Tax treatment of Gratuity after Increase in limit from 3.50 lakh to 10 lakh

The government notified the Payment of Gratuity (Amendment) Act, 2010 on May 18, 2010, which increases the limit of gratuity payment to employees in the specified sectors/establishments covered under the Payment of Gratuity Act, 1972 (“Gratuity Act”). After the amendment, these employees are eligible to receive gratuity up to Rs 10,00,000, which was earlier restricted to Rs 3,50,000. Thus, crores of workers will be benefited in establishments covered by the Gratuity Act.

Meaning of Gratuity :-Gratuity refers to the emoluments received by an employee from his employer in gratitude for the services rendered. Such sum can be paid on retirement, resignation, superannuation, death or disablement. Under the Gratuity Act, the sum can be paid only after an employee has rendered continuous service of not less than five years. Exceptions being termination of employment on account of death/disablement.

Eligibility criteria:-Gratuity shall be payable to an “employee” on the termination of his employment after he has rendered continuous service for not less than five years.

• On his superannuation.

• On his retirement or resignation.

• On his death or disablement due to accident or disease.

Note: However, the condition of five years of continuous service is not necessary if service is terminated due to death or disablement.

To whom is Gratuity Payable?

Gratuity is normally payable to the employee himself, however in the case of death of the employee it shall be paid to his nominee & nomination has been made to his heirs. Incase the nominee is a minor; share of the minor shall be deposited with the controlling authority who shall invest the same for benefit of the minor, until he/she attains majority.

Taxability of Gratuity

From a tax perspective, gratuity received by an employee is taxable as salaries. The Income tax Act segregates the employees receiving gratuity on the following basis:

==> Government employees;

==> Non – Government employee covered under the Gratuity Act.

==> Non – Government employee and not covered under the Gratuity Act.

Based, on the above segregation, necessary exemptions from tax can be claimed on the gratuity received.

Exemption available for employees covered under the Gratuity Act

In case of employees covered under the Gratuity Act, exemption is limited to the extent of minimum of the following:

i) Gratuity actually received

ii) 15 days salary for every completed year of service or part thereof (i.e. services in excess of 6 months will be treated as full year service)

iii) Rs 3,50,000 (the maximum limit as provided in the Gratuity Act)

The increase in limit to Rs 10,00,000 in the Gratuity Act (from the erstwhile Rs 3,50,000) in a way indicates that the tax exemption may also increase.

As per the Act, the gratuity amount is 15 days’ wage multiplied by the number of years put in by you. Here wage refers to basic salary plus dearness allowance. Take the monthly salary drawn by you last (basic + dearness allowance) at the time of resignation or retirement. Divide this by 26. This gives you your daily salary. Multiply this amount by 15 days, and further by the number of years of service you have put in.

If you have put in 10 years and seven months in an organisation, your service period will be taken to be 11 years. But if your service tenure is 10 years and five months, then for the purpose of this calculation your tenure will be taken to be 10 years only.

Take an example. Suppose that your average monthly salary is Rs 26,000. Your daily salary will be Rs 1,000. Multiply this by 15 and then by 10. The gratuity you are entitled to after 10 years of service will be Rs 1.5 lakh.

Formula :- Gratuity shall be calculated as per the below formula:

Gratuity = Last drawn salary x 15/26 x No. of years of service

Your last drawn salary will comprise your basic + DA. For computation of gratuity, your service period will be rounded off to the nearest full year.

Tax impact of the amendment

The tax impact can be explained by way of an example. Suppose, Mr A retires from a software company after servicing for 35 years and at the time of retirement his basic salary was Rs 50,000 per month.

Upon retirement, Mr A is eligible for a gratuity payout of Rs 10,00,000 and is covered under the Gratuity Act.

This example indicates that by increasing the limit, Mr A will be getting more gratuity and also a significant tax benefit.

Taxable amount of gratuity in different scenarios

Taxable Gratuity – Pre Amendment Taxable Gratuity – Post Amendment

Least of the following shall be exempt :

1) Actual gratuity received – Rs 10,00,000

2) 15 days salary for every completed year of service or part thereof – 50,000*15/26*35 = Rs 10,09,615

3) Rs 3,50,000 Least of the following shall be exempt :

1) Actual gratuity received – Rs 10,00,000

2) 15 days Salary for every completed year of service or part thereof – 50,000*15/26*35 = Rs 10,09,615

3) Rs 10,00,000

Exempt Gratuity = Rs 3,50,000 Exempt Gratuity = Rs 10,00,000

Taxable Gratuity = Rs 10,00,000- 3,50,000 = Rs 6,50,000 Taxable Gratuity = Rs 10,00,000- 10,00,000 = NIL

Open issues

There are some open issues in terms of the date from which the higher limit is applicable and whether a separate clarification/notification will come from a tax perspective. The increase in limit has got the president recently and it seems that the open issues will get clarified soon.

Conclusion

The above amendment in the Gratuity Act is a welcome step by the government and will bring lots of cheer to employees across the private sector.

SEZ Computation of Profit

S. 10 AA (7): (Clause – 6 of Finance Bill, 2010)

Background:-Section 10AA was inserted in the Income-tax Act, 1961 (“the Act”) by the Special Economic Zones Act, 2005 (“the SEZ Act”) with effect from 10-2-2006. The section was enacted specially with respect to provide tax exemption to the newly established units in the Special Economic Zone (“the SEZ”). For claiming deduction under section 10AA of the Act following conditions are to be satisfied:

(i) The assessee being an entrepreneur as defined under section 2(j) of the SEZ Act has to set up a unit in the SEZ;

(ii) The unit so set up by the assessee should commence to manufacture or produce articles or things or provide any service during the previous year commencing after 1-4-2006;

(iii) The undertaking should not be formed:

(a) by splitting up, or by the reconstruction, of a business already in existence; or

(b) by a transfer to new business of machinery and plant previously used for any purpose by the assessee;

(iv) The assessee has exported goods or provided services out of India from the SEZ, whether physically or otherwise;

(v) The books of account are audited and audit report is filed along with the return of income and the assessee claims the deduction in its return of income;

If the assessee satisfied the above conditions then prior to 2009, hundred per cent (100%) of the profit or gains derived from export of goods or from services is deductible for a period of 5 (five) consecutive assessment years and thereafter, fifty per cent (50%) of the profit or gains derived from export of goods or from services is deductible for the next 5 (five) years. Profits derived from the export of articles or things or services would be the amount which bears to the profits of the business of the undertaking, being the unit, the same proportion as the export turnover in respect of such articles or things or services bears to the total turnover of the business carried on by the assessee. Accordingly, the formula for computing deduction under section 10AA prior to 2009 was as under:

Profits of the business of the Unit x Export Turnover of the Unit

Total Turnover of the business carried out by the assessee

This formula was seemingly created discrimination between assessees who were having multiple units in the SEZ as well as in the domestic tariff area (DTA) and the assessees who were having units only in the SEZ. Here it may be pertinent to note that section 10AA itself clarified that the word, ‘assessee’ for the purpose of this section would mean an entrepreneur referred to in section 2(j) of the SEZ Act, as such the word, ‘assessee’ referred to in the formula should be an undertaking in the SEZ.

However, in order to remove this anomaly, the aforesaid provision of the sub-section (7) of section 10AA was amended by section 6 of the Finance (No. 2) Act, 2009, so as to substitute the reference to “assessee” by the word “undertaking”. Accordingly, the exemption under section 10AA was to be computed with reference to the total turnover of the undertaking in the SEZ and not with reference to the total turnover of the business of the assessee. The said amendment made by Finance (No. 2) Act, 2009 become effective from 1-4-2010 and accordingly, applied in relation to the A.Y. 2010-11 and subsequent years. At the time when this amendment by the Finance (No. 2) Act, 2009 was made doubts were expressed as to whether the amendment should be retrospective or prospective from 2010-11 so as to streamline the provisions of the section.

Amendment Made

Now, in order to make the amendment effective for earlier years that is from the year in which the provisions of section 10AA came into force, it is amended in Finance Bill, 2010, by inserting a proviso to sub-section (7), which reads as under:

“Provided that the provisions of this sub-section [as amended by section 6 of the Finance (No. 2) Act, 2009] shall have effect for the assessment year beginning on the 1st day of April, 2006 and subsequent assessment years.”

To provide that the provision of sub-section (7), as amended by Finance (No. 2) Act, 2009, will apply retrospectively from the A.Y. 2006-07 and subsequent assessment years.

Comments

By the amendment, now the method of computation of profits eligible for tax holiday in case of SEZ undertakings is streamlined retrospectively that is since introduction of the provisions of section 10AA of the Act.

Derivatives are speculative transactions if not for bona fide hedging

ACIT vs. Dinesh K. Mehta HUF (ITAT Mumbai)

S. 43(5): Derivatives are speculative transactions if not for bona fide hedging

In respect of AY 2005-06, the assessee, a dealer in shares, entered into transaction of purchases of Nifty Futures, which being a derivative instrument, was settled by payment of differences and not actual delivery of shares. The assessee argued that the transactions were hedging transactions meant to minimize the loss due to fluctuation of price of shares held as stock-in-trade and could not be regarded as speculative transactions u/s 43(5) so as to disallow the loss from being set off against other income. The AO took the view that a derivatives transaction could be regarded as a hedging transaction u/s 43(5)(b) only to the extent of the inventory of shares held by the assessee and that the excess would be regarded as a speculative transaction. As, on the date the Nifty Futures were purchased, the inventory of shares held by the assessee was less that the value of the Futures, the loss was treated as a speculation loss. The CIT (A) allowed the appeal on the ground that the s. 43(5)(d) inserted by FA 2005 w.e.f. 1.4.2006 (which provides that derivatives are not speculation transactions) was clarificatory). On appeal by the Revenue, HELD reversing the CIT (A):

(i) In Shree Capital Services 121 ITD 498 (Kol) it has been held by the Special Bench that the amendment to s. 43(5)(d) is neither clarificatory nor retrospective in operation. Consequently, derivatives can be considered non-speculative u/s 43(5)(b) only to the extent they are for hedging purposes;

(ii) The argument of the assessee that to constitute a hedging transaction u/s 43(5)(b), a transaction need not be in the same shares held by the assessee as inventory or that the value of hedging transactions should be equal to or less than the value of inventory held by the assessee is not acceptable. Circular No. 23D dated 12-9-1960 makes it clear that bona fide hedging transactions shall not be regarded as speculative provided that the hedging transactions are up to the amount of his holdings and confined to shares in his holding. The value and volume of hedging transactions should be in equal proportion and the hedging transaction should be in respect of the same scripts held by the assessee;

(iii) If the arguments of the assessee are accepted, it will lead to a situation where all speculative transactions will be claimed as hedging transactions and the purpose behind s. 73 of not permitting set off of speculative loss against business income will become redundant. The fact that in Nifty futures and index futures there cannot be any identification of shares does not change the position in law till the insertion of s. 43(5)(d);

(iv) As the AO has gone by the overall value of inventory without individual script wise tally (though required to be done), the plea of the assessee that the loss in purchase of Nifty Futures should not be considered as speculative to the extent of the value of inventory held by the Assessee on a particular day is acceptable.

TDS on Non-resident – No PAN – What’s the rate?

Section 206AA starts with the words “Notwithstanding anything contained in any other provisions of this Act”. This is a non-obstante clause which means that the provisions of section 206AA shall override other provisions of the Act. If we go through Section 90(2), it provides that ‘Where the Central Government has entered into an agreement with the Government of any country outside India or specified territory outside India, as the case may be, under sub-section (1) of section 90, for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee. Does this mean that new section 206AA overrides section 90(2), so that, notwithstanding the provisions of section 90(2), deduction of TDS shall be at the rate of 20% wherever the non-residents have not obtained/furnished PAN? The DTAAs are entered into by the Executive with the power and rights given under Article 73 of the Constitution. So far, the law has been clear that Article 73 will have the effect of the DTAA overriding the Act, as the Executive has to exercise jurisdiction keeping in mind DTAA obligations and commitments made. This proposition has been also been reiterated in CIT Vs. Davy Ashmore Ltd (190 ITR 626 CAL), CIT Vs. R.M.Muthiah (202 ITR 508 KAR), CIT Vs. VR.S.R.M.Firm (208 ITR 400 MAD), Arabian Express Ltd of United Kingdom and Others Vs. UOI (212 ITR 31 GUJ) and CIT Vs. Visakhapatnam Port Trust (144 ITR 146 AP)

In a recently reported judgement of the Bombay High Court in CIT Vs. Siemens Aktiongesellschaft (310 ITR 320), Their Lordships while interpreting the provisions of the Act in relation to Double Taxation Avoidance Agreements held that “The rule of referential incorporation or incorporation cannot be applied when dealing with a treaty between two sovereign nations. Though it is open to a sovereign Legislature to amend its laws, a DTAA entered into by the Government in exercise of the powers conferred by section 90(1) of the Income tax Act, 1961, while considering section 90(2) has to be reasonably construed”. The CBDT has also clarified in Circular No: 333 dated 02-04-1982 as follows “The correct legal position is that where a specific provision is made in the DTAA, that provision will prevail over the general provisions contained in the Income Tax Act, 1961. In fact the DTAA which have been entered into by the Central Government under section 90 of the Income tax Act, 1961 also provide that, the laws in force in either country, will continue to govern the assessment and taxation of income in the respective country, except where provisions to the contrary have been made in the agreement”.

Meanwhile, the CBDT Chairman has made it clear that there was “no legal lacuna” in stipulating a higher TDS rate of 20 per cent on payments made to non-residents who do not have or furnish PAN to the deductor. The CBDT Chairman could have elaborated a bit more and specified the grounds on which he felt that there was no legal lacuna in the amendment. For the Non-residents the choice appears to be, (a) either obtain and furnish PAN to avoid 20% TDS or (b) suffer 20% TDS, then obtain PAN, file the Income tax Return and get the excess tax if any refunded! I am sure every one would prefer the first option.

Income earned abroad can’t be taxed, if the same is not chargeable to tax under the general provisions of the I-T Act

In a recent ruling Mumbai Income Tax Appellate Tribunal (ITAT) [2010- T11-41-ITAT-MUM-INTL] in the case of J Ray McDermott Eastern Hemisphere Ltd. (Taxpayer) held that receipts pertaining to transportation and installation contract executed by the Taxpayer outside India cannot be taxed under the special provisions, which provide for taxation of certain income of a non-resident on presumptive basis, if the income is not chargeable to tax under the general provisions of the Income Tax Act, 1961.

Background and facts of the case

The Taxpayer, a company tax resident of Mauritius, was engaged in the business of designing, fabrication, construction and installation of platforms, docks, pipelines, jackets and other similar activities which are used in the exploration and production of mineral oil.

The Taxpayer undertook and executed a contract for transportation and installation work under certain well platforms projects to be used in mineral oil exploration viz. N-11 and N­12.

While filing its tax return, the Taxpayer did not offer the receipts pertaining to activities carried on outside India for tax.

The Income Tax Act contains special provisions for taxation of income arising to a non-resident for providing services used in mineral oil exploration. Under this provision, 10% of the gross receipts of the non-resident is deemed to be income chargeable to tax.

The Tax Authority ruled that as the source of income is related to an agreement for work to be carried on in India, the whole of the receipts would be taxable under the Income Tax Act. Further, as income is computed on presumptive basis under the Income Tax Act, the distinction between activities carried on in India and those outside India is not relevant and the gross receipts would be taxable.

The first appellate authority reversed the decision of the Tax Authority.

Aggrieved, the Tax Authority appealed against the decision of the first appellate authority.

Contentions of the Taxpayer

Income pertaining to installation and transportation activities carried on outside India is not taxable under the Income Tax Act.

Alternatively, income pertaining to the above activities or work carried on outside India cannot be attributable to a permanent establishment (PE) in India.

Contentions of the Tax Authority:-The entire receipt arising on execution of the contract for installation and transportation is attributable to the PE of the Taxpayer in India.

Ruling of the ITAT

The ITAT upheld the decision of the first appellate authority. The ITAT held that only income which is reasonably attributable to operations carried on in India is taxable in India. Income computed on presumptive basis can be taxed in India only if such income is chargeable to tax under the general provisions of the Income Tax Act.

The ITAT placed reliance on rulings in the case of Saipem SPA v. DCIT [88 ITD 213] (Delhi ITAT) and McDermott ETPM Inc. v. DCIT [92 ITD 385] (Mumbai ITAT) , rendered in a similar context wherein it had been held that before computing income on presumptive basis, it needs to be ensured that such income falls within the scope of total income as envisaged under the Income Tax Act.

Comments

In the case of a non-resident, the Income Tax Act provides for computation of income on a deemed basis as a percentage of the amount paid to a taxpayer on account of provision of services and facilities, supply of plant and machinery etc. to be used in prospecting for mineral oil in India. Generally, in such cases, a portion of the income from the execution of contracts could arise outside India and may not be taxable under the general provisions of the Income Tax Act.

The basis for taxation of the entire receipts pertaining to portions of the contract executed in and outside India has been a subject matter of litigation. In the case of CIT v. Halliburton Offshore Services Inc., the Uttarakhand High Court (HC) had ruled that the provision of the Income Tax Act envisaging computation of income on presumptive basis is a complete code in itself. The HC further ruled that the amount of income computed thereunder would be taxable in India, irrespective of such income falling within the scope of total income as envisaged under the Income Tax Act. However, in the present ruling, the Mumbai ITAT has relied on rulings by other benches of the ITAT and has held that the special provisions relating to presumptive basis of taxation do not override the general provisions that determine scope of total income of a non-resident.

Read more: http://www.taxguru.in/income-tax-case-laws/income-earned-abroad-can%e2%80%99t-be-taxed-if-the-same-is-not-chargeable-to-tax-under-the-general-provisions-of-the-i-t-act.html#ixzz0oFqDDX1l

E*Trade Mauritius Ltd

The Authority for Advance Rulings (AAR) in the case of E*Trade Mauritius Ltd. (AAR No. 826 of 2009) has held that that capital gains arising from the sale of shares in an Indian company would be exempt from tax in India under Article 13(4) of the India-Mauritius Tax Treaty (tax treaty).

The AAR, while relying on the principles laid down by the Supreme Court in the case of Union of India v. Azadi Bacho Andolan [2003] 263 ITR 706 (SC) , observed that -

if a resident of a third country seeks to take advantage of the tax relief and economic benefits under any tax treaty through a conduit entity, the legal transactions entered into by that conduit entity cannot be declared invalid.

the design of tax avoidance by itself is not objectionable if it is within the framework of law and not prohibited by law.

Facts of the case

E*Trade is an indirect subsidiary of E*Trade Financial Corporation, USA (US Co) which sold its stake in IL&FS Investmart Ltd.(IL&FS), an Indian company to HSBC Violet Investments (Mauritius) Ltd. (HSBC), another Mauritius company.

E*Trade made an application under section 197 of the Income-tax Act, 1961 (the Act) to the tax authorities for issue of a ‘Nil’ withholding certificate authorising HSBC not to deduct any tax from the sales proceeds payable to E*Trade.

The tax authorities issued a certificate under section 197 of the Act directing HSBC to deduct tax on the amounts paid to E*Trade. E*Trade filed a writ petition before the Bombay High Court challenging the said certificate.

With the consent of the parties, the Bombay High Court by its order dated 26 September 2008 disposed of the writ petition directing E*Trade to file a revision application before the Director of Income Tax (International Tax) (DIT). Pending the decision of the DIT, HSBC was also directed to deposit a sum of INR 245 million which would be withheld from the consideration paid to E*Trade. It is important to note that the High Court did not get into the merits of the case.

Pursuant to the High Court’s order, the DIT, in his revision order confirmed the position taken by the tax authorities regarding withholding of tax by HSBC. Accordingly, the Bombay High Court, in its order dated 23 March 2009 directed the release of INR 243.1 million from the deposited amount to the government and the refund of the balance amount to E*Trade.

E*Trade thereafter approached the AAR to determine the taxability of the said transaction under the tax treaty.

Issue before the AAR :- Whether E*Trade is exempt from payment of capital gains tax in India under the tax treaty in respect of the transfer of shares of an Indian company to another Mauritius entity?

Tax department’s contention

The real and beneficial owner of the capital gains from the sale of IL&FS shares is the US Company which controls E*Trade. E*Trade is merely a façade established by the US holding Company to avoid capital gains tax in India.

The DIT has taken a prima facie view that the capital gains arising from the aforesaid transaction is taxable in the hands of the US entity.

The Tax authorities have observed as follows:

-Investment in IL&FS has been funded by way of corresponding equity investments from US Co (the parent of E*Trade Mauritius).

-Personnel of US Co were appointed as Directors / employees of IL&FS.

-Executives deputed to IL&FS were in charge of key functions of IL&FS.

-US Co exercises shareholders rights in IL&FS.

The term ‘beneficial ownership’ referred to in Circular 789 was used in the Circular in the context of the Article dealing with dividends and it shall be confined only to dividends. Therefore, the Circular would not be applicable in determining the eligibility to claim Treaty benefits vis-a-vis Capital gains(See Note-1).

There is sufficient justification to make further enquiries to arrive at the finding regarding the beneficial owner of the gains and to unravel the correct facts as regards the source of funds, treatment of shareholding, the manner of accounting and the role played by the US Co in the deal. It is, therefore, inappropriate at this stage to give a ruling on the questions raised by the applicant.

Taxpayer’s contentions

E*Trade Mauritius is entitled to Capital gains exemption under Article 13(4) of tax treaty in relation to the aforesaid transaction.

E*Trade has filed all relevant material and clarifications before the AAR. The enquiry by the Tax Authorities as to whether or not E*Trade Mauritius is merely a façade is a futile and wholly unnecessary exercise in view of the Central Board of Direct taxes (CBDT) Circular No 789 which is binding on the Tax department and the law is clarified by the Supreme Court in Azadi Bachao Andolan’s case.

AAR’s ruling

Applicability of Circular 789 to Capital Gains

Circular 789 applies to dividends as well as capital gains arising from the sale of shares of Indian companies.

It seems to be untenable that a certificate of residence will not be relevant to determine the beneficial ownership of capital gains.

If a resident of Mauritius who gets dividends from the shares is considered to be the beneficial owner thereof, there is no rational reason to view the ownership of gains arising from their transfer on a different footing.

Eligibility to claim benefits under the India-Mauritius Tax Treaty

Reliance on Azadi Bachao Andolan’s case

The issue needs to be determined in light of the principles laid down by the Supreme Court in the case of Azadi Bachao Andolan. The AAR observed that in Azadi Bachao Andolan’s case, the Supreme Court found no legal taboo against ‘treaty shopping’. Treaty shopping and the underlying objective of tax avoidance/mitigation was apparently not equated to a colourable device. That means, if a resident of a third country, in order to take advantage of the tax relief and economic benefits arising from the operation of a Treaty between other countries through a conduit entity set up by it, the legal transactions entered into by that conduit entity cannot be declared invalid. The motive behind setting up such conduit companies and doing business through them in a country having beneficial tax treaty provisions was held to be not material to judge the legality or validity of the transactions.

The AAR further observed with respect to Azadi Bachao Andolan’s case that a transaction which is ‘sham’ in the sense that ‘the documents are not bona fide in order to intend to be acted upon but are only used as a cloak to conceal a different transaction would stand on a different footing.

On the facts of the present case, it is difficult to assume that the capital gain has not legally arisen in the hands of E*Trade Mauritius especially in view of above principles laid down by the Supreme Court that the motive of tax avoidance is not relevant so long as the act is done within the framework of law.

E*Trade held to be the real owner of shares

In the context of the facts of the case, the AAR further inferred that:

-the source of funds for the purchase of shares is traceable to the holding company; or

-the holding company had played a role in suggesting or negotiating the sale; or

-the consideration received ultimately goes to the parent company in the form of dividends; or

? -the diminution of capital of E*Trade Mauritius immediately after the transaction would not lead to a legal inference that the holding company in reality owned the shares.

t is unrealistic to expect that a subsidiary would conduct its business independent of any control and assistance by the parent company.

The subsidiary has its own corporate personality and the fact that the holding company exercises acts of control over its subsidiary would not in the absence of compelling reasons dilute the separate legal identity of the subsidiary.

Thus, in the present case, to take a view that the recipient of capital gains arising from transfer of shares is the US entity and not E*Trade Mauritius would be contrary to the ground realities of the mutual business and economic relations between a holding and subsidiary company and the inter-se legal structure.

Hence, it is clear that E*Trade was the legal owner of IL&FS’s shares, the transaction was validly entered into by E*Trade Mauritius (being backed up by Board’s resolutions) and E*Trade was the actual recipient of the sale price.

Conclusion

In view of the above observations, E*Trade Mauritius would be entitled to the exemption from capital gains under Article 13(4) of the tax treaty in respect of the aforesaid sale of IL&FS shares to HSBC.

The AAR further observed that whilst it is not within the domain of the AAR to restrain the tax authorities from making enquiries or elicit further information, the scope of such enquiry ought to be limited in the light of the observations in the ruling and could only be within the confines of the legal position clarified by the Supreme Court and in this order.

Comments

The AAR has applied Circular 789 and reiterated the principles laid down by the Supreme Court in the case of Azadi Bachao Andolan in the context of the tax treaty that a TRC is conclusive evidence of tax residency and eligibility of a Mauritius entity to avail benefits under the tax treaty. It also reiterates the principle that tax planning, as long as within the legal framework is permissible.

Even though the decision of the AAR is legally binding only on the parties involved in the particular case, the ruling would have a persuasive value in a similar litigation before the Indian tax authorities and courts.

Note:-1

Extracts of CBDT Circular No. 789 is given below:

“…….It is hereby clarified that wherever a certificate of residence is issued by the Mauritian authorities, such certificate will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the DTAC accordingly.

3. The test of residence mentioned above would also apply in respect of income from capital gains on sale of shares. Accordingly, FIIs, etc. which are resident in Mauritius should not be taxable in India on income from capital gains arising in India on sale of shares as per paragraph 4 of article 13.”

Support services does not ‘make available’ any technology to the Applicant

Summary of a recent ruling of the Authority for Advance Rulings (AAR) in the case of Ernst and Young Pvt. Ltd. (Applicant) on the taxability of payments made for support services provided by an affiliate in the UK to the Applicant. The AAR held that the provision of support services does not ‘make available’ any technology to the Applicant and, hence, the payments made are not taxable in India as ‘fees for technical services’ (FTS) under the India-UK tax treaty (Tax Treaty).

Background and facts of the case

The Applicant is a company incorporated in India and is engaged in providing consultancy services. The Applicant is one of the member entities of Ernst & Young Global (EYG).

Ernst & Young (EMEIA) Services Ltd. (EY EMEIA), a limited liability company incorporated in the UK, is also a member of EYG. It provides support services in various fields such as area, global and market development etc. to the other member entities of EYG (Support Services). The member entities gain access to standardized human, financial and other resources to maintain uniformity in practices/approaches in business and to ensure that consistent, high quality professional services are provided to the client base of all member entities of EYG.

The Support Services are provided under an area services and market development agreement (Agreement) entered between EY EMEIA and the other member entities of EYG. Under the Agreement, costs incurred for providing the services are allocated to the member entities, in accordance with an agreed formula.

The Support Services are provided from the UK. EY EMEIA does not have a permanent establishment (PE) under the Tax Treaty or any fixed base in India.

Under the Tax Treaty, technical or consultancy

services received by a UK resident from an Indian resident are taxed as FTS, if such services ‘make available’ technical knowledge, skill, experience etc. to the recipient of the services.

Issue before the AAR :-Whether payment of the costs allocated by EY EMEIA to the Applicant for providing the Support Services is taxable in India.

Contentions of the Applicant

The Support Services rendered by EY EMEIA to the Applicant does not satisfy the ‘make available’ requirement under the Tax Treaty as they do not result in transfer of any technical know-how, technical plan/design to the Applicant. A technology is considered ‘made available’ only when the person acquiring the service is enabled to apply the technology.

Hence, the payments made to EY EMEIA for the Support Services rendered to the Applicant do not qualify as FTS under the Tax Treaty.

The payments received are in the nature of business profits of EY EMEIA since it is engaged in the business of providing access to central resources and services to various member entities. However, in the absence of a PE of EY EMEIA in India, the business profits are not taxable in India under the Tax Treaty.

Ruling of the AAR

Some of the categories of the Support Services provided by EY EMEIA are in the nature of management services. However, services of managerial nature are not included within the FTS definition of the Tax Treaty. The Tax Treaty covers only technical or consultancy services. Many of the Support Services could be technical or consultancy in nature. However, the more important question is whether EY EMEIA has ‘made available’ to the Applicant the technical knowledge, skill, know-how, experience etc. by providing the Support Services.

The provision of the Support Services is aimed at facilitating uniformity and seamless quality in the business dealings of the member entities. It does not amount to ‘making available’ the technical knowledge and experience of EY EMEIA to EYG member entities.

There is no transfer of technical know-how nor can it be said that the Applicant has been enabled to apply the technology which is possessed by EY EMEIA.

The ‘make available’ requirement under the Tax Treaty is not satisfied and, hence, the payment received by EY EMEIA is not taxable as FTS under the Tax Treaty.

In the absence of a PE of the UK entity in India, such payments are not taxable in India.

Comments

While payments to a non-resident for managerial, technical or consultancy services are generally taxed in India as FTS under the domestic tax law, a number of tax treaties restrict the taxability of FTS to only technical or consultancy services that ‘make available’ technical knowledge, skill, experience, know-how etc. to the service recipient. The concept of ‘make available’ has been subject to several decisions of the second appellate authority as well as the AAR. These decisions have confirmed that a service can be ‘made available’ only if the recipient of the service is enabled to apply the technology or know-how contained in the service.

The present ruling reinforces the principles that have emerged from earlier case laws and clarifies that disseminating information, furnishing guidelines and suggesting plans aimed at uniformity and quality do not amount to ‘making available’ technical knowledge and experience.

A ruling by the AAR is binding only on the Applicant, in respect of transaction in relation to which the ruling is sought and on the Tax Authority, in respect of the Applicant and the said transaction. However, it does have persuasive value and the courts in India, the Tax Authority and the appellate authorities do recognize the principles and ratios laid down by the AAR, while deciding similar cases.

Karnataka HC judgment on Negotiable Instruments Act upheld

Karnataka HC judgment on Negotiable Instruments Act upheld



Whether a cheque bounces due to insufficiency of fund in the bank account of the drawer, or whether he issues a ‘stop payment’ order to the bank, the consequences under the Negotiable Instruments Act would be the same, the Supreme Court held last week in the appeal, Rangappa vs Sri Mohan. Upholding the conviction of the drawer of the cheque, passed by the Karnataka high court, the Supreme Court further explained that when a cheque is issued, there is a presumption that it is to clear a debt or liability. The drawer of the cheque can, however, rebut the presumption. “There can be no doubt that there is an initial presumption which favours the complaining person,” the judgment said.

10 steps to Register a Company in India

10 steps to Register a Company in India :

The steps of registering a company in India are as under:

Step 1 – Acquire director identification number (DIN) by filling Form DIN-1. The temporary DIN is immediately issued which must then be printed, signed and sent to RoC for its consent along with the identity and address proofs.

The Identity Proof should contain any one of the following:

• PAN Card

• Driving License

• Passport

• Voter Id Card

The Residence Proof should contain any one of the following:

• Driving License

• Passport

• Voter Id Card

• Telephone Bill

• Ration Card

• Electricity Bill

• Bank Statement

Step 2 – Acquire digital signature certificate. This certificate can be acquired from any one of the six private bureaus sanctioned by MCA 21. Director of the company is required to submit the recommended application form along with the identity and residence proof.

Step 3 – To attain name of the Company, Form No. 1A should be filled citing the address of the Registered Office of the projected firm along with the signature of one of the promoters. A maximum of 6 proposed names can be presented which are verified by RoC staff for any resemblance with other company names in India. This process takes two days for attaining consent of the name

Step 4 – Arrange for stamping of the Memorandum and Articles with the appropriate stamp duty. The price of stamp duty differs from state to state.Stamp duty need to paid online.

The documents should be signed by the firm’s promoters after the MOA and AOA have been stamped. Besides the promoter’s signature, other information which must be filled in applicant’s handwriting is the company’s name, description of company’s activities and motive, father’s name, address, occupation and number of shares subscribed.

Step 5 - Attain the Certificate of Incorporation from the Registrar of Companies, Ministry of Corporate Affairs. File e-form 1; e-form 18; and e-form 32 online on the Ministry of Company Affairs website. Along with these papers, copies of agreement of the original directors and signed and sealed form of the Memorandum and Article of Association must be enclosed in Form 1.

Step 6 – Make a seal (applicable for the private limited companies). Making a company seal is not a legal obligation for the firm to be integrated, but firms require a seal to deliver share certificates and other certificates.

Step 7 – Attain a Permanent Account Number (PAN) from National Securities Depository Ltd. (NSDL) or the Unit Trust of India (UTI) Investors Services Ltd., as outsourced by the Income Tax Department. Each person is entitled to state his or her Permanent Account Number (PAN) for the purpose of tax payment under the Income Tax Act, 1961 and the Tax Account Number (TAN) for submitting tax reduced at source. One can get PAN application from IT PAN Service Centers or TIN Facilitation Centers using Form 49A with the acknowledged copy of the certificate of registration, released by the Registrar of Companies along with the identity and residence proof.

Step 8 – Attain a Tax Account Number (TAN) for income taxes abstracted at source from the Assessing Office of the Income Tax Department. The Tax Account Number (TAN) is required by anyone accountable for deducting or gathering tax. The prerequisites of Section 203A of the Income Tax Act state that all individuals who subtract or collect tax at the source must submit an application for a TAN. The submission for allotment of a TAN must be registered using Form 49B and deposited at any TIN Facilitation Center certified to accept-TDS returns.

Step 9 – Enroll with the Office of Inspector, Shops, and Establishment Act (State/Municipal). Under this procedure, a proclamation incorporating the names of employer’s and manager’s and the establishment’s name (if any), postal address, and group must be delivered to the local shop inspector with the pertinent fees.

Step 10 – Register the company for Value-Added Tax (VAT) at the Commercial Tax Office (State). Registration of VAT requires filling up of a prescribed Form along with the following documents:

• Attested copy of the memorandum and articles of association of the company,

• Residence proof,

• Proof of location of company,

• Applicant’s one current passport-sized photograph,

• Copy of PAN card,

• Challan on Form No. 210

Employer’s contribution towards overseas social security – not taxable : ITAT Delhi

Background :-Recently, the Income Tax Appellate Tribunal, New Delhi (ACIT vs Harashima Naoki Tashio, ITA No. 4634/Del/) has held that the employer’s contribution towards the social security in the home country of the employee is not taxable in the hands of the employee as a perquisite.

Facts of the case

• Harashima Tashio (‘the employee’), a Japanese national, was working as a General Manager with an Indian company.

• The employee’s residential status for the financial year 2003-04 was that of a ‘resident but not ordinarily resident’

• In the return of income filed for the said financial year, the employee did not offer to tax the employer’s contribution towards social security, health insurance etc. in Japan.

Issue before the Tribunal :-Whether the employer’s contribution towards social security, health insurance, etc. in Japan was liable to tax in the hands of the employee?

The employee’s contention

• The employer’s contribution towards social security, health insurance, etc. was made under statutory provisions in Japan.

• The said contribution did not give any vested right to the employee in the year of contribution.

• The employee may or may not get any benefit depending upon happening or non-happening of an event which is beyond the control of the employee. It was only a contingent benefit to the employee.

• The issue in hand is fully covered in the favour of the employee in earlier decisions of the Tribunal2 wherein contribution towards social security made by the employer in the home country of the foreign national was held to be not taxable as a perquisite.

• Therefore, in the instant case, the amount contributed by the employer should not be treated as a taxable perquisite in the hands of the employee.

The Assessing officer’s (AO) decision :-The AO added the employer’s contribution towards social security, health insurance, etc. in Japan to the taxable income of the employee in India.

The Commissioner of Income-tax (Appeals) [CIT(A)] decision:-The CIT(A) on the basis of Tribunal earlier decisions on the similar matter deleted the addition made by the AO.

The tax department’s contention before the Tribunal:-The tax department contented that it should be granted time to go through the decisions relied by the employee and for that matter the case should be adjourned.

The Tribunal’s decision

• The issue in the instant case is clearly covered in favour of the employee as per four decisions relied by the assignee. The said decisions are binding on the Tribunal.

• The tax department’s request for grant of additional time to distinguish such decisions vis-à-vis the issue in the instant case or to point out some contrary view was not reasonable.

• In view of above, the employer’s contribution towards social security, health insurance, etc. in Japan is not liable to tax as a perquisite in the hands of the employee.

Note:-1

• ACIT vs Eric Matthew Gottesman (2007) 15 SOT 301 (Del)

• ACIT, Circle 47(1) vs Hideki Ishihara in ITA No. 1906/Del/08

• ITO vs Lukas Fole (2009) 124 TTJ (Pune) 965

• Gallotti Raoul vs ACIT 61 ITD (Bom.) 453

UK rules for determining tax residency in the UK Background

The Inland Revenue (now HMRC) in the United Kingdom (UK) in the Gaines-Cooper case has clarified the rules in respect of determining tax residency in the UK.

The Decision

The case was not about the residence status of the taxpayers as such, but rather an application for judicial review on the basis HMRC had, in effect, “moved the goalposts” in the middle of the game by changing the rules for determining a tax payer’s residence status.

Over the years many taxpayers have relied on guidance set out in the Inland Revenue booklet 1R20. In Gaines-Cooper, the taxpayers argued that the Inland Revenue had, in effect sought to re-write these rules in their own favour upsetting what taxpayers had come to regard as established practice.

The Court of Appeal rejected this contention. The Court acknowledged that taxpayers were entitled to rely on 1R20:

“it does provide guidance as to particular circumstances in which the Revenue gives a binding and lawful assurance that it will treat a taxpayer, whose case falls within the circumstances described as not resident and not ordinarily resident.” (Per Lord Justice Moses).

However, the Court also held that while IR20 could be relied upon, the Inland Revenue had not sought to change how it interpreted the “rules” in IR20:

“The Revenue has not been shown to have altered its interpretation and application of IR20 to these appellants’’ cases.” (Per Lord Justice Moses).

There are thus three key points arising from this decision

(a) that I1R20 did have importance and could be relied upon by taxpayers (although I1R20 has now been replaced the same principles should apply to other HM1RC guidance of a similar nature).

(b) But I1R20 is only general guidance and has to be applied to the facts of a particular case. Each taxpayer has to satisfy himself he or she is within the ambit of the guidance (“unless the facts of the taxpayer’s case are beyond all reasonable dispute, the very terms of I1R20 provide no certainty of the outcome of any claim to resident or non¬resident status” per Lord Justice Moses). I1R20 is not a substitute for professional advice.

(c) The Inland 1Revenue have not changed the law or practice.

Profits / losses on futures and options contracts (derivative transactions) would be in the nature of ‘Business Income’: AAR

Recently, the Authority for Advance Rulings (AAR) in the case of Royal Bank of Canada (A.A.R No 816 of 2009) has held that the profits / losses on futures and options contracts (derivative transactions) carried out by Canadian entity would be in the nature of ‘Business Income’. Further since the entity did not have a Permanent Establishment (PE) in India, as per Article 5 of the India-Canada tax treaty (the tax treaty), the Business Income of the applicant would not be taxable in India.

While pronouncing the ruling, the AAR has also made some important observations on the taxation of income earned by Foreign Institutional Investors (FII) in India.

Facts of the case

The applicant, a public company incorporated under the Bank Act of Canada, is engaged in the business of banking and other financial services. It also trades in securities (including derivatives) in various parts of the world including India. In India, the applicant is registered as a FII with the Securities and Exchange Board of India (SEBI) since March 2008 and is mainly dealing in the derivatives segment of the Indian Stock Exchanges, where stock / index futures and stock / index options are traded. The derivative transactions undertaken by the applicant are part of its trading activity.

Issue before the AAR

• Whether the profits/losses from derivative transactions carried out by the applicant are to be treated as ‘Business income’ or ‘Capital gains’ under the Income-tax Act, 1961 (the Act) and the tax treaty?

• If profits from derivative transactions are characterized as business income then in absence of PE of the applicant in India, whether such business profits are taxable in India?

Taxpayer’s contentions

• The applicant contended that the derivative transactions undertaken by it are part of its trading activity. The object in purchasing derivative is to resell the same at appropriate time and earn income. At times, the applicant sells derivatives first and then purchases them.

• The profits or loss arising from derivative transactions will be reflected as business profits in the financial statements and it will be taxed in Canada accordingly. Accordingly, the profits earned/or loss from derivative transactions should be characterised as business profits or loss.

• Further, the applicant did not have fixed place of business in India. Therefore, the applicant claimed that it does not have PE in India. Hence, in view of Article 7 of the tax treaty, the business income earned by the applicant from trading in derivatives is not taxable in India.

Tax department’s contentions

• The tax department contended that in terms of SEBI and Foreign Exchange Management Act Regulations, the applicant is only allowed to make ‘investments’ in the capital market in India. Therefore, the trading of derivatives on stock exchanges would also amount to an investment activity and the income earned from such activity would be in the nature of ‘Capital gains’.

• The tax department further contended that that the applicant’s income from dealing in derivatives has necessarily to be brought within the purview of section 11 5AD of the Act which is a self contained code applicable to the FIIs. It was argued that, for the FIIs, section 11 5AD contemplates income from dividend, interest and capital gains only. Therefore, the applicant could only have earned ‘capital gains’ from the transfer of securities which would be taxable in India under the provisions of section 11 5AD of the Act.

AAR’s ruling

• The AAR observed that the issue of the character of income relating to exchange traded derivative contracts having a maximum of three months trading cycle has been considered by the AAR in the case of Morgan Stanley & Co. [2004] 142 Taxman 630 (AAR). In this case, the AAR held that the income earned by a UK company from exchange traded derivatives in India was to be regard as ‘business profits’ as per the provisions of India? UK tax treaty and it cannot be regarded as income in the nature of capital gains.

• Accordingly, after considering the decision of its own in the case of Fidelity North Star Fund [2007] 288 ITR 641 (AAR), the AAR held that income arising from the ‘derivative transactions’ is to be regarded as ‘business income’ and in the absence of PE in India of the applicant such ‘business income’ was held not liable to be taxed in India as per Article 7(1) of the tax treaty.

• The AAR also made some significant observations in the context of FII taxation which are given below:

o Tax department’s contention that there is a prohibition of trading in Derivatives under the FEMA or SEBI Regulations is unsustainable.

o Investment in Derivatives does not necessarily exclude trading transactions.

o Giving an undertaking for abiding by SEBI Rules and Regulations, would have no bearing on the characterization of income.

o The purpose and purport of section 11 5AD of the Act is to provide for special or concessional rate of taxation in relation to securities received or arising from the income of FIIs. The contention of the tax department that for FIIs there cannot be any income outside section 11 5AD is not sustainable.

o The observation of AAR in Fidelity North Star that there was no prohibition in law as far as the exchange traded derivatives were concerned cannot be faulted.

o Irrespective of the provisions of the Act, the applicant can seek the benefit of tax treaty provisions. If the income derived can be characterised as business income, such income cannot be taxed in the absence of a PE in India.

o A special provision in the Act cannot be pressed into service to deny the benefit which is otherwise due to FII under the tax treaty provisions notwithstanding their conflict with the domestic law of income tax.

Our Comments :-In line with the earlier ruling in Morgan Stanley & Co. the AAR has once again ruled that FIIs income from trading in derivatives is ‘business income’ and not capital gains. Further in the absence of a PE in India, the business income would not be subject to tax in India.