(222.5 KiB, 559 DLs)

Employees’ PF/ ESI Contribution is not covered by s. 43B & is only allowable as a deduction u/s 36(1)(va) if paid by the “due date” prescribed therein

In AY 2008-09 the assessee collected employees’ contribution to the Provident Fund and ESIC but did not pay it within the due date prescribed by the relevant legislation. The amount was, however, paid before the due date of filing the ROI. The AO assessed the said amounts as income u/s 2(24)(x) but declined to grant a deduction u/s 36(1)(va) as the amount had been paid after the due date. The CIT(A), relying on Alom Extrusions 319 ITR 306 (SC) and AIMIL 321 ITR 508 (Del) held that the amounts had to be allowed as a deduction u/s 43B as they had been paid before filing the ROI. On appeal by the department to the Tribunal, HELD reversing the CIT(A):

S. 43B covers only the sums payable by way of contribution by the assessee as an employer, i.e., the employer’s contribution to the PF and ESI funds. It does not cover the employees contribution. While the employer’s contribution is allowable u/s 37(1), the employees’ contribution collected by the employer is deemed to be his income u/s 2(24)(x) and is allowable as a deduction u/s 36(1)(va) only if it is paid to the relevant fund by the due date as prescribed in the relevant legislation. Even if one assumes that s. 43B(b) applies to s. 36(1)(va) payments, a deduction would not be admissible because the s. 36(1)(va) payments are not ‘otherwise allowable’ if they are paid beyond the “due date”. The decisions in Vinay Cement 213 CTR (SC) 268 & Alom Extrusions 319 ITR 306 (SC) are not an authority on the point that employees’ contributions are also covered by s. 43B. Though in AIMIL 321 ITR 508 (Del) it was held that employees’ contribution to EPF and ESI funds are covered by s. 43B, it cannot be followed because (i) the Court moved on the premise that employees’ contribution is subject to clause (b) of s. 43B and did not notice the condition in s. 36(1)(va), (ii) the decision by the tribunal, which was approved by the High Court in AIMIL was rendered without considering the decision of the Special Bench in ITC Ltd & (iii) it is inconsistent with Godaveri (Mannar) Sahakari 298 ITR 149 (Bom). Accordingly, AIMIL cannot be followed and the deductibility of employees’ contribution has to be seen only with reference to s. 36(1)(va) (together with grace period) (Bengal Chemicals & Pharmaceuticals (included in file) & ITC Ltd 112 ITD 57 (Kol)(SB) followed)

(125.7 KiB, 621 DLs)

No S. 14A/ Rule 8D disallowance without showing how assessee is wrong

In AY 2009-10, the assessee earned tax-free dividend of Rs. 32 lakhs on investments that had been made in earlier years. The assessee claimed that as he had not incurred any expenditure to earn the dividend income, no disallowance u/s 14A was permissible. The AO rejected the claim and made a disallowance by applying Rule 8D. The CIT(A) deleted the disallowance on the ground that the AO had mechanically applied Rule 8D to compute the disallowance. On appeal by the department to the Tribunal, HELD dismissing the appeal:

The AO has not brought on record anything which proves that there is any expenditure incurred towards earning of dividend income. The AO has not examined the accounts of the assessee and there is no satisfaction recorded by the AO about the correctness of the claim of the assessee and without the same he invoked Rule 8D. While rejecting the claim of the assessee with regard to expenditure or no expenditure, as the case may be, in relation to exempted income, the AO has to indicate cogent reasons for the same. The AO has not considered the claim of the assessee and straight away embarked upon computing disallowance under Rule 8D of the Rules on presuming the average value of investment at ½% of the total value. This is not permissible (J. K. Investors (Bombay) followed)

(79.1 KiB, 460 DLs)

S. 153A: After expiry of s. 143(2) time limit, s. 143(1) assessment is final & addition u/s 153A can be made only if incriminating material is found in search

For AY 2005-06, the AO passed an intimation u/s 143(1) accepting the return as filed. Subsequently, there was a search u/s 132. The AO noticed that an amount of Rs. 93 lakhs received by the assessee as a loan in earlier years had been treated as a gift and credited to the capital account. He passed an assessment order u/s 153A in which he held that the said amount was assessable as a cash credit u/s 68. The CIT(A) partly confirmed the addition. Before the Tribunal, the assessee argued that as no incriminating material was found during the search, the addition could not be made u/s 153A. HELD by the Tribunal upholding the plea:

In All Cargo Global Logistics 137 ITD 287 (Mum)(SB), the Special Bench held that in a case where the assessment has abated the AO can make additions in the assessment, even if no incriminating material has been found. However, in a case where the assessment has not abated, an assessment u/s 153A can be made only on the basis of incriminating material (i.e. books of account & other documents found in the course of search but not produced in the course of original assessment and undisclosed income or property disclosed during the course of search). On facts, as the assessment was completed u/s 143(1) and the time limit for issue of s. 143(2) notice had expired on the date of search, there was no assessment pending and there was no question of abatement. Therefore, the addition could be made only on the basis of incriminating material found during search. As the addition u/s 153A was made on the information/material available in the return of income (i.e. the information regarding the gift was available in the return of income as capital account had been credited by the assessee by the amount of gift) and not on the basis of any incriminating material found during the search, the AO had no jurisdiction to make the addition u/s 153A.

(221.0 KiB, 1,431 DLs)

Taxation of foreign professional firms & concept of “force of attraction” under India-UK DTAA explained. Linklaters LLP 40 SOT 51 (Mum) held to be not good law

The assessee, a U.K. partnership firm of Solicitors, provided legal consultancy services in connection with different projects in India and claimed that the taxability of the income arising there from had to be processed under Article 15 (“independent professional services“) of the India-UK DTAA. The AO rejected the claim regarding applicability of Article 15 and held that as the assessee had a PE in India as per Article 5 and as the services had been rendered in India, the entire income was chargeable to tax in India under Article 7. In AY 1996-97, the Tribunal (82 ITD 106 (Mum)) accepted the claim of the assessee that if the aggregate period of stay of the employees/ partners did not exceed 90 days, the income was not taxable under Article 15 of the DTAA and if it exceeded that period, only the Indian activity was taxable u/s 9(i). The said verdict was affirmed by the Bombay High Court in 176 Taxman 485. Later, another Bench in Linklaters LLP vs. ITO 40 SOT 51 (Mum) held that as the aforesaid verdicts of the Tribunal & High Court in Clifford Chance turned on the basis that fees for technical services rendered outside India were not chargeable to tax u/s 9(1)(vii) and that they were not good law in view of the retrospective amendment to s. 9(1) by the Finance Act, 2010 w.e.f. 1.6.1976 which provided that “fees for technical services” would be taxable in India even if they were rendered outside India. In Linklaters LLP it was also held that the expression “directly or indirectly attributable” in Article 7(1) triggered the “force of attraction” rule and that the entire earnings relatable to the projects in India would be chargeable to tax in India. As there was doubt as to the correctness of the view in Linklaters, the Special Bench was constituted to consider two issues (i) whether the verdict of the High Court in Clifford Chance was good law after the retrospective amendment to s. 9 & (ii) whether the expression “directly or indirectly attributable to the PE” in Article 7(1) meant that the consideration attributable to the services rendered in the State of residence is taxable in the source State. HELD by the Special Bench:

(i) The view taken by the Tribunal and the High Court in Clifford Chance was that if Article 15 of the India-UK Treaty is not applicable because the stay of the partner exceeded 90 days, then the taxability of the income would be determined by s. 9(1)(i) of the Act. It was held that for determination of income u/s 9(1)(i), the territorial nexus doctrine plays an important part and if the income arises out of operations in more than one jurisdiction, it would not be correct to contend that the entire income accrues or arises in each of the jurisdictions. The High Court applied the law laid down by the Supreme Court in the context of s. 9(1)(i) that if all the operations are not carried out in the taxable territories, the profits and gains of business deemed to accrue in India through and from business connection in India shall be only such profits and gains as are reasonably attributable to the operations carried out in the taxable territories. Accordingly, the view expressed in Linklaters LLP that the judgment of the Bombay High Court is based on the premise of s. 9(1)(vii) and that the said premise no longer holds good in view of the retrospective amendment is not correct. The law laid down by the High Court continues to be good law;

(ii) As regards the rule of “force of attraction“, Article 7(1) provides that the profits of the UK enterprise “directly or indirectly attributable to the PE” may be assessed in India. The connotation of what is “directly attributable to the PE” is set out in Article 7(2) while the connotation of what is “indirectly attributable to the PE” is set out in Article 7(3). When the connotation of “profits indirectly attributable” to the PE is defined specifically in Article 7(3), one cannot refer to Article 7(1) of the UN Model Convention which is materially different from Article 7(1) & 7(3) of the India-UK DTAA. The reliance placed in Linklater on the UN Model Convention to come to the conclusion that the connotation of “profits indirectly attributable to PE” in Article 7(1) incorporates the “force of attraction” rule thereby bringing an enterprise having a PE in another country within the fiscal jurisdiction of that another country to such a degree that such another country can properly tax all profits that the enterprise derives from that country – whether the transactions are routed and performed through their PE or not – is clearly misplaced and not acceptable.

(270.1 KiB, 892 DLs)

Law on what constitutes a PE and how to attribute profits to a PE explained

The Tribunal had to consider the following legal issues: (i) whether the assessee could be said to have a PE in terms of Article 5(1) and 5(2) of the DTAA? (ii) what is the correct method to allocate profits to the PE?, (iii) whether fees for software is assessable as royalty after the retrospective amendment to s. 9(1)(vi) and (iv) whether the payment for link charges is taxable as ‘equipment royalty’? HELD by the Tribunal:

(i) The assessee’s argument that it does not have a PE under Article 5(1) cannot be accepted because its employees frequently visited the premises of CIS to provide supervision, direction and control over the operations of CIS and such employees had a fixed place of business at their disposal. CIS was practically the projection of assessee’s business in India and carried out its business under the control and guidance of the assessee and without assuming any significant risk in relation to such functions. Besides the assessee has also provided certain hardware and software assets on free of cost basis to CIS. However, it does not constitute a dependent agent PE in terms of Article 5(4) and 5(5) of the DTAA;

(ii) The correct approach to arrive at the profits attributable to the PE should. be as under: (i) compute the Global operating Income percentage of the customer care business as per annual report/10K of the company, (ii) this percentage should be applied to the end-customer revenue with regard to contracts/projects where services were procured from CIS. The amount arrived at is the Operating Income from Indian operations, (iii) the operating income from India operations is to be reduced by the profit before tax of CIS. This residual is now attributable between US and India, (iv) the profit attributable to the PE should be estimated on residual profits as determined under Step 3 above;

(iii) As regards the taxability of software license fees, he retrospective amendment to s. 9(1)(vi) by the Finance Act, 2012 widens the scope of the term “royalty” but does not impact the provisions of the DTAA in any manner. Consequently, the purchase of software falls within the category of copyrighted article and not towards acquisition of any copyright in the software and hence the consideration is not assessable as Royalty. Even otherwise, as the payment is in the nature of reimbursement of expenses, it is not taxable in the hands of the assessee (B4U International Holding & Nokia Networks OY followed);

(iv) As regards the payment of link charges as equipment royalty, there is no transfer of the right to use, either to the assessee or to CIS. The assessee has merely procured a service and provided the same to CIS, no part of equipment was leased out to CIS. Even otherwise, the payment is in the nature of reimbursement of expenses and accordingly not taxable in the hands of the assessee.

(218.3 KiB, 569 DLs)

Transfer Pricing: “High End” Cos in ITES/BPO sector comparable to “Low End” ones

The assessee raised three contentions in support of the contention that its charges were at ALP: (i) that the assessee was engaged in the “low end” activity of “voice based call centre” and that the comparables chosen by the TPO were not functionally comparable as they were engaged in the “high end” activity of “knowledge process outsourcing (KPO)“, “software development” etc, (ii) that the margin has to be computed on the basis of return on asset employed (ROA) or on capital employed (ROCE) and not on the basis of operating cost & (iii) that as its income was exempt u/s 10A, there was no ‘tax avoidance‘ and the transfer pricing provisions could not apply. HELD by the Tribunal:

(i) The argument that the ITES/BPO industry has several segments starting from low end segment such ‘call centre’, ‘customer care’ to high end segments such as ‘KPO’, ‘content development’ etc. in which there is wide variation in the billing rates and that high end services are not comparable to the low end services is not acceptable because under Rule 10B(2) the comparability of an international transaction with an uncontrolled transaction has to be judged with the reference to the services provided, functions performed, asset employed and risk assumed. All companies which are in the ITES segment are providing similar services and difference is in the internal working which is reflected through difference in qualifications and skills of the employees. The difference in skill/ qualification of the employees and their payment structure and the difference in billing rate does not affect the comparability in any significant manner under TNMM;

(ii) Though Rule 10B(1)(e) gives the option of computing the margin in relation to asset employed (ROA or ROCE), the OECD and the United Nations TP manual provide that ROCA/ROA are suitable only for manufacturing and other capital or asset intensive industries and not for the service sector. In the case of service companies, the main asset is employees which is not reflected in the balance sheet and, therefore, ROCA/ROA will not be an appropriate method for the purpose of computation of margin;

(iii) The argument that as the assessee’s income is exempt u/s 10A, there was no tax avoidance in transferring profit to a low tax jurisdiction is not acceptable because the law has to be applied as enacted. There is no provision in the transfer pricing regulations that for applying the said provisions the revenue has to prove tax avoidance. Once there is a international transaction, the ALP has to be computed as per the prescribed methods.

(129.5 KiB, 680 DLs)

S. 43(5): Loss on foreign currency forward contracts by a manufacturer/ exporter is a “speculation loss” and not a “hedging loss”

The assessee, a dealer in diamonds, entered into forward contracts in US dollars. Some of the contracts were cancelled during the year and some were outstanding at the end of the year. The assessee suffered a loss of Rs. 4.02 crores on account of the cancellation and “marked to market” of the said forward contracts and claimed that sum as a deduction. The AO & CIT(A), relied on Instruction No. 03/2010 dated 23-3-2010 and held that the said loss arose on account of a “speculative transaction” while the assessee claimed that it arose out of a “hedging transaction”. HELD by the Tribunal:

There is a difference between a “speculative transaction” and a “hedging transaction”. S. 43(5) defines a “speculative transaction” to mean a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. Proviso (a) to s. 43(5) refers to a “hedging transaction” as a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchandising business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him. In order for a transaction to be a “hedging transaction”, the commodity dealt in should be the same. If the subject matter of the transaction is different, it cannot be termed a hedging transaction. Also, the merchandise in respect of which the forward transactions have been entered into by the assessee must have a direct connection with the goods sold by him. On facts, as the assessee was not dealing in Foreign Exchange, the forward transactions entered into by it cannot be held to be hedging transactions. As the assessee is dealing in diamonds, only the forward contracts entered into for diamonds would be covered by Proviso (a) to s. 43(5). Consequently, the loss suffered by the assessee is a speculative loss.

(201.7 KiB, 852 DLs)

S. 14A: Rule 8D cannot be invoked without showing how assessee’s claim is wrong

In AY 2008-09, the assessee had PMS investments in shares of Rs. 202 crores and other investments on which it earned dividends of Rs. 8.14 crores. The assessee claimed that the dividends were received only on a few scrips and computed s. 14A disallowance by identifying specific expenditure at Rs. 1.55 crores. The AO, without showing how the assessee’s method was wrong, invoked Rule 8D and made a disallowance of Rs. 2.39 crores. This was upheld by the CIT(A). On appeal by the assessee to the Tribunal, HELD reversing the AO & CIT(A):

The condition precedent for the AO to invoke Rule 8D is that he first must examine the accounts of assessee and then record by giving cogent reasons why he is not satisfied with the correctness of the assessee’s claim. In the absence of an examination of accounts and the recording of satisfaction, Rule 8D cannot be invoked. On facts, the assessee had itself disallowed interest, Demat charges and administrative expenses. The AO had not examined the accounts or given a finding how the assessee’s computation was wrong. Consequently, the invocation of Rule 8D was improper and the disallowance was not permissible (Godrej & Boyce 328 ITR 81 (Bom), Maxopp Investment 247 CTR 162 (Del), Walfort Share 326 ITR 1 (SC), Hero Cycles 323 ITR 518 (P&H), Justice Sam P Bharucha & Pawan Kumar Parameshwar Lal followed)

(338.2 KiB, 487 DLs)

Transfer Pricing: Domestic leg of cross-border deal, even if consequential to overseas deal by parent AE, not covered if terms not dictated by parent AE

Eastman Kodak, USA, entered into an agreement with Onex Healthcare Holdings, USA, for the global sale by Eastman of the medical business to Onex for a consideration of USD 23.5 Billion. Pursuant to this, the assessee, the Indian subsidiary of Eastman Kodak, sold the Indian business to the Indian subsidiary of Onex for a consideration of USD 13.54 Million. The assessee claimed that as it was not an Associated Enterprise of the buyer and as both the seller and the buyer were residents, the transfer pricing provisions did not apply. However, the TPO invoked s. 92B(2) and held that though the transaction was with a person other than an AE, it attracted the transfer pricing provisions as there was a prior agreement in relation to the said transaction between such other person and the AE and/or the terms of the relevant transaction were determined in substance between such other person and the AE. The TPO computed the ALP by applying the “ratio of revenue” method and determined the ALP at USD 32.9 million and made an adjustment of Rs. 79.96 crores. This was upheld by the DRP. On appeal by the assessee to the Tribunal, HELD reversing the TPO & DRP:

(i) Though s. 92B(2) provides for a situation where even a transaction between two non-associated enterprises can be subject to the transfer pricing provisions, it is essential that there should first be an “AE” with whom there exists an “international transaction” before it can be examined whether the international transaction with the “the non-AE” exists or not. On facts, the agreement between the two foreign companies was independent of the agreement between the two Indian domestic companies. The assessee had full authorization to perform and take its own decision with regard to the sale of the imaging segment to the buyer. Even if one accepts that the sale agreement by the assessee was as the result of prior agreement or was consequential upon the agreement between the two non resident companies, yet, as the holding company had not dictated the terms and conditions of the sale and the entire exercise of transfer of imaging segment was independently done on its own terms by the assessee and the buyer, the deeming provision of s. 92B(2) does not apply. The Department’s argument that the legal character of the assessee and the other enterprise be disregarded due to the influence of the agreement between the foreign holding companies is not acceptable (Vodafone vs. UOI 341 ITR 1 (SC) followed);

(ii) Further, the TPO was not justified in adopting an alien method for arriving at the ALP. U/s 92C(1) read with Rule 10B, the ALP can be determined only by adopting one of the prescribed methods and by no other (LG Electronics (SB) followed).

(113.9 KiB, 445 DLs)

Transfer Pricing: Turnover filter must be applied to exclude giant companies from comparison

The assessee, a provider of software development services, claimed that in determining the ALP under TNMM, Infosys Technologies & Wipro were not comparable entities given their extreme large turnover in comparison to that of the assessee. To oppose this, the Department relied on Capgemini India (ITAT Mum) where it was held that the concept of economy of scale was not applicable to service oriented companies and that the turnover filter could not be applied to exclude companies with an extremely large turnover. HELD by the Tribunal:

Though in Capgemini it was held that the concept of economy of scale is relevant only for manufacturing concerns, which have high fixed assets, and not for service concerns and that the turnover filter cannot be applied to exclude companies with an extremely large turnover from comparison, a contrary view has been taken in Deloitte Consulting 145 TTJ 589 (Hyd) that “giant” companies like Wipro are not at all comparable with smaller “pygmy” companies. Consequently, giant companies line Wipro and Infosys cannot be taken as comparables as their turnover is multiple number of times higher compared to that of the assessee and the TPO erred in considering their PLI to arrive at the arithmetic mean.