(159.2 KiB, 1,318 DLs)

No capital gains in a business reorganization if consideration not determinable. Transfer pricing law does not apply if there is no income

The applicant, a USA company, held shares in an Indian company. As part of a bankruptcy reorganization process, the shares in the Indian company together with other non-Indian assets & liabilities were transferred to other USA companies. The liabilities taken over were more than the assets. The agreement provided that the transfer of the shares was without consideration. The AAR had to consider (i) whether the liabilities of the transferor taken over by the transferee could be said to be “consideration” for transfer of the Indian shares so as to make it chargeable to capital gains and (ii) whether even if there was no chargeable ‘capital gains’, the applicant could be assessed on an ‘arms length” basis under the transfer pricing provisions. HELD answering both questions in favour of the applicant:

(i) The effect of B. C. Srinivasa Setty 128 ITR 294 (SC) is that ss. 45 & 48 are an integrated code and must be read together. If there is no ‘consideration’ u/s 48 there can be no capital gains u/s 45. The ‘profit or gain’ or ‘the full value of the consideration’ envisaged by ss. 45 & 48 is not something which remains ambivalent or indefinite or indeterminable and cannot be arrived at on notional or hypothetical basis. It must be a distinctly and clearly identifiable component of the transaction. It cannot be implied or assumed;

(ii) The liabilities of the applicant taken over as a part of reorganization cannot be treated as consideration nor can it adopted as a measure of consideration for the transfer of shares. The parties did not intend that a specified extent of liabilities taken over should be treated as consideration for the transfer of shares. One cannot find consideration for the transfer by means of conjectures and assumptions. When entire assets and liabilities are taken over in order to reorganize the business, it is difficult to envisage that a proportion of liabilities constitutes consideration for a particular transfer. No commercial or accountancy principle supports such inference. It is difficult if not impossible to predicate that a given part of the liabilities represents the consideration for transfer and such consideration has been passed on to the transferor. One has to consider the entire purpose and substratum of reorganization and cannot import artificial notions of consideration. Accordingly, the take over of liabilities under the reorganization plan cannot be treated as consideration for the transfer of the Indian company shares by the applicant;

(iii) The argument of the Revenue that the transfer pricing provisions will apply even if there is no income is not acceptable. S. 92 is not an independent charging provision but deals with “Computation of income from international transactions”. It provides that “any income arising from an international transaction shall be computed having regard to the arm’s length price”. The expression ‘income arising’ postulates that the income has arisen under the substantive charging provisions of the Act. S. 92 is not intended to bring in a new head of income or to charge tax on income which is not otherwise chargeable under the Act.

(127.7 KiB, 1,408 DLs)

Ishikawajima Harima (SC) doubted / distinguished

Where the assessee, an Australian company, entered into an agreement with Reliance and it was agreed that the consideration thereof constituted “royalty” but the assessee claimed (i) that the said royalty was “effectively connected” with a permanent establishment (PE) and consequently assessable as business profits, (ii) that the portion of such “profits” as was not “attributable” to the PE was not assessable to tax in India and (iii) that even otherwise the royalty was not assessable to tax in view of Ishikawakima 288 ITR 408 (SC) where it was held that fees for technical services (and royalty) was not assessable to tax u/s 9(1)(vii) (9(1)(vi)) if it was not rendered and utilized in India, HELD:

(i) In order to be “effectively connected”, the PE should be engaged in the performance of royalty generating services. There must be a real and intimate connection and clear co-relation between the services giving rise to royalty and the PE. A connection between the PE and the contract is not enough;

(ii) On facts, as the bulk of the work was done outside India, the royalty was not “effectively connected” with the PE so as to qualify as business income. The fact that the said work was done based on inputs from India and the end-product was delivered and utilized in India was not relevant as that was pursuant to a different agreement;

(iii) Ishikawajima cannot be read to mean that the mere existence of a PE is enough to trigger the exclusion clause and cause royalty income to be assessed as business income. It does, however, imply that there may be situations where though the royalty may be “effectively connected” with the PE, still it may not be “attributable” to the PE;

(iv) It is not clear why in Ishikawajima reference has been made to s. 9(1) (vii) (c) instead of s. 9 (1) (vii) (b) even though the two deal with different situations and why it was stated that s. 9 (1)(vii) (c) requires that the services have to be rendered as well as utilized in India in order to be taxable in India even though the word “rendered” is not to be found even in the inapplicable clause (c). Though it is difficult to find an answer, the dicta has to be respected without invoking the doctrine of per incuriam as far as possible;

(v) Further, though in Ishikawajima it was observed that “the legal fiction created by s.9 should be construed having regard to the object which it seeks to achieve”, it was not indicated as to what is the object of the said provision that deters the legal fiction being carried to the extent specifically provided by the language of the section. The object of s. 9(1) is to deem certain incomes as accruing or arising in India so as to widen the net of taxation and this object will not be defeated if the legal fiction enacted by s. 9 is taken to its logical extent (other judgements of SC referred to where it was held that a fiction has to be given full effect);

(vi) Though in Ishikawajima it was held that the location of the source of income within India would not render sufficient nexus to tax the income from that source, this cannot be construed to mean that the age-old test of source of income should be eschewed altogether while considering territorial nexus (other judgements of SC on territorial nexus referred to);

(vii) There is a doubt why Ishikawajima proceeded on the basis that the offshore services performed by the contractor executing a turn key project as a step-in-aid to the execution of the project and deploying those services in India had no real connection to the Indian territory even though it gave rise to a ‘live link’ with the Indian territory and why it was felt that the income arising therefrom did not accrue or arise in India, not to speak of deemed accrual;

(viii) A decision not expressed and accompanied by reasons and not proceeded on a conscious consideration of issue cannot be deemed to be a law having binding effect as is contemplated under Art.141 of the Constitution. That which has escaped in the judgment is not the ratio decidendi;

(ix) Though the AAR has to give full effect to the law laid down in Ishikawajima vis-à-vis s. 9 (1) (vii) and territorial nexus, on facts, there was territorial nexus and a “live link” because a part of the services were rendered in India. The extent and magnitude of services is not decisive.

See Also: Clifford Chance (Bom), Siemens AG (Bom) and Taxability of royalties and fees.

A non-resident earning long-term capital gains on transfer of listed securities is entitled to the benefit of the lower tax rate in the proviso to section 112(1) in addition to the benefit granted by the first proviso to s. 48.

(ii) Interest paid to the other shareholders pursuant to the order of SEBI to compensate for the delay is a part of the cost of acquisition of shares both in the plain sense and in the commercial sense because without such payment the acquisition would not have been possible.

Where the facts showed that the income arising from the sale proceeds of exported goods had actually been received in India because the applicant’s banks at Chennai had been crediting the amounts received from the importer/buyer to the account of the applicant, HELD

(i) Where the income is actually received or has accrued in India, the resort to deeming provision is not warranted and s. 5(2) is sufficient to create a charge in respect of non-resident’s income. Clause (b) to Explanation 1 makes no difference to this position.

(ii) As the right to receive the payment has arisen in India on account of export sales of gold jewellery to the importers abroad, the income actually accrues or arises in India and there is no scope for the argument that the accrual is nullified by clause (b) of Explanation 1 to section 9(1). Clause (b) does not have the effect of preventing the accrual of income altogether.

Where the assessee foreign company was a golf organizer and entered into arrangements with Indian parties for conducting golf events in India and earned income by way of sponsor fees, management fees etc and the question arose whether such income was taxable in India, HELD:

(i) In order to constitute a “permanent establishment” under Article 5.1 of the Treaty, there had to be a “fixed place” through which “the business was carried on”.

(ii) During the days when the golf tournament is conducted, the Golf Course can be regarded as a “place of business” because the center of income earning activities was at that particular place and the Golf Course was at the disposal of the applicant for the stipulated time frame and it could exercise some limited rights. The fact that the duration is short is not relevant.

(iii) However, the words ‘carried on’ conveys the ingredient of regularity, continuity and repetitiveness and as there was a solitary or isolated activity during the year, it was difficult to infer the existence of a PE.

Where the applicant sought an advance ruling on the question whether the tax payable on the sale of listed equity shares would be 10 per cent of the amount of capital gains as per the proviso to s. 112(1) and the CIT filed a strong objection to the application on the ground that as the ADIT had already passed an order u/s 197, entertaining the application would amount to “subverting the ordinary process of judicial determination prescribed under the Act” and create ‘judicial disarray’, HELD castigating the CIT that:

(i) The s. 197 proceedings did not create any embargo because the order had worked itself out and in any event the s. 197 order was a tentative measure for TDS and did not in anyway fetter the jurisdiction of the AAR.

(ii) The CIT had attempted to denude the AAR of its undoubted jurisdiction by raising a bogey of creating “judicial disarray” even when it was seeking to exercise its legitimate jurisdiction. This was not in keeping with healthy traditions. The CIT’s attempt to belittle the role of the AAR in the statutory scheme of adjudication could not be countenanced. Dismay expressed over the language adopted by the CIT.

Where the assessee conducted sophisticated and technical bioanalytical tests for its clients but did not reveal to them as to how it conducts those tests or the inputs that have gone into it, so as to enable them to carry out those tests themselves in future and the question arose whether the fees received for such services could be assessed as “fees for technical services” or as “royalty” under the India-Canada DTAA, HELD

(i) In order to consider the meaning of the term “make available” in Article 12 of the India-Canada DTAA, one can have regard to the India-USA DTAA. The term requires that the service provider should also make his technical knowledge, experience, skill, know-how etc., known to the recipient of the service so as to equip him to independently perform the technical function himself in future, without the help of the service provider. In other words, payment of consideration would be regarded as ‘fee for technical / included services’ only if the twin test of rendering services and making technical knowledge available at the same time is satisfied.

(ii) On facts, as the tests carried out by the applicant did not enable the applicant’s client to derive requisite knowledge to conduct the tests or to develop the technique by itself, it could not be considered to “make available” technical knowledge, skill etc to the payer;

(iii) The fees were also not chargeable to tax as “royalty” because the applicant used its experience and skill itself in conducting the bioequivalence tests, and provided only the final report containing conclusions to its clients and the information concerning scientific or commercial experience of the applicant or relating to the method, procedure or protocol used in conducting bioequivalence tests was not imparted to the clients.

(iv) what distinguishes a contract for provision of know-how from a contract for rendering advisory services is the concept of ‘imparting’. An adviser or consultant, rather than imparting his experience, uses it himself. All that he imparts is the conclusion that he draws from his own experience.

See Also: Diamond Services International Ltd. vs. UOI (Bom)

For purposes of Article 20 of the India-Korea DTAA, a Government undertaking with corporate status cannot be equated to the Government. Even if the Articles of Incorporation make it clear that the Government has pervasive control over the undertaking, it still cannot be treated to be a wing or an integral part of the Government. However, the fundamental requirement of Article 20(1)(a) is that the remuneration should be paid by the Contracting State. Even if it is paid out of funds allocated by the Government to the undertaking specifically towards personnel expenses, the requirement of Article 20(1) is satisfied. It is as good as payment by the State itself. The expression “payment by a Contracting State” cannot be given a rigid or literal interpretation so as to cover the payments made directly by Government or a department of the Government. Even if the payment is made out of State’s funds set apart for that purpose, the requirement of Section 20(1)(a) will be attracted and the Indian income-tax cannot be levied in such a case.

Where the applicant had entered into a joint venture with two Indian companies for providing consultancy services for the development of tunnels and the question was whether the JV constitutes an ‘Association of Persons’, HELD:

(i) An ‘AOP’ is one in which two or more persons join in a common purpose or common action with the object of producing income, profits or gains. The control and management must be unified.

(ii) On facts, as the client had entered into a contract with the ‘consortium’ and each of the companies was made ‘jointly and severally’ liable and the other provisions revealed unity of action, common management and planned coordination among the JV partners, there was an AOP.

(iii) The fact that the contract distributed duties and responsibilities and that no member could bind the other did not affect the integrity of the association;

(iv) Also, the fact that there is no sharing of profit or loss and each member of JV makes its own investment and maintains its own accounts and receives payment directly from the client (pursuant to a consolidated invoice) does not detract from the existence of an AOP. Ruling in Van Oord 248 ITR 399 distinguished on facts.

Where the applicant entered into a contract with Raytehon USA for the acquisition of hardware and customized software and the title to the hardware was to pass outside India and all activities under the contract (except for installation and support activities) were to be performed by Raytheon outside India, HELD:

(i) The profits on sale of hardware are not assessable to tax in India in the absence of a PE;

(ii) As regards the profits from supply of documents and software, as there was a mere right to use and not an outright sale of the same, it constitutes “royalty” u/s 9 (1) (vi) and Article 12 of DTAA;

(iii) The judgement of the Supreme Court in Tata Consultancy Services that once software is put on a CD it becomes a sale of goods is not applicable as it is rendered under the sales-tax Act. Under the I. T. Act, right to use software is ‘royalty’ irrespective of the fact that it is on a CD.

(iv) Profits from installation, testing and training services are chargeable as “fees for technical/included services”.