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February 2017

CORPORATE UPDATE

IN THIS ISSUE

Direct Tax International Taxation Transfer Pricing Domestic Taxation Indirect Tax Service Tax GST Foreign Exchange Management Act Recent Notifications Corporate Law Recent Notifications

Direct Tax

International Taxation

1. Supply of software embedded in hardware does not constitute 'Royalty' under the India-China Double Taxation Avoidance Agreement ('DTAA')  [CIT International Tax v/s ZTE Corporation [2017] 77 taxmann.com 304 (Delhi)

The High Court of Delhi, in a recent pronouncement has reiterated that sale of software, being an integral part of hardware, cannot be characterised as 'Royalty' in terms of the provisions of the Agreement for Avoidance of Double Taxation (‘DTAA’) between India and China.

The assessee, a tax resident of China, supplied telecom equipment with embedded software to its customers in India. It was contended that receipts against such sales are in the nature of business profits, which are not exigible to tax in India, in the absence of Permanent Establishment ('PE'). The revenue authorities held that such receipts ought to be regarded as 'Royalty' under the Income-tax Act, 1961 ('Act') as well as the DTAA.

While examining this aspect, the Hon’ble High Court relied upon the decision in DIT v/s Ericson A.B. [2012] 204 Taxman 192 (Del) and held that supply of software along with the hardware does tantamount to sale of a ‘copyrighted article’ and not a ‘copyright’. Thus, the income arising from the sale of such software (bundled on hardware) is in the nature of business profits.

Whilst holding so, the Hon’ble Court elaborately discussed the provisions of the Copyright Act, 1957. The Court also highlighted the fact that the software supplied in the instant case enabled the use of hardware, without which, use of hardware was impossible. The Hon’ble Court did also observe that the nomenclature and the separate invoicing pattern do not alter the nature of the transaction.

In view thereof, it was held that the software embedded in the hardware shall be regarded as sale of ‘goods’ and hence, the consideration thereof ought to be characterized as Business Profits rather than Royalty. As such, in the absence of any PE in India, the business profits would not liable to tax in India.

2. Core Sales and Marketing Activities conducted by Indian affiliates shall lead to incidence of a PE in India  [GE Energy Parts v/s DIT, International Tax [2017] 78 taxmann.com 2 (Delhi)]

Recently, the Tribunal, Delhi Bench, held that the expatriates operating out of the Indian Liaison Office of the group, supported by the staff of an Indian affiliate, shall lead to incidence of a Fixed Place PE as well as an Agency PE in India.

The assessee is a part of GE Group and a tax resident of USA (hereinafter referred as 'GE US'). The assessee, along with other group entities, is engaged in the business of manufacture and supply of equipments to its customers in India.

One of the group entities, namely General Electric International Operations Company ('GEIOC') had set up a Liaison Office ('LO') in New Delhi, India. Various expatriates, employed by a US group company, namely GE International Inc. ('GEII'), were positioned at the Indian LO for conducting marketing and sales activities on behalf of various foreign group entities (including the assessee). Furthermore, in terms of an agreement between GEIOC and an Indian affiliate, namely GE India Industrial Private Limited ('GEIIPL'), the employees of GEIIPL were to support the expatriates in their activities in India.

The assessee claimed that no income was liable to tax in India as the assessee was engaged only in carrying on liaison activities and not any business or commercial activities in India. However, upon assailing certain documentary evidence obtained during a survey operation on the premises of the LO, the revenue authorities contended that a PE is constituted in India. Firstly, it was alleged that the premises of the LO was being used as a sales outlet and thus, constituted a Fixed Place PE in terms of Article 5(1) of the DTAA between India and US. Secondly, it was contended that such expatriates and employees were infact, engaged in activities such as negotiation of contracts, securing of orders as well as conclusion of contracts and thus, incidence of Dependent Agent PE does also arise.

The Hon’ble Tribunal, after examining the facts and arguments put forth by both sides and the evidence furnished on record, held that incidence of a Fixed Place PE as well as Dependant Agent does arise in the instant case.

While examining the aspect of Fixed Place PE, the Tribunal observed that the following three fundamental tests ought to be fulfilled:

  • Firstly, that a fixed place of business should exist, i.e. the fixed place should be at the disposal of the foreign enterprise with some degree of permanence. The Tribunal observed that the expatriates operating from the LO had specific chambers (at their constant disposal), with affixed nameplates along with secretarial staff. The support staff of GEIIPL also occupied the premises of the LO and worked under the direct control and supervision of the expatriates. The Tribunal also observed that the LO had exceeded the scope of the activities permitted by the Reserve Bank of India.
  • Secondly, that business should be wholly or partly carried on from such fixed place. In this regard, it was observed that the expatriates were involved in all the core activities of business, i.e. significant and essential part of sale activities right from bidding, proposal development and negotiation and thus, this test was satisfied.
  • Thirdly, it was observed that the activities, being core activities of business, could not be brought within the exception carved out in Article 5(3)(e) of the DTAA in respect of ‘activities of preparatory and auxiliary in nature’.

As regards the aspect of Dependent Agent PE, the Tribunal observed as under:

  • The Tribunal held that the expatriates and the employees of GEIIPL had an authority to conclude contracts on behalf of the overseas entities. While holding so, the Tribunal clarified that it is immaterial whether all aspects or elements of the contract were negotiated by the agent or not.
  • Furthermore, the Tribunal did also examine whether the case of the assessee could be brought under the exception of ‘agents of an independent status’ carved out in Article 5(5). The assessee argued that the said employees were representing multiple entities. Thus, one of the conditions specified in Article 5(5) that the agent must work ‘wholly or almost wholly on behalf of the enterprise’ is not satisfied in the instant case. The Tribunal held that group companies ought to be considered as one unit and not multiple units.

The Tribunal also observed that even otherwise, such agents were not independent agents in the ordinary course of business but rather are dependent agents, as such. Such dependent agents are out rightly excluding from the exceptions carved out in Article 5(5) of the DTAA.

As regards the aspect of attribution, the revenue authorities applied a profitability rate of 10% to the PE, which was sustained by the Tribunal. While arriving at the profitability of 10%, reference from drawn from the provisions of section 44BBB of the Act which provides for a presumptive profit rate of 10% for specified non residents carrying on business through a PE in India. However, the rate of attribution of profits was computed at 35% by the revenue, based on the pronouncement of the Delhi High Court in Rolls Royce PLC and the Tribunal, Delhi Bench in ZTE Corporation.

The Tribunal, on comparison of the activities performed by the PE in the aforesaid decision, vis a vis the activities performed in the instant case, held that an attribution rate of 25% of the profits would be appropriate.

It would be apt to mention that in another recent decision of the Tribunal, Delhi Benches (DDIT Vs. Nipro Asia Pte. Ltd), a similar profitability of 10% with attribution rate of 30% was arrived, , where a branch office was involved in marketing and after sale activities in India.

 

3. Place Of Effective Management Rules applicable only to Companies having turnover in excess of INR 50 Crores  [Circular No. 08 of 2017 dated 23rd February 2017]

One of the notable recent amendments in the arena of direct taxation is the introduction of the Place Of Effective Management ('POEM') concept for determination of tax residence of foreign companies. The POEM rules came into effect from the tax year 2016-17, i.e. Assessment Year 2017-18.

In the month of January, the Central Board of Direct Taxes (‘CBDT’) had issued certain guiding principles with regard to the application of POEM rules. While issuing the press release, the CBDT did also indicate that the aforesaid rules shall apply only to companies having a turnover exceeding INR 50 Crores (approximately Euro 6.6 million).

The aforesaid monetary threshold has now been formally codified (which otherwise, was only part of the earlier press release), in the recent Circular issued on February 23, 2017.

4. DTAA between India and Israel has been amended  [Notification no. 10/2017 F.No. 500/14/2004 - FTD- III]

The Indian Government of India has notified the protocol amending the DTAA between India and Israel. The protocol has introduced an Article on Exchange of Information based on internationally accepted practices. The amended treaty does also permit the application of domestic anti abuse provisions (such as GAAR) to prevent abuse of treaty provisions.

5. Protocol signed to amend the DTAA between India and Austria  [Press Release dated 06 February 2017]

Recently, the Government of India and Austria have signed a protocol to amend the existing provisions of DTAA between the two countries. The protocol has been signed to broaden the scope of exchange of information and curb evasion of taxes in both the countries.

The protocol has not been notified as yet in India.

(Contributed by: Mr. Anuj Mathur/ Ms. Purnima Bajaj)

Transfer Pricing

6. Re-opening of assessment proceedings on the basis of preceding year’s transfer pricing adjustment upheld by High Court

In the recent decision of Magneti Marelli Powertrain India Pvt. Ltd v/s DCIT (TS-68-HC-2017(DEL)-TP), the Hon’ble High Court of Delhi ('HC') dismissed the writ petition filed by the assessee seeking to quash the reassessment proceedings proposed by the Assessing Officer ('AO') based on the transfer pricing adjustment made in preceding year.

On the facts of the case, the AO issued notice under section 148 of the Act, proposing to reopen the proceedings for AY 2010-11 and the “reason to believe” as cited by AO was the transfer pricing adjustment of payment for technical know-how, made in preceding year i.e. AY 2009-10. The AO observed that payment for such technical know-how was also made in AY 2010-11, where the matter was not referred to Transfer Pricing Officer ('TPO') even though the value of international transaction exceeded Rs. 15 Crores.

Against such aforesaid notice, the assessee filed writ petition before HC. In the writ petition, the assessee relied upon the decisions of Delhi High Court in CIT v. Cheil Communications India Pvt. Ltd. (354 ITR 549 (Del)) and CIT v. Batra Bhatta Co. (321 ITR 526 (Del)) to contend that notice of reopening of assessment cannot be sustained. The assessee contended that reopening is not valid as contention of the revenue authorities in AY 2009-10 were not accepted by HC and the matter was restored to the TPO.

The HC observed that the decisions relied upon by the assessee were not applicable on the facts of the case as the AO has recorded ‘reason to believe’ in the notice to reopen the assessment of the assessee, unlike in the cases relied upon by the assessee. The HC also observed that notice under section 148 was issued based upon the situation prevailing on the date it was issued and the power under section 147/ 148 is of the widest amplitude and it would be hazardous for the court to set aside or quash the notice which cites one reason.

Based upon this, writ petition filed by the assessee was dismissed by the Hon’ble HC.

7. Capacity utilization adjustment in assessee’s margin held unacceptable in the absence of similar adjustment in comparable companies’ margin

In a recent decision in the matter of Royal Star Jewellery Pvt. Ltd. v. The ACIT (TS-43-HC-2017(BOM)-TP), the Hon’ble High Court of Bombay ('HC') upheld the order of  Income Tax Appellate Tribunal ('ITAT') that claim of abnormal expenses on account of capacity underutilization by the assessee is not acceptable in the absence of figures of capacity utilization of the comparables.

On facts of the case, the assessee is engaged in the manufacturing of diamonds studded jewellery and trading of diamonds. During the relevant AY, it entered into the transactions of import of diamonds from its AE and export of diamond studded jewellery to its AE which were benchmarked by applying Transactional Net Margin Method ('TNMM') in its Transfer Pricing Study Report. The matter was referred to TPO, who selected certain additional comparables and rejected the claim of the assessee of abnormal expenses on account of capacity underutilization. Accordingly, adjustments were made by TPO. The DRP upheld the order of TPO based on margins of comparable companies chosen by TPO. The ITAT also upheld the adjustment made by the TPO for abnormal expenses on account of capacity underutilization and held that no material has been placed on record by the assessee relating to capacity utilization of the comparables.

Aggrieved, the assessee filed an appeal before the HC only on the ground relating to the non-adjustment of capacity underutilization. The assessee contended that the approach of ITAT is erroneous on facts and in law because the assessee could not have been called upon to produce such data for comparables. The assessee relied upon the decisions of Punjab and Haryana High Court in the case of Knorr-Bremse India Pvt. Ltd. v. CIT (2016) 380 ITR 307 and Mumbai ITAT in the case of JCIT v. Kiara Jewellery (P.) Ltd.[2014] 45 taxmann.com 548 (Mumbai-Trib.).

The HC held that the above mentioned cases were not applicable on the facts of the case as relevant material/ documents was placed on record in the said cases.

In view of these observations, the court found no infirmity in the order of ITAT and thus rejected the appeal filed before the HC.

(Contributed by: Ms. Shweta Kapoor)

Domestic Taxation

8. Assets of a closed unit and forming part of Block of Assets are eligible for depreciation as held by High Court of Delhi in case of Sony India Pvt Limited v/s CIT [TS-46-HC-2017 (Del)]

The Hon'ble High Court of Delhi (HC) in a recent decision of Sony India Pvt Limited ('the Appellant') allowed depreciation on assets forming part of block of assets in respect of the Appellant's unit which was sold during the relevant Assessment Year ('AY').

The background of the case is as under:

  • The Appellant, a wholly owned subsidiary of Sony Corporation, Japan was engaged in the assembling and distribution of colour televisions, audio products and high-end electronic goods, including DVDs and handycams. It imported goods from its Associated Enterprises (AEs) and rendered advisory services and software development services to such AEs.
  • During the relevant AY 2005-06, the Appellant closed down its manufacturing activity in Daru Hera plant and sold the said unit. All the assets of that unit were also sold and transferred.
  • The assets were part of a block of assets on which Appellant claimed Rs. 4,42,22,475/- u/s 32 as depreciation, as there was some positive balance still left in the block. It may be noted that section 32 provides for depreciation on block of assets concept .
  • The Assessing Officer('AO') disallowed the claim, holding that the Appellant was neither the owner of the plant and machinery nor used it for the purpose of business since the unit was closed.
  • On appeal, Commissioner of Income Tax(Appeals) (CIT(A)) & Income Tax Appellate Tribunal (ITAT) affirmed AO’s orders.
  • ITAT's decision was based on the fact that the Appellant was neither the owner of the plant and machinery and the building nor the assets were used by the Appellant owing to the closure of the unit and the transfer of assets. Further, it was never established by the Appellant that business of manufacturing and trading constituted one composite business. Therefore, the appellant was not entitled to depreciation.

Aggrieved, the Appellant filed an appeal before Hon'ble HC.

Before the Hon'ble HC, the Appellant submitted that after the amendment to section 43 and section 50 brought into by Finance Act, 1988, whenever an Assessee maintains several capital assets which form a block, the composite nature of the Asset block and its tax treatment cannot be dependent upon whether the whole exists or parts thereof are sold-off or transferred. The Appellant also relied on Hon'ble HC rulings in case of Ansal Properties and Infrastructure Limited [(2012) 207 Taxmann 61 (Del)] and Oswal Agro Mills Limited [(2012) 341 ITR 467 (Del)].

Hon'ble HC reversing the decision of ITAT, relied on coordinate bench ruling in case of Ansal Properties (supra), stated that facts in the said case and in the instant case of the Appellant are similar. In Ansal Properties, the HC observed:

"19. In the present case, there is no finding of the Assessing Officer or the appellate authorities that the block of assets carrying the same rate of depreciation ceased to exist or that after adding the three elements mentioned in Section 50, there was surplus on the full value of consideration received or accruing as a result of transfer of plant and machinery or the building. It is not the finding of the Assessing Officer that the block of assets entitled to the same percentage of depreciation ceased to exist or there was a surplus in the block of assets carrying the same rate of depreciation. The Assessing Officer has proceeded on the basis that the division itself constitutes a separate and an independent block of assets. Appendix to the Rules as noticed above, is not a unit/division specific but is rate of depreciation specific, as all assets prescribed the same rate of depreciation are clubbed and are a part of the same block of assets. The view we have taken finds resonance and acceptance in two decisions of the Delhi High Court in Commissioner of Income Tax versus Eastman Industries Limited, 174 Taxman 344 and Commissioner of Income Tax v/s Oswal Agro Mills Limited, (2012) 341 ITR 467 (Del.).''

The Appeals were accordingly allowed.

(Contributed by: Ms. Ritu Gyamlani)

Indirect Tax

Service Tax

1. Extension of date of payment of service by the service provided in case of Online Information and Database Access or Retrieval services ('OIDAR')

Vide Notification No. 6/2017-Service Tax dated 30 January 2017, the due date for payment of Service tax for the month of December 2016 and January 2017, in case of OIDAR services has been extended up to 6 March 2017.

Applicability of Service tax on services by way of transportation of goods by a vessel from a place outside India to the customs station in India w.r.t. goods intended for transhipment to any country outside India.

Vide Circular No. 204/2/2017 - Service Tax dated 16th February, 2017 it has been clarified that with respect to goods imported into a customs station in India intended for transhipment to any country outside India, since destination of such goods is a county outside India, services by way of transportation of goods by a vessel from a place outside India to the customs station in India are not exigible to Service tax in India.

GST

2. GST Council Meeting Update

GST Council meeting was held on 18th February, 2017 wherein Draft Compensation Bill was finalised and Finance Minister has formally announced that the government is targeting to implement GST from 1 July, 2017.

GST Council also cleared the final drafting of the anti-profiteering clause to ensure that benefit of lower taxes gets shared with the consumers.

GST Council will meet again on March 4 and 5 to finalize the GST laws. Post finalization, Central GST Act (CGST) and Integrated GST Act (IGST) would be tabled before the Parliament in the second half of the Budget session which begins on March 9, 2017.

(Contributed by: Mr.Shashank Goel/ Mr.Karan Chandna)

Foreign Exchange Management Act

Recent Notifications

1. Foreign Exchange (Compounding Proceedings) Rules, 2000 - Compounding of Contraventions under FEMA, 1999

The following amendments have been made in the Foreign Exchange (Compounding Proceedings) Rules, 2000, as amended from time to time, regarding the delegation of powers to the Regional Offices of the Reserve Bank of India to compound the contraventions under Foreign Exchange Management Act:

  • It has been decided to delegate further powers to Regional Offices of Reserve Bank of India to compound the contraventions in respect of delay in filing the Annual Return on Foreign Liabilities and Assets (FLA Return), by all the Indian Companies which have received Foreign Direct Investment in the previous year(s) including the current year.
  • The powers as stated in Para 1 above, have been delegated to all Regional Offices (except Kochi and Panaji), without any limit on the amount of contravention.
  • Kochi and Panaji Regional offices can compound the above contraventions for amount of contravention below Rupees One hundred lakh (Rs.1,00,00,000/-) only. The contraventions of Rupees One hundred lakh (Rs.1,00,00,000/) or more under the jurisdiction of Kochi and Panaji Regional Offices will continue to be compounded at Central Office level.
  • Accordingly applications for compounding the contraventions in respect of delay in filing the Annual Return on Foreign Assets and Liabilities may be submitted to the concerned authorities.

The above modifications have come into force with immediate effect from the date of issue of the Circular, i.e. February 02, 2017.

[Source: RBI A.P. (DIR Series) Circular No. 29 dated February 02, 2017]

2. Policy on foreign investment in Infrastructure Companies in Securities Market - Amendment to paragraph 5.2.21 of Consolidated FDI Policy (Circular of 2016)

Department of Industrial Policy and Promotion (‘DIPP’) under the Ministry of Commerce and Industry, has issued Press Note 1 (2017 Series) vide D/o IPP File No. 9/3/2016-FC.I dated 20th February, 2017, amending the Consolidated FDI Policy with respect to foreign direct investment in Infrastructure Companies in the Securities Market with immediate effect. Accordingly, Paragraph 5.2.21 of the ‘Consolidated FDI Policy Circular of 2016’ has been amended and the revised position is as follows:

(A) Existing Position

Foreign Investment in infrastructure companies in securities markets is presently allowed upto 49% under automatic route subject to certain restrictions as hereunder:

a) Foreign Institutional Investors (‘FIIs’)/ Foreign Portfolio Investors (‘FPIs’) are allowed to invest in securities market only through purchases.
b) Non-resident investor or entity, including the persons acting in concert cannot hold more than 5% of equity in commodity exchanges.
c) Foreign investment in the commodity exchanges is subject to the guidelines of Central Government/ SEBI from time to time.

(B) Revised Position

Although the sectoral cap remains the same under the revised position, the other conditions to such foreign direct investment have been amended to bring in better uniformity and clarity. The “other conditions” have been substituted as under:

a) the foreign investments in such infrastructure companies, including investment by FPIs, shall be subject to  Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012 and  Securities and Exchange Board of India (Depositories and Participants) Regulations, 1996 and other guidelines/ regulations issued by Central Government, RBI or SEBI from time to time.

[Source: Press Note No. 1 (2017 Series) issued by Government of India, Ministry of Commerce & Industry, Department of Industrial Policy & Promotion, dated 20th February, 2017]

(Contributed by: Mrs. Ruchi Sanghi)

Corporate Law

Recent Notifications

1. Closure of place of business of a Foreign Company

Section 391(2) of the Companies Act, 2013 ('Act') provides as under:

“The provisions of Chapter XX shall apply mutatis mutandis for closure of the place of business of a foreign company in India as if it were a company incorporated in India.”

The above provision which has come into force from 15th December, 2016 has been causing practical difficulties for closure of place of business of a foreign company in India.

The Ministry of Corporate Affairs ('MCA') has since clarified that the provision as contained in Section 391(2) of the Act would apply only in case of a foreign company which has issued prospectus or IDR, pursuant to the provisions of Chapter XXII of the Companies Act, 2013.

In terms of the above, in the case of those foreign companies which have not issued prospectus/ IDR, the provisions of Section 391(2) will not apply. In respect of such foreign companies, the provisions as contained in Section 380(3) of the Act will apply, which is much simpler to follow, as hitherto before.

A copy of the General Circular No. 01/2017 dated 22nd February, 2017 issued by the MCA is attached.

(Contributed by: Ms.Shikha Nagpal)

IMPORTANT

DATES TO REMEMBER
Particulars Date

Deposit of TDS for the month of March, 2017

Apr 07 , 2017

Deposit of Service Tax for the month of March, 2017

Mar 21 , 2017

For further information, please contact:

Mr. C. S. Mathur

Tel: 91-11-47102200 Email: csm@mpco.in

Mr. Vikas Vig

Tel: 91-11-47103300 Email: vvig@mpco.in

Ms. Surbhi Vig Anand

Tel: 91-11-47102250 Email: surbhivig@mpco.in

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