “looked at and not looked through” and seen as a whole and not by adopting a “dissecting approach”. A contract for sale of goods differs from a contract for installation and commissioning of a project. The tests relevant for considering where the title to the equipment, passed would not be relevant while construing the terms of a supply and erection contract. On facts, the contract is for erection and commissioning of 36 manometer gauges and not one for sale of equipment or erection of the equipment. It is a composite & indivisible contract for supply and erection at sites within the territory of India and cannot be split. The income accrued in India and was assessable u/s 44BB.

(187.0 KiB, 755 DLs)

Selective buy-back of shares in lieu of dividend is a “colourable transaction”

The Applicant’s shares were held 48.87 % by a US company & 25.06% by a Mauritius company. The rest was held by a Singapore company and the public. The Mauritius company was ultimately held by another US company. Since 1.4.2003, when s. 115-O was introduced, the Applicant did not (to avoid DDT) distribute dividend. Instead, it let its reserves grow and offered a buy-back in the year 2008. The buy-back was accepted only by the Mauritius company, in whose hands the capital gains u/s 46A, were not assessable under the India-Mauritius DTAA. The other shareholders did not accept the offer. A second offer was proposed which also was accepted only by the Mauritius company and not by the other shareholders. The Applicant sought a ruling on whether the gains as a result of the buy-back would be capital gains u/s 46A in the hands of the Mauritius company and exempt under Article 13 of the India-Mauritius DTAA. HELD by the AAR;

Though the Applicant was making regular profits, it did not declare any dividends after the introduction of s. 115-O and allowed its reserves to grow. This was only to avoid paying DDT. The buy-back was a “colourable device” devised to avoid tax on distributed profits u/s 115-O because while it would result in repatriation of funds to the Mauritius company, that would constitute “capital gains” in the hands of the recipient, and not be assessable to tax in India under Article 13 of the India-Mauritius DTAA. The fact that the other major shareholders did not accept the buy-back was significant. A buy-back results in a release of accumulated profits which is assessable as “dividend”. The exemption to treat the buy-back proceeds as capital gains is only in respect of a genuine buy-back of shares. As the transaction is colourable, it is not a transaction in the eye of law and has to be ignored and the arrangement has to be treated as a distribution of profits by a company to its shareholders which is assessable as dividend in the hands of the recipient.

(119.3 KiB, 573 DLs)

S. 47(iv) relief not available if holding co and nominees hold 100% of subsidiary

The applicant, a German company, held 99.99% of the shareholding of an Indian company. The rest of the shares were held by other companies as nominees of the applicant. The Indian company proposed a buy back of shares u/s 77A of the Companies Act which would have resulted in transfer of shares of the Indian company from the applicant to the Indian company at a price to be determined. The applicant claimed that as it and its nominees held 100% of the shares of the Indian company, the exemption conferred by s. 47(iv) on transfers between holding company and 100% subsidiary applied and s. 46A would not apply. HELD by the AAR:

(i) S. 47(iv) exempts a transfer of a capital asset by a company to its subsidiary if “the parent company or its nominees hold the whole of the share capital of the subsidiary company”. The word used is “or” and not “and”. The assessee held only 99.99% of the shareholding. The shares held by the nominees cannot be considered as held by the assessee. If, under Indian law (s. 49 (3) of the Companies Act), a company cannot by itself hold 100% of the shares in a subsidiary, it would only mean that Parliament did not intend to confer the benefit of s. 47(iv) on such a parent company. Though this approach confines the relief to a particular species of parent companies, it does not mean that the provision is unworkable. If the nominees are treated as holding the shares benami for the parent company, it would offend the Benami Transactions (Prohibition) Act, 1988 and also violate s. 49(3) of the Companies Act. The nominees can also not be regarded as a trustee in view of s. 153 of the Companies Act. The result is that the applicant does not hold 100% of the share capital of the subsidiary and so s. 47(iv) is not attracted;

(ii) S. 46A, which provides that in the case of a buyback, the difference between the consideration and the cost of acquisition shall be deemed to be capital gains is a special provision and prevails s. 45. S. 47 overrides s. 45 but not s. 46A. There is no reason to enquire whether s. 46A is a charging section or not. The result is that even if the exemption in s. 47(iv) is held applicable, it does not override s. 46A and the applicant is subject to capital gains.

(157.2 KiB, 474 DLs)

S. 245R(2): Pendency of question in payee’s hands disbars payer’s application

The Applicant, a PSU, entered into an offshore services contract with a Russian company for setting up a power plant. The Applicant claimed that the income arising to the Russian company from offshore supply of equipment was not chargeable to tax in India and that it was not liable to deduct/ bear TDS thereon u/s 195. However, as in the assessment of the Russian company, the AO had already taken the view that the income from offshore supply was chargeable to tax u/s 44BBB and the issue was pending before the Tribunal, the question arose whether the application was maintainable in view of clause (1) of the Proviso to s. 245R(2) which provides that an application is not maintainable if the question raised in it “is already pending before any income-tax authority or Appellate Tribunal, or any Court.” The Applicant claimed that the pendency in the case of the recipient did not affect the maintainability in the context of the payer’s obligation to deduct tax u/s 195. HELD rejecting the application:

The argument that the pendency of the question in the case of the recipient cannot bar the application in the case of the payer is not acceptable because an “advance ruling” is a determination in relation to a “transaction”. A “transaction” always involves the payer and payee. It is not possible to separate an applicant from a transaction while he is seeking a Ruling, since the Ruling relates to a transaction undertaken by him or to be undertaken by him. A ruling also cannot be divorced from a transaction. The question posed before the income-tax authorities in the case of the recipient and before the AAR in the case of the payer is the same, namely, whether the income is assessable to tax. Consequently, the bar in s. 245R(2) applies and the payer’s application is not maintainable. The contrary view taken by the AAR in Airports Authority of India In re 168 Taxman 158 is not correct (Foster (AAR No. 975 of 2009) followed).

(224.5 KiB, 880 DLs)

Gains arising on sale of shares of foreign company by NR to NR taxable in India if the foreign co only held Indian assets

Two French companies named “Murieux Alliance” (‘MA’) and “Groupe Industrial Marcel Dassault” (“GIMD”) held shares in another French company named “ShanH”. MA & GIMD acquired shares in an Indian company named “Shantha Biotechnics Ltd” (“Shantha”). The shares in Shantha were transferred to ShanH. MA and GIMD subsequently sold the shares in ShanH to another French company named “Sanofi Pasteur Holding”. The assessees filed an application for advance ruling claiming that as the two French companies had sold the shares of another French company to a third French company, the gains were not chargeable to tax in India. The department opposed the application on the ground that ShanH was formed with no purpose other than to hold the shares of the Indian company and that the transaction was taxable in India. HELD upholding the department’s plea:

(i) Azadi Bachao Andolan, though binding on the AAR, may not be the final word because under the proviso to s. 245R(2), the AAR is entitled to disallow an application if the question raised therein relates to an issue which is designed, prime facie, for the avoidance of income-tax. The AAR is entitled to see whether the steps taken were a device to avoid liability to tax. Also it is difficult to accept the arguments based on Azadi Bachao Andolan because that judgement appears to proceed on the basis that the views expressed by Chinnappa Reddy, J. were his own and did not represent the view of the Court as a whole. The view that has emerged is that notwithstanding the legal validity of a transaction or a set of transactions, if the purpose was to create a legal smoke screen to avoid the payment of tax that would legitimately be due as having arisen on the basis of a transaction or an event, the legal effect of the transaction in the context of the taxing statute, has to be considered, notwithstanding its reality or validity;

(ii) On facts, the French company’s (ShanH) only asset were the shares in the Indian company & it had no other business. When its shares were sold, what really passes were the underlying assets and the control of the Indian company. A gain was generated by the transaction. If the transaction is accepted at face value, control over Indian assets and business can pass from hand to hand without incurring any liability to tax in India. Such transactions have to be treated as ineffectual. It is not necessary to ignore the existence of ShanH to come to a conclusion that what is put up is a facade in the context of the tax law and would amount to a scheme for avoidance of tax;

(iii) Under Article 14(5) of the India-France DTAA, gains from the alienation of shares representing a participation of at least 10% in an Indian company may be taxed in India. Here, though the shares being transferred are that of a French company, the situs of the underlying assets & controlling interest cannot be ignored. What is involved in the transaction is an alienation of the assets and controlling interest of an Indian company. Consequently, even though such interest is not an alienation of the shares of an Indian company, still, on a purposive construction of Article 14(5), the capital gains is taxable in India.

(315.4 KiB, 812 DLs)

License fee for Software, even if “copyrighted article”, taxable as “royalty”

The applicant was the developer of software. It granted a non-exclusive and non-transferable license to an Indian company to use the software without any sub-licensing rights. The licensee was not allowed to modify the software programme and could make copies only for its own use. The applicant filed an application for advance ruling in which it claimed, relying on Dassault Systems 322 ITR 125 (AAR) and Tata Consultancy Services 271 ITR 401 (SC), that the transaction involved the use/ right to use of a “copyrighted article” but not the “copyright” itself and so the license fees were not assessable to tax as “royalty” u/s 9(1)(vi) of the Act & Article 12 of the India-Sri Lanka DTAA. HELD rejecting the applicant’s plea:

S. 9(1)(vi) & Article 12 define the term “royalty” to include any payment for the use of, or the right to use, a “copyright” of scientific work. Software programmes are a “copyright” and are protected under the Copyright Act, 1957. As the software programme is a “copyright”, any payment received for transferring the right to use it is “royalty” as defined in the Act. The argument that there is a distinction between a “copyright” and a “copyrighted article” is not acceptable because there is no such distinction made either in the Income-tax Act or the Copyright Act. The use of software involves the use of the copyright; the software cannot be divorced from the copyright itself. Accordingly, even a fee for the use of a “copyrighted article” is assessable as “royalty”. (Microsoft/Gracemac 42 SOT 550 (Del) followed; Dassault Systems 322 ITR 125 (AAR) not followed; Tata Consultancy 271 ITR 401 (SC) distinguished)

(199.6 KiB, 656 DLs)

Off-shore supplies not taxable despite composite contract & PE’s role in clearance

The assessee, a Korean company, entered into three contracts with Delhi Transco Ltd for (i) offshore supply contract on CIF basis, (ii) onshore supply contract and (iii) onshore service contract. The applicant claimed that the income arising from the offshore supply contract was not taxable in India. The revenue claimed that the profits from the off-shore supply was taxable in India on the basis that (a) though the supply contract was awarded separately, any breach under one contract was deemed breach of the other contracts, (b) the award of separate contracts did not dilute the responsibility of the applicant for successful completion of the facility as per specifications, (c) the three contracts were composite contracts and one could not exist without the other, (d) the offshore supplies were on CIF basis and the contracts for offshore supply and onshore contracts were signed on the same date, (e) the insurance requirement of the offshore supplies contract require that the applicant will take out and maintain insurance of cargo, installation, worker compensation, etc, (f) the case is not a case of a sale simpliciter but is for full package involving onshore services. It could not have made a difference had the contract been one instead of three divisible contracts. HELD rejecting the contentions of the department:

(i) The clauses in the offshore supply contract agreement regarding the transfer of ownership, the payment mechanism in the form of letter of credit which ensures the credit of the amount in foreign currency to the applicant’s foreign bank account on receipt of shipment advice and insurance clause establish that the transaction of sale and the title took place outside Indian Territory. The ownership and property in goods passed outside India. The transit risk borne by the applicant till the goods reach the site in India is not necessarily inconsistent with the sale of goods taking place outside India. The parties may decide between them as to when the title of the goods should pass. As the consideration for the sale portion is separately specified, it can well be separated from the whole. (Ishikwajima Harima 288 ITR 410 (SC) & Hyosung Corporation 314 ITR 343 (AAR) followed; Ansaldo Energia SPA 310 ITR 237 (Mad) distinguished);

(ii) Nothing in law prevents parties to enter into a contract which provides for sale of material for a specified consideration although they were meant to be utilized in the fabrication and installation of a complete plant;

(iii) Though the assessee had a PE in India, that came into existence for the purpose of carrying out the contract for onshore supplies and services etc and had no role to play in offshore supplies. Even if the PE was involved in carrying on some incidental activities such as clearance from the port and transportation, it cannot be said that the PE is in connection with the offshore supplies.

(363.0 KiB, 703 DLs)

Non-residents not eligible for benefit of second proviso to s. 112

The applicant, a company based in Scotland sold shares of Cairns India Limited to Petronas Corporation Intl. Limited for a consideration of USD 241,426,379 in off-market-mode and not through a recognized stock exchange. The assessee filed an application for advance ruling claiming that it was entitled to the benefit of the Proviso to s. 112 (1) and liable to pay tax at 10% of the capital gains. The Revenue resisted the plea on the ground that the benefit of the Proviso to s. 112 was available only to assessees who were eligible to the benefit of indexation in the second proviso to s. 48 and as the assessee was not eligible for indexation, it could not claim the benefit of the lower rate of tax in the Proviso to s. 112. HELD upholding the Revenue’s plea:

The expression “before giving effect to the 2nd proviso to s. 48‟ in the Proviso to s. 112(1) pre-supposes the existence of a case where computation of long-term capital gains could be made in accordance with the formula contained in the 2nd proviso in s. 48. It means that the asset must be one qualified for indexation under the second proviso to s. 48. There is no justification in not giving effect to the words used in the proviso. As the 2nd proviso to s. 48 is not applicable to non-residents, occasion to apply the proviso to s. 112(1) does not arise. A non-resident foreign company cannot claim the double benefit of protection against rupee value fluctuation as well as indexation (Timken 294 ITR 513 (AAR) not followed; BASF AG 293 ITR (AT) 1 followed).

(179.3 KiB, 777 DLs)

Transfer Pricing: Despite “Implicit support” by holding company, subsidiary entitled to pay holding company at arms’ length for “explicit support”

The assessee, a wholly-owned subsidiary of General Electric Capital US (GECUS), was in the business of providing financial services and took loans for this purpose in the form of commercial paper and unsecured debentures. Between 1988 and 1995, GECUS provided to the assessee, at no cost, an explicit guarantee for its debt issuances. From 1996, GECUS began charging a fee equal to 1% of the face amount of the assessee’s debt issuances for that same guarantee which amounted to about $135.4 million. The assessee’s claim for deduction of the fee was denied by the tax department u/s 69(2)/247(2) (transfer pricing provisions) on the ground that as there was “implicit support” by GECUS to the assessee, the payment of the guarantee fee was “superfluous” and not at arms’ length. This was reversed by the Tax Court on the basis that by the explicit guarantee from the holding company, the assessee had a better rating and had to pay lower interest and received a benefit which was valued at 1.83%. As the fee paid for the benefit was only 1%, it was at arms’ length. On appeal by the department, HELD dismissing the appeal:

(i) In determining the arms length price, all economically relevant factors (including the “implicit support” that the subsidiary enjoys from the holding company) have to be considered. The explicit guarantee by the holding company also has a value to the subsidiary (Para 1.6 of the OECD Commentary on Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations referred). The question is how much an arm’s length party, benefiting from the implicit guarantee would be willing to pay for the explicit guarantee;

(ii) The “yield method” can be adopted which requires a comparison between the credit rating which an arm’s length party, in the same circumstances as the assessee, would have obtained and the credit rating which would have been obtained without the explicit guarantee. On facts, it was shown that the assessee would have enjoyed a lower credit rating without the explicit guarantee from the holding company and would have had to pay a higher interest than it did with the explicit guarantee. The incremental cost that the assessee would have had to pay if it did not have the explicit guarantee was valued at 1.83% and so the guarantee fee was at arms length.

(312.2 KiB, 1,064 DLs)

Australian Tax Office Ruling on Transfer Pricing Implications

The Australian Taxation Office has issued a ‘Taxation Ruling’ dated 9.2.2011 in which it has discussed the application of the transfer pricing provisions to business restructuring by multinational enterprises.

The Ruling considers situations where such transfers occur between MNE members to implement changes in the MNE’s existing business arrangements or operations. Common examples are product supply chain restructurings involving conversion of a distributor into a sales agency arrangement or of a manufacturer into a provider of manufacturing services. Business restructurings also commonly involve the transfer of the ownership and management of intangibles such as patents, trademarks and brand names.

The Ruling explains the following process for setting or reviewing transfer pricing

Step 1: Characterize the international dealings between the associated enterprises in the context of the taxpayer’s business

 

Step 2: Select the most appropriate transfer pricing methodology or methodologies

 

Step 3: Apply the most appropriate method and determine an arm’s length outcome

The Ruling refers extensively to the “Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines)”.

The Ruling also gives practical examples to explain the transfer pricing law.