Routers and switches should be classified as part of computers and be eligible for 60% depreciation

Routers and switches should be classified as part of computers and be eligible for 60% depreciation

In a recent decision Special Bench (SB) of the Mumbai Income Tax Appellate Tribunal in the case of Datacraft India Ltd. (Taxpayer) [ITA No.7462 & 754/ Mum/ 2007]on the issue of whether routers and switches can be classified as computer entitled to depreciation at 60% or have to be classified as general plant and machinery entitled to depreciation at 25%, under the provisions of the Indian Tax Laws (ITL) held that the definition of computer should not be restricted to the central processing unit (CPU) of computer, but should also extend to all the input and output devices which support computer in the receipt of input and outflow of output to and from computer. In view of the broader definition given to computers, routers and switches, which form part and parcel of computer, also qualify for depreciation at 60%.

Background and facts

The Taxpayer is engaged in the business of data communication, design, development, purchase and sale of networking products, their maintenance and installation etc.

For tax years 2001-2002 and 2002-2003, the Taxpayer claimed depreciation on routers and switches at the rate of 60% by classifying them as ‘computers’.

The Tax Authority rejected Taxpayer’s contention and held that routers and switches, being equipments which are used as networking tools, would fall under the general category of ‘plant and machinery’ and the rate of depreciation applicable would be 25%.

On appeal by the Taxpayer against the Tax Authority’s order, the first appellate authority ruled in favor of the Taxpayer and held that routers and switches, being an indispensable part of computer just like keyboard or mouse or printer, should form part of computer.

The Tax Authority preferred further appeal before the second appellate authority (Tribunal). Special Bench (SB) was constituted to decide on the issue of classification of routers and switches as ‘computer’ or ‘plant and machinery’ for the purposes of depreciation allowance.

Tax Authority’s contentions

Routers are nothing but telecommunication device meant for transmitting data from one computer to another or from one network to another and, hence, are not computers.

Definition of computer, given in the Information Technology Act, 2000 (Info Tech Act), cannot be considered for the purpose of granting depreciation under the ITL, as the scheme of both the laws is entirely different.

Oxford dictionary defines computer functions to mean performance of logic, arithmetic, data storage, communication and control functions. Since routers do not perform such processing functions, they cannot be treated as computer.

Taxpayer’s contentions

Meaning of computer should not be restricted to processing device alone. It should also mean the essential input/output devices which facilitate the operation of computer.

Routers and switches are input/output devices and are attached to computer. They have no independent utility and have to work necessarily with computer and are considered as integral part of computer.

SB decision

Upholding the contentions of the Taxpayer, the SB held as follows:

In the absence of specific definition of the term in the ITL, it is understood as per common parlance and commercial parlance tests. Test of predominant function and usage is applied in understanding such undefined terms. In common sense, computer is popularly understood to mean any electronic or other high speed data processing device which performs ‘logical, arithmetic and memory functions on data’ and includes all input and output devices which are connected to it.

The scope, purpose and substance of Info Tech Act are quite different from the context of the provisions of the ITL. However, the meaning of the term ‘computer’ as given in Info Tech Act matches with common parlance meanings. Such a meaning can, hence, be considered as an aid in understanding the term ‘computer’ for ITL purposes.

Routers can best be equated with a hardware device that routes data from a local area network to another network connection. A router acts like a coin sorting machine, allowing only authorized machines to connect to other computer systems.

The main function of routers is to receive data from one computer and make it available to another computer for further processing and viewing. As a result, routers have an essential function of supporting commercial organization to facilitate the flow of data from one computer to another for processing or storage.

Switches are shorter version of routers and perform functions which are similar to routers within a limited sphere.

Like computer hardware, a router in itself is not a computer as it neither performs any logical, arithmetic or intermediary functions on data nor does it manipulate or process data. However, routers and switches can be classified as computer hardware when they are used along with a computer and their functions are integrated with a computer.

The SB compared the CPU of computer akin to the human brain and observed that as the brain alone is not considered as the body; the CPU alone cannot be described as a computer. All devices such as keyboard, mouse etc. would also form part of computer.

[2] The SB also commented on the decisions of the Kolkata Tribunal in the case of Samiran Majumdar [280 ITR 74] , relied by the Taxpayer, and the Mumbai Tribunal in the case of Routermania Technologies (P) Ltd. [3] [16 SOT 384], relied by the Tax Authority. The SB observed that the decision of the Kolkata Tribunal, holding printer and scanner are depreciable as ‘computers’, was a better view of the matter than the view of the Mumbai Tribunal. The Mumbai Tribunal had taken a narrower view and held that routers which did not perform logical, arithmetical or memory functions by manipulation of electronic impulses etc. are not computers.

The SB, however, clarified that machines or equipments such as television set, mobile phones etc., which take assistance of computer functions, are not computers.

Comments

A Special Bench is generally constituted when there are conflicting decisions of the Tribunals or the matter pending for adjudication is of considerable importance. It is also a well-settled convention to consider the Special Bench’s decision as binding on the division benches of the Tribunal.

The present decision should assist in addressing the principle that predominant function of the routers and switches determines its classification. On application of functional test, any ancillary and supplemental components of a computer which is essential in the working of computer would form part of computer.

Maintenance of stock of goods by the foreign enterprise at the customer’s location for standby use may not give rise to PEMaintenance of stock of goods by the foreign enterprise at the customer’s location for standby use may not give rise to PE

Maintenance of stock of goods by the foreign enterprise at the customer’s location for standby use may not give rise to PE


Facts


Airlines Rotables Ltd. (“assessee”) is a company incorporated under the laws of United Kingdom (“UK”). The assessee is engaged in the business of providing spares and component support for aircraft operators.

The assessee has entered into an agreement with Jet Airways Limited (“Airline”), for rendering certain support services.

As per the terms of the agreement,

– When a part! component of the aircraft is not in a condition to be used, the assessee is required to repair and overhaul the component! part. The repair and overhauling of defective part! components is to be done outside India.

– In addition, the assessee is to provide replacement components on exchange basis till the original components are repaired and overhauled.

– To ensure that the replacement for the defective part! components is readily available, a consignment stock of the replacement parts! components is kept at the warehouse of Airline.

– The consignment stock lying in India would remain the property of the assessee at all times.

Issues before the Tribunal

Whether the assessee had a Permanent Establishment (“PE”) in India on account of maintenance of consignment stock of goods at the warehouse of the Airline.

Ruling of the Tribunal

Fixed Place PE

Under Article 5(1) of the double taxation avoidance agreement between India and UK („Tax Treaty”), a fixed place PE is said to exist in India when the assessee is said to have a fixed place of business through which the business is carried out – wholly or partly. There are three criterions embedded in this definition:

– Physical criterion: Existence of physical location;

– Subjective criterion: Right to use that place. i.e. the physical location should be at the disposal of the assessee; and

– Functionality criterion: Carrying out of business through that place

It is only when the three conditions are satisfied that a fixed place PE can be said to have come into existence.

The Tribunal held that mere existence of a physical location is not enough. The location should also be at the disposal of the assessee and it must be used for the business of the assessee as well. Although the consignment stock of the assessee was stored at a specific physical location, the storage facility was under the control of the Airline and the assessee did not have any place at its disposal enabling it to carry out its business from that location.

The Tribunal held that the business of the assessee cannot be said to have been carried on at the location of Airline as the business with regard to the consignment of replacement stock was over when the consignment is given for standby purposes to the Airline.

When the physical location at which consignment stock is kept does not project the business of the assessee, it cannot be said that such a location constitutes a PE of the assessee in India.

Agency PE

There is no material to establish that the Airline or its staff constituted a dependent agent of the assessee. Airline will at best be an independent agent and custodian of the consignment stock.

The consignment stock is not maintained by the Airline for delivery for or on behalf of the assessee. The delivery in the present case is for standby use and not for sale.

Hence the assessee did not have an agency PE in India.

The tribunal held that the onus is on the revenue to demonstrate that a PE of the foreign enterprise exists in India.

Royalties for use of equipment in India

The Tribunal held that merely because an amount is not taxable in India as business profits, it is not the end of the road so far as taxability of the consideration for use of replacement components in India is concerned. Since the revenue authorities have failed to consider as to whether the consideration for use of the replacement components could be considered as royalty income i.e. „for use of industrial, commercial or scientific equipment? under Article 1 3(3)(b) of the Tax Treaty, the matter was remanded back to the Commissioner of Income Tax (Appeals) for that purpose.

Conclusion

The Tribunal has held that a simple maintenance of stock of goods by the foreign enterprise at the customer?s location for standby use may not constitute a PE, while keeping the issue open with regard to royalty on use of equipment.

Source: Airlines Rotables Limited, UK Vs JDIT (Appeal No. 3254 / Mumbai / 2006)

Royalty on software

Payment received on account of supply of software products to independent third party re-sellers in India not royalties but business income

The applicant is a company incorporated in Japan and is engaged in the business of providing Products Lifecycle Management software solutions, applications and services. These software products are standardized and not customized or tailor-made. It markets its products in India through a distribution channel of third party resellers comprising Value Added Resellers (VAR) who resells the software to end-users. The product is sold by the applicant to VAR at standard list price less discount. The VAR sells the product to the end-users at an independent price determined by them. The end-user enters into an End User License Agreement („EULA?) with the applicant and the VAR for the product supplied. VAR gets the order from end-users and places a back-to-back order to the applicant. On acceptance of the order by the applicant, the applicant provides the license key via e-mail to the customer so that the customer will directly download the product through the web-link. The applicant has no presence in India whether through any employee or in the form of any office or place of business.

Question before AAR

Whether the payment received by the applicant from the sale of software products to independent third party resellers will be taxable in India as business profits under article 7 of Indo-Japan Double Taxation Avoidance Agreement (DTAA) and will not constitute „royalties and fees for technical services? per article 12 of DTAA?

Contentions of the applicant

• The transaction is in the nature of purchase of intangible copyrighted products by VAR for re-sale to end users and such sale and purchase is on a principal to principal basis.

• The copyrighted software containing computer program gets transferred to the end user and not the copyright therein. The copyright continues to be vested in its entirety with the applicant and none of the rights therein are made available to VAR or end-user. Only a limited right to use a copyrighted product is transferred.

• The rights associated with the copyright are those which enable the recipient to commercially exploit the product. VAR has not been given any such right.

• A non-exclusive license to the end-user to have access to the licensed program for the licensee?s internal use, does not amount to the use of copyright or the right to use the same.

• The consideration received by the applicant from VAR with reference to the transaction entered into with end-users is not a consideration for the use of any of the copyrights in the software.

• VAR cannot be treated as an agency Permanent Establishment („PE?) of the applicant for the following reason:

– It is a non-exclusive distributor transacting with the applicant on a principal to principal basis.

– It is a distinct legal entity neither related to the applicant nor under the same / common management.

– Economic risks of the products are borne by VAR only.

– VAR is not concluding any contracts or securing orders wholly or almost wholly on behalf of the applicant.

• The income representing the payment received from VAR cannot be treated as „royalties? within the meaning of article 12.3 of DTAA but as business profits. As the applicant has no PE in India, the income is not taxable in India per provisions of DTAA.

Contentions of the revenue

• The license fee paid by the customer in India is for the transfer of rights in respect of copyrights in the software or for the use of computer program embedded in it.

• The payment is made for obtaining a right to copy the program on to the hard disc and to use it and therefore falls within the scope of the Indian Copyright Act, 1957 („CR Act?). Alternatively, the right of sale is also recognized as part of copyright in relation to computer program and such right is given under a license to reseller, so CR Act is again attracted.

• It is clear from EULA that the product is licensed and not sold and the consideration received is license fees.

• VAR is acting on behalf of the applicant for securing the customers to whom the products and services of the applicant are to be licensed. VAR is acting as a dependent agent of the applicant and therefore, the applicant has an agency PE in India.

Observations of the AAR

Royalty income

• The term royalties has been defined both under the provisions of Income-tax Act, 1961 („ITA?) and under the provisions of article 12 (3) of the DTAA. Both the definitions mandate either the use of or right to use or transfer of „copyright of literary or scientific work?. In order to characterize the income as royalties, the applicant must have a right to use the copyright contained in the software.

• The term „copyright? is not defined under the provisions of the ITA and therefore, it would be appropriate to refer to the provision of CR Act. An exclusive licensee is recognized as an owner of the copyright under the CR Act as he is entitled to all the remedies by way of injunction, damages etc. for the infringement of a right.

• The copyright is an intellectual property right that belongs to the owner or its assignees. The ownership of copyright carries with it a bundle of rights which by and large are directed towards exploitation of this intangible property right. If any of the rights are parted with in favour of another so that the other person can enjoy that right in the same manner in which the owner can, it can be said that those specific rights concerning the use of copyright have been conferred on him.

• Adaptation of computer program to ensure its utilization for the purpose for which it was supplied does not constitute an „infringement? under the CR Act. If there is no infringement, it cannot be held that there is a transfer of „copyright? as defined in CR Act.

• A non-exclusive and non-transferable license enabling the use of license product cannot be construed as an authority to enjoy any or all rights ingrained in a copy right. It is so in the present case at hand.

• The use of the word „including the granting of a license? in the definition of „royalty? does not mean that each and every license is contemplated to be included therein. A non-exclusive license permitting use for in-house purpose would not be covered therein.

• The definition of royalty under the ITA for use of process is also not attracted in the present case.

Agency PE

• The existence of agency PE can not be sustained on the grounds that VAR i) is not confined to the dealing only with the applicant, ii) its business is not controlled by the applicant except to the extent necessary to promote its own business, iii) it does not negotiate or conclude contracts with the end-users on behalf of the applicant, and iv) it determines its own price, does not notify or render account to the applicant for the amount collected from the end use.

Ruling of AAR:-

• Neither any right in relation to copyright has been transferred, nor any right to use the copyright has been conferred on the licensee. Therefore, the payment received by the applicant from VAR on account of supplies of software products to the end customers does not result in any income in the nature of royalties to the applicant.

• Per article 7 of the DTAA, the applicant does not have any PE in India and therefore the payments received by the applicant cannot be taxed as business profits in India.

Source: AAR No. 821/2009 in the case of M/s Dassault Systems K.K.

Transfer Pricing-Marketing Intangibles

Maruti Suzuki India vs. ACIT (Delhi High Court)

Transfer Pricing Law for user of foreign trademarks & advertisement expenditure laid down

The assessee manufactured cars using the brand name “Maruti”. It entered into an agreement with Suzuki, Japan, pursuant to which it began manufacturing cars using the brand name “Suzuki”. The TPO issued a show-cause notice in which he alleged that the substitution of the brand name “Maruti” for the name “Suzuki” meant that the assessee had sold the “Maruti” brand to Suzuki. On that basis, he determined the “arms length” sale proceeds at Rs. 4,420 crores. The assessee filed a writ in which the TPO was allowed to pass an order subject to the outcome of the Petition. In the order, the TPO abandoned the theory of “sale” to Suzuki but instead held (without giving the assessee a show-cause notice in this behalf) that as the assessee was using the trademark “Maruti-Suzuki”, the “Suzuki” trademark had “piggybacked” on the “Maruti” trademark without payment of any compensation by Suzuki to the assessee. He alleged that “Maruti” was a “super-brand” while “Suzuki” was a “weak-brand”. He held that the assessee was not liable to pay Suzuki for the trademark “Suzuki” but instead Suzuki was liable to pay the assessee for “piggybacking” on the trademark “Maruti”. He also held that the advertisement expenses incurred by the assessee had gone to benefit Suzuki. He accordingly directed that an adjustment of Rs. 206 crores be made in the hands of the assessee. HELD remanding the matter to the TPO:

(i) While the onus is on the assessee to satisfy the AO/TPO that the arm‘s length price computed by it is in consonance with s.92, the AO/TPO can reject the price computed by the assessee only if he finds that the data used by the assessee is unreliable, incorrect or inappropriate or he finds evidence, which discredits the data used and/or the methodology applied by the assessee;

(ii) The TPO/AO is obliged to give the assessee an opportunity to produce evidence in support of the arm‘s length price and before making adjustments, he is obliged to convey to the assessee the grounds on which the adjustment is proposed to be made and give the assessee an opportunity to controvert the grounds on which the adjustment is proposed;

(iii) Re user of trademark by the domestic entity on discretionary / mandatory basis: If a domestic Associate Enterprise uses a foreign trademark, no payment to the foreign entity on account of such user is necessary in case the user of the trademark is discretionary. However, the “income” arising from such transaction is required to be determined at arm‘s length price;

(iv) If a domestic Associate Enterprise is mandatorily required to use the foreign trademark on its products, the foreign entity should make payment to the domestic entity on account of the benefit the foreign entity derives in the form of marketing intangibles from such mandatory use of the trademark. Even where payment is made by the foreign entity, the arm‘s length price in respect of the international transaction needs to be determined taking into consideration all the rights obtained and obligations incurred by the parties under the international transaction including the value of marketing intangibles obtained by the foreign entity on account of compulsory use of its trademark by the domestic entity. Suitable adjustments in this regards will have to be made considering the individual profiles of these entities and other facts and circumstances justifying such adjustments.

(v) Re advertisement expenditure incurred for the trademark: The expenditure incurred by a domestic Associate Enterprise on advertising of its products using a foreign trademark does not require any payment or compensation by the owner of the foreign trademark/logo to the domestic entity on account of use of the foreign trademark/logo in the advertising undertaken by it, so long as the expenses incurred by the domestic entity do not exceed the expenses which a similarly situated and comparable independent domestic entity would have incurred.

(vi) If the expenses incurred by the domestic Associate Enterprise are more than what a comparable independent domestic entity would have incurred, the foreign entity needs to suitably compensate the domestic entity in respect of the advantage obtained by it in the form of brand building and increased awareness of its brand in the domestic market. The said “arms length price” should be determined by taking into consideration all the rights obtained and obligations incurred by the two entities, including the advantage obtained by the foreign entity.

(vii) In determining whether the advertisement expenses incurred by the domestic Associate Enterprise on advertising the brand trademark/logo of the foreign entity are more than what an independent domestic entity would have incurred, the TPO has to identify appropriate comparables and make suitable adjustments considering the individual profiles of these entities and other facts and circumstances justifying such adjustments.

Sec 195

Obligation to withhold tax attracted only when the payment to a non-resident is wholly or partially chargeable to tax in India

Prasad Production Ltd. (Taxpayer) was awarded a contract by the Government of the State of Andhra Pradesh to establish IMAX Theatre at Hyderabad. The Taxpayer entered into an agreement with IMAX Ltd., Canada for purchase of the system (which included supply of equipment, installation, testing and initial training) as well as transfer of technology. As per the agreement, the total consideration for purchase of the system was US$ 1,365,000 and US$ 950,000 was towards technology transfer fee. During the year under consideration, the Taxpayer remitted US$ 902,500 to IMAX Ltd. on account of system cost without withholding tax thereon.

The Assessing Officer (AO) was of the view that the amount remitted by the Taxpayer was for provision of technical services1 by IMAX and was chargeable to tax in the hands of IMAX. The AO relied on the judgment of Supreme Court in the case of Transmission Corporation of AP Ltd. (239 ITR 587) to conclude that since the Taxpayer has not obtained any order for lower or Nil tax withholding, the gross sum remitted by the Taxpayer was liable to tax and accordingly raised the tax demand against the Taxpayer. The Commissioner (Appeals) cancelled the order of the AO holding that the amount of remittance represents a part of sales consideration of the equipment and hence not chargeable to tax at all. Aggrieved by the said order of the Commissioner (Appeals), the Revenue filed an appeal before the Income Tax Appellate Tribunal (“ITAT”).

Issues before ITAT

• Is it obligatory for the Taxpayer to withhold tax on the entire payment to a non-resident where no application for lower or Nil rate of tax withholding is made to the AO?

• Whether the Taxpayer has the discretion to determine chargeability to tax in respect of the remittance to the non-resident?

Contentions of the appellant [Revenue]

• Relying on the judgment in the case of Transmission Corporation (supra) and the decision of Karnataka High

Court in the case of Samsung Electronics (320 ITR 209), Revenue contended that the Taxpayer has no discretion to decide whether to withhold or not to withhold tax. If such discretion is given, the Taxpayer would sit in the chair of the AO and section 195 will become inoperative.

• Where according to the Taxpayer the entire sum was not chargeable to tax, the Taxpayer has to approach the AO for determination of rate of withholding. The Taxpayer cannot decide the taxability of the payment on his own, it has to be decided by the AO or a Chartered Accountant (“CA”) issuing the certificate on tax withholding.

• Tax withholding is only a tentative determination of tax and subject to assessment in the hands of the payee.

Contentions of the respondent [Taxpayer]

• Installation assistance and initial training were auxiliary to the sale of original equipment and were inextricably and essentially linked to the sale of equipment. Fees for installation assistance and initial training were not in the nature of fees for technical services and the amount of remittance represented a part of sale consideration of equipment, hence not chargeable to tax.

• In the case of Transmission Corporation (supra), it was held that tax is to be withheld only on that portion of the remittance which forms part of taxable income. The Karnataka High Court in the case of Samsung (supra) has extended the applicability of the decision in the case of Transmission Corporation (supra) to cases where the entire income may not be chargeable to tax. In the case of Samsung (supra), the Supreme Court decision in the case of Eli Lily (312 ITR 225) was not considered wherein it was held that where a particular income is not chargeable to tax, then the withholding tax provisions cannot come in.

• Tax is to be withheld only if income is chargeable to tax under the ITA. Income is chargeable to tax if it is a part of the total income of the payee and not otherwise. Where income is not chargeable to tax, there would be no withholding tax liability under the ITA.

• The revenue has through various circulars given a choice to the Taxpayer to either apply to AO under section 195(2) or to obtain a certificate from a CA in lieu thereof. This aspect has not been considered by Karnataka High Court in Samsung decision.

• Section 195(2) is not mandatory. Application for lower or „Nil? tax withholding under section 195(2) is supplementary to section 195(1) and if the Taxpayer has a bona fide belief that the amount is not chargeable to tax, then the Taxpayer need not undergo the procedure under section 195(2).

• It was contended that the Samsung decision is contrary to various Supreme Court and High Court decisions including earlier decisions of the Karnataka High Court as well as the circulars issued by the Revenue and thus the same is not binding.

Observations and Ruling of the ITAT

• In the case of Transmission Corporation (supra), the argument of the Taxpayer was that section 195 is applicable only if the whole of the payment constitutes income chargeable to tax which was rejected by the Supreme Court.

• As per the decision in the case of Transmission Corporation (supra), the person making payment to the non resident would be liable to deduct tax at source if the payment so made is chargeable to tax under the ITA. Impliedly, if the payment is not so chargeable, the payer would not be liable to withhold tax. This is again clarified by the Supreme Court in the case of Eli Lily (supra).

• Where the Taxpayer has a bona fide belief that no part of the payment bears income character, section 195(1) would be inapplicable and hence there is no question in going into the procedure prescribed under section 195(2).

• The ITAT rejected the argument of the Revenue that the Taxpayer cannot decide the taxability of payment on its own and it has to be decided by the AO or the CA from whom the certificate of tax withholding is obtained. The ITAT observed that where the Taxpayer is expected to know what income is taxable in his own case, the Taxpayer can certainly consider the chargeability in respect of payment made to the payee. Here the Taxpayer is only considering the chargeability of a particular income for withholding tax and not determining the tax liability of the total income of the payee. Thus, it is the Taxpayer who is the first person to decide whether the payment he is making bears any income character or not.

• The payer is an assessee and liable to the assessed for withholding tax. The payer has the right to defend the proceedings against him in respect of withholding tax, despite the entire exercise being tentative in nature. The ultimate result would depend on what is determined in the assessment of the recipient. The result in the case of the recipient will determine whether the payer can be treated as assessee in default or not.

• If the payer is under bona fide belief that no part of the payment is chargeable to tax, he is neither required to approach the AO under section 195(2) nor is he required to furnish the CA certificate. CA certificate is to be obtained by the payer for complying with the manual of Reserve Bank of India for the purpose of making remittance as mandated by the circulars of the Revenue.

• If the bona fides of the payer are doubtful, the payer will have to face all the consequences under the ITA. Ultimate liability of the payer as well as consequence of disallowance of expenses on account of non-deduction of tax at source would depend on the assessment in the case of the payee.

• In the present case, the agreement between the Taxpayer and IMAX is very clear to point out that IMAX is to install the equipment, test it and also provide training for up to four projectionists. The AO has mistaken these services to be as payment of technology transfer whereas they are auxiliary to the sale of the equipment. The Revenue has not been able to show cause that these services are independent of the equipment. Thus, US$ 902,500 being part of equipment price is not chargeable to tax in India and Taxpayer was justified in not withholding tax thereon.

Key takeaways

The obligation to withhold tax does not arise if the payment is not chargeable to tax. The payer can decide whether the payment to be made is chargeable to tax or not. Where the payer has a bona fide belief that no part of the payment bears income character, payer would not have any liability to withhold tax thereon. As the tax is not deductible in such a case, payer is not obligated to seek a withholding tax determination from the AO as prescribed under the ITA.

Source: ITO vs. M/s Prasad Production (ITA T Chennai Special Bench) ITA No. 663/Mds/2003, Decision dated 9 April 2010

No PE arises on deputation on hire basis

Mumbai Tribunal rules that no Permanent Establishment arises on deputation on hire basis. Further, no income arises to recipient on reimbursement of salary costs

• Tekmark Global Solutions LLC (“Tekmark?), a tax resident of the USA, deputed its personnel to Lucent Technologies Hindustan Private Limited („Lucent India?)

• As per the agreement between Tekmark and Lucent India, Tekmark to make arrangements to depute personnel based on specific requirements from Lucent India.

• Deputed personnel remain on the payroll of Tekmark and related costs to be charged to Lucent India.

• Such deputed personnel work under the direction, supervision and control of Lucent India

• Tekmark is not responsible for the work done / action performed by such deputed personnel.

• Lucent India has a right to send the deputed personnel back to Tekmark if not found suitable.

Issues before the Tribunal

• Whether the deputation of personnel by Tekmark to Lucent India could result in a Permanent Establishment (PE) for Tekmark in India.

• If a PE is held to exist in India, whether any profits could be attributed to Tekmark in India.

Ruling of the Tribunal

• When the services rendered are independent of and not under the control of Tekmark, the deputed persons cannot be considered as constituting permanent establishment of Tekmark in India. The tribunal based this ruling on the following facts:

• Tekmark is only providing personnel to work under the control and supervision of Lucent India and is not rendering any technical services to Lucent India.

• The deputed personnel are for all practical purposes employees of Lucent India and carry out the work alloted by Lucent India.

• Tekmark has no control over the activities or work to be performed by the deputed personnel and Lucent India has the right to remove the deputed personnel from services.

• The actual salary of the deputed personnal reimbursed by the Indian company is only reimbursement of salary payable by the Indian company, advanced by Tekmark.

• Even assuming that there is a PE in India, no income arises as only the actual salary of the deputed personnel is reimbursed by Lucent India. The Tribunal placed reliance on the following decisions in concluding that there is no income in reimbursement of expenses.

o CIT vs Industrial Engineering Projects (P) Ltd – 202 ITR 1014 Del

o CIT vs Siemens – 310 ITR 320 Bom

Comments:-This is yet another decision on the issue of whether the deputation of personnel by an overseas entity results in Permanent Establishment in India and the related attribution of profit and withholding tax issues.

Maintenance of stock by customer does not constitute a PE.

In a recent ruling Mumbai Income Tax Appellate Tribunal (Tribunal) in the case of Airlines Rotables Ltd., UK (Taxpayer) [ITA No. 3254/Mum/06F ] on the issue of whether maintenance of stock of goods, belonging to the Taxpayer, by its Indian customer results in the Taxpayer having a permanent establishment (PE) in India, under the India UK Tax Treaty (UK Treaty) reaffirmed some general principles relating to PE, the Tribunal further ruled that the Taxpayer does not have a PE under the basic rule or the agency rule. The Tribunal remanded the matter to the first appellate authority to determine if any part of the consideration could be taxed as royalty for use of equipment by the customer.

Facts

The Taxpayer is a company incorporated in the UK. Its main business is providing spares and component support to aircraft operators.

The Taxpayer entered into an agreement with Jet Airways Ltd. (Customer), an Indian aircraft operator, for providing certain support services in respect of aircraft.

The agreement requires the Taxpayer to repair the component when it becomes operationally unserviceable and to provide replacement of the component during the interim period.

The consideration received by the Taxpayer is divided into two segments: (a) For repairing and overhauling of the components. (b) For use, or right to use, of the replacement components.

In order to ensure adequate availability of the components, the Taxpayer maintains stock of such replacement components at the operational bases of the Customer in India, as also in the UK at the Taxpayer’s main depot. The Customer holds the component stock as a bailee (delivery of goods without transfer of ownership). The component stock continues to remain the property of the Taxpayer at all times.

The issue in dispute is whether the maintenance of the component stock constitutes a PE of the Taxpayer in India under the UK Treaty. The Tax Authority concluded that there exists a PE in India and the first appellate authority concurred with the Tax Authority’s view and determined 10% of gross receipts of the Taxpayer as profits attributable to the PE.

Aggrieved by the first appellate authority’s order, the Taxpayer appealed to the Tribunal.

Tax Authority’s contentions

The Tax Authority relied on a statement obtained from stores staff of the Customer to conclude that the staff of the Customer were acting as agents of the Taxpayer in maintaining the component stock. This resulted in an agency PE coming into existence under Article 5(4) of the UK Treaty.

Also, since the Taxpayer’s stock was permanently kept at fixed places in India, with clear identification of each stock item, the Taxpayer has a fixed place of business in India.

Delivery of repaired component stock amounts to sales, which has to be understood in its widest meaning in relation to business transactions. Since income arises to the Taxpayer out of such delivery of goods and the repaired component, the benefit of exclusion in clauses (a) and (b) in Article 5(3) of the UK Treaty, in relation to use of facility for storage or display and in relation to the maintenance of stock solely for storage respectively, is not available to the Taxpayer.

Taxpayer’s contentions

Since the Taxpayer does not have a PE in India, its business profits are not taxable in India.

Without prejudice, even if there were a PE, the application of an ad hoc rate of 10% on its entire gross receipts for India was not appropriate. The finding that the entire profits from Indian sales were attributable to the PE in India was also inappropriate, in view of the fact that the repair operations were carried out entirely outside India.

Tribunal ruling

PE under the basic rule

• As per the basic rule in Article 5(1) of the UK Treaty, a PE is said to exist when an enterprise of one country has a fixed place of business in the other country through which the business is wholly or partly carried out. Thus, the following three criteria are embedded in this definition:

•

o Physical criterion i.e., existence of a physical location.

o Subjective criterion i.e., right to use that place.

o Functionality criterion i.e., carrying out of business through that place.

• It is, thus, necessary that for a PE to exist not only should there be a physical location through which the business of the foreign enterprise is carried out, but also should such a place be at the disposal of the foreign enterprise. In other words, the foreign enterprise should have some sort of right to use the said physical location for its own business.

• In the present case, there is no doubt the consignment stock of the Taxpayer is stored at a specified physical location. However, this storage was under the control of the Customer and the Taxpayer did not have any place at its disposal.

• When the physical location at which the consignment stock is kept does not result in virtual projection of the Taxpayer into India, it cannot be said that the location constitutes a PE of the Taxpayer.

PE under the agency rule

• Under Article 5(4)(b) of the UK Treaty, a foreign enterprise can have a PE if a person, other than an agent of independent status, maintains stock of goods from which he regularly delivers on behalf of the foreign enterprise.

• A dependant agent PE (DAPE) can come into existence only when the business of the Taxpayer is carried out through the DAPE. In the present case, no business is carried out through the agent, even if the Customer is regarded as an agent. Maintaining the consignment stock by the Customer is the end result of the Taxpayer’s business and not an intermediate step to get the business.

• There is no material to establish or indicate that the Customer constitutes a DAPE of the Taxpayer. Even if one assumes that the Customer can be treated as an agent of the Taxpayer, the Customer, at best, will be an agent of independent status. Further, the Customer maintains the consignment stock for standby use and not for delivery, on behalf of the Taxpayer.

• The Taxpayer, therefore, does not have a PE in India and, accordingly, there is no question of quantification of income attributable to the PE under the UK Treaty.

Taxation as royalties

• Where the payment is not taxable as business profits under Article 7 of the UK Treaty because a PE is not constituted, taxability is required to be examined under Article 13 of the UK Treaty that provides for taxation of ‘equipment royalty’ i.e., whether the consideration is for use, or right to use, of the components.

• Thus, non-taxability under Article 7 will still mean that application of Article 13 is to be considered and adjudicated upon. Since this aspect had not been heard by any lower authorities, it was remanded to the first appellate authority to adjudicate only on this limited aspect.

Comments

This ruling reaffirms some of the general principles for determining existence of PE under the basic rule as well as the agency rule.

With regard to the basic rule, this ruling confirms that mere existence of a physical location is insufficient to result in a PE if the foreign enterprise does not have some sort of a right to use the location for its business. This ruling clarifies that mere presence of goods belonging to the foreign enterprise at the physical location does not result in the physical location being at the disposal of the foreign enterprise.

On agency PE, this ruling clarifies that maintenance of stock of goods by a person in India should not result in a PE if the goods are maintained for subsequent use and not for onward delivery on behalf of the foreign enterprise.

Fees for Technical Services, even if rendered outside India, are taxable.

Mumbai Tribunal Ruling: Fees for Technical Services, even if rendered outside India, are taxable consequent to retrospective amendment in Section 9 by the Finance Act, 2010 (Ashapura Minichem Limited v. ADIT)(ITA No. 2508/M/2008)

Facts:

Ashapura Minichem Limited (AML/Assessee), an Indian company entered into an agreement on 5 April 2007 with China Aluminum International Engineering Corp. Ltd. (CAIECL), a company based in China. AML, was in the process of building an alumina refinery in Gujarat and in this regard it was to pay a sum of USD one million in consideration of bauxite testing services availed from and for preparation of test reports by CAIECL. These services were rendered by CAIECL in its laboratories in China. These test reports of bauxite samples were to cover complete chemical composition of bauxite, physical phase constitution of bauxite, abradability test of bauxite, pre-desilication of bauxite, digestion performance test and red mud settling performance test.

AML approached Tax Department by filing an application under section 195 of the Income tax Act (Act) at the time of remittance of this sum to CAIECL for obtaining a nil withholding tax certificate. The Assessing Officer (AO) passed an order directing AML to deduct tax at source on the ground that these services rendered by CAICEL were in the nature of ‘fees for technical services’ as per Article 12 of India-China Double Tax Avoidance Agreement (‘tax treaty’).

On appeal, the Commissioner of Income tax [CIT (A)] upheld the order of the AO. Therefore, AML preferred an appeal before the Income tax Appellate Tribunal (Tribunal).

Contention of the Assessee:

In order attract taxability under section 9(1 )(vii) (fees for technical services), not only that the services should be utilized in India, but should also be rendered in India.

The testing services were rendered in China and not in India; and therefore, these services would not be considered as fees for technical services as defined in section 9(1 )(vii) of the Act. In this connection, reliance was placed on Ishikawajima Harima Heavy industries Ltd. v. DIT (288 ITR 408) (SC) and Clifford Chance v DCIT (318 ITR 297)(Bom).

Even in terms of Article 12 of the India-China tax treaty, taxability of fees for technical services can only arise when not only the services are used in India but also rendered in India.

Unlike the provisions in most other tax treaties, the taxability of fees for technical services in the India-China tax treaty has an additional requirement of ‘place of performance’ in the source country, to be satisfied before it can be taxed as fees for technical services in the source country.

In order to highlight that India-China tax treaty is unique in its wordings and its scope as far as taxability of fees for technical services is concerned, an attention was invited to the provisions of India-China tax treaty, China-Pakistan tax treaty, India-Israel tax treaty, India-South Africa tax treaty and India-Germany tax treaty.

In view of the above, it was contended that if at all this amount is liable to tax in India, it is by way of business profits only; and in the absence of any Permanent Establishment of CAIECL in India, such business profits would not be liable to tax in India.

Contention of the Revenue:

If the royalties and fees for technical services can only be taxed in India only when not only the services are utilised in India; but also rendered in India, the source rule will cease to have any meaning.

The judgement of the Supreme Court in the case of Ishikawajima (supra) and Bombay High Court in the case of Clifford Chance (supra) are contrary to the legislative intent and the doubts, if any, have been set at rest by the retrospective amendment in Explanation to section 9(1)(vii), as introduced in Finance Act, 2010. Once the amendments are carried out in the Act, these judicial precedents will no longer constitute good law.

As regards the applicability of Article 12 of India-China tax treaty is concerned, it was contended that the deeming provision of Article 12(6) [royalties or fees for technical services shall be deemed to arise in a Contracting State where the payer is a resident of a Contracting State] is quite clear and categorical, and therefore, it was urged to give it a sensible and reasonable meaning which makes the provision workable rather than making the provision redundant.

The services rendered by CAIECL are liable to tax under domestic tax law as well as tax treaty.

Tribunal’s observation and Ruling:

As per the retrospective amendment in section 9(1) by the Finance Act, 2010, utilisation of services in India is enough to attract its taxability in India. To that extent, recent amendment in the statute has virtually negated the judicial precedents supporting the proposition that rendition of services in India is a sine qua non for its taxability in India.

The impugned receipt of fees of technical services from AML is to be deemed to accrue or arise in India under section 9(1 )(vii) of the Act.

As per Article 12(4) of India-China tax treaty, technical services provided by a resident of China to a resident of India are liable to tax in India. Even under deeming provisions contained in Article 12(6), the said fees are liable to tax in India.

The argument that in using the words “in the Contracting State“, Article 12(4) incorporates the “place of performance test” and negates the “source rule” and that services rendered offshore are not taxable is not acceptable for two reasons. Firstly, because the expression “provision for services” is wider than the term “provision for rendering of services” and covers services rendered in the one State but used in the other State. Secondly, because the interpretation will render Article 12(6) redundant. A literal interpretation to a tax treaty which renders a treaty provision unworkable should be avoided. In this regard, the Tribunal has reiterated the Principles of treaty interpretation.

In view of the above, AML was liable to deduct tax at source under section 195 of the Act at the time of remittance of fees to CAIECL.

Comments :

The Legislature, in wanting to nullify the effect of the Supreme Court judgement in the case of Ishikawajima (supra), had attempted to amend the Act in 2007 by the Finance Act, 2007 by adding an explanation to section 9(2) of the Act, with retrospective effect from 1 June 1976. However, subsequently the Karnataka High Court in the case of Jindal Thermal Power Company Ltd. v. DIT (182 Taxman 252) held that the explanation, i.e. the 2007 amendment (supra), in its present form, does not do away with the requirement of rendering services in India, for such fees for technical services to be taxable under section 9 of the Act. In order to remove any doubt about the legislative intent of the aforesaid source rule, the amendment has been carried out again in section 9 by the Finance Act, 2010. This judgement has brought out this aspect by holding that as per the retrospective amendment in section 9(1) by the Finance Act, 2010, utilisation of services in India is enough to attract its taxability in India. However, it would be interesting to see how the Courts will interpret the law even after the amendment to section 9, as regards the taxability of payments for fees for technical services, irrespective of territorial nexus of such fees to the state of India.

Although this judgement is in line with the retrospective amendment in section 9 to the extent of taxability of fees for technical services in the hands of a non-resident, we believe that as far as payer’s obligation to withhold tax under section 195 is concerned, he may not be hit by the retrospective amendment in section 9 in the absence of any such extension of retrospective effect either in section 195 or section 201 of the Act. This is on the basis that the payer has withheld tax in a bonafide manner applying the law prevalent at the time of remittance. Further, the withholding tax is in the nature of vicarious liability and therefore, the payer should not be considered as ‘an assessee in default’ on account of any retrospective amendment carried out subsequently in the charging section of the Statute. In this connection, reliance can placed on the decision rendered by Nagpur bench of Tribunal in the case of Canara Bank v ITO (ITA Nos.366 to 370/Nag/2007) and Hyderabad Tribunal in the case of State Bank of India v DCIT (20 10- TIOL-23 1 -ITAT-HYD). Thus, expecting the tax payer to act on foresight of a retrospective amendment would be hit by the doctrine of impossibility of performance

Source : http://www.taxguru.in/income-tax-case-laws

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