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International Tax Update: July 2018

International Taxation / Transfer Pricing

Transfer Pricing

Foreign Companies with Place of Effective Management (POEM) in India – to be considered as resident Indian Company and suffer tax as applicable to a foreign company 40% (w.e.f. 1st April 2017)
Notification No. S. O. 3039(E) dated 22nd June, 2018 

The said notification provides following clarification with regards to taxation of foreign companies in India once they become resident in India on account of their POEM being in India.

  • The said company though treated as a resident in India will be tax at 40% rate as applicable to a foreign company.
  • Computing the written down value of depreciable assets and determining depreciation which can be claimed on these assets.
  • Determining how to arrive at brought forward loss and unabsorbed depreciation.
  • Determining the amount of set off and carry forward of brought forward loss and unabsorbed depreciation.
  • Applicability of withholding of taxes as per the provisions of Chapter XVII-B (TDS provisions) of the Act before and after becoming a resident in India.
  • Applicability of the provisions of Section 195(2) of the Act as applicable to a non-resident
  • Entitlement to relief or deduction of taxes paid in accordance with the provisions of Section 90 or Section 91 of the Act.
  • Income on which foreign tax has been paid or deducted, is offered to tax in more than 1 year, credit of foreign tax would be allowed across those years in the same proportion in which the income is offered to tax or assessed to tax in India.

The said notification also gives clarification on preparation of profit and loss account and balance sheet as well as carry forward of loss and unabsorbed deprecation where the accounting year of the foreign company does not end on 31st March.

Recent Judicial Decisions

International Taxation

Non-Exclusive Reseller Agreement for sale of content delivery solutions directly to customers in India, not taxable as FTS/ Fees for Included Service (FIS) or Royalty under the Income Tax Act, 1961 (the Act) or under India-US Tax Treaty.
Akamai Technologies Inc. [93 471)(AAR)

The Applicant was a technology company and a leading global service provider, for accelerating content and business processes online (Solutions). It catered to customers having web based applications/ websites, etc. on the Internet, so as to help deliver the web content faster and more reliably. The applicant also handled specific requirements of the customers. The Applicant had built its Akamai EdgePlatform® comprising of 73,000 secure servers equipped with proprietary software and deployed in 70 countries. The Akamai EdgePlatform® pulled content from the customer’s web server by replicating the data therefrom, and continually monitors the Internet traffic, trouble spots and overall conditions.
This information was used intelligently to optimize routes and replicate content for faster, more reliable delivery. The end-users access the customer’s website through the Akamai EdgePlatform®, thereby avoiding the slower web server maintained by the customer.
In order to sell its Solutions in India, the Applicant had entered into an Akamai Services Reseller Agreement with Akamai India. Under this Reseller Agreement, the Applicant appointed Akamai India as a non-exclusive reseller, who was authorized to resell the Applicant’s Solutions, directly to customers in India. Akamai India did not have any rights, title and interest in any of the intellectual property and software of the Applicant. The Applicant contended that the payments received by it from Akamai India, for the above referred services were not taxable in India as FTS, as the Solutions are not in the nature of managerial consultancy or technical services.
Taxability as fees for technical Service
The Solutions provided by the Applicant were neither specialized, nor exclusive and did not cater to individual requirements of the customer. The Solutions are offered by the Applicant through its Akamai EdgePlatform® and they remain the same for all customers, who availed the Applicant’s facility, irrespective of the business/website content. The AAR took note of the Supreme Court decision in the case of M/s Kotak Securities Limited (383 ITR 1), wherein it was held that where a standard facility is provided to all those who are willing to pay for it, then such standard facility cannot be termed as FTS.

Taxability as Royalty
The applicant itself had exploited the right to use, operate or control its technology/intangibles, without granting the right to use the same to Akamai India/the Indian customers. The customers/ end users were neither provided with any access to the Applicant’s infrastructure including software or hardware, nor was such access even required for availing the standard facility. The payment received by the Applicant, was not for the use of or right to use any equipment and thus, cannot constitute “royalty”.
Determination of PE
The Applicant did not have any office or any other establishment in India. Neither it hired any employees in India, nor its personnel/ employees visited India. Accordingly, the Applicant was not having a fixed place PE as per Article 5(1) of the Tax Treaty.
As per the Reseller Agreement, Akamai India would resell the Applicant’s Solutions by directly entering into contracts with customers in India and invoice the India customers for the Solutions. Akamai India was required to dedicate adequate resources, financial and otherwise, maintain facilities and staff to re-sell the Solutions.
The Reseller Agreement did not create a principal-agent relationship between the Applicant and the Reseller. The relationship between the two was that of independent contractors. Neither party had powers to direct or control the day-to-day activities of the other. Akamai India concluded all contracts in its own name, did not maintain any stock of goods of the Applicant. It merely purchased Akamai Solutions from the Applicant for onward sale to Indian customers. Akamai India had secured orders and entered into the contract with customers in India on its own account, and not on behalf of the Applicant. The relationship between the two was on a principal-to-principal basis. Accordingly, Akamai India was not a PE of the Applicant as per Article 5(4) of the Tax Treaty.
The AAR held that once income does not accrue or arise in the hands of the Applicant as Royalty or FTS/FIS, the question of existence of a PE under Article 5 becomes irrelevant and academic. Since, no income arose in the hands of the Applicant in India; there was no requirement to withhold tax under Section 195 of the Act.

International Taxation

Rendering of services for domain registration is rendering of services in connection with use of an intangible property, which is similar to trademark. Therefore, charges received for said services was taxable as “royalty” as per Section 9(1)(vi) of the Act LLC vs. ACIT (92 241)(Delhi Tribunal)

The assessee, a limited company based in USA, was engaged in the business as accredited domain name registrar authorized by Internet Corporation for Assigned Names and Numbers (‘ICANN’). The assessee, filed its tax return declaring income of Rs. 20.43 crores, being income from web hosting services/ on demand sale. The assessee offered the same as royalty, which was assessed as FTS by the AO. The assessee also had income from domain registration fees of Rs. 17.42 crores, which was claimed as not taxable in India. The AO, however assessed the said income also as “royalty”.
The limited question before the Tribunal was whether the domain registration fee received by the assessee can be taxed as ‘royalty’.

The Tribunal made note of the fact that domain registration was an integral part of the services, which were offered by the assessee. The assessee could not distinguish how domain registration charges were different from web hosting charges. The web hosting charges were duly admitted by the assessee itself, as royalty. Domain registration partake the character of web hosting charges, since without domain registration being in place, web hosting was not possible.
As domain registration charges was essentially charged for granting right to use the servers of the assessee and the fact that domain registration, being the pre-condition to web hosting, rendering of services for domain registration was rendering of services in connection with the use of an intangible property, which was similar to trademark. Therefore, the charges received by the assessee for services rendered in respect of domain name was taxable as “royalty” under Section 9(1)(vi) of the Act.

International Taxation

Rendering of service through deployment of personnel having requisite experience and skill which could not have been performed by service recipient on its own, without recourse to the service provider does not qualify as FIS as per India US Tax Treaty

Petronet LNG Ltd. (92 407)(Delhi Tribunal)

The assessee an Indian Company made payments to US Company for rendering consultancy services in connection with review of the alternative vaporization process for the LNG terminal and recommend a suitable process to the assessee. The scope involved study of the benefits of various scheme for generating power through the utilization of LNG. The AO, disallowed the claim for deduction of expenses by invoking Section 40(a)(i) of the Act. The AO categorized the payments made to US company as FTS under the Act.

The services rendered qualified as FTS as per Section 9(i)(vii) of the Act. However, Article 12(4) of the India US Tax Treaty dealing with FIS, require that technical knowledge, experience skill etc. should be ‘made available’ to the recipient of such services.
In order to qualify as FIS, mere rendering of services involving technical knowledge, skill etc., is not sufficient. It contemplates that the person utilizing the service should be able to make use of such technical knowledge, skill etc. on his own and without recourse to the service provider in future. The services provided by the US company involved deployment of personnel having the requisite experience and skill to perform the services. It was not possible that the assessee would be able to carry out such services in future, on its own,without recourse to the US Company. The nature of services rendered did not indicate making available any technical knowledge, skill, know-how etc. to the assessee. Thus, said payment would not qualify as fee for included services as per the provisions of the India-US Tax Treaty.
Accordingly it was held that assessee was not required to deduct TDS under Section 195 of the Act and disallowance of expenses under Section 40(a)(i) of the Act was not justified.

International Taxation

Income from offshore supply was not taxable in India, as the project office in India did not have any role in such offshore supply

Samsung Heavy Industries Co. Ltd. vs. DCIT (93 224)(Delhi Tribunal)

The assessee, who was a tax resident of South Korea, was engaged in the business of heavy engineering. The assessee was awarded a contract to perform certain activities within India and outside India. The activities relating to design and engineering were performed in Malaysia, fabrication took place in Korea and Malaysia, transportation took place from Malaysia to India and the jackets arrived at the offshore site in India, whereas the installation and commission took place at Mumbai offshore. The assessee had opened a Project office (PO) in Mumbai for the purpose of coordination and communication between the parties to the contract.
The appellant had filed its return of income declaring loss of Rs.89.73 crores which relates to the onshore activities i.e. installation and commissioning. The AO assessed the total income of the appellant at Rs.176.02 crores holding that there is a fixed place PE in India under Article 5(1)/ 5(2) of the tax treaty. The AO attributed revenue from activities carried on outside India to the alleged PE in India, brushing aside the contention of the assessee that the alleged PE of the appellant had no role to play in design, fabrication, etc. of the platforms which was carried on outside India. The AO attributed an adhoc 25% of the gross revenues, received by the assessee under the project attributed to the alleged PE in India.
Article 7(2) of the India- Korea Tax Treaty provides that profits attributable to the PE are the profits that the PE might be expected to make, if it were a separate and independent enterprise engaged in the same or similar activities, under the same or similar conditions, taking into account the functions performed, assets used and risks assumed through the PE and through other parts of the enterprise.
There were only 2 employees, working for the PO and they were neither technically capable, nor equipped to carry out the work pertaining to offshore supply of platforms. Their role was limited to acting as a communication channel between the assessee and ONGC. The activities undertaken by the PO was thus an activity which will qualify as preparatory or auxiliary as per Article 5(4) of the India-Korea Tax Treaty.

The AO did not bring on record any evidence or material in support of the contention that the office at Mumbai had any role to play in respect of offshore supplies. Accordingly, income from offshore supplies could not be attributed to its alleged PE in Mumbai.

International Taxation

Consideration received by assessee from various entities on account of sale of software was sale of copyrighted article and was not royalty within meaning of Article 13 of India UK Tax Treaty

DCIT vs. Micro Focus Ltd. (94 Tribunal)

The assessee-company was engaged in the business of development and distribution of software products in India, either through its distributors or directly to the customers. The assessee entered into contracts with its customers on principal to principal basis and sale of software licenses were concluded outside India (offshore supplies). The AO held that consideration received by the assessee from various entities on account of sale of software was “royalty” within the meaning of Article 13 of the India UK Tax Treaty.

The assessee had entered into the Distributor Agreement which gave non-exclusive rights to only distributor to market and distributes the software products to 3rd parties, throughout the territory. The Distributor would act as independent contractor only and would neither act on behalf of assessee, nor purport to represent the assessee in any way. The assessee entered into contracts with its customers on principal to principal basis and the sale of software licenses was made outside India, no portion of sale was carried out in India and the payment was made directly by the customers to the bank account in UK.
The assessee was therefore, only selling copyrighted article and there was no payment for use of copy right or acquiring the right to use the copyright. Accordingly, the same could not be covered within the definition of “royalty” in India-UK Tax Treaty. The payment made for the use of copyrighted article would be “business income” and not royalty.

Transfer Pricing

Indian subsidiary negotiating and finalizing price with the customers in India was treated as Dependent Agent PE, even though final contracts were signed by the foreign entity. Where Transfer Pricing (TP) analysis of the Indian subsidiary did not correctly reflect functions carried out by it, further profit can be attributed to the Indian PE, even where it is claimed that payment made is at arm’s length price.(ALP)

Daikin Industries Ltd. vs. ACIT (Del. ITAT)(TS-395-ITAT-2018(DEL)-TP) (Delhi Tribunal)

The assessee, a Japanese entity was engaged in development, manufacture, assembly and supply of air-conditioning and refrigeration equipments. The assessee was having a wholly owned subsidiary in India, DAIPL. The assessee sold air conditioners etc. worth Rs. 55.15 crore to DAIPL and also made direct sales worth Rs. 45.40 crore to 3rd parties in India.
The assessee paid commission of 10% to DAIPL for rendering services in connection with direct sales made by it, in India, as enumerated in the Service Agreement. The assessee claimed that the role of DAIPL was that of a mere communication channel, restricted to forwarding the customer request for procuring products to it and forwarding its quotation and contractual proposal to the customers. The functions of identifying customers, negotiating and finalizing prices with customers in India etc. were exclusively done by the assessee directly from Japan.

The assessee before the Tribunal contended that some of its employees visited India for having discussions with customers in India. However, the fact was that such visiting employees rendered only consultancy services etc., which were separately charged to DAIPL. The Tribunal accordingly held that the AO rightly contended that the assessee cannot claim such personnel to be engaged in negotiating the prices. The Tribunal remarked that “in a highly competitive industry of air-conditioning and refrigeration equipments, tremendous efforts are required to be made for effecting sales. The contention of the assessee that customers in India were directly approaching it in Japan and marketing efforts were made from Japan, was not only vague, but also devoid of merit. For selling the same products, in the capacity of a distributor, DAIPL has incurred huge Selling and Distribution expenses. The Tribunal therefore noted that it failed to comprehend as how to the assessee could make direct sales to customers, without the support of DAIPL.
The Tribunal also observed that though no authority apparently vested in DAIPL to finalize the contracts of direct sales in India, the activities of negotiating and finalizing the contracts etc., constituting substance of any sale transaction, were indeed performed by DAIPL. Mere fact that the assessee was formally signing the contracts of sale did not, in any manner, alter the position.
DAIPL was habitually exercising authority in India to conclude contracts on behalf of the assessee, though such contracts were formally signed by the assessee in Japan and therefore would constitute a PE in India as per Article 5 of India-Japan Tax Treaty. DAIPL was securing orders in India ‘almost wholly’ for the assessee as substantive parts of the key activities in making sales were done by DAIPL from India. Accordingly, DAIPL constituted a DAPE of the assessee in India under the Article 5 of the India Japan Tax Treaty.
No further attribution where AE compensated at ALP

The TPO had considered the international transaction of commission paid by the assessee to DAIPL for rendering marketing support services, at ALP. The TPO, in the order passed of DAIPL had accepted the international transaction of ‘commission received on direct sales (Market Support Services)’ to be at ALP. Before the Tribunal, the assessee submitted that in such circumstances, no further income could be attributed to the operations carried on by the assessee in India. The assessee relied on SC ruling in Morgan Stanley & Co. [TS-5-SC-2007], wherein it was held that once the TP analysis was undertaken, there was no further need to attribute profits to PE which was an associated enterprise and remunerated on an arm’s length basis taking into account all the risk taking functions of the multinational enterprise.

The Tribunal took note of the fact that the assessee had entered into agreement with DAIPL and paid commission, only for rendering two services i.e.. forwarding the customers’ request of procuring products to the assessee and to forward the assessee’s quotation & contractual proposal to the customers. However, DAIPL had carried out a whole range of functions in selling the products of the assessee in India, which, apart from the 2 functions elaborated in the Agreement, also included negotiating & finalizing the price and concluding contracts with the customers in India. These other functions were neither borne out from the Agreement, nor declared by DAIPL and further no consideration was awarded for them. There was no occasion for the TPO to determine the ALP of the transaction of receipt of commission as inclusive of such other functions as well. Had such other functions been declared, the entire FAR (Functions performed, assets utilized and risks undertaken)analysis would have undergone a complete change.
The Tribunal rejected the assessee’s contentions that since the assessee’s international transaction was considered at ALP, no further income should attributed to the operations carried on by the assessee in India.

Transfer Pricing

High Court dismissed the appeal filed by the Income Tax Department with the observation that invocation of Rule 10B(1)(e)(iii), which allows adjustment in net profit margin because of factual difference between the assessee and the comparable, does not give rise to any substantial question of law
Petro Araldite Pvt. Ltd [TS-317-HC-2018(BOM)-TP] (Bombay High Court)

The assessee, was engaged in the business of manufacturing and dealing in basic liquid and solid resins as well as formulations. The assessee had entered into international transaction of export of finished goods to Associated Enterprise (AE), import of raw materials from AEs and payment of management charges to AE. The assessee aggregated all the international transactions for benchmarking and adopted Transactional Net Margin Method (TNMM) as the most appropriate method (MAM).
The TPO recomputed the assessee’s margin to 8.63% as the assessee had not considered depreciation. The TPO also carried out a fresh search and selected 4 comparables, and computed the average margin of the comparables considering the Profit Level Indicator (PLI) as operating profit/total cost at 13.50% as against assessee’s margin of 9.48% and proposed TP adjustment.
The assessee, before the CIT(A) contended that its claim for capacity utilization adjustment was ignored. The CIT(A) accepted all the contentions of the assessee and deleted the TP adjustment.
The Tribunal upheld the assessee’s claim for adjustment on account of capacity utilization on the grounds that difference in capacity utilization materially affects the profit margin. If there was a difference in the level of capacity utilization of the assessee and the level of capacity utilization of the comparable, then adjustment would be required to be made to the profit margin of the comparable on account of difference in capacity utilization in terms of Rule 10B(1)(e)(iii) of the Rules.

In the assessee’s case, considering that capacity utilization of comparables materially affected the profit margin, the invocation of Rule 10B(1)(e)(iii) of the Rules, cannot be found fault with. The High Court held that invocation of Rule 10B does not give rise to any substantial question of law, as the said Rule is self-evident. The High Court accordingly dismissed the appeal filed by the Income Tax Department.

Transfer Pricing

Where financials of the AEs is not available in public domain, the said AE cannot be selected as tested party
GKN Driveline (India) Ltd [TS-297-ITAT-2018(DEL)-TP] (Delhi Tribunal)

The assessee was engaged in the business of manufacture and sale of instant velocity joints. The assessee had entered into various international transactions and had followed transaction-by-transaction approach to determine the ALP. The assessee had selected comparable profits method (CPM) as the most appropriate method and the AE was selected as the tested party. The TPO rejected the assessee’s approach by applying TNMM as the most appropriate method. The TPO also selected the assessee, as the tested party. The TPO noted that the assessee had failed to provide complete financial data of AE and accordingly, held that the AE could not be considered as tested party.
The TPO also rejected the assessee’s benchmarking approach by considering the following factors:
 Based on functions, assets and risks (FAR) analysis, the assessee had lesser complex operations and limited risks;
 CPM mark-up would be heavily influenced by the accounting conventions used by an enterprise to classify cost of goods sold or operating expenses and would vary among uncontrolled parties; and
 Reliability of CPM could be adversely affected by factors such as cost structure, business, management efficiency etc.

The Tribunal highlighted important aspects to be considered for selection of tested party based on para 3.18 of OECD guidelines as follow:
 The choice of selecting tested party for compatibility is only available in Comparable Uncontrolled Price (CUP), TNMM;
 The tested party should be the least complex party to the controlled transactions;
 Availability of most reliable data of the tested party on the public domain and requirement of minimum adjustments is also one of the most important aspects while selecting the tested party; and
 FAR study of the tested party should be detailed being less complex vis-à-vis the other entity.
The assessee had not provided any details regarding FAR of AE to ascertain it to be least complex nature. The assessee had itself submitted that it did not have financials of the AE, as the same were not available in the public domain. The assessee submitted only profitability details for products of AE’s having 100% external sales. Accordingly, the Tribunal set aside the matter to the file of TPO with the direction that the assessee cannot select AE as tested party, where it did not have proper data of AE to demonstrate FAR analysis.

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