Fastest Growing Economies of the World

If you think that China is the world's fastest growing economy, think again.

However, among the major (or large) economies, China does remain the fastest growing economy. But if you take smaller nations too in the list, China slips down the list.

Similarly, India too has been for a while considered to be the second fastest growing economy after China. The reality however is different.

Asia and Africa account for the world's fastest growing economies, says Economy Watch.

Many of the nations in this list have a smaller base and even a small amount of robust economic activity impacts overall growth figures. However, it is significant to note that some of these nations which showed hardly any growth in the past are now speeding along merrily on the path to economic development and well being.

The most recent quarterly Global Economic Outlook from Fitch Ratings says that the economic recovery rate across the world is encouraging despite significant financial market volatility.

The global ratings agency says that the global economy will grow at 3.4 per cent this year, up from its previous projection of 3.2 per cent, at 3 per cent in 2011 and at 3.3 per cent in 2012.

1. Ghana: 20.146%

Many economists believe that Africa is the next boomtown. Several African nations are now growing at a rapid pace, trying to make lives better for their people. None more so than Ghana.

For quite a long time, Ghana received many an unflattering adjectives to describe its economy: 'worst managed', 'disastrous', etc. However, the small African nation has since then come a long way and is the world's fastest growing economy today.

Ghana's economy is growing at a blistering 20.15 per cent, says Economy Watch. It's a $23.4-billion economy.

Blessed with rich reserves of natural resources, Ghana has suddenly turned around and is now speeding along the growth path.

Ghana suffered the most due to the ineffective economic policies of past military governments, says Wikipedia, but the new government has managed to bring the country out of economic doldrums.

Economic reforms, political stability, low crime rate, and an overhaul of earlier policies have made the nation very attractive to foreign investors.

2. Qatar: 14.337%

With a GDP growth rate of 12.337 per cent, Qatar is the world's second fastest growing economy, says Economy Watch. It's a $132-billion economy.

The economy of Qatar, one of the world's largest exporters of petroleum, is primarily oil-based. High oil and gas prices have boosted the economy of this Gulf state over the last few years.

The per capita income of Qataris is $66,100, the sixth highest in the world.

The nation's economy mainly depends on its huge oil and natural gas reserves. There is no income tax in Qatar.

Qatar is an oil- and gas-rich nation with world's third largest gas reserves.

The country has excellent infrastructure which was further boosted as it hosted the 2006 Asian Games too. Within the other Gulf region, the nation is a role model for its economic and social transformation, says Wikipedia

3. Turkmenistan: 12.178%

Turkmenistan is blessed with the world's fourth-largest reserves of natural gas. The country is also the world's 10th largest producer of cotton.

It is the world's third fastest growing nation with a GDP growth rate of 12.18 per cent, according to Economy Watch. It is a $41-billion economy.

Although oil and gas is the biggest revenue generator for Turkmenistan, agriculture too accounts for a healthy percentage of its GDP.

Citizens in Turkmenistan get 120 litres of petrol free every month for car drivers, while truck/bus drivers get 200 litres of petrol free. Apart from this, electricity too is subsidised for the citizens

4. China: 9.908%

China is the world's fourth fastest growing economy at 9.908% GDP growth rate, and in monetary terms it is of the order of a whopping $6 trillion, says Economy Watch.

China, which most economists believe could soon upstage the United States as the world's largest economy, showed some signs of slowing down.

However, the rising inflation rates in China are posing a new challenge to the country.

China's gross domestic product grew 9.6 per cent in the third quarter as compared to the same period last year. The growth rate slowed down from 11.9 per cent in the first quarter and 10.3 per cent in the second quarter.

Analysts said that the Chinese government's steps to 'cool the housing market and bank lending' and the shutting down of outdated industrial capacity' led to the slowdown in its economy in the third quarter of 2010.

5. Liberia: 9.003%

Even though Liberia remains one of the poorest countries on earth, it has shown robust economic activity in the last few years.

This African nation is the world's fifth fastest growing economy with a GDP growth rate of 9.003 per cent, says Economy Watch. It is a $1.05 billion economy.

The nation has rich reserves of iron ore, and also exports rubber exports. In the last few years, it has been receiving a lot of foreign direct investment which has resulted in higher employment, better infrastructure and increased economic activity.

6. India: 8.43%

Economy Watch says that the India, at 8.43 per cent GDP growth rate, is the world's sixth fastest growing economy. India is a $1.5-trillion economy.

However, Finance Minister Pranab Mukherjee has exuded confidence that the Indian economy would shortly revert to 9 per cent growth rate but identified rising prices as a major concern, although inflation has declined to 8.6 per cent from double digits in June.

The India growth story is enviable. Despite plaguing problems, India has emerged stronger and resilient to the global crisis so far.

India is expected to be the world's fastest growing economy by 2018, according to Economist Intelligence Unit (EIU), the research arm of the Economist magazine.

Driven by good performance of agriculture and manufacturing, the Indian economy grew by 8.9 per cent in the second quarter of the current fiscal, up from 8.7 per cent in the corresponding period a year ago.

The growth rate for the first quarter was revised upwards to 8.9 per cent from 8.8 per cent.

This took the overall economic expansion during the first half (April-September) to 8.9 per cent, up from 7.5 per cent in the corresponding period a year ago.

India, the second largest growing economy will overtake China as the fastest growing major economy with an average of 8 per cent in the next five years, the report stated earlier this year. China witnessed 11.9 per cent growth in the same quarter.

For India, the ideal inflation rate would be 4-5 per cent although it may be difficult to attain.

Attributing inflation mainly to rising food prices, Mukherjee said, "in terms of consumer price indices (retail prices), inflation in the three major groups -- industrial workers, agricultural labour and rural labour -- have come down to single digit level."

Regarding economic growth, Mukherjee said he hoped it would be 8.5 per cent (plus/minus 0.25 per cent) during 2009-10, rising further to 9 per cent in short term.

Having achieved over 9 per cent rate for the three consecutive years, the economic growth dipped to 6.7 per cent during 2008-09, mainly on account of the global financial meltdown.

However, it picked up to 7.4 per cent in 2009-10 and recorded 8.8 per cent in first quarter of the current fiscal

7. Angola: 8.251%

Angola is the world's seventh fastest growing economy at a GDP growth rate of 8.251 per cent, as per the Economy Watch report. It is a $ 99-billion economy.

Battered by a civil war for close to 25 years, Angola has since then come a long way.

Fresh pro-people and pro-reform policies have seen funding from the International Monetary Fund and other global lenders rising. These funds are being utilised to create infrastructure in the nation, thus generating employment and healthy economic activity.

Angola is an oil-rich state and most of its economy is based on the oil and gas industry, but agriculture too plays a significant role. Wikipedia says that Luanda, the capital of Angola, is the nation's economic and commercial hub.

Political and economic stability have resulted in Angola's growth rate rising at a blistering pace. However, the nation remains mired in poverty.

8. Iraq: 7.873%

Iraq is growing at 7.873 per cent, making it the world's eighth fastest growing economy, according to Economy Watch. It is a $93-billion economy.

The war ravaged nation of Iraq is slowly trying to come out of the devastation it suffered through wars over the last two decades.

The oil and gas industry is the mainstay of the Iraqi economy. Close to 90 per cent of its foreign exchange revenues comes from the export of oil. With some amount of stability coming to the nation, infrastructure-building/replacement is the priority for Iraq.

These reconstruction measures have led to a churn in the economic activity in the country, leading to generation of jobs.

9. Ethiopia: 7.663%

Economy Watch says that with an annual GDP growth rate of 7.663 per cent, Ethiopia is the world's ninth fastest growing economy. It is a $31.7-billion economy.

Over the last two decades, Ethiopia has been noticing the fruits of focussed efforts at propelling its economy. Some reforms were undertaken in spite of opposition from various political quarters in the country.

However, a constant tug of war between the political parties and the severe drought that hit the nation some years ago have had a hugely debilitating effect on the nation's economic health.

Agricultural activity, says Wikipedia, accounts for more than 40 per cent of Ethiopia's GDP. Coffee beans are Ethiopia's largest export commodity

10. Mozambique: 7.548%

Mozambique, a member of the Southern African Development Community, is the world's 10th fastest growing economy with a GDP growth rate of 7.548 per cent. It is a $10.5-billion economy.

The SADC free trade plan aims at eliminating tariffs and trade barriers, thus making it more competitive, says Wikipedia.

Despite having been described as a 'success story' by the World Bank and the IMF, Mozambique continues to languish in poverty. But its economic reforms have begun to bear some fruit as more and more of the nation's population gets access to better facilities, albeit slowly.

Big foreign institutional investments in large projects across various industry sectors have revived the nation's economy.

Like in India, a majority of the population in Mozambique too is engaged in the agriculture sector.

11. Timor Leste (East Timor): 7.4%

Timor Leste (or East Timor) is the world's eleventh fastest growing economy with an annual GDP growth rate of 7.4 per cent. It's a tiny, $732-million economy.

East Timor's economy is mainly driven by the sectors of agriculture and oil and gas.

An invasion by Indonesia in 1999 led to more than 70 per cent of East Timor's economic infrastructure being destroyed, says Wikipedia. Later, intervention by the United Nations, UN-appointed peacekeepers, and foreign funding helped rebuild the nation's infrastructure.

Some large projects too revived the nation's economic activity. Today, it is one of the rising economic stars in Asia.

12. Laos: 7.395%

The GDP growth rate of Laos is 7.395 per cent, making it the world's 12th fastest growing economy. It is a $6.9-billion economy.

Agriculture is the most important part of the Laotian economy. Over 80 per cent of the country's working people are engaged in the agri sector. The sector also accounts for about 50 per cent of the nation's GDP, says Wikipedia.

Laos's economy is dependent on trade with Thailand, Vietnam, China and other South East Asian nations. Foreign investment has recently been pouring into the country, giving a much-needed boost to the economy. Its tourism industry has been growing rapidly in the last few years.

Captive service provider cannot be compared with Infosys

Court : Delhi bench of the Income-tax Appellate Tribunal

Brief : ITAT Delhi held that a captive service provider assuming minimal risks, cannot be compared to a large company like Infosys Technologies Limited which assumes all risks leading to greater rewards.

Citation : Agnity India Technologies Private Limited Vs. ITO (ITA No. 3856(Del)/ 2010)

Facts of the case

The taxpayer is a wholly owned subsidiary of BayPackets Inc., USA and is engaged in the business of software development in the field of telecommunication for its parent company. The taxpayer also enjoys a tax holiday.

The taxpayer operating at a net profit margin of 17 percent over costs, identified 23 comparables in the TP documentation resulting in arm’s length net profit margin of 10 percent over costs.

The Transfer Pricing Officer (TPO) rejected few comparables identified by the taxpayer on the basis of functional dissimilarity and wages/ sales ratio. The TPO also included Infosys Technologies Limited (Infosys) and Satyam Computers Services Ltd. (Satyam) as comparables and thereby determined the arms length net profit margin at 27.08 percent over costs.

On objections raised by the taxpayer before the Dispute Resolution Panel (DRP), Satyam was excluded by the DRP since the data available was not reliable. However, Infosys was retained, leading to an arm’s length net profit margin of 25.6 percent over costs.

Against the order of the assessing officer, an appeal was filed by the taxpayer to the Income Tax Appellate Tribunal (the Tribunal).

Tribunal’s Ruling

The Tribunal ruled in favor of the taxpayer. The key aspects of Tribunal’s order are summarised below:

The Tribunal held that the taxpayer was not comparable to Infosys Technologies Limited since Infosys is a giant in the area of development of software and assumes all risks, leading to higher profit as compared to the taxpayer which is a captive unit and assumes only limited currency risks.

The Tribunal also referred to other reasons given by the taxpayer for establishing that Infosys was not comparable to the taxpayer, including:

Infosys renders diversified services as compared to the taxpayer which is only rendering software development services

Vast difference in turnover/capital of Infosys and of the taxpayer

Infosys owns proprietary products as compared to none owned by the taxpayer

Infosys renders onshore and offshore services equally as

compared to taxpayer which only renders offshore services

Infosys incurs a substantial expenditure on advertising/ sales promotion and research & development which are not incurred by the taxpayer

After exclusion of Infosys, the arms length net profit margin based on rest of the comparable companies was found to be consistent with the net profit margin of the taxpayer.

The Ruling emphasises that a pigmy enterprise cannot be compared with a giant company and that functions, assets and risks analysis is critical to comparability.

Losses on un-matured forward contracts cannot be considered as notional or contingent in nature

Losses on un-matured forward contracts cannot be considered as notional or contingent in nature

Court : Mumbai Bench of the Income-tax Appellate Tribunal

Brief : In this case Special Bench of the Income-tax Appellate Tribunal dealt with the issue of allowability of losses on account of unmatured forward contracts in foreign exchange entered into by the taxpayer. The Special Bench while dismissing the contentions of the tax department held that the loss on unmatured forward contracts is in the nature of anticipated losses and not a contingent loss. The Special Bench observed that a binding obligation (although not fully ascertainable) arose against the taxpayer the moment it entered into forward foreign exchange contract. The Special Bench has relied on the recent decision of the Supreme Court in the case of CIT v. Woodward Governor of India [2009] 312 ITR 254 (SC) wherein the Supreme Court had held that exchange fluctuation loss arising on mark- to-market restatement of liability which is revenue in nature is an allowable loss. The Special Bench further observed that where profits were being taxed by the tax department in respect of such unmatured foreign exchange contracts then there was no reason to disallow the loss on such contracts.

Citation : DCIT v. Bank of Bahrain & Kuwait [2010-TIOL-447-ITAT-MUM-SB]

Judgment :

Facts of the case

• The taxpayer, a non-resident company carrying on banking business in India, entered into forward contracts with its clients to buy or sell foreign exchange at an agreed price on a future date. In cases where the date of maturity of the contract falls beyond the end of the accounting period, the taxpayer evaluates the unmatured forward contracts on the last day of the accounting period on the basis of rate of foreign exchange prevailing on that date and books the loss or profit accordingly. Accordingly the taxpayer booked losses of INR 1.2 million.

• However, the Assessing Officer (AO) observed that the principles of taxation require that actual profit or loss was to be brought to tax and not contingent losses. And since in a forward contracts, liability arises only on the date on which the contracts mature such losses should not be allowed as a deduction..

• The AO also referred to the Madras High Court’s decision in the case of Indian Overseas Bank v. CIT [1990] 246 ITR 206 (Mad) wherein it was held that before settlement of contracts in foreign currency, no actual profit could accrue and the amount in question represented notional profits only. Accordingly, the AO disallowed the loss of INR 1.2 million treating the same as notional loss.

Taxpayer’s contentions

• The taxpayer contended that as per the Reserve Bank of India guidelines, it was required to revalue its outstanding foreign exchange forward contract as per the rates notified by the Foreign Exchange Dealers Association of India (FEDAI) on 31 March every year. Therefore it had to re-assess the anticipated loss at the end of the year in accordance with the method of accounting consistently followed by it.

• The taxpayer relied on the Supreme Court’s decision in the case of Investment Ltd v. CIT [1970] 77 ITR 533 (SC) wherein, it has been held that the method of accounting consistently and regularly followed by the taxpayer cannot be discarded by the tax department merely on the ground that a better method of accounting could be the alternate one.

• In the case of Woodward Governor India (P) Ltd, the Supreme Court has held that the additional liability on account of fluctuation in foreign currency as on 31 March 1991 in respect of foreign currency working capital loans outstanding on that date was an allowable revenue loss and was not notional or contingent.

• A forward exchange creates a binding obligation arises which is required to be discharged. Therefore, the physical delivery of foreign currency on the date of maturity does not wipe out the present liability incurred by the taxpayer.

• The loss on the revaluation of the outstanding forward exchange contracts is to be allowed on the well recognised principle that taxpayer’s stock/circulating capital has to be valued at cost or market price, wherever is lower.

Tax department’s contentions

• The taxpayer was carrying on banking business in India and it is not the taxpayer’s business to deal in forward contracts. It entered into forward contracts with its clients to buy or sell foreign currency at an agreed price on a future date in order to in order to avoid wide fluctuation in foreign currency.

• The Tribunal’s decision in the case of Deutsche Bank A.G v. DCIT [2003] 86 ITD 431 (Mum) and the decision of the Bombay High Court in the case of CIT v. Bank of India [1996] 218 ITR 371 (Bom) proceeded on the footing that the securities were stock-in-trade. However, in the present case there is no material to prove that forward contract to buy or sell foreign currency itself constitutes the stock-in-trade and therefore these cases are not applicable to the case under consideration.

• The Supreme Court in the case of Woodward Governor of India observed that as per Accounting Standard (AS) -11 on “Effect of Changes in Foreign Exchange Rates”, effect of changes in exchange rate vis-à-vis monetary items denominated in a foreign currency has to be taken into account for giving accounting treatment on the balance sheet date. The tax department contended that in the present case, since no transaction has been entered into in the books of account, there was no monetary item requiring adjustment of exchange rate difference.

• The tax department relied on the Bombay High Court’s decision in the case of CIT v. Kamani Metals and Alloys Ltd [1994] 208 ITR 1017(Bom) wherein, the taxpayer had entered into a contract with MMTC for purchase of copper cathodes at a particular rate. The High Court observed that the material was received in the next accounting period and therefore there was no closing stock of the material in the hands of the taxpayer. Accordingly, the High Court held that the material contracted to be purchased could not be regarded as taxpayer’s stock-in-trade and hence, could not be valued in the accounts as such.

• The liability accrues or arises only on the date of maturity of the contract and estimated liability as per FEDAI guidelines cannot be allowed under the Act.

Special Bench’s ruling

• The Forward exchange contract creates a continuing binding obligation on the date of contract against the taxpayer to fulfill the same on the date of maturity.

• As observed by Supreme Court in the case of Woodward Governor, AS -11 which is mandatory requires that when the transaction is not settled in the same accounting period as that in which it occurred, the exchange differences arises in more than one period. The principle laid down by Supreme Court that in case of a working capital loan, loss on account of fluctuation in foreign currency as on the date of foreign exchange is an item of expenditure under Section 28 of the Income-tax Act, 1961 (the Act) would be applicable in this case too.

• Contingent liability is not allowed as a deduction. However, if an anticipated liability is coupled with present obligation and only quantification can vary depending upon the terms of contract, then a liability is said to have crystallised on the date of balance sheet date. Hence anticipated losses on account of existing obligation, determinable with reasonable accuracy have to be taken into account. Reliance was placed on the decision of the Supreme Court in the case of Bharat Earth Movers v. CIT [2000] 245 ITR 428 (SC).

• It is a settled law that a method of accounting regularly employed by the taxpayer cannot be disregarded by the AO unless he is of the opinion that profits are not correctly deductible from such method of accounting as per the provisions of section 145(3) of Act. However, the AO cannot reject the method of accounting followed by the taxpayer merely on the ground that a better method of accounting could be the alternate one. However, in the present case, though observations have been made by the AO to this effect but actual disallowance has been made by treating the impugned amount as contingent liability.

• The Special Bench observed that there was no dispute that the foreign exchange currency held by the taxpayer bank was its stock-in-trade and the taxpayer had entered into forward foreign exchange contracts in order to protect its interest against the wide fluctuation in the foreign currency itself. Therefore, this contract was incidental to taxpayer’s holding of the foreign currency as current asset. Towards this, the Special Bench relied on the Calcutta Special Bench decision in the case of Shree Capital Services Ltd. v. ACIT [2009] 121 ITD 498 (Kol) (SB)

• The Special Bench also observed that tax department had for the Assessment Year 2002-03 and 2003-04 assessed the taxpayer in respect of the profit shown by the Bank on restatement of outstanding forward foreign exchange. Accordingly, there was no reason to disallow the loss as claimed by taxpayer in respect of same contracts on the same footing.

Our Comments

This is welcome decision of the Mumbai Special Bench where it is held that losses arising on account of unmatured forward contracts are not notional in nature. This decision holds importance since prior to this decision there were no clear judicial precedents directly on the point. Before this decision reliance was generally placed on RBI guidelines, Accounting Standards and the Supreme Court decision in the case of Woodward Governor of India.

It is interesting to note that the Central Board of Direct Taxes had issued Instruction no. 03/20 10 dated 23 March 2010 to the effect that losses arising on account of year-end valuation of forex-derivatives are to be disallowed on the ground that these are contingent and notional in nature.

Pan for Non Residents

Non-resident individuals and organisations need to have a Permanent Account Number (PAN) number if they receive an income and need to file returns in India. PAN is issued by the Income Tax (IT) Department to all assessees and quoting of PAN is compulsory in all returns filed with the IT department.

The PAN number comprises of ten alphanumeric characters and is issued in the form of a laminated card. A PAN card is required for both resident as well as non-resident assessees. In case of non-resident assessees, there are a few minor changes in the requirements for an application.

A non-resident assessee is:

A citizen of India residing outside India at the time of making application

Not a citizen of India i.e. foreign citizen

Other than individual (a company, trust, firm, etc) - not a citizen of India - having no office of its own in India.

The following points should be noted while applying for the PAN:

AO Code : AO code pertaining to International Taxation Directorate should be used.

Address: A foreign address can be provided as residential (only for individuals) and office address by such applicants, if they do not have any Indian address of their own. Individual applicants may indicate any address (residential or office -whether Indian or abroad) as the address for communication.

Additional courier charges for PAN card dispatch shall be payable by applicant at the time of making application if the address for communication is a foreign address. Complete address including name of state, province (if applicable) and name of country should be clearly mentioned in the application as part of the address.

A proper zip or pin code, if applicable, should be provided by the applicant. Further, a valid email address must be provided by such applicants. It is to be noted that providing details of Residential Address (RA) is not mandatory in the PAN application for such applicants. However, if RA details are provided, proof of identity and address in respect of RA shall be required in addition to those of the applicant.

Photograph and signature: Individual applicants should provide their own recent colour photograph of prescribed size. This is not applicable for other applicants. Application should always be signed by the applicant himself / herself in all cases (for individuals). In case of applicants other than individuals, application should be signed by an authorized signatory on behalf of the applicant (eg director of the company or partner of the firm or trustee of the trust, etc).

Even if the RA details are provided, the application should be signed by the applicant (in case of individual applicants) or by the authorized signatory (for non-individual applicants).

Payment received for sale of copyright article does not amount to royalty under the India – USA tax treaty

Payment received for sale of copyright article does not amount to royalty under the India – USA tax treaty

Court : Mumbai bench of the Income-tax Appellate Tribunal

Brief : Recently, the Mumbai bench of the Income-tax Appellate Tribunal held that the payment received by the taxpayer company towards the sale of copyright article does not amount to royalty within the provisions of Article 12(3) of the India-USA tax treaty (tax treaty).

Citation : DDIT v. Alcatel USA International Marketing Inc [2010-TII-123-ITAT-MUM-INTL]

Facts of the case

The taxpayer, a tax resident of USA, was marketing and selling Alcatel products to customers outside USA. The taxpayer supplied software under the Subscriber Data Note (SDN) network software agreement to Reliance Infocomm Ltd (RIL) for the purpose of telecommunication network of RIL.

• The Agreements clearly mentioned that

The taxpayer grants a perpetual, irrevocable, non-exclusive, unrestricted right to Reliance for the use of Software within Reliance’s network. However, title to the copyright in software remains with the taxpayer.

Reliance shall not transfer, assign, sublicense or outsource the license without the written permission of the taxpayer except where it is required for its own network.

Reliance shall not use the software for commercial time sharing with non-affiliate third parties, rental, lease and sub-licensing to non affiliate third parties and service-bureau purposes.

• The taxpayer company received consideration of INR 167.26 million for the supply of the said software. The software supplied by the taxpayer company to RIL creates a database to store subscriber profiles and other information, e.g. customer phone number, calling plan, etc and make this information available to different network element requesting it.

• The AO treated the consideration received by the taxpayer as royalty taxable in India.

Taxpayer’s contentions

• The taxpayer contended that the consideration received for the supply of software was not taxable in India as the same was in the nature of business profit and not royalty and in the absence of PE of taxpayer in India the consideration received was not taxable in India.

Tribunal’s ruling

• The Tribunal observed that identical issue has been dealt by Delhi Tribunal in taxpayer’s own case for assessment year 2003-04. The Delhi Tribunal after relying on the decision of the Delhi Special Bench in the case of Motorola Inc. Ericsson Radio Systems AB and Nokia Corporation v. DCIT [2005] 96 TTJ 1 (Del) (SB) held that the transaction under consideration cannot be considered as royalty under the provisions of Act or under the tax treaty.

• The Tribunal, after examining the relevant clauses of the agreement between the taxpayer and RIL and the provisions of the Act and the tax treaty, held that payment received by the taxpayer company towards the sale of copyright article does not amount to royalty within the meaning of Article 12(3) of the DTAA between India and USA

Arm's length price should be based on the functional and asset profile of the company

Arm's length price should be based on the functional and asset profile of the company

Court : Mumbai Bench of the Income Tax Appellate Tribunal

Brief : The Mumbai Bench of the Income Tax Appellate Tribunal ('the Tribunal'), in the case of ITO v. Zydus Altana Healthcare Pvt. Ltd. [2010-TI I-29-ITAT–MUM-TP], while deciding the case in favour of the assessee, ruled that the determination of arm's length price should be based on the functional and asset profile of a company and profit margins earned by comparable companies should be adjusted for functional differences between the tested party and the comparables. The Tribunal also ruled that in case an assessee's income is exempt from tax (and taxable in the overseas jurisdiction), this factor should be considered by the revenue authorities while undertaking a tax assessment since in such a situation, there is no benefit to the assessee in charging its associated enterprise a lower mark-up.

Citation : ITO v. Zydus Altana Healthcare Pvt. Ltd. [2010-TI I-29-ITAT–MUM-TP]

Judgement :

Facts- The assessee is a Joint Venture between Cadila Healthcare Ltd., and Byk Gulden Lomberg GmbH Germany ("BGL"). The assessee, a 100% export oriented unit is engaged in the manufacture and export of pharmaceutical intermediates exclusively for BGL. The assessee also provides clinical trial services with respect to molecules developed from the research undertaken by BGL for which it is remunerated on a cost plus 5% basis. In addition, the assessee receives reimbursement from BGL of certain clinical trial expenses.

During the course of transfer pricing ("TP") assessment proceedings, the Transfer Pricing Officer ("TPO") accepted the assessee's export prices of pharmaceutical products to be at arm's length. The TPO, however, proposed an adjustment to the transfer price for the transaction involving clinical trial services provided by the assessee to its Associated Enterprise ("AE"). For this purpose, the TPO identified a set of companies providing clinical trial services to third parties and determined the arm's length cost plus mark up at 17.14%.

The Assessing Officer ("AO") passed an order, incorporating the transfer pricing adjustment proposed by the TPO, against which the assessee filed an appeal before the Commissioner of Income-Tax, Appeals ("CIT (A)"). The CIT(A), based on the facts of the case, deleted the adjustment proposed by the TPO, aggrieved by which the Indian Revenue authorities brought an appeal before the Tribunal.

Revenue Contentions

Key contentions of the Revenue were as follows:

•           The assessee as per the recitals of the research and development ("R&D") services agreement was entrusted to perform certain R&D service work on contract research basis on behalf of BGL. However, the CIT(A) did not examine the relevant articles of the R&D services agreement and wrongly held that the assessee is merely engaged in providing support services in the nature of facilitation/coordination services between BGL and the hospitals.

•           The nature of expense reimbursements made by the AE to the assessee for the clinical trial services clearly indicated that the assessee had full-fledged infrastructure facilities for conducting R&D activities.

•           Though the CIT(A) rightly referred to the guidelines provided by the Special Bench of Bangalore ITAT in the case Aztec Software Technology Services Ltd. v. ACIT [2007 - TII – 01 - ITAT – BANG – SB - TP] for selecting comparable companies based on functional analysis, the CIT(A) had not applied such guidelines to the facts of the present case thereby wrongly rejecting the search conducted by the TPO for comparable transactions with respect to the clinical R&D work undertaken by the assessee on behalf of the AE.

 Assessee Contentions

Key contentions of the assessee were as follows:

•           The assessee did not undertake clinical trials on its own. It only acted as a facilitator / co-ordinator between BGL and the hospitals which performed the clinical trials. This was evidenced by the fact that the reimbursement received by the assessee primarily related to expenses incurred towards hospitals for clinical tests undertaken by them on the molecules that were developed by BGL. Therefore, the functions performed by the assessee with respect to the clinical trials service transaction were limited and were essentially in the nature of administrative services, including data collation and compilation, maintenance of documentation, liaising with doctors, etc.

•           The assessee did not have the necessary infrastructure to undertake R&D activities. The TPO, during the course of the assessment proceedings, agreed to the fact that the assessee could not be characterised as a contract research organisation.

•           Comparables selected by the TPO were in a different line of business to that of the assessee.

Tribunal Ruling

The Tribunal held as follows:

•           The entire research activity relating to molecules was carried out in three phases. Under Phase I, the main molecules were generated by BGL and its effectiveness over Indian patients was to be examined by carrying out clinical trials in Phase II and Phase III. Thus, the major part of the research activity was Phase I in which molecules per se were generated, and not Phase II and Phase III, which involved only clinical trials being conducted by third parties i.e. hospitals, which the assessee only paid for. Further, the assessee's infrastructure was limited to furniture, vehicle, office equipments and computers, which were not sufficient for carrying out an entire research activity.

Therefore, the assessee's activity was more in the nature of coordinating / facilitating such clinical trials carried out at various hospitals rather than performing the R&D function itself, for which a return of 5 per mark-up on costs was suitable.

•           Referring to Rule 10B(1)(a)(ii) of the Indian Income-tax Rules, 1962 ("the Rules"), the Tribunal held that the TPO when selecting comparables should have made necessary adjustments for functional differences.

•           In case an assessee's income is exempt from tax (and taxable in the overseas jurisdiction), this factor should be considered by the revenue authorities while undertaking a tax assessment since in such a situation, there is no benefit to the assessee in charging its associated enterprise a lower mark-up.

Based on the above, the Tribunal upheld the order of the CIT(A) and rejected the transfer pricing adjustment made by the AO thereby deciding the case in favour of the assessee.

Conclusion

In establishing the functional profile of the assessee and evaluating its return, the Tribunal had correctly examined the nature of activities and contribution of the assessee in the value chain. It had also given due consideration to the tangible asset profile of the assessee. However, the Tribunal, in its ruling, did not provide its views on certain determinative aspects relating to who exercises control over the R&D function, who has the risk bearing capacity, who contributes to intangible creation, etc.

Further, with respect to comparability adjustments, although no guidance was provided, the Tribunal reiterated the need to make appropriate adjustments to comparables while applying a transfer pricing method and determining the arm's length price.

The Tribunal also ruled that in case an assessee's income is exempt from tax (and taxable in the overseas jurisdiction), this factor should be considered by the revenue authorities while undertaking a tax assessment.

Tags : Cadila Healthcare, Byk Gulden Lomberg GmbH Germany,  Zydus Altana Healthcare , transfer pricing , Arm's length price .

Payment received by the taxpayer for sale of shrink wrapped software is not in the nature of royalty within the meaning of Article 12(3) of the India-USA tax treaty

Court : Mumbai bench of the Income-tax Appellate Tribunal

Brief : Recently, the Mumbai bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of ADIT v. Solid Works Corporation [2010-TII-130-ITAT-MUM-INTL] Judgment date 1 April 2010, Assessment Year 2005-06) held that payment received by the taxpayer for sale of shrink wrapped software is not in the nature of royalty within the meaning of Article 12(3) of the India-USA tax treaty (tax treaty).

Citation : ADIT v. Solid Works Corporation [2010-TII-130-ITAT-MUM-INTL]

Judgement : Facts of the case

The taxpayer, a tax resident of USA, develops and markets 3D mechanical design solution. The software named Solidworks 2003 is provided in a packed form to the customers in India alongwith an end user license agreement (EULA).

The designed data prepared by software provides data which are 100 percent editable.

The taxpayer owns and retains all copyright, trade mark, trade secrets and other proprietary rights. Further, the end user is not permitted to make any modification, make works derivative of the software, reverse engineer, decompile, disassemble or otherwise discover the source code of the software.

For the purposes of marketing the shrink wrap software, the taxpayer entered into agreement with various distributors/resellers in India. However, distributors do not get any right to disassemble, decompile or reverse engineer the software. Also, distributors do not get any exclusive distributor right.

The taxpayer observed that shrink wrap software was sold to customers for their personal use without transfer of any copyright, trade mark, or patent etc. Accordingly, the taxpayer took the view that the payment received for supply of software was not payments received for royalty as per the tax treaty.

Further, the taxpayer took a view that since it did not have a permanent establishment (PE) in India, its business income was not taxable as per Article-7 of the tax treaty.

The AO held that the payment received by the taxpayer, for the use of software, was in the nature of royalty as per the tax treaty.

Further, the AO levied interest under section 234B of the Income tax Act, 1961 (the Act).

Issue before the Tribunal

Whether the payment for obtaining Computer Software is in the nature of ‘Royalty’ and therefore liable for taxation in India within the meaning of Article 12(3) of the tax treaty?

Whether interest under section 234B of the Act can be levied when all payments to taxpayer are subject to deduction of tax at source?

Tribunal’s ruling

The Tribunal observed its earlier decision in the taxpayer’s own case (DDIT v. Solid Works Corporation (ITA no. 3095/Mum/2007)), the key points of which are as follows:

The distributor is not authorised to enter into any contract directly or indirectly on behalf of the taxpayer. Also, the distributor cannot tamper with or remove from the original packaging and all the product shall be distributed by the distributor as it is.

The EULA provides facility to ultimate consumer to install software on his computer and use it personally without allowing any right to the consumer of disassemble, reverse engineer, decompile the software.

Customer was also not entitled to sell, license, sub-license, transfer, assign, lease or rent the software. Therefore it is clear that end user and distributor did not have any right over the copyright of the software.

The Tribunal relied on the Supreme Court’s decision in the case of Tata Consultancy Services Pvt. Ltd. v. State of Andhra Pradesh (2004) 271 ITR 401 (SC) in which it was held that the copyright in the software programme remains with the originator but the moment copies are made and marketed, it becomes goods liable to sales tax.

The definition of royalty as per the tax treaty requires that there should be a transfer of copyright. Sale of software by the taxpayer to the distributor or end user does not involve any transfer of copyright either in part or in whole. Accordingly, consideration paid by the distributor cannot be said to be a payment for right to use copyright or transfer of use of copyright.

2. Relying on the decision in taxpayers own case, the Tribunal held that the payment received by the taxpayer for sale of shrink wrapped software was not in the nature of royalty within the meaning of Article 12(3) of the tax treaty.

3. With regard to levy of interest under section 234B of the Act, the Tribunal relied on its earlier decision in the taxpayer’s own case and also relied on Delhi Special Bench decision in the case if Motorola Incorporation v.. DCIT (2005) 95 ITD 269 (Del) (SB) & Mumbai High Court decision in the case of DIT v.. NGC Network Asia LLC (2009) 313 ITR 187 (Bom). It was held that when a duty is cast on the payer to pay the tax at source, on failure, no interest can be imposed on the taxpayer.

Our Comments

This is a welcome decision in which the Mumbai tribunal held that the payment received by the taxpayer for sale of shrink wrapped software was not in the nature of royalty within the meaning of Article 12(3) of the tax treaty.

In a recent decision in the case of Dassault Systems K.K. [2010-TIOL-02-ARA-IT] the Authority for Advanced Ruling on similar facts held that the payments received by the applicant cannot be construed as ‘royalty’ taxable within the provisions of the Act or the India-Japan tax treaty. A similar view was also adopted by the Bangalore Tribunal in the recent decision in the case of M/s Velankani Mauritius Ltd & M/s Byedesign Solutions Ltd. v. DDIT (2010-TII-64- ITAT-BANG-INTL) where it held that income from sale of software cannot be treated as royalty under the Income-tax Act, 1961 or the India-Mauritius tax treaty

It is important to note that recently, the Supreme Court in the case of CIT v. M/s Oracle Software India Ltd. [2010-TIOL-04-SC-IT] has held that process of transforming a blank Compact Disks (CDs) into software loaded disks by duplicating the master copy of the software on it, constitutes ‘manufacture or processing of goods’. Based on this decision it may be possible to contend that providing shrink wrap software may result into provision of goods and not service and therefore, to be treated as business income and not royalty income.

It is pertinent to note that how some of the developed economies have treated such payment as not resulting into royalty payments. As per the US regulations when there is a transfer of software program that would effectuate a minimal use of the copyright in the program then such minimal use should be disregarded for characterization purposes as it is merely ‘de minimis’ to the entire transaction. Further, the technical advisory group of Organization for Economic Co-operation and Development also had similar view which held that if the consideration is paid for a right other than a right in the intellectual property, then in that event, the payment made should not be treated as royalty as it is a purchase for the purpose of use of the product. The Singapore Government has also specifically granted exemption from withholding taxes to importers of shrink-wrapped software.

Tags : Solid Works Corporation, shrink wrapped software, royalty , DTAA, India-USA tax treaty

TDS On Software -Microsoft Ruling Delhi ITAT

Tax is payable on import of all software , even if the sale does not involve exercise of copyright, according to a Delhi tax tribunal order in a case relating to Microsoft .

 

While the order, passed on October 28, is significant in terms of the liability to withold tax from payments made while importing software, the Delhi Income-Tax Appellate Order (ITAT) attracted the attention of tax professionals on account of its observation that questioned the sanctity of tax treaties.

 

In the order, which may spark multiple litigations , the division bench of ITAT observed that it is not necessary that provisions of tax treaties always override the provisions of domestic tax laws. In a situation, where a provision in the domestic tax law is incorporated after the signing of a Double Taxation Avoidance Agreement (DTAA), it is the domestic law that will override DTAA. According to the existing position, if there is a conflict between domestic tax laws and treaty provisions, the latter is supreme.

This is the first time that a judicial body or quasi judicial body has observed that domestic law can override treaty provisions. This observation was made while holding that royalty is payable by Microsoft. The ITAT has for the first time challenged the superiority of DTAAs India has signed with many countries.

The order says, “Assuming there was a conflict between the Act and the DTAA, the proposition that DTAA will prevail over the Act is not infallible. Later domestic tax legislation can override treaty provisions if there is an irreconcilable conflict (Gramophone India case).”

While the judgement assumes importance because of its offbeat approach on the sanctity of tax treaties, the order has a direct bearing on the software industry in India which now has to pay tax on all imports of software, irrespective of whether the purchase is a copyright or not.

Currently, there are some judgements in favour of the assessee, if the software is a single user licence for use by oneself. In such cases, the licence was tantamount to a copyrighted product and, hence, should not suffer withholding tax because there is no exploitation of copyright in the licence. The Delhi ITAT order changes this.

Vispi Patel of Vispi T Patel & Associates said, ”The Delhi bench has quoted Supreme Court order in the case of Gramophone India. The context in both the cases are different and, therefore, it is not right in applying the same yardstick in the case of Microsoft.”

“The order is a significant departure from how payments for purchase of off-the-shelf software have been viewed by the appellate authorities earlier. It holds that such payments would be for use of a copyright (and not for use of copyrighted article) and would be taxable on a gross basis. The far reaching implications of this proposition apart, the judgement speaks of a treaty override by a subsequent domestic legislation if there is an ‘irreconcilable conflict’ .

 

Delhi ITAT order questions the sanctity of tax treaties

 

Tribunal rules that provisions of tax treaties need not always over ride domestic tax laws

Against current practices, if a domestic tax law is incorporated in a DTAA, the former will override the latter

Software industry will have to pay tax on all software imports , whether the purchase is a copyright or not.

Transfer of shares to wholly owned Indian subsidiary not taxable in India

Transfer of shares to wholly owned Indian subsidiary not taxable in India

Court : Authority for Advance Rulings (AAR)

Brief : Authority for Advance Rulings (AAR) concluded that gains derived from the transfer of shares by a Mauritius company to its wholly owned subsidiary in India would not be taxable in India under the Indian Income Tax Act (ITA), nor would such gains be subject to the Minimum Alternate Tax (MAT) (Praxair Pacific Limited (A.A.R. No. 855/2009)). The AAR further clarified that benefits under the India-Mauritius tax treaty would be available to the Mauritius Company.

Citation : Praxair Pacific Limited (A.A.R. No. 855/2009)

Background:-Praxair Pacific Limited (“PPL”), a company incorporated in Mauritius, proposes to transfer its 74% equity stake in Jindal Praxair Oxygen Company Private Limited (“JPOCPL”) to its wholly owned subsidiary in India, Praxair India Private Limited (“Praxair India”). The consideration for the proposed transfer is stated to be determined on the basis of cost, unless a higher consideration is required under the pricing guidelines prescribed by the Reserve Bank of India as applicable for transfer of shares.

Issues before the AAR

• Whether the investment held by PPL in equity shares of JPOCPL would be considered as “capital asset” under section 2(14) of the Income-tax Act, 1961 (“ITA”)?

• Whether transfer of JPOCPL from PPL to its wholly owned subsidiary Praxair India would be liable to tax in India in view of the exemption under section 47(iv) of the ITA?

Please note Exemption under section 47(iv) of the ITA is available if the capital asset is transferred by a holding company to its wholly owned Indian subsidiary.

• Whether PPL would be entitled to the benefits of the India – Mauritius Tax Treaty (“Treaty”) and whether the gain arising to PPL would be liable to tax in India having regard to the provisions of Article 13 of the Treaty?

•Whether the gains arising to PPL from the sale of equity shares of JPOCPL would be taxable in India in the absence of Permanent Establishment (“PE”) of PPL in India in light of the provisions of Article 7 read with Article 5 of the Treaty?

•Whether PPL would be liable to Minimum Alternate tax under the ITA?

•Where the gains arising to PPL on account of the proposed transfer is not taxable in India under the Act or the Treaty, whether Praxair India, the transferee company, is required to withhold tax in accordance with the provisions of section 195 of the ITA?

•If the gains are not taxable in India, whether PPL is required to file any return of income of income under section 139 of the ITA? This question was not pressed by PPL.

•Whether the proposed transfer of equity shares by PPL to Praxair India attracts the transfer pricing provisions of section 92 to 92F of the ITA?

Contention of the applicant

• The shares held by PPL in JPOCPL are not held as stock-in-trade but represent investments and thus should be classified as a capital asset.

• As PPL proposes to transfer its equity shareholding in JPOCPL to Praxair India, its wholly owned subsidiary in India, the provisions of section 47(iv) of the ITA are fulfilled. Gains, if any, on the transfer of equity shares in JPOCPL would not be taxable in India.

• PPL would not be liable to tax book profits or Minimum Alternate tax under the ITA as the provisions of section 11 5JB would be applicable only to domestic companies and not to foreign companies.

• The gains from the proposed transfer of shares in JPOCPL by the Applicant would not be taxable in India as capital gains or business income in the light of the treaty.

• In case the proposed gains are not considered as capital gains but as business income, such business income will not be taxable in India since PPL does not have a PE in India.

Observations / Rulings of the AAR

• The shares in JPOCPL have been held as “Non-current assets – investment in subsidiaries” since 1995 and were never a subject matter of any transaction till date. As the shares were not held as stock in trade, the nature of the investment in these shares is held to be a “capital asset” as defined in section 2(14) of the ITA.

• As PPL proposes to transfer its equity share holding in JPOCPL to Praxair India which is its wholly owned subsidiary in India, the conditions under section 47(iv) of the ITA are fulfilled and hence the gains if any arising on transfer would not be taxable in India.

• As PPL is tax resident of Mauritius and has been issued Tax Residency Certificate by the Mauritius Revenue Authority, it would not be subjected to tax in India on the capital gains arising from the proposed transaction in India under the Treaty.

• The annual accounts of the applicant cannot be prepared in accordance with Schedule VI of the Companies Act 1956. The provision under the ITA relating to Book Profits Tax is not designed to be applicable to a foreign company which has no presence or PE in India. The AAR relied on its ruling in the case of Timken USA (AAR 836 of 2009) where it was held that under the Companies Act 1956 only such foreign companies who have established a place of business within India are required to make out a Balance Sheet and Profit and Loss account as required under the said Act.

• Sections 11 5JB of the ITA is not attracted in the case of PPL.

• The transfer pricing provisions of section 92 to 92F of the ITA would not be attracted in the absence of liability to pay tax on the capital gain.

Conclusion: - Gains from the transfer of shares by a Mauritius company to its wholly owned subsidiary in India would not be taxable in India either under the ITA. The AAR has also reiterated the benefit of the India- Mauritius tax treaty would be available to PPL as it had adequate tax residency certificate issued by the Mauritius Revenue Authority. Further, the gains from such transfer would not be subject to Minimum Alternate Tax as the provisions under the ITA governing such tax do not apply to a foreign company that has no presence or PE in India

Software is “goods”, its supply may be a “service” and not a “sale”

Infotech Software Dealers Association vs. UOI (Madras High Court)

Though software is “goods”, its supply may be a “service” and not a “sale”

S. 65(105)(zzzze) of the Finance Act, 1995 inserted by the F (No. 2) Act, 2009 provides for the levy of service tax on “any service provided … to any person, by any other person in relation to information technology software for use in the course, or furtherance, of business or commerce, including … acquiring the right to use information technology software …” The Petitioner, an association of software resellers, contented inter alia that as software had been held to be “goods” by the Supreme Court in Tata Consultancy Services 271 ITR 401 and as there was a “sale” attracting VAT, there could not also be a “service” and that s. 65(105)(zzzze) was unconstitutional. HELD dismissing the Petition:

(i) Two questions arise for consideration: (a) whether software is goods and (b) if so, whether in all case of transactions, it would amount to sale or in some transactions it could be considered to be a service;

(ii) All software is “goods”. Article 366(12) of the Constitution defines the term “goods” to include all materials, commodities and articles. It is an inclusive definition. Though a software programme consists of various commands which enable the computer to perform a designated task and the copyright in that programme remains with the originator of the programme, yet because software is an article of value, it is “goods”. Indian law does not make a distinction between tangible property and intangible property. Tata Consultancy Services 271 ITR 401 (SC) followed;

(iii) However, while software is “goods”, all transactions are not necessarily a “sale”. The transaction may be one which is either an ‘exclusive sale’ or ‘an exclusive service’ or one which has the elements of a sale and service. A perusal of a sample ‘End User Licence Agreement’ (EULA) shows that the dominant intention of the parties is that the developer keeps the copyright of each software is only the right to use with copyright protection. By the agreement, the developer does not sell the software as such. The Petitioner in turn enters into a EULA for marketing the software to the end-user. Accordingly, when a transaction takes place between the Petitioner and its customers, it is not the sale of the software as such, but only the contents of the data stored in the software which would amount to only service. To bring the deemed sale under Article 366(29A)(d) of the Constitution, there must be a transfer of right to use any goods and when the goods as such is not transferred, the question of deeming sale of goods does not arise and in that sense, the transaction would be only a service and not a sale;

(iv) Accordingly, the argument that as software is ‘goods’, all transactions of canned / packaged software or customized software is a sale is not acceptable. The question whether a transaction amounts to a sale or service depends upon the individual transaction. Parliament cannot be said not to have the legislative competence to tax the transaction if it is shown to be a service.

Note: In Velankani Mauritius vs. DDIT (ITAT Bangalore), Kansai Nerolac Paints vs. ADIT (ITAT Mumbai) & Dassault Systems 229 CTR 105 (AAR) it has been held relying on Tata Consultancy Services 271 ITR 401 (SC) that income from software supply is not “royalty” but is “business profits” & not chargeable to tax in the absence of a PE. See Also update on Samsung Electronics 227 CTR 335 (Kar).

Per hour billing rate published by NASSCOM for a specific business segment as an external CUP in determining the arm’s length price

Facts :-The Mumbai bench of the Income Tax Appellate Tribunal (ITAT) has recently pronounced its ruling on an appeal originating from a transfer pricing adjustment imposed on 3 Global Services Private Limited (“assessee”). The assessee operates in the voice based customer care segment within the IT-enabled services (ITeS) industry. During financial year 2003-04, the assessee rendered services to its associated enterprises (“AEs”). The Comparable Uncontrolled Price (CUP) method was selected as the most appropriate method to justify the arm’s length result of transactions with its AE. In order to apply the CUP method, the assessee relied on hourly rates of “Customer Care” segment as published by NASSCOM and a report prepared by M/s Batliwala & Karani Securities Pvt. Ltd.

During the course of assessment proceedings, the transfer pricing officer (TPO) rejected the CUP method selected by the assessee and chose the Transactional Net Margin Method (TNMM) as the most appropriate method for evaluating the international transaction. The TPO selected five companies for comparability purposes which operate in various segments, viz, KPO, content development, data conversion, software etc. These segments differ in essence from the voice based customer care segment to which the assessee belongs. The TPO computed the average margin of five companies at 6.28% resulting in an upward adjustment of Rs 6.73 crore to the income of the assessee. The AO passed the final order in conformity with the order of the TPO.

Proceedings before CIT(A)

Aggrieved by the order of the TPO/AO, the assessee preferred an appeal before CIT (A). The assessee contended that per hour rate relied upon by it relates specifically to voice-based ITeS services hence are comparable. Further, third-party transactions are priced on the basis of hourly rates and not as a percentage of costs. On the technicalities of the transfer pricing analysis, the assessee appealed that the usage of TNMM as the most appropriate method is not justifiable in view of availability of CUP which has not been rebutted by TPO. Further, the set of companies considered by the TPO/AO for arriving at the at arm’s length price under TNMM are not comparable given functional differences and erroneous margin computation by the TPO.

Ruling of CIT (Appeals)

The CIT (A) upheld the conclusions reached by the assessee and observed:

Per hour rate of customer care segment as reported by NASSCOM is based on actual billing rates offered by a member of independent enterprise and therefore the rate represent the arithmetic average of comparable uncontrolled rates.

Per hour rate of specific companies engaged in voice based services sector, as per Batliwala Karani Securities (I) Pvt. Ltd., ranges between $10 to $13 whereas appellant’s per hour rate is $13.09 which is within the arm’s length rage. Therefore, CUP method is justified in this case

The companies selected by the TPO are functionally different from assessee as these are not from voice?

based BPO services segment. Hence such companies are not comparable while applying the TNMM;

Even if the CUP is not applied, the appellant has generated reasonable amount of profit.

Ruling of the ITAT

Aggrieved by the decision, the revenue appealed before the ITAT, Mumbai Bench. The ITAT passed its order in conformity with the order of the CIT(A) and observed that:

The specific rates provided by the NASSCOM report, are specific to voice-based ITeS services segment under which the assessee falls;

Billing rate per hour of the assessee is in line with the man hour rate prevalent in the industry;

The companies selected by the TPO are not comparable as they operate in a segment different from that of the assessee; and

Computation of the average margin of companies selected by the TPO are incorrect and hence cannot be relied upon

In these circumstances, the CUP method as followed by the assessee is the most appropriate method.

Conclusion

The ruling emphasizes that per hour rate of a specific sub segment of ITeS industry may be considered as CUP provided the assessee applying such rate belongs to the specific sub segment. Further, companies which operate in a different segment of the industry cannot be selected as comparables for application of TNMM.

It is important to bear in mind that in an earlier ruling by Bangalore ITAT in case of Aztec Software & Technology Service Ltd its was held that average per hour rate given by NASSCOM cannot be considered as it is an average of transactions quite different in nature and content than the taxpayer. OECD’s transfer pricing guidelines also asserts that unadjusted industry average rate should not be considered as CUP.

(Source: DCIT Vs. M/s 3 Global Services Pvt. Ltd. ITA No 1812/Mum/09)

International Tax -MAT & Share Transfer

Minimum Alternate Tax (MAT) provisions not applicable to foreign companies if no physical presence in India

The applicant is a company incorporated in the United States and is a leading manufacturer of engineered bearings, alloys etc. The applicant has a significant shareholding in an Indian listed company, which was initially set up as joint venture with Tata Iron and Steel Company. As part of a global restructuring exercise, the applicant proposes to transfer its shareholding in the Indian company to a company incorporated in Mauritius. The proposed transfer would be undertaken on the Bombay Stock Exchange and subject to Security Transaction tax (STT). The shares are held by the applicant for more than 12 months.

Capital gain on transfer of long term equity shares is exempt from tax in India under the Income-tax Act, 1961 (ITA) if STT is paid on the same.

Issue before Authority for Advance Ruling (AAR)

The issue before the AAR is whether MAT provisions are applicable to a foreign company having no physical business presence in India?

Ruling of the AAR

• The AAR distinguished its earlier ruling in the case of P.NO 14 of 1997 (234 ITR 335) wherein it had held that a foreign company would be subject to MAT provisions. The critical factor for distinguishing was on the basis that in the earlier ruling the applicant had a project office in India, which constituted a Permanent Establishment and was preparing its financial statements as required under Indian Companies Act.

• In order to comply with the requirement of MAT provisions regarding preparing Profit & Loss Account in accordance with the provisions of the Indian Companies Act, it is essential that the foreign company should have a place of business within India.

• In the present case, the applicant does not have a place of business in India; hence compliance of preparation of Profit & Loss Account as per the Indian Companies Act could not be possible.

• The MAT provisions are applicable to a company. Under the ITA, Company has inter-alia been defined to include a body corporate incorporated outside India ie foreign company. As per the AAR, the context in which Company is used for MAT provisions should not include a foreign company for the following reasons:

- Income which does not have a source in India cannot be made part of the book profit

- The annual accounts including Profit & Loss Account cannot be prepared in the prescribed manner for the worldwide income and presented before the company in its General Meeting.

- The Finance Minister’s speech and the memorandum explaining the introduction of MAT provisions would become out of sync if the meaning of company for MAT provisions would include a foreign company.

Conclusion:-As per the provisions of the ITA, rulings pronounced by the AAR are applicable only with respect to the applicant. However, there are certain judicial precedents which have held that ruling pronounced by the AAR do have a persuasive value. Accordingly, the aforesaid ruling could potentially come as an aid for foreign companies having no presence in India and are earning passive income from India to argue that MAT provisions are not applicable. For example, this ruling could be beneficial for capital gains made by Foreign Institutional Investors or Private Equity Funds investing in the Indian stock markets or unlisted Indian companies.

Transfer of shares by a foreign company to its wholly owned Indian subsidiary not taxable in India

Praxair Pacific Limited (PPL ), a company incorporated in Mauritius, proposes to transfer its 74% equity stake in Jindal Praxair Oxygen Company Private Limited (JPOCPL) to its wholly owned subsidiary in India, Praxair India Private Limited (Praxair India). The consideration for the proposed transfer is stated to be determined on the basis of cost, unless a higher consideration is required under the pricing guidelines prescribed by the Reserve Bank of India as applicable for transfer of shares.

Issues before the AAR

• Whether the investment held by PPL in equity shares of JPOCPL would be considered as “capital asset” under section 2(14) of the Income-tax Act, 1961 (“ITA”)?

• Whether transfer of JPOCPL from PPL to its wholly owned subsidiary Praxair India would be liable to tax in India in view of the exemption under section 47(iv) of the ITA?

Exemption under section 47(iv) of the ITA is available if the capital asset is transferred by a holding company to its wholly owned Indian subsidiary.

• Whether PPL would be entitled to the benefits of the India – Mauritius Tax Treaty (“Treaty”) and whether the gain arising to PPL would be liable to tax in India having regard to the provisions of Article 13 of the Treaty?

• Whether the gains arising to PPL from the sale of equity shares of JPOCPL would be taxable in India in the absence of Permanent Establishment (“PE”) of PPL in India in light of the provisions of Article 7 read with Article 5 of the Treaty?

• Whether PPL would be liable to Minimum Alternate tax under the ITA?

• Where the gains arising to PPL on account of the proposed transfer is not taxable in India under the Act or the Treaty, whether Praxair India, the transferee company, is required to withhold tax in accordance with the provisions of section 195 of the ITA?

• If the gains are not taxable in India, whether PPL is required to file any return of income of income under section 139 of the ITA? This question was not pressed by PPL.

• Whether the proposed transfer of equity shares by PPL to Praxair India attracts the transfer pricing provisions of section 92 to 92F of the ITA?

Contention of the applicant

• The shares held by PPL in JPOCPL are not held as stock-in-trade but represent investments and thus should be classified as a capital asset.

• As PPL proposes to transfer its equity shareholding in JPOCPL to Praxair India, its wholly owned subsidiary in India, the provisions of section 47(iv) of the ITA are fulfilled. Gains, if any, on the transfer of equity shares in JPOCPL would not be taxable in India.

• PPL would not be liable to tax book profits or Minimum Alternate tax under the ITA as the provisions of section 11 5JB would be applicable only to domestic companies and not to foreign companies.

• The gains from the proposed transfer of shares in JPOCPL by the Applicant would not be taxable in India as capital gains or business income in the light of the treaty.

• In case the proposed gains are not considered as capital gains but as business income, such business income will not be taxable in India since PPL does not have a PE in India.

Observations / Rulings of the AAR

• The shares in JPOCPL have been held as “Non-current assets – investment in subsidiaries” since 1995 and were never a subject matter of any transaction till date. As the shares were not held as stock in trade, the nature of the investment in these shares is held to be a “capital asset” as defined in section 2(14) of the ITA.

• As PPL proposes to transfer its equity share holding in JPOCPL to Praxair India which is its wholly owned subsidiary in India, the conditions under section 47(iv) of the ITA are fulfilled and hence the gains if any arising on transfer would not be taxable in India.

• As PPL is tax resident of Mauritius and has been issued Tax Residency Certificate by the Mauritius Revenue Authority, it would not be subjected to tax in India on the capital gains arising from the proposed transaction in India under the Treaty.

• The annual accounts of the applicant cannot be prepared in accordance with Schedule VI of the Companies Act 1956. The provision under the ITA relating to Book Profits Tax is not designed to be applicable to a foreign company which has no presence or PE in India. The AAR relied on its ruling in the case of Timken USA (AAR 836 of 2009) where it was held that under the Companies Act 1956 only such foreign companies who have established a place of business within India are required to make out a Balance Sheet and Profit and Loss account as required under the said Act.

• Sections 11 5JB of the ITA is not attracted in the case of PPL.

• The transfer pricing provisions of section 92 to 92F of the ITA would not be attracted in the absence of liability to pay tax on the capital gain.

Conclusion:-Gains from the transfer of shares by a Mauritius company to its wholly owned subsidiary in India would not be taxable in India either under the ITA. The AAR has also reiterated the benefit of the India- Mauritius tax treaty would be available to PPL as it had adequate tax residency certificate issued by the Mauritius Revenue Authority. Further, the gains from such transfer would not be subject to Minimum Alternate Tax as the provisions under the ITA governing such tax do not apply to a foreign company that has no presence or PE in India

Source: M/s. Praxair Pacific Limited (A.A.R. No. 855/2009 dated 23 July 2010)