Service Tax On Cross-Border Transactions Material... · Service Tax On Cross-Border Transactions (iv) determination of place of provision of service for both import and export of

1INTERNATIONAL TAX & FINANCE CONFERENCE

Service Tax On Cross-Border Transactions

Service Tax On Cross-Border Transactionsby CA A. R. Krishnan

SYNOPSIS

Particulars Para No. Page No.

1. Introduction 1.1 – 1.3 4

2. The New system of taxation – basic framework 2 5

• Significant changes 2.1 5 • Charge of service tax – 3 conditions 2.2 – 2.3 6

3. Taxable territory 3 6

4. Place of Provisions of Service Rules - General 4 6

• Preliminary 4.1 6 • Basic philosophy 4.2 – 4.4 7 • Purpose 4.5 7

5. Place of Provision of Service Rules – specific rules 5 8

• General Rule – location of service recipient [rule 3] 5.1 – 5.2 8 • Place of provision of ‘performance based’ services to 5.3 – 5.6 8/9

be location where the services are actually performed [rule 4]

• Place of provision of services relating to immovable 5.7 9 property would be the location of immoveable property [rule 5]

• Place of provision of services relating to events to be the 5.8 10 place where the event is actually held [rule 6]

• Place of provision of ‘performance based’ or ‘immovable 5.9 – 5.10 10 property based’ or ‘event based’ services where they are provided at more than one location including a location in the taxable territory [rule 7].

• Where provider and receiver are located in taxable 5.11 – 5.13 11 territory the place of provision of services shall be the location of service recipient [rule 8].

• Place of provision of ‘specified services’ shall be the 5.14 – 5.16 12/13 place of service provider [rule 9].

• Place of provision of goods transportation services other 5.17 13 than a goods transportation agency services shall be the place of destination of goods [rule 10].

• Place of provision of services of a goods transportation 5.18 13 agency (GTA) shall be the location of the ‘person liable to pay tax’ [rule 10 - proviso]

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• Place of provision of passenger transportation services shall 5.19 13 be the place of embarkation for ‘continuous journey’ [rule 11]

• Place of provision of services provided on board a conveyance [rule 12]. 5.20 13

• Powers to notify description of services or circumstances for 5.21 14 certain purposes [rule 13].

• Tie breaker test – later rule to apply [rule 14] 5.22 14

• Summing up 5.23 14

6. Export of Services 6 15

• Conditions for export [Rule 6A of Service Tax Rules, 1994] 6.1 15 • Export benefits 6.2 15

7. Import of Services 7 16

• The reverse charge mechanism in case of imports 7.1 – 7.2 16 • When to pay service tax in case of reverse charge 7.3 16 • No threshold 7.4 17

8. Other Matters 8 17

• Date of determination of rate of tax, value of taxable service 8.1.1 17 and rate of exchange

• Exemption to services provided to an SEZ 8.2 18

9. Conclusion 9 18

10. Epilogue 10 1811. Case Studies 11.1 – 11.4 19/21 Annexure A: Location of service provider and service recipient

• Rules to determine Location of service provider and A1 – A4 22 service recipient

• Establishment A5 – A6 23 • Business Establishment A7 23 • Fixed Establishment A8 23/24 • Usual Place of Residence A9 25 • Establishment most directly concerned in providing/ receiving A10 – A14 25-27

a service relevant. • Establishment in taxable territory and non-taxable territories A15 – A17 28

of a person are considered as separate entities • Diagrammatic examples of application of the rules to determine A18 28/30

location of service provider and service recipients. • Flow diagram to determine location of service provider / 31

recipient as given in Education Guide



Exhibits :

1. Text of relevant provisions of Chapter V of the Finance 32 Act, 1994 providing for ‘taxable territory’ and ‘Place of provision of Service’ (i) Extent, Commencement and Application [s. 64] (ii) Definition of “India” [s. 65B(27)] (iii) Definition of “Service” [s. 65B(44)] (iv) Definition of “Taxable territory” [s. 65B(52)] (v) Charge of service tax [s. 66B] (vi) Determination of place of provision of service [s. 66C]

2. Text of Place of Provision of Services Rules, 2012 34 (“PoP Rules”) [Notn. No. 28/2012 dated 20.6.2012]

3. Circular No. 163/14/2012 dated 10th July, 2012 38



1. Introduction

1.1 Simply put, a transaction1 across the borders of a country involving another country would be considered as a cross-border transaction. In the context of services a typical cross-border transaction maybe represented pictorially as under :

1.2 The service may emanate from a country outside India, say USA, where the service provider (SP) is situated and received by a service receiver (SR) in India or vice versa. The former would be termed as ‘import’ of services and the latter would be considered as ‘export’ of services. Thus, a study of service tax in a cross-border transaction would cover essentially a study of import and export of services. However, the study of import and export of services is peculiar, unique and quite distinct from import and export of goods. Services unlike goods are intangible and their supply is not characterised by physical movement to clearly demarcate and indicate when and where a service is imported or exported. Further services are diverse in nature and different rules are necessary to determine the situs of services. Hence specific rules need to be made to determine the situs of supply of services popularly known as the ‘Place of Supply Rules’ in order to determine whether a service is liable for service tax in a country. In India recently the place of supply rules have been issued known as ‘Place of Provision of Service Rules, 2012’ (“PoP Rules") effective from 1.7.2012 [Exhibit 2].

1.3 Before I present my analysis of the service tax law from the perspective of cross-border transactions it is to be noted that Chapter V of the Finance Act, 1994 (hereinafter referred to as the 'Act'), which is the law governing service tax, is relatively a recent piece of legislation. The law is at its nascent stage (in fact at its evolutionary stage2), more so in the context of

1 In a lighter vein a cross border transaction is a transaction due to which both the departments (Income tax and Excise) would be cross with you and you would have to search for the Holy Cross!

2 It is both evolving and revolving !



cross-border transactions, and hence the interpretation thereof is handicapped by the lack of precedents. I have also made certain references to the law as prevailing in UK (Value Added Tax Act, 1994) and European Union (EU) (Sixth Directive on VAT ) since several concepts appear to have been borrowed from them. Needless to say, the said references (including case law) have only been made for a comparative analysis and hence would have only persuasive value for interpretation. Further, more importantly, the Central Board of Excise & Customs (CBEC) has issued ‘Taxation of Services – An Education Guide’ dated 20.6.2012, inter alia giving detailed explanation on the Place of Provision of Service Rules, 2012 (“PoP Rules) in Guidance Paper 5 - “Place of Provision of Service Rules, 2012”. My analysis of the PoP Rules in this paper draws heavily from the said Education Guide. References have been made to paragraph numbers of the Education Guide in the footnotes and in the text in italics. However, the Education Guide itself carries an important caveat as under:

“It is clarified at the outset that this guide is merely an educational aid based on a broad understanding of a team of officers of the issues. It is neither a "Departmental Circular" nor a manual of instructions issued by the Central Board of Excise and Customs. To that extent it does not command the required legal backing to be binding on either side in any manner. The guide is being released purely as a measure of facilitation so that all stakeholders obtain some preliminary understanding of the new issues for smooth transition to the new regime.”

In this regard, it is to be noted that various issues have been analysed with the limitations arising due to the PoP Rules being just in place w.e.f. 1.7.2012. Hence there is a total absence of precedents. The limitations may be overcome by the passage of time as the law gets evolved.

N.B. : The full text of the Education Guide is available at www.cbec.gov.in. It is important to refer to it so as to understand the Government’s thinking on PoP.

2. The New system of taxation – basic framework

Significant changes

2.1 A virtual metamorphosis of the service tax law, i.e. Chapter V of the Finance Act 1994 (i.e. the law governing service tax), is made by the Finance Act, 2012 w.e.f. 1.7.2012. Some of the significant changes are:

(I) replacement of the definition section 65 by a new definition section 65B which inter alia for the first time defines the term ‘service’ [s. 65B(44)] – a longfelt cry of the taxpaying fraternity. Thus, the definition of various services and the definition of ‘taxable service’ has been done away with. The new definition section also defines the terms ‘taxable territory’ and ‘India’;

(ii) replacement of the existing charging section 66 by a new charging section 66B which inter alia specifically mentions that the ‘taxable event’ must happen in the ‘taxable territory’;

(iii) introduction of the concept of exclusion of services by a ‘negative list’ and inclusion of services by a ‘declared list’;



(iv) determination of place of provision of service for both import and export of services by a common set of rules called ‘Place of Provision of Services Rules, 2012’ so as to determine the place of provision of services.

(v) Laying down principles for interpretation of service descriptions and taxability of 'bundled services’ (s. 66F) instead of the principles classification of services (section 65A).

Charge of service tax – 3 conditions

2.2 The new charging section 66B provides that there shall be levied a tax @12% of ‘the value of all services other than those specified in the negative list provided or agreed to be provided in the taxable territory, by one person to another…’. Thus, in order for the charge of service tax to crystallise three conditions are required to be satisfied -

(a) there must be a ‘service’ provided or agreed to be provided by one person to another;

(b) the service provided must not be specified in the ‘negative list’;

(c) the service must be provided in the ‘taxable territory’;

If the above conditions are satisfied the charge of service tax crystallizes and the ‘taxable event’ viz., the service (provided or agreed to be provided) becomes impregnated with the levy. The measure of the charge is 12% [exclusive of cess] of the ‘value of services’.

2.3 The first two aspects of the charge viz., what is a service and what are the services specified in the ‘negative list’ is not the subject of my paper. The focus of my paper is when would a service be considered to be provided in the ‘taxable territory’.

3 Taxable Territory

3.1 The new charging section 66B provides that there shall be levied a tax @12% of ‘the value of all services other than those specified in the negative list provided or agreed to be provided in the taxable territory, by one person to another…’. Thus, section 66B clearly provides that the taxable event i.e. the ‘service’ must happen in the ‘taxable territory’. The term ‘taxable territory’ has been defined in section 65B(52) as ‘the territory to which the provisions of this Chapter apply’. By section 64(1) Chapter V of the Finance Act, 1994 (i.e. the law governing service tax) extends to the whole of ‘India’ except the State of Jammu & Kashmir. The term ‘India’ has been defined in section 65B(27) which is given in Exhibit 1 and on a reading of which it can be inferred that, broadly speaking taxable territory means India minus Jammu & Kashmir.

4. Place of Provision of Service Rules – General

Preliminary

4.1 The Central Government has been empowered u/s. 66C to enact rules to determine when would the service be considered as provided in the taxable territory i.e. rules to determine the place of provision of service. The Place of Provision of Services Rules, 2012 [“PoP Rules”] is notified vide notification no. 28/2012-ST dated 20.6.2012 which is effective from 1.7.2012 [Refer Exhibit 2]. The PoP Rules would be effective for the first time in India. Prior to 1.7.2012, there were separate rules for determining ‘import of services’ [Taxation of Services (provided from outside and received in India) Rules, 2006] and ‘export of services’ [Export of Services Rules, 2005] but no rules to determine the place of provision of services. However, w.e.f. 1.7.2012, the PoP Rules has been enacted to determine when the services would be considered as provided in the taxable territory and when it would not. Thus, the present PoP Rules is neutral to Imports and Exports. With the introduction of the PoP Rules, the import



and export rules3 have been rescinded. The only requirement would be whether a service is provided in the taxable territory (pursuant to place of provision of service rules). If yes – liable, if no – not liable.

Basic philosophy

4.2 The Place of Provision of Service Rules [“PoP Rules”] provide where a service is deemed to have been provided. If the place of provision of service is in the taxable territory it will be liable for service tax. If the place of provision of service is not within the taxable territory it will not be liable for service tax.

4.3 The essence of the PoP Rules is that service is to be taxed in the jurisdiction of the place of consumption of service. In practice, the “place of consumption” i.e. the place where a service is used may not often be very easy to ascertain and may often lead to controversies. Hence the PoP Rules have been formulated specifically fixing the place of consumption by legislation. Further, the Education Guide clarifies that ‘nearest ‘proxies’ are adopted to provide specificity in the interpretation as well as application of the law.’

4.4 The basic rule is that the place of provision of service shall be the location of the service receiver. However, exceptions have been provided in case of performance based services, immovable property based services, certain specified services and transportation service etc., where other criteria such as location of service provider, location of performance of service, etc., are relevant. Services being intangible, the provision thereof is volatile and transient. Determining the location of the service provider and service recipient maybe possible with better precision as against the place of provision of service. Hence the location of the service provider and service recipient are used as proxies. Further, location of the service provider and service recipient determined pursuant to the PoP Rules and Explanation 3(b) to section 65B(44) [refer Exhibit 1] is very crucial to determine the place of provision of the service. Infact in many cases it would be where the service provider or service recipient is located and not where the service is provided or utilised. The location of service provider and location of service recipient are sought to be defined separately – a write up of which is given in the Annexure A.

Purpose

4.5 The PoP Rules are intended to be relevant for the following4:

(i) Taxation of cross-border transactions in services.

(ii) Transactions with service providers and service recipients in the state of Jammu & Kashmir and the rest of India. If service is provided in Jammu & Kashmir – not liable, if provided in rest of India – liable.

(iii) Service providers operating within India with multiple locations and without centralised registration – the PoP Rules would be relevant in determining the jurisdiction applicable for their operations.

(iv) Determination as to when a service is ‘wholly consumed’ in a Special Economic Zone (“SEZ”) to avail outright exemption.

3 The Export of Services Rules, 2005 and the Taxation of Services (Provided from Outside India and Received in India) Rules, 2006.

4 Para 5.1.2 of the Education Guide.



5. Place of Provision of Service Rules – specific rules

General Rule – location of service recipient [rule 3]

5.1 The general or default rule is that the place of provision of a service shall be the location of the service receiver unless the transaction of service falls within any of the other rules mentioned below [paras 5.2 – 5.22]. The Education Guide in para 5.3.1 sums up the impact of this rule as under:

“The principal effect of the Main Rule is that:-

A. Where the location of receiver of a service is in the taxable territory, such service will be deemed to be provided in the taxable territory and service tax will be payable.

B. However if the receiver is located outside the taxable territory, no service tax will be payable on the said service.”

The above has been pictorially captured by the Education Guide (para 5.3.2) as under:

Taxable territory Non-taxable territory

ABC NT DEF

Service Provider Receiver

T

PQR T XYZ

Receiver Service provider

T = Taxable NT = Non-Taxable

5.2 In case the location of the service receiver is not available in the ordinary course of business, the place of provision shall be the location of the service provider.

Place of provision of ‘performance based’ services to be location where the services are actually performed [rule 4]

5.3 The place of provision of ‘performance based services’ shall be the location where the services are actually performed. ‘Performance based’ services are categorised by the PoP Rules to be of two types which may conveniently be described as:

(i) Work upon ‘goods’;

(ii) Work upon ‘individuals’.

5.4 Type 1: Work upon goods i.e. services provided in respect of ‘goods’ that are required to be made physically available by the recipient of service to the provider of service, or to a person acting on behalf of the provider of service, in order to provide the service. In such cases the place of provision of service would be where the services are actually performed. Example,



repairs, courier, cargo handling, storage, technical testing, inspection, etc5. The Education Guide has clarified (para 5.4.1) that this category will not cover ‘goods’ provided by the service recipient which are not material to the provision of the service by the service provider e.g., free samples provided by a client – manufacturer to a market research agency to be distributed in order to conduct a survey.

5.5 The above rule has two exceptions:

(i) when such services are provided from a remote location by way of electronic means the place of provision shall be the location where goods are situated at the time of provision of service.

(ii) the performance based criteria will not apply in the case of a service provided in respect of goods that are temporarily imported into India for repairs, reconditioning or reengineering for re-export, subject to conditions as may be specified in this regard. No such conditions have been specified so far.

5.6 Type 2: Work upon individuals i.e. services provided to an individual, represented either as the recipient of service or a person acting on behalf of the recipient, which require the physical presence of the receiver or the person acting on behalf of the receivers, with the provider for the provision of the service. In such cases the place of provision of service would be where the services are actually performed. These are essentially personalized services e.g., beauty treatment, cosmetic surgery, classroom teaching, etc6.

Place of provision of services relating to immovable property would be the location of immoveable property [rule 5].

5.7 The place of provision of the following services shall be the place where the immovable property is located or intended to be located [i.e. property to come into existence]:

(i) services provided directly in relation to an immovable property. This would include services granting right to use, occupation, enjoyment and exploitation of immoveable property or services ‘upon’ or for bringing into existence an immoveable property or services that alter the nature and value of the property or services for transfer of, or determination of title to, the property7. E.g. construction, repair, renovation of a building or a civil engineering work; survey / exploration / exploitation of land and sea-bed, property management, etc8. This would not include services that have only an indirect bearing on an immoveable property e.g., services of a tax consultant on capital gains on land or feasibility studies for an investment in a property, advice on property prices, etc.9;

(ii) services provided by experts and estate agents in relation to immoveable property e.g., auctioneers, engineers, valuers, surveyors, legal services in relation to planning permission, etc.10;

(iii) provision of hotel accommodation by a hotel, inn, guest house, club or campsite, by whatever name called;

(iv) grant of rights to use immovable property e.g. renting;

5 Para 5.4.1 of the Education Guide6 Para 5.4.3 of the Education Guide.7 Para 5.5.2 ibid.8 Para 5.5.3 ibid.9 Para 5.5.2 and 5.5.5 of the Education Guide.10 Para 5.5.3 ibid.



11 Para 5.7.1 of the Education Guide

(v) services for carrying out or co-ordination of construction work, including architects or interior decorators.

Place of provision of services relating to events to be the place where the event is actually held [rule 6]

5.8 The place of provision of the following services shall be the place where the event is actually held–

(i) Services provided by way of –

(a) admission to; or

(b) organisation of, and

(ii) services ancillary to admission of

a cultural, artistic, sporting, scientific, educational, or entertainment event, or a celebration, conference, fair, exhibition, or similar events. However, it is to be noted that admission to entertainment events and amusement facilities is covered in the Negative List [s. 66D(j)] and “entertainment event” has been defined in section 65B(24) to include concerts, drama, sporting events, etc. Hence admission to such entertainment events would not be liable for service tax and hence the PoP Rules would not be relevant for these events.

Place of provision of ‘performance based’ or ‘immovable property based’ or ‘event based’ services where they are provided at more than one location including a location in the taxable territory [rule 7].

5.9 Where any ‘performance based’ or ‘immovable property based’ or ‘event based’ services referred to paras 5.3 to 5.8 above are provided at more than one location, including a location in the taxable territory, its place of provision shall be the location in the taxable territory where the greatest proportion of the service is provided. Example11, where a firm provides technical inspection and certification services of a product to its client at Maharashtra (say, 20%), Kerala (say, 25%) and Colombo (say, 55%), then notwithstanding that the greatest proportion of the service is done at Colombo – a non-taxable territory, the place of provision of the entire service would be the place where the greatest proportion of the service within the taxable territory is done i.e. Kerala. Thus, in service exports even if a small percentage of the work is carried out in India, the exporter would have to pay service tax on the entire amount though the major part of the service is provided in non-taxable territory. Similarly, in case of service imports, the recipient maybe liable to pay service tax under reverse charge on the whole value even if a small percentage of the work is carried out in India. Hence, the said rule would cause undue hardships in cases where the service providers are required to perform substantial part of their service outside the taxable territory and only a small part of the service is performed in India.

5.10 Under the present Export of Service Rules, 2005, if a ‘performance based’ service is partly performed outside India it would be considered as performed outside India and be entitled to export exemption. Under the PoP Rules, this exemption would not be available by virtue of the above rule. However similar imports would continue to be liable for service tax on the entire amount.

Where provider and receiver are located in taxable territory the place of provision of services shall be the location of service recipient [rule 8].



5.11 The basic philosophy of the PoP Rules is to fix the location where service is provided based on the consumption. The general rule (Rule 3) is that the place of provision of a service shall be the location of the service receiver unless the transaction of service falls within any of the other rules. In some cases, (as explained above) the place of provision of service is based on the other criteria viz., where -

(i) the service is actually performed (Rule 4); or

(ii) the land is located (Rule 5); or

(iii) the event is actually held (Rule 6).

However, Rule 8 of the PoP Rules overrides rule 4, 5 and 6 by providing that where the location of the service provider as well as that of the service receiver is in the taxable territory, the place of provision of the service shall be the location of the service receiver. The implication of this rule is that it overrides rules 4 to 6 (paras 5.3 to 5.8). For example12, the place of provision of helicopter repair services performed in Nepal would be Nepal (i.e. non-taxable territory) by virtue of rule 4 [refer para 5.3]. But if the service provider and the service receiver are located in India (e.g. Hindustan Aeronautics Ltd. – the service provider and Pawan Hans Ltd. – the service recipient) the services would be considered as provided in India (in the taxable territory), notwithstanding rule 4.

5.12 In this regard the following maybe noted. It appears that rule 4, 5 and 6 is necessary since the nature of services envisaged in the said rules indicate that the services are consumed where -

a. it is actually performed (Rule 4); or

b. the land is located (Rule 5); or

c. the event is actually held (Rule 6).

Thus it is dependent on where the services have been utilised and not where the provider or receiver of service is located. If the services covered in rule 4, 5 and 6 of the PoP Rules are utilized outside the taxable territory the consumption of the services can be said to have taken place outside the taxable territory. The mere fact that both the service provider and service receiver are located within the taxable territory may not alter the above position. However, the philosophy of the PoP rules is otherwise. The intention of rule 8 it appears is to trigger the ‘proxy’ rule and consider the location of service recipient as place of provision and not where the service is actually utilized in a case where the service provider and recipient are based in the taxable territory!

5.13 However, conversely, even if the place of provision of service is in the taxable territory but the provider and the receiver of the service are located outside the taxable territory, the services are exempted vide entry 34(c) of Notification no. 25/2012-ST dated 20.6.2012. Thus, if a French architect provides a UK company certain designs for an office to be located in India the place of provision of the services by virtue of rule 5 would be in the Taxable Territory. However, it would be exempt from service tax due to Notification no. 25/2012-ST dated 20.6.2012.

12 Para 5.8.2 of the Education Guide



Place of provision of ‘specified services’ shall be the place of service provider [rule 9].

5.14 The place of provision of the following ‘specified services’ shall be the location of the service provider:

(a) Services provided by a banking company, or a financial institution, or a non-banking financial company, to ‘account’ holders’. The word ‘account’ is defined in rule 2(b) of the PoP Rules as ‘an account bearing interest to the depositor and includes a non-resident external account and non-resident ordinary account’. The Education Guide clarifies that the services normally provided to account holders are operation of bank accounts, transfer of money, lending etc.; and services not normally provided to account holders are financial leasing, merchant banking, securities and forex broking, advisory services, etc.13 For services provided to non-account holders, the place of provision of service would be location of service recipient (rule 3 – para 5.1 above – default rule) where it is known (ascertainable in the ordinary course of business) and the location of the service provider otherwise14;

(b) Online information and database access or retrieval services;

(c) Intermediary services (see para 5.15 below);

(d) Service consisting of hiring of means of transport, upto a period of one month.

5.15 An ‘intermediary’ is defined in rule 2(f ) as meaning “a broker, an agent or any other person, by whatever name called, who arranges or facilitates a provision of service (hereinafter called the main service) between two or more persons, but does not include a person who provides the main service on his account.” The Education Guide has clarified (para 5.9.6) the following points -

(a) There are two supplies in a situation involving an intermediary-

(i) the supply of services by the principal to a third party;

(ii) the supply of services by the intermediary to the principal.

An intermediary is essentially an agent, whose services to his principal are clearly identifiable and have a distinct value and who cannot alter the nature and value of the supply made by the principal to the third party.

(b) An intermediary for goods (e.g., a commission agent for goods or a stock broker) is not covered by this rule but only an intermediary for services is covered. The place of provision of the services of an intermediary for goods is the location of service recipient.

(c) A person who arranges or facilitates the provision of service (referred to as main service) but provides the main service on his own account is also not covered by this rule.

Further, the Education Guide gives the following examples of intermediaries (para 5.9.6):

(i) Travel Agent (any mode of travel);

(ii) Tour operator

(iii) Commission agent (for services)

(iv) Recovery agent.

13 Para 5.9.3 and para 5.9.4

14 Para 5.9.4 ibid.



5.16 The Education Guide has clarified (para 5.9.6) that a freight forwarder who buys-in and sells freight transport as a principal would not be regarded as an intermediary and place of provision of service which in this case will be place of transportation of goods will be governed by rule 10 [refer para 5.17]. However, if the freight forwarder acts as an agent of an importer or an exporter by arranging freight transport, he would be considered as an ‘intermediary’ and place of provision of service would be his location. The Education Guide has also clarified (para 5.9.6) that the call centres who provide services to their clients by dealing with the customers of the clients on the client’s behalf, but actually provide these services on their own account, will not be categorised as intermediaries.

Place of provision of goods transportation services other than a goods transportation agency services shall be the place of destination of goods [rule 10].

5.17 The place of provision of services of transportation of goods (except by a goods transportation agency or by way of mail or courier) shall be the place of destination of the goods. Thus, services provided by shipping lines / airlines for transportation of goods from India to a place outside India (exports) would not be liable (since it would be considered as provided in non-taxable territory). As regards imports i.e. services provided by shipping lines / airlines for transportation of goods from a place outside India to a place in India, the place of provision of service is India. However, it maybe noted that the services by way of transportation of goods by an aircraft or vessel from a place outside India to the customs station of clearance in India is an item in the negative list [section 66D(p)] and hence would not be taxable.

Place of provision of services of a goods transportation agency (GTA) shall be the location of the ‘person liable to pay tax’ [rule 10 - proviso]

5.18 The place of provision of service in case of GTA services shall be location of the person liable to pay tax. In terms of rule 2(1)(d)(i)(B) of the Service Tax Rules, 1994, for services of goods transportation agency services in case of specified categories of persons liable to pay the freight, such persons liable to pay freight would be the person liable to pay service tax and if such person is located in a non-taxable territory it is the GTA who would be liable to pay service tax.

Place of provision of passenger transportation services shall be the place of embarkation for ‘continuous journey’ [rule 11]

5.19 The place of provision in respect of a passenger transportation service shall be the place where the passenger embarks on the conveyance for a continuous journey. Continuous journey is defined in rule 2(d) of the PoP Rules to mean a journey for which –

(a) a single ticket is issued; or

(b) more than one ticket or invoice is issued at the same time, either by one service provider or through one agent acting on behalf of more than one service provider,

and which involves no stopover between any of the legs of the journey for which one or more separate tickets or invoices are issued.

Place of provision of services provided on board a conveyance [rule 12].

5.20 Place of provision of services provided on board a conveyance during the course of a passenger transport operation, including services intended to be wholly or substantially consumed while on board, shall be the first scheduled point of departure of that conveyance for the journey. The example given by Education Guide (para 5.12.2) is as under:



“A video game or a movie-on-demand is provided as on-board entertainment during the Kolkata-Delhi leg of a Bangkok-Kolkata-Delhi flight. The place of provision of this service will be Bangkok (outside taxable territory, hence not liable to tax).

If the above service is provided on a Delhi-Kolkata-Bangkok-Jakarta flight during the Bangkok-Jakarta leg, then the place of provision will be Delhi (in the taxable territory, hence liable to tax).”

Powers to notify description of services or circumstances for certain purposes [rule 13].

5.21 In order to prevent double taxation or non-taxation of the provision of a service, or for the uniform application of rules, the Central Government shall have the power to notify any description of service or circumstances in which the place of provision shall be the ‘place of effective use and enjoyment of a service’. In this regard it has to be appreciated that under the service tax law there are no Double Tax Avoidance Agreements between Governments of various countries to provide relief from double taxation in case where Indian service tax is payable on services provided by an overseas company which is also charged to VAT (or other similar taxes) in the country of the overseas company. Further, the law on service tax also does not have a section parallel to section 91 of the Income tax Act, 1961 to provide for a unilateral tax relief.

Tie breaker test – later rule to apply [rule 14]

5.22 Where the provision of a service is, prima facie, determinable in terms of more than one rule discussed above, it shall be determined in accordance with the rule that occurs later among the rules that merit equal consideration.

Summing up

5.23 The above rules may be summed up in a table as under:

Sl. No. Description of service Place of Provision of service

1. All services (except if specifically Location of service recipient. If covered below) location of service recipient not available in ordinary course, location of service provider.

2. Specified ‘performance based’ services Location of performance of service

3. Services relating to ‘immoveable property’ Where the immoveable property is located or intended to be located

4. Services relating to ‘events’ Where the event is actually held

5. Performance based / immoveable Location in the taxable territory where property based / event based services the greatest proportion of service is provided at more than one location provided. including a location in the taxable territory.

6. Where the service provider and receiver Location of service recipient are located in the taxable territory notwithstanding the location of performance, immoveable property or event 7. Specified services (services provided Location of service provider to account holders by banks, etc.;



online information and database access or retrieval services; intermediary services; and hiring of means of transport upto a month)

8. Goods transport (other than by a goods Location of destination of goods transportation agency or by way of mail or courier)

9. Goods Transport Agency services Location of the person liable to pay (i.e. transport by road in a goods carriage) service tax.

10. Passenger transportation services Place of embarkation for ‘continuous journey’

11. Services on-board a conveyance First scheduled point of departure

12. Services prima facie fitting into two or more Later rule to apply of the above rules - tie-breaker

6. Export of Services

6.1 Conditions for export [Rule 6A of Service Tax Rules, 1994] : Export of services shall now be governed by new Rule 6A of the Service Tax Rules 1994. The essential requisites before a service can be designated as export service are:

(i) It must be a ‘service’ as defined under section 65B(44);

(ii) the service provider must be located in the ‘taxable territory’15;

(iii) the service receiver must be located outside India. Thus, if the service recipient is located in the state of J&K it would not be considered as exports;

(iv) the service is not a service specified in the ‘negative list’;

(v) the place of provision of the service is outside India. Thus, if the place of provision of service is outside the taxable territory but in the state of J&K it would not be considered as exports;

(vi) the payment for such service is received by the service provider in convertible foreign exchange; and

(vii) the service provider and service receiver are not merely establishments of a distinct person under ‘Explanation 2(b)’ [should read as Explanation 3(b)] of clause 44 of s. 65B(44) of the Act [see Annexure A – para A15 – A16]. Thus, services provided by a branch in the taxable territory to its head office outside India would not be considered as exports.

All the above conditions must be satisfied to avail the status of export of service.

6.2 Export benefits

6.2.1 If the service qualifies to be an export of service, the service provider can avail the following benefits:

(i) Refund of Cenvat Credit duty / tax paid on the inputs / input services used for export of services [Rule 5 of the Cenvat Credit Rules, 2004 read with Notification no. 27/2012-CE (NT) dated 18.6.2012];

15 Taxable Territory = India minus J & K



(ii) Rebate of the duty / tax paid on inputs / input services used for export of services [Notification no. 39/2012-ST dated 20.6.2012].

6.2.2 It may not be out of place to mention that an exporter of goods also is entitled to the following exemptions / rebates:

(i) Exemption to GTA services received by exporter of goods [Notification No. 31/2012 dated 20.6.2012]

(ii) Exemption to Overseas Commission agent’s services received by exporter of goods [Notification No. 42/2012 dated 29.6.2012]

(iii) Rebate of service tax paid on services received by an exporter of goods. [Notification No.41/2012 dated 29.6.2012]

7. Import of Services

7.1 The reverse charge mechanism in case of imports : Where the service provider is located outside the taxable territory and the service recipient is located in the taxable territory and the place of provision of the service is the taxable territory, the service recipient is the person liable for paying service tax. This is the ‘reverse charge mechanism’. [Refer section 68 of the Act read with Rule 2(1)(d)(i)(G) of Service Tax Rules,1994 and Notification No. 30/2012 dated 20.6.2012].

7.2 However, the following exemptions apply in case of reverse charge mechanism:

(i) Services received from a service provider located in a non-taxable territory by -

(a) the Government, a local authority or an individual in relation to any purpose other than industry, business or commerce; or

(b) an entity registered under section 12AA of the Income tax Act, 1961 (43 of 1961) for the purposes of providing charitable activities; or

(c) a person located in a non-taxable territory.

[Notification no. 25/2012-ST dated 20.6.2012 (Entry 34)].

(ii) Taxable services involving import of technology is exempt from so much of the service tax leviable thereon, as is equivalent to the amount of cess paid on the import of technology under the provisions of Section 3 of the Research and Development Cess Act, 1986 subject to certain conditions [Notification no. 14/2012-ST dated 17.3.2012].

7.3 When to pay service tax in case of reverse charge

7.3.1 Under rule 6(1) of the Service Tax Rules, 1994 service tax is required to be paid by the 5th / 6th of the month immediately following the month (for corporates) in which the service is deemed to be provided as per the Point of Taxation Rules, 2011 (“PoT Rules”).

7.3.2 Date of payment in case of transactions with overseas non-associated enterprises: As per rule 7 of the PoT Rules, -

(i) If the service provider is paid within 6 months from the date of invoice, the PoT is the date of payment. Thus, service tax is to be paid by the 5th / 6th of the month immediately following the calendar month in which the value of taxable services is ‘paid’; or



(ii) If the value of taxable service is not paid within 6 months from the date of invoice, the PoT would be –

(a) date of issue of invoice where the invoice is issued within 30 / 45 days of the date of completion of provision of services;

(b) date of completion of service, if the invoice is not so issued.

Thus, service tax is to be paid by the 5th / 6th of the month immediately following the calendar month in which the invoice is issued / service is completed. Thus, where the payment is not made to the service provider within six months, the due date for payment of tax would automatically relate back i.e. the PoT date would be the date of issue of invoice by the service provider or the date of completion of service by the service provider instead of the date of disbursement of payment. Thus, this would result in a case where post six months, a service recipient may have to pay interest for the back period.

7.3.3 Date of payment in case of transactions with overseas associated enterprises : As per rule 7 of the PoT Rules in case where –

(a) The transaction is with an associated enterprise as defined in section 92A of the Income-tax Act, 1961; and

(b) The service provider is located outside India

the point of taxation shall be the earliest of the following dates –

(i) date on which credit is made in the books of account of the service recipient; or

(ii) date on which payment has been made.

This rule is intended to cater to situations where the service recipient is liable to pay service tax under the reverse charge in respect of services received from overseas entities who are associated enterprises. Thus, service tax is to be paid by the 5th / 6th of the month immediately following the calendar month in which the credit / debit is made or the payment is made, whichever is earlier.

7.4 No threshold : The exemption scheme for small service providers upto Rs. 10 lakhs would not be available in case of a reverse charge.

8. Other Matters

Date of determination of rate of tax, value of taxable service and rate of exchange

8.1.1 A new section 67A has been inserted w.e.f. 28.5.2012 to prescribe the relevant date for the application of rate of exchange, valuation or rate of service tax. The new section provides that the rate of service tax, value of a taxable service and rate of exchange, if any, shall be the rate of service tax or value of a taxable service or rate of exchange, as the case may be, in force or as applicable at the time when the taxable service has been provided or agreed to be provided. The time when the taxable service has been provided or agreed to be provided is determined under the Point of Taxation Rules, 2011. This section would address the issue with regard to the rate of exchange that must be applied to determine the value of a taxable service where invoiced amount is in foreign currency. In such cases, the rate of exchange applicable shall be the rate prevailing at the time when services are deemed to have been provided as per the PoT Rules i.e. date of issue of invoice/date of payment/date of completion of service as the case may be. The rate of exchange would be the Customs notified exchange rates under the Explanation to section 14 of the Customs Act, 1962. The Customs notifies the exchange rates from time to time.



8.2 Exemption to services provided to an SEZ

8.2.1 The PoP Rules are also relevant to claim exemption to services provided to an SEZ unit / developer vide Notification No. 40/2012 dated 20.6.2012.

9. Conclusion

9.1 The above study of the implication of service tax on cross-border transactions is essentially a ‘limited review’ from an author having ‘limited resources’ on a subject with ‘unlimited’ issues and ramifications with ‘limited precedents’. In fact this generation would be the precedent for the next generation. Today when we talk of international tax we would look at the direct tax and the indirect tax implications and sometimes a combination of both, one having relevance to the other - a confluence or marriage with a big dowry (perfectly legal) and bounty for the Government.

10. Epilogue

10.1 In the paper presented by me in 2006 on the same topic at the same forum I had mentioned in my Epilogue that the study on direct tax implications on cross-border transactions will have a new found cousin or twin viz., service tax on cross border transactions. I concluded with the following poem then:

Income tax on cross-border transactions has now a twin

Service tax on cross-border transaction is its new found kin

However, the study of service tax has some off spin and leg spin

Resulting in a tail spin and head spin

Sometimes it pricks like a pin

But the professionals who have the knowledge of the Income-tax twin

Will certainly win

On the study of this new found twin.

10.2 Now I conclude16 as under:

Income tax and service tax have become cross-border twins

But each pricks with its own pin

Income tax is aligned to its international kin

Service tax - Search is on for an international kin.

In this context UK (VAT) would be in,

But it would only be a cousin

And not a direct twin,

Of course service tax PoP would result in a lot of din,

With both sides committing sin

Only time would erase the sin

But in this confusion and din,

16 With poetic licence



The tax professional can raise the toast with a gin.

Long live income tax and service tax twins

Creating a lot of din

For tax professionals to spin

And craft their win

All at the cost of the assessee’s skin!

11. Case Studies

11.1 Moon UK Ltd. is a company incorporated in UK and engaged in the business of broadcasting television and radio programmes from UK (The signals are beamed from UK). The programmes are broadcast throughout the world including India. Moon UK has a subsidiary in India (“Moon India”) for the purpose of marketing the services of Moon UK, procuring business, collecting broadcasting subscriptions, advertisement revenue, etc. Moon India gets a commission as a percentage of the advertisement and subscription revenue generated from India. The commission is payable by Moon UK in foreign exchange. The subscriber base consists of individual households as well as business entities while the advertisement revenue comes from the ad agencies who book advertisement slots for their clients or sometimes directly through the advertisers. As regards the advertisement revenue, Moon UK invoices the advertisement agency or advertiser, as the case may be, who pay the charges to Moon India. Moon UK does not charge service tax on its invoice to the customers. Moon India, deducts its commission and remits the balance to Moon UK in foreign exchange. Further, the advertisement agencies pay service tax only on the agency commission (of 15% received from the advertisers) and not on the media cost (i.e. Moon UK’s charges) (85%). Analyse the service tax implications for – (i) Moon UK; (ii) Moon India; (iii) advertisement agencies (iv) Advertisers (v) Subscribers – both Individual households and Business Entities.

11.2 Richie Rich Bank Plc. UK (RR-UK) has an Indian branch, Richie Rich India (RR-India) through which it provides banking services in India. RR-UK has under a framework agreement with Consultancy Plc. UK (CP-UK) contracted to avail consulting services from CP-UK to implement an ERP programme for all its branches throughout the world. CP-UK operates in India through its wholly owned subsidiary Consultancy Ltd. [CL-India] to which CP-UK has sub-contracted the work to provide the consultancy services to RR-India. The work orders for provision of services by CP-UK at its branch in India i.e. RR-India are signed by RR-UK and CP-UK in turn gives work orders to CL India. CL-India charges its fee to CP-UK, which in turn charges RR-UK who thereafter recharge to RR-India. What are the service tax implications for RR-UK, RR-India, CP-UK and CL-India?



11.3 Travel India Ltd. (TI) is a foreign exchange dealer and is in the business of selling travellers cheques (TCs) and prepaid debit cards to travellers going abroad. The traveller’s cheques and prepaid debit cards are issued by M/s. TF Plc. (TF) a UK financial institution. TCs can be used by the traveller without any additional charge at the time of usage but in case of prepaid debit cards TF charges the traveller each time a payment/withdrawal is made. TI gets a commission from TF based on the face value of travellers cheques and prepaid debit cards sold by it to the travellers. A traveller who wishes to buy TCs worth say $100 or load $100/- in his debit card would pay Rs. 5,000/- ($1 = Rs. 50/-) to TI. TI would remit $100 to TF by debit to its NOSTRO account with a bank DB, Germany. DB pays an interest to TI on the NOSTRO account balance but charges TI for the operation of the NOSTRO account. Analyse the service tax implications. [Please Refer circular no. 163 dated 10.7.2012 – Exhibit 3]

11.4 M/s. Everywhere Transport Ltd., a logistics company, is engaged in providing door-to-door international multimodal transportation services. It essentially undertakes to transport cargo from the factory of the shipper to the consignee’s factory. The transportation generally involves more than one mode of transportation viz., road, sea, rail and air. The processes involved in is illustrated as follows. Everywhere enters into a contract with the shipper having his plant at Surat to export a consignment of textiles to a consignee at Düsseldorf, Germany ‘by sea’. However, Everywhere agrees to pick up the cargo from the factory and reach it to the destination. Everywhere engages the following:

(i) a local transporter to move the empty containers from the container yard to the plant and thence transport laden containers from the plant to the load port, say, Kandla for onward transport by sea;

(ii) a shipping line for transport by sea from Kandla to the destination port, say, Hamburg;

(iii) a transporter or their counterpart in Hamburg to move the laden containers from Hamburg to the consignee at Düsseldorf.

During the interval for changing the mode of transport from sea to road or vice versa the cargo maybe stored in a warehouse. At the plant Everywhere would issue a “Multimodal Transport Document” (MTD) to the shipper accepting the goods for transportation from Surat to Düsseldorf. In the MTD the ‘place of acceptance’ would be shipper’s plant; the ‘port of loading’ would be Kandla; the ‘port of discharge’ maybe Hamburg and the place of discharge would be Düsseldorf.

Everywhere incurs the following expenses :



(i) Ocean Freight payable to the shipping line;

(ii) Terminal Handling payable to the port;

(iii) Cargo Handling payable to an agency;

(iv) Road transport charges payable to a transporter;

(v) Storage and Warehousing payable to a warehouse keeper.

For convenience of understanding the process is depicted pictorially as under.

For the entire single transportation contract, Everywhere charges the shipper by issuing two invoices for the following:

(i) Ocean Freight;

(ii) Inland Haulage Charges (charges for inland transportation by goods by road) (“IHC”) and terminal handling charges (“THC”).

In the alternative it may charge single amount towards its service. Analyse the service tax implications.



ANNEXURE A

Location of service provider and service recipient

Rules to determine Location of service provider and service recipientA1. The ascertainment of location of the service provider and the service recipient are significant

in the PoP Rules.

A2. The “location of the service provider” is ascertained by the application of the following rules in seriatum -

Rule 1: where the service provider has obtained a single registration, whether centralized or otherwise, the premises for which such registration has been obtained.

Rule 2 : where the service provider is not covered by rule 1 above, the location of service provider would be determined by the following rules:

(i) the location of his ‘business establishment’; or

(ii) where the services are provided from a place other than the business establishment, that is to say, a ‘fixed establishment’ elsewhere, the location of such establishment; or

(iii) where services are provided from more than one establishment, whether business or fixed, the establishment most directly concerned with the provision of the service; and

(iv) in the absence of such places, the usual place of residence of the service provider.

A3. The “location of the service recipient” is ascertained by the application of the following rules in seriatum –

Rule 1 : where the service receiver has obtained a single registration, whether centralized or otherwise, the premises for which such registration has been obtained;

Rule 2 : where the service recipient is not covered by rule 1 above, the location of service recipient would be determined by the following rules:

(i) the location of his business establishment; or

(ii) where services are used at a place other than the business establishment, that is to say, a fixed establishment elsewhere, the location of such establishment; or

(iii) where services are used at more than one establishment, whether business or fixed, the establishment most directly concerned with the use of the service; and

(iv) in the absence of such places, the usual place of residence of the service receiver which in case of telecommunication service, shall be the billing address.

A4. The terms ‘establishment’, ‘business establishment’, ‘fixed establishment’, ‘establishment most directly concerned in providing the service’, etc. have not been defined in the law. Hence meanings of these terms are to be ascertained as is generally understood and in the context in which they are used. As regards the term usual place of residence, it is defined only for body corporates as the place of incorporation or where they are legally constituted. The terms are explained below.



EstablishmentA5. The Black’s Law Dictionary - 6th edition – page 546 defines the term “establishment” as

follows:

“Establishment. An institution or place of business, with its fixtures and organised staff. Abnie vs. Ford Motor Co. Ohio Com. Pl. 195 N. E. 2d 131, 135. State of being established.”

Thus, the term establishment envisages a structure or a place as well as human resources to conduct the business. A ‘branch’ or ‘agency’ or ‘representational office’ in any territory is considered to be an ‘establishment’ in the territory [Explanation 3 to s. 65B(44)].

A6. An establishment could be a ‘business establishment’ or a ‘fixed establishment’.

Business Establishment

A7. The Education Guide clarifies that “a business establishment is the place where the essential decisions concerning the general management of the business are adopted, and where the functions of its central administration are carried out. This could be the Head Office or a factory or a workshop or shop / retail outlet. Most significantly, there is only one business establishment that a service provider or receiver can have.” In this context one may also usefully refer to the TRU circular dated 27.7.2005 which in the context of the erstwhile explanation to s. 65(105) had clarified as follows: “The business establishment is the principal place of business, usually head office or headquarters or the seat from which business is run. There can be only one such place. A business may have headquarters in one country but branches in many other countries. A company may be incorporated in one country but does the business entirely from a head office in another country. In such cases, business establishment is treated to be in a country where the business is entirely done from the head office.”

Fixed Establishment

A8. The term “fixed establishment” consists of two words “fixed” and “establishment”. As explained in para A5 above an “establishment” is a place having a structure and human resources to carry on business. Further the word “fixed” would denote that the establishment must have a sufficient degree of permanence. Thus, the definition of the term as clarified in the Education Guide i.e. “a place (other than a business establishment) which is characterised by a sufficient degree of permanence and suitable structure in terms of human and technical resources to provide the services that are to be supplied by it, or to enable it to receive and use the services supplied to it for its own needs.” would be within the normal meaning of the term. In a nutshell three factors are determinative of a ‘fixed establishment’: (i) a place; (ii) people, (iii) with a degree of ‘permanence’ [the three PPPs like a three piece suit!].

Illustrations(Per Education Guide – para 5.2.7 – illustrations 2 & 3)

• An overseas business house sets up offices with staff in India to provide services to Indian customers. Its fixed establishment is in India.

• A company with a business establishment abroad buys a property in India which it leases to a tenant. The property by itself does not create a fixed establishment. If the company sets up an office in India to carry on its business by managing the property, this will create a fixed establishment in India.



(Per Notice issued under the UK VAT law17)

• An overseas business sets up a branch comprising staff and offices in the UK to provide services. The UK branch is a fixed establishment.

• An overseas television company sends staff and equipment to the UK to film for a week. The temporary presence of human and technical resources does not create a fixed establishment in the UK.

• A company with a business establishment overseas owns a property in the UK which it leases to tenants. The property does not in itself create a fixed establishment. However, if the company has UK offices and staff or appoints a UK agency to carry on its business by managing the property, this creates a fixed establishment in the UK.

• An overseas business contracts with UK customers to provide services. It has no human or technical resources in the UK and therefore sets up a UK subsidiary to act in its name to provide those services. The overseas business has a fixed establishment in the UK created by the agency of the subsidiary.

• A company is incorporated in the UK but trades entirely overseas from its head office in the USA, which is its business establishment. The UK registered office is a fixed establishment.

• A UK company acts as the Operating Member of a consortium for offshore exploitation of oil or gas using a fixed production platform. The rig is a fixed establishment of the Operating Member.

(Per Foreign court decisions)

• Gaming machines installed by a company on board a sea-going ship which are maintained intermittently by sending staff was held not to be a fixed establishment18.

• Mere presence of a fleet of cars in another country which were leased to customers in the country without the presence of a storeroom or office or staff was held not to be a fixed establishment19.

• On facts, a wholly owned UK subsidiary which was a ‘mere auxiliary organ’ of its overseas parent [being ‘dependent’ for key financial, contractual and managerial decisions on the parent] was held to be a ‘fixed establishment’ of the overseas parent in UK20.

17 Para 3.4.1 of Notice 741A titled “Place of Supply of Services” issued by Her Majesty’s Revenue & Customs (HMRC) January 2010 [similar to the circulars issued by CBEC] which has a similar concept of ‘fixed establishment’.

18 Gunter Berkholz vs. Finanzamt Hamburg – Mitte – Altstadt vs. [1985] European Court Reports (ECR) I-2251 [European Court of Justice (“ECJ”)]

19 ARO Lease BV vs. Inspecteur (1997) ECR I – 4383 (ECJ); Lease Plan Luxembourg SA vs. Belgian State (1998) ECR I – 2553 (ECJ).

20 Commissioners of Customs and Excise vs. DFDS A/S (1997) ECR I-1005 (ECJ); Chinese Channel (Hongkong) Ltd. vs. Commissioners of Customs and Excise (1998) Simon’s Tax Cases 347 (High Court of Justice – Queens Bench Division, UK).



Usual Place of Residence

A9. The term ‘usual place of residence’ for a ‘body corporate’ (i.e. incorporated bodies) is defined by the Explanation to clauses (h) and (i) of rule 2 to mean the place of incorporation or where they are legally constituted. As regards individuals, to whom the criterion of ‘usual place of residence’ would apply more appropriately the Education Guide clarifies the meaning of the term as follows:

“The usual place of residence of an individual is the place (country, state, etc.) where the individual spends most of his time for the period in question. It is likely to be the place where the individual has set up his home, or where he lives with his family and is in full time employment. Individuals are not treated as belonging in a country if they are short term, transitory visitors (for example if they are visiting as tourists, or receive medical treatment or for a short term language / other course). An individual cannot have more than one place of usual residence.”

Illustrations

(Per Notice issued under the UK VAT law21)

• A company incorporated in Bermuda has no business or fixed establishment anywhere in the world but its board of directors meet from time to time in different countries, including the UK. The company belongs in Bermuda where it is incorporated.

• A person lives in the UK, but commutes to France daily for work. He belongs in the UK.

• Overseas forces personnel on a tour of duty in the UK live in rented accommodation with their families. They have homes overseas to which they periodically return on leave. They belong in the UK throughout their tour of duty.

Establishment most directly concerned in providing/ receiving a service relevant.

A10. The rules provide that where services are provided / received from more than one establishment, whether business or fixed, the establishment most directly concerned with the provision / receipt of the service would be relevant. Thus, where a provider who has his headquarters in the US and a branch in India provides services directly from his headquarters to an Indian company, the location of the service provider would be US (i.e. outside the taxable territory) although he has an establishment in India and the location of service recipient would be India i.e. taxable territory. However, where the Indian branch provided services to the Indian company, the location of both the service provider and service recipient would be India.

A11. In this context, in order to ascertain the ‘establishment more directly concerned in providing the service’, the Education Guide provides guidance as follows:

“This will depend on the facts and supporting documentation, specific to each case. The documentation will include the following:-

• the contract(s) between the service provider and receiver;

• where there are no written contracts, any written account (documents, e-mail etc.) between parties which sets out in detail their understanding of the oral contract;

21 Para 3.5.1 of Notice 741A titled “Place of Supply of Services” issued by Her Majesty’s Revenue & Customs (HMRC) January 2010 [similar to the circulars issued by CBEC] which has a similar concept of ‘usual place of residence’.



• in particular, for suppliers, from which establishment the services are actually provided;

• in particular, for receiver, at which establishment the services are actually consumed, effectively used or enjoyed;

• details of how the business fits into any larger corporate structure;

• the establishment whose staff is actually involved in the execution of the job;

• performance agreements (which may be indicative both of the substance and actual nature of work performed at a particular establishment).”

A12. The following parameters are given in Notice issued under the UK VAT law22 for determining the establishment most directly concerned in providing / receiving the service:

“If, as either the supplier or the recipient of services, you have establishments in more than one country, the supplies you make from, or receive at, each establishment have to be looked at separately. For each supply of services, you are regarded as belonging in the country where the establishment most directly connected with that particular supply is located.

To decide which establishment is most directly connected with the supply, you should consider all the facts, including:

• for suppliers, from which establishment the services are actually provided

• for recipients, at which establishment the services are actually consumed, effectively used or enjoyed

• which establishment appears on the contracts, correspondence and invoices

• where the directors or others who entered into the contract are permanently based, and

• at which establishment decisions are taken and controls are exercised over the performance of the contracts.

Normally it is the establishment actually providing or receiving the supply of services which is the establishment most directly connected with the supply, even if the contractual position is different.”

A13. In this regard, the concept of ‘establishment more directly concerned in providing the service’ is to be tested in Indian Courts in the context of service tax. Here one judicial pronouncement in the context of UK VAT law maybe referred to which has evolved a test. In Chinese Channel (Hongkong) Ltd. vs. Commissioners of Customs and Excise (1998) Simon’s Tax Cases 347 (High Court of Justice – Queens Bench Division, UK), a Hong kong company (CCHK) provided broadcasting services to its subscribers in Europe (including UK). CCUK an associated company in the UK solicited subscriptions, checked credit ratings and collected the subscriptions. CCUK also engaged in editorial and production of the tapes it received from CCHK and also provided local community news services. On facts, the Court found that CCUK was a fixed establishment in the UK of CCHK though a separate legal entity since it was not independent of CCHK. The issue then was whether the service is supplied

22 Para 3.6 of Notice 741A titled “Place of Supply of Services” issued by Her Majesty’s Revenue & Customs (HMRC) January 2010 [similar to the circulars issued by CBEC] which has a similar concept.



from the fixed establishment. The Court held that in order to determine this: “It is not just a matter of comparing the activities of the two companies. It is more important, …, to consider the significance of those activities and the part they play in their contribution to the service supplied ...” The Court held that the services provided to the subscribers “was the facility of receiving broadcasts selected by CCHK. This consisted of the provision of a right, the transmission of programmes and the content of those programmes.” This the Court held was provided by CCHK from Hongkong and not by CCUK from UK. Thus, in order to ascertain the ‘establishment more directly concerned in providing the service’ the test adopted is to consider the significance of the activities performed by the establishments in question and the part they play in their contribution to the service supplied.

A14. Illustrations given in Notice issued under the UK VAT law23

Where a supplier has more than one establishment :

• A company whose business establishment is in France contracts with a UK bank to supply French speaking staff for the bank’s international desk in London. The French company also has a fixed establishment in the UK created by a branch, which provides staff to other customers. The French establishment deals directly with the UK bank without any involvement of the UK branch. The staff is supplied by the French establishment.

• An overseas business establishment contracts with private customers in the UK to provide information. The services are provided and invoiced by its UK branch. Customers’ day to day contact is with the UK branch and they pay the UK branch. The services are actually supplied from the UK branch which is a fixed establishment.

Where a recipient has more than one establishment:

• A UK supplier contracts to supply advertising services. Its customer has its business establishment in Austria and a fixed establishment in the UK created by its branch. Although day-to-day contact on routine administrative matters is between the supplier and the UK branch, the Austrian establishment takes all artistic and other decisions about the advertising. The supplies are received at the overseas establishment.

• A UK accountant supplies accountancy services to a UK incorporated company which has its business establishment abroad. However, the services are received in connection with the company’s UK tax obligations and therefore the UK fixed establishment, created by the registered office, receives the supply.

• A customer has a business establishment in the UK and a fixed establishment in the USA created by its branch. The UK establishment contracts a UK company to provide staff to the USA branch. The supplier invoices the UK establishment and is paid by them. The services are most directly used by the USA branch and therefore are received at the overseas establishment.

Establishment in taxable territory and non-taxable territories of a person are considered as separate entities

23 Para 3.6.1 of Notice 741A titled “Place of Supply of Services” issued by Her Majesty’s Revenue & Customs (HMRC) January 2010 [similar to the circulars issued by CBEC] which has a similar concept.



A15. A ‘branch’ or ‘agency’ or ‘representational office’ in any territory is considered to be an ‘establishment’ in the territory [Explanation 3 to s. 65B(44)]. Further, Explanation 3(b) to s. 65B(44) defining the term ‘service’ provides that an establishment (e.g. branch, agency or representative office) of a person located in the taxable territory and another establishment of such person located in a non-taxable territory will be separate persons.

A16 One consequence of the above would be that a transaction between say, a US Head office of a company and its Indian branch would be considered as ‘service’ with the location of the service provider as US (outside the taxable territory) and the location of the service recipient would be India (taxable territory). This is a deeming fiction intended to get over the normal principle that one cannot provide service to onself.

A17 Another consequence of the rule stated above is that where the service provider / recipient has a business / fixed establishment in several countries each of these establishments would be treated as separate persons and accordingly, the location of the service provider / recipient vis-à-vis the particular service would be determined by this rule. For e.g. where the US branch of an Indian company receives services from its overseas suppliers the location of both the service provider and service recipient would be considered as outside the taxable territory.

Diagrammatic examples of application of the rules to determine location of Service Provider and service recipients

A18. The application of the above rules to determine location of Service Provider (SP) and Service Recipient (SR) can be explained by way of diagrammatic examples.

Example 1

Business establishment of A Inc. a US company provides services directly to a fixed establishment of an Indian Company PQR Ltd.



Example 2

US Fixed establishment of A Inc. a US company provides services to a US Fixed establishment of an Indian Company PQR Ltd.

Example 3

US Fixed establishment of PQR Ltd. an Indian company provides services to the Indian Fixed establishment of an Indian Company A Ltd.



Example 4

US Fixed establishment of PQR Ltd. an Indian company provides services to a US Fixed establishment of an Indian Company A Ltd.

Example 5

US Fixed establishment of PQR Ltd. an Indian company provides services to an Indian Fixed establishment of the same Indian Company PQR Ltd.



FLOW DIAGRAM TO DETERMINE LOCATION OF SERVICE PROVIDER / RECIPIENT AS GIVEN IN EDUCATION GUIDE



EXHIBIT 1

TEXT OF RELEVANT PROVISIONS OF CHAPTER V OF THE FINANCE ACT, 1994 PROVIDING FOR ‘TAXABLE TERRITORY’ AND ‘PLACE OF PROVISION OF SERVICE’

(i) Section 64: Extent, Commencement and Application

(1) This Chapter extends to the whole of India except the State of Jammu and Kashmir.

(2) It shall come into force on such date as the Central Government may, by notification in the Official Gazette, appoint.

(3) It shall apply to taxable services provided on or after the commencement of this Chapter.

(ii) Section 65B(27): Definition of “India”

In this Chapter, unless the context otherwise requires,

(27) "India" means,-

(a) the territory of the Union as referred to in clauses (2) and (3) of article 1 of the Constitution;

(b) its territorial waters, continental shelf, exclusive economic zone or any other maritime zone as defined in the Territorial Waters, Continental Shelf, Exclusive Economic Zone and other Maritime Zones Act, 1976; (80 of 1976.)

(c) the seabed and the subsoil underlying the territorial waters;

(d) the air space above its territory and territorial waters; and

(e) the installations, structures and vessels located in the continental shelf of India and the exclusive economic zone of India, for the purposes of prospecting or extraction or production of mineral oil and natural gas and supply thereof;

(iii) Section 65B(44): Definition of “Service”

(44) "service" means any activity carried out by a person for another for consideration, and includes a declared service, but shall not include-

(a) to (c) …..

Explanation 1…….

Explanation 2……

Explanation 3.- For the purposes of this Chapter,-

(a) …….

(b) an establishment of a person in the taxable territory and any of his other establishment in a non-taxable territory shall be treated as establishments of distinct persons.

Explanation 4…….

(iv) Section 65B(52): Definition of “Taxable territory”

(52) “taxable territory” means the territory to which the provisions of this Chapter apply.

(v) Section 66B: Charge of service tax on and after Finance Act, 2012

There shall be levied a tax (hereinafter referred to as the service tax) at the rate of twelve per cent on the value of all services, other than those services specified in the negative list, provided



or agreed to be provided in the taxable territory by one person to another and collected in such manner as may be prescribed.

(vi) Section 66C: Determination of place of provision of service

(1) The Central Government may, having regard to the nature and description of various services, by rules made in this regard, determine the place where such services are provided or deemed to have been provided or agreed to be provided or deemed to have been agreed to be provided.

(2) Any rule made under sub-section (1) shall not be invalid merely on the ground that either the service provider or the service receiver or both are located at a place being outside the taxable territory.



EXHIBIT 2

TEXT OF PLACE OF PROVISION OF SERVICES RULES, 2012 (“POP RULES”) NOTIFICATION NO. 28/2012-ST, DATED 20-6-2012

In exercise of the powers conferred by sub-section (1) of section 66C and clause (hhh) of sub-section (2) of section 94 of the Finance Act, 1994 and in supersession of the notification of the Government of India in the Ministry of Finance, Department of Revenue, number 9/2005-ST, dated the 3rd March, 2005 published in the Gazette of India Extraordinary, Part II, Section 3, Sub-Section (i) vide number G.S.R. 151 (E) dated the 3rd March, 2005 and the notification of the Government of India in the Ministry of Finance, Department of Revenue, number 11/2006-ST dated the 19th May, 2006 published in the Gazette of India Extraordinary, Part II, Section 3, Sub-Section (i) vide number G.S.R. 227 (E) dated the 19th May, 2006, except as respects things done or omitted to be done before such supersession, the Central Government hereby makes the following rules for the purpose of determination of the place of provision of services, namely:-

1. Short title, extent and commencement

(1) These rules may be called the Place of Provision of Services Rules, 2012.

(2) They shall come into force on 1st day of July, 2012.

2. Definitions

In these rules, unless the context otherwise requires,-

(a) "Act" means the Finance Act, 1994 (32 of 1994);

(b) "account" means an account bearing interest to the depositor, and includes a non-resident external account and a non-resident ordinary account;

(c) "banking company" has the meaning assigned to it in clause (a) of section 45A of the Reserve Bank of India Act, 1934 (2 of 1934);

(d) "continuous journey" means a journey for which a single or more than one ticket or invoice is issued at the same time, either by one service provider or through one agent acting on behalf of more than one service provider, and which involves no stopover between any of the legs of the journey for which one or more separate tickets or invoices are issued;

(e) "financial institution" has the meaning assigned to it in clause (c) of section 45-I of the Reserve Bank of India Act,1934 (2 of 1934);

(f ) "intermediary" means a broker, an agent or any other person, by whatever name called, who arranges or facilitates a provision of a service (hereinafter called the main service) between two or more persons, but does not include a person who provides the main service on his account.;

(g) "leg of journey" means a part of the journey that begins where passengers embark or disembark the conveyance, or where it is stopped to allow for its servicing or refueling, and ends where it is next stopped for any of those purposes;

(h) "location of the service provider" means-

(a) where the service provider has obtained a single registration, whether centralized or otherwise, the premises for which such registration has been obtained;

(b) where the service provider is not covered under sub-clause (a):




(ii) where the services are provided from a place other than the business establishment, that is to say, a fixed establishment elsewhere, the location of such establishment; or

(iii) where services are provided from more than one establishment, whether business or fixed, the establishment most directly concerned with the provision of the service; and

(iv) in the absence of such places, the usual place of residence of the service provider.

(i) "location of the service receiver" means:-

(a) where the recipient of service has obtained a single registration, whether centralized or otherwise, the premises for which such registration has been obtained;

(b) where the recipient of service is not covered under sub-clause (a):


(ii) where services are used at a place other than the business establishment, that is to say, a fixed establishment elsewhere, the location of such establishment; or

(iii) where services are used at more than one establishment, whether business or fixed, the establishment most directly concerned with the use of the service; and

(iv) in the absence of such places, the usual place of residence of the recipient of service.

Explanation:-. For the purposes of clauses (h) and (i), "usual place of residence" in case of a body corporate means the place where it is incorporated or otherwise legally constituted.

Explanation 2:-. For the purpose of clause (i), in the case of telecommunication service, the usual place of residence shall be the billing address.

(j) "means of transport" means any conveyance designed to transport goods or persons from one place to another;

(k) "non-banking financial company" means-

(i) a financial institution which is a company; or

(ii) a non-banking institution which is a company and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner; or

(iii) such other non-banking institution or class of such institutions, as the Reserve Bank of India may, with the previous approval of the Central Government and by notification in the Official Gazette specify;

(l) "online information and database access or retrieval services" means providing data or information, retrievable or otherwise, to any person, in electronic form through a computer network;

(m) "person liable to pay tax" shall mean the person liable to pay service tax under section 68 of the Act or under sub-clause (d) of sub-rule (1) of rule 2 of the Service Tax Rules, 1994;



(n) "provided" includes the expression "to be provided";

(o) "received" includes the expression "to be received";

(p) "registration" means the registration under rule 4 of the Service Tax Rules, 1994;

(q) "telecommunication service" means service of any description (including electronic mail, voice mail, data services, audio text services, video text services, radio paging and cellular mobile telephone services) which is made available to users by means of any transmission or reception of signs, signals, writing, images and sounds or intelligence of any nature, by wire, radio, visual or other electro-magnetic means but shall not include broadcasting services.

(r) words and expressions used in these rules and not defined, but defined in the Act, shall have the meanings respectively assigned to them in the Act.

3. Place of provision generally

The place of provision of a service shall be the location of the recipient of service: Provided that in case the location of the service receiver is not available in the ordinary course of business, the place of provision shall be the location of the provider of service.

4. Place of provision of performance based services

The place of provision of following services shall be the location where the services are actually performed, namely:-

(a) services provided in respect of goods that are required to be made physically available by the recipient of service to the provider of service, or to a person acting on behalf of the provider of service, in order to provide the service:

Provided that when such services are provided from a remote location by way of electronic means the place of provision shall be the location where goods are situated at the time of provision of service:

Provided further that this sub-rule shall not apply in the case of a service provided in respect of goods that are temporarily imported into India for repairs, reconditioning or reengineering for re-export, subject to conditions as may be specified in this regard.

(b) services provided to an individual, represented either as the recipient of service or a person acting on behalf of the recipient, which require the physical presence of the receiver or the person acting on behalf of the receiver, with the provider for the provision of the service.

5. Place of provision of services relating to immovable property

The place of provision of services provided directly in relation to an immovable property, including services provided in this regard by experts and estate agents, provision of hotel accommodation by a hotel, inn, guest house, club or campsite, by whatever, name called, grant of rights to use immovable property, services for carrying out or co-ordination of construction work, including architects or interior decorators, shall be the place where the immovable property is located or intended to be located.

6. Place of provision of services relating to events

The place of provision of services provided by way of admission to, or organization of, a cultural, artistic, sporting, scientific, educational, or entertainment event, or a celebration, conference, fair, exhibition, or similar events, and of services ancillary to such admission, shall be the place where the event is actually held.



7. Place of provision of services provided at more than one location

Where any service referred to in rules 4, 5, or 6 is provided at more than one location, including a location in the taxable territory, its place of provision shall be the location in the taxable territory where the greatest proportion of the service is provided.

8. Place of provision of services where provider and recipient are located in taxable territory

Place of provision of a service, where the location of the provider of service as well as that of the recipient of service is in the taxable territory, shall be the location of the recipient of service.

9. Place of provision of specified services

The place of provision of following services shall be the location of the service provider:-

(a) Services provided by a banking company, or a financial institution, or a non-banking financial company, to account holders;

(b) Online information and database access or retrieval services;

(c) Intermediary services;

(d) Service consisting of hiring of means of transport, upto a period of one month.

10. Place of provision of goods transportation services

The place of provision of services of transportation of goods, other than by way of mail or courier, shall be the place of destination of the goods:

Provided that the place of provision of services of goods transportation agency shall be the location of the person liable to pay tax.

11. Place of provision of passenger transportation service

The place of provision in respect of a passenger transportation service shall be the place where the passenger embarks on the conveyance for a continuous journey.

12. Place of provision of services provided on board a conveyance

Place of provision of services provided on board a conveyance during the course of a passenger transport operation, including services intended to be wholly or substantially consumed while on board, shall be the first scheduled point of departure of that conveyance for the journey.

13. Powers to notify description of services or circumstances for certain purposes

In order to prevent double taxation or non-taxation of the provision of a service, or for the uniform application of rules, the Central Government shall have the power to notify any description of service or circumstances in which the place of provision shall be the place of effective use and enjoyment of a service.

14. Order of application of rules

Notwithstanding anything stated in any rule, where the provision of a service is, prima facie, determinable in terms of more than one rule, it shall be determined in accordance with the rule that occurs later among the rules that merit equal consideration.



EXHIBIT 3

CIRCULAR NO. 163/14/2012-ST, Dated: July 10, 2012

Subject: Clarification on service tax on remittances - regarding.

Concerns have been expressed in various forums regarding the leviability of service tax on the remittance of foreign currency in India from overseas.

2. The matter has been examined and it is clarified that there is no service tax per se on the amount of foreign currency remitted to India from overseas. In the negative list regime, ‘service’ has been defined in clause (44) of section 65B of the Finance Act 1994, as amended, which excludes transaction in money. As the amount of remittance comprises money, the activity does not comprise a ‘service’ and thus not subjected to service tax.

3. In case any fee or conversion charges are levied for sending such money, they are also not liable to service tax as the person sending the money and the company conducting the remittance are located outside India. In terms of the Place of Provision of Services Rules, 2012, such services are deemed to be provided outside India and thus not liable to service tax.

4. It is further clarified that even the Indian counterpart bank or financial institution who charges the foreign bank or any other entity for the services provided at the receiving end, is not liable to service tax as the place of provision of such service shall be the location of the recipient of the service, i.e. outside India, in terms of Rule 3 of the Place of Provision of Services Rules, 2012.

5. This Circular may be communicated to the field formations and service tax assessees, through Public Notice/ Trade Notice. Hindi version to follow.



Notes



Notes


Important Principles in Interpretation of Tax Treaties

Important Principles in Interpretation of Tax Treatiesby CA Gautam Doshi

1 Objective The objective of the paper is to facilitate discussions on certain principles of interpretation of

tax treaties and some interesting international tax issues where interpretation principles play a key role.

Globalisation in the current environment has resulted into widening of businesses outside the domestic territory. This has led to an increase in cross-border transactions; and tax forms a considerable part of the overall cost of doing business today. A country’s appetite for tax being insatiable, both the countries between which a cross-border transaction takes place would want to levy tax on income from the transaction. This creates a need for an international tax law that deals with such tax conflicts. Resolving tax conflicts can be achieved through tax treaties between the Contracting States, the objectives of which include:

• To promote fairness by imposing equal tax burdens on domestic and foreign tax payers with equal income and ability to pay, regardless of the source of income

• To enhance domestic competitiveness through fiscal measures and to promote economic growth

• To obtain a fair share of the revenues from cross-border transactions

Therefore, tax treaties mainly aim to avoid double taxation and to create legal certainty for the benefit of the Contracting States as well as the tax payer. Achieving the objective of tax treaties inter alia requires equal and consistent interpretation of terms of the treaty in both the Contracting States.

2 Interpretation of Tax Treaties – an introduction

• What is interpretation?

Interpretation means to make the meaning clear, to unfold a text. Words do not have any single, true, absolute, objective meaning; they require interpretation to determine their meaning in any particular setting. Language can be ambiguous due to several reasons, such as, multiple meanings of the same words, difference in the context in which the same words are used, manner in which words are combined, etc.

• Objective of tax treaties

Some of the key objectives of tax treaties are to allocate taxing rights between two Contracting States and avoid double taxation of same income in more than one Contracting States. Treaties, negotiated by officials of two Governments (consensus reached by verbal / written communications) are a representation (a form of communication) to the citizens of two countries. Hence, there may be several occasions when the communication needs to be given a meaning to achieve its objective(s).

• Who needs to interpret tax treaties?

— Tax payers – for determination of their own tax liabilities in cross-border transactions and for the purpose of withholding tax in case of payments to non-residents

— Tax authorities – for determining tax liabilities of tax payers



— Legislators – for the purpose of drafting / amending legislations

— Academicians – for giving a view on interpretation, which is widely accepted

• Different approaches to interpretation leading to different results

— Literal interpretation: Terms of tax treaties are given a literal meaning, i.e. not reading between the lines.

— This approach was followed by United Kingdom in the past, where judges were bound by the wording of the statute (especially with regard to tax laws); and were not permitted to consider the intention of the legislators or the equity of the matter1. They have now deviated from this approach in recent years and are taking the purposive view as discussed hereinafter.

— This purposive approach encourages overall fairness but may reduce certainty.

— Legislative interpretation: Tax treaties are interpreted according to the original intent, even departing from the literal language of the treaty, where the intent is clearly evident.

— Purposive interpretation: The economic or social purpose and the purpose of the legislation are looked at, beyond what was contemplated in the words of the treaty. Emphasis is given to substance over form through a contemporary purposive interpretation.

Courts in Israel prefer a “purposive” instead of “strict” or “literal” construction2.

Thus, different principles are used by countries for interpreting tax treaties which make it difficult to formulate interpretive principles in precise terms. For effective interpretation of tax treaties, it is therefore necessary to reconcile the various national methods of interpretation. But, we must realise that there are no hard and fast rules and often it is very difficult to distinguish between the various approaches to interpretation.

3 Principles of interpretation - Vienna Convention on the Law of Treaties • Background

The Vienna Convention on Law of Treaties (‘VCLT’) was enacted in 1969 and entered into force in 1980. At the international level, the VCLT is binding among states which are signatories after it entered into force. The VCLT essentially codifies the existing norms of customary international law on treaties; therefore, it is also considered to be binding on non-signatories and applicable to both past and future treaties.

Article 31, 32 and 33 of the VCLT pertain to interpretation of treaty. (Refer Annexure I for full text of Article 31, 32 and 33 of VCLT)

• VCLT principles

— Article 31(1) provides a general approach and some specific rules to interpretation. It provides that a treaty is to be interpreted based on the text of the relevant provision i.e. ordinary meaning, within the context of the treaty as a whole and in light of

1 Klaus Vogel on double taxation conventions (2007)2 Klaus Vogel on double taxation conventions (2007)



the purpose of the treaty. Article 31(2), (3) and (4) elaborate the general rule by specifying what the context of the treaty is and what additional material3 should be taken into account along with the context. These paragraphs also provide that if appropriate, a term in the treaty may be given a special meaning rather than an ordinary meaning.

— Article 31(1), although laying down a basic principle, does not specify how much weight must be given to the three elements i.e. text, context and purpose in any particular case. This can lead to supporting any type of interpretative approach. A literal approach can be justified on the basis of the reference to the text of the treaty in Article 31(1). There is nothing in Article 31(1) to prevent an interpreter from concluding that, if the words of a treaty provision are reasonably clear, the treaty may be interpreted according to its plain language without regard to the context and purpose. Another approach would be that the text of the treaty must be the dominant consideration; however, it may not be the exclusive consideration, i.e., the context and purpose of the treaty should be taken into account, if the clear meaning of the text of the treaty would lead to absurd consequences which could never have been intended.

Hence, interpretation based on Article 31 would still require substantial degree of judgement.

— Article 32 deals with supplementary means of interpretation and in what circumstances these should be used. It provides that in interpreting the terms of a treaty, supplementary materials, especially, the preparatory work for the treaty may be used. The Article, however, limits the use of such material to certain circumstances – (a) where after applying principles of Article 31 the provisions are ambiguous or obscure; (b) where application of Article 31 produces absurd or unreasonable result; or (c) to confirm the meaning resulting by application of Article 31.

Under Article 32, supplementary materials are considered to be less authentic than the materials mentioned in Article 31. Thus, they are accorded a secondary or supplementary role in the interpretative process. However, the supplementary materials may be given more weight in appropriate circumstances than the more authentic materials covered under Article 31. When to take recourse to Article 32 by itself requires substantial degree of judgment and there is no specified hierarchy or assigned weight between Articles 31 and 32.

• How do Articles of VCLT help

While the principles of VCLT may by themselves need to be interpreted to be applied, the Articles do give guidance/direction and in particular accept the validity of usage of supplementary materials for interpretation of treaties.

• India perspective

India is not a signatory to the VCLT. There are few cases where principles of VCLT have been applied / referred to. Some instances are as follows:

3 Agreement / instrument relating to conclusion of treaty, subsequent agreement, practice as regards the treaty / its interpretation, rules of international law as may be relevant.



In the case of Hindalco Industries Ltd. vs. ACIT [2005] 94 ITD 242 (Mum), importance of VCLT has been acknowledged in interpreting the provisions of tax treaties as under:

“The tax treaties are international agreements entered into between States. The conclusion and interpretation of such convention is governed by public international law, and particularly, by the Vienna Convention on Law of Treaties of 23 May 1969. The rules of interpretation contained in the Vienna Convention, being customary international law also apply to the interpretation of tax treaties...”

The cases British Airways Plc.vs. DCIT [2002] 80 ITD 90 (Del), James Mackintosh & Co P Ltd vs. ACIT [2005] 93 ITD 466 (Mum) and P No 28 of 1999, in re (2000) 242 ITR 208 (AAR), and several others endorse recourse to VCLT for interpretation of tax treaties, despite the fact that India is not a signatory to VCLT.

4 Aids to interpretation Interpretation of language in the treaties largely involves deciphering the intention of two

Contracting States at the time of negotiation and at conclusion of the treaties. Hence, supplementary materials that reasonably reflect the intentions may be looked into. These materials may be bilateral, i.e., exchanges between the two Contracting States, unilateral, i.e., issued or compiled by one of the Contracting States or multilateral i.e. shared amongst/commented by various nations.

Some important aids are discussed as follows :

• Memorandum of Understanding (‘MoU’)

An MoU is a document agreed upon between the two Contracting States on interpretation of certain terms in the treaty. It is a document agreed upon by Contracting States regarding interpretation of certain terms contained in the tax treaty. The MOU can be agreed and entered at the same time when the treaty is signed or the Contracting State may want to enter into MOU at a subsequent stage.The MOU to the tax treaty between India and USA was signed on the same day4 on which the tax treaty was signed and should be considered to be a part of the tax treaty. Revision of an MoU, however, may be easier than re-negotiation or amendment to the tax treaty per se.

Since an MoU is based on the common interpretation of both the parties; it is a meaningful source for interpreting the tax treaty.

• Protocol

A protocol is an indispensable and integral part of a tax treaty and has the same binding force as the main clauses of a tax treaty5. A protocol to a later treaty between two countries could apply while interpreting the predecessor treaty between the same countries6.

• Technical explanation

Technical explanations are often issued by US for interpretation of tax treaties. Such technical explanations are unilateral material to aid interpretation by the US authorities and may be of persuasive value to the other Contracting State. However,

4 12 September 1989

5 DCIT vs. ITC Ltd (2002) 82 ITD 239 (Kol ITAT)

6 Decca Survey Overseas Ltd vs. The ITO (ITA Nos. 8506/Bom/90 & 8625/Bom/91)



if such explanations were to be a part of the exchange / correspondence between two Contracting States in the negotiation process, the same may be used as more useful aid to interpret the respective tax treaties.

Having said the above, if a technical explanation with regard to another tax treaty (say Country X and Country Y) existed at the time of negotiation of the tax treaty between Country X and India and such technical explanation was referred to in the course of discussion, it may be right to assume that both India and Country X accepted that meaning when they entered into a tax treaty using the same language.

• Model Convention and commentaries to Model Conventions

A Model Convention (‘MC’) provides a common format and wording as a basis for drafting bilateral tax treaties. The use of a standard form of words helps in uniform interpretation and application of the treaties based on them. MC are used by the Contracting States either without change or adapted, as deemed appropriate at the time of negotiation of the tax treaties.

The commentary to the MC is an interpretation of the MC and reflects the current views on existing provisions and on their application to specific situations. Since this is a material shared / commented upon by various nations, it is a multilateral aid for interpretation.

— Whether MC and Commentary are binding

The MC is only a recommended format with no legal binding force either at the international or national level. The MC represents a soft obligation for the OECD member States. Specific reservations to the MC as well as the Commentary can be found in the OECD commentary. Any deviations and references are meant to reflect the intention of the negotiators.

The commentary to the OECD MC has been adopted by the OECD member States as the primary basis for drafting and interpreting tax treaties. For non-OECD States, the commentaries are a persuasive factor in treaty interpretations7. If the tax treaty adopts the language of the MC then the interpretation placed on the commentary may be acceptable or will at minimum serve as a guide to what the parties intended.

The MC and its commentary reflect a meaning which can be said to have been inherent even if it was not consciously considered by the parties.

— Effect of revisions/updation to MC and commentary

The OECD MC and the commentary are subject to periodic and timely updates. The use of subsequent amendments or additions to the commentary as an interpretation of previously concluded tax treaties is not universally acceptable. Klaus Vogel accepts and reiterates the established view that changes in the text of the Articles in the MC do not affect the previous agreements.

— India perspective

Indian courts have had divergent views on reference to OECD commentary.

Some decisions where reliance has been placed on OECD commentaries include, CIT vs. Visakhapatnam Port Trust [1983] 144 ITR 146 (AP), CIT vs. Vijay

7 Roy Rohatgi, Basic international taxation: Vol 1 (2005)



Ship Building Corp [2003] 261 ITR 113 (Guj), Union of India vs. Azadi Bachao Andolan [2003] 203 ITR 706 (SC). There are also judgements where OECD / UN Commentaries have been expressly considered persuasive and have been given due weight e.g. Motorola Inc vs. DCIT [2005] 95 ITD 269 (Del)(SB), Graphite India Ltd vs. DCIT [2003] 86 ITD 384 (Kol), James Mckintosh & Co (P) Ltd v. ACIT [2005] 93 ITD 466 (Mum), Metchem Canada Inc vs. DCIT [2005] 100 ITD 251 (Mum).

However, contrary views have also been expressed by the Indian courts, which have ruled that OECD commentary is not a safe or acceptable guide or aid for interpretation of the provisions of a tax treaty by India with other countries e.g. The Apex Court decision in the case of CIT vs. P.V.A.L Kulandagan Chettiar [2004] 267 ITR 654 (SC). Also, in the case of P No 28 of 1999, In re [2000] 242 ITR 208 (AAR) the Authority of Advance ruling refused to follow the OECD commentary observing that “it is contrary to the well-established principle of statutory interpretation.”

India has also expressed reservation on OECD commentary in respect of certain Articles. This is reflective of the interpretation that the Indian authorities may unilaterally want to adopt; however, may not be reflective of the negotiations between a Contracting State and India. Hence, interpretation based on India’s reservation may not be regarded conclusive of the intention of both Contracting States; unless a bilateral agreement expressly provides so, irrespective of whether the treaty is entered into before or after India’s expressing the reservation. As of now, use of India’s reservation as an aid of interpretation of Indian tax treaties by the Indian tax authorities / Courts is not in vogue. Having said this, the reservations are clear indicators of the interpretation which Indian Revenue authorities are likely to adopt but, not necessarily of the interpretation which is likely to find favour with Appellate authorities or of the interpretation which the Revenue authorities may agree to adopt in the course of any Mutual Agreement Procedure (MAP).

• Commentaries of authors

In interpreting a tax treaty, the question arises whether one can consider the views of authors / academicians. Numerous rules, canons and principles are laid down by the authors to be used as tools in interpretation of treaties, and to serve as useful guidelines to the drafting of treaty provisions. This may not be strictly followed; however, the tax payers and courts may consider the views expressed by the authors / academicians. Also, in case conflicting views are propounded by authors, this aid to interpretation may not prove to be helpful.

In several of Indian case laws, authors’ commentaries have been relied upon by the Indian courts for interpretation of tax treaties. These cases include, Ishikawajma-Harima Heavy Industries Ltd vs. DIT [2007] 288 ITR 408 (SC), UOI vs. Azadi Bachao Andolan [2003] 263 ITR 706 (SC), CIT vs. Vijay Ship Breaking Corpn [2003] 261 ITR 113 (Guj), and Abdul Razak A Meman, In re [2005] 276 ITR 306 (AAR).

On the other hand, there have been cases, where the judiciary has disagreed with international commentaries, such as, P No 24 of 1996, In re [1999] 237 ITR 798 (AAR) and Tata Iron & Steel Co Ltd, In re [1999] 69 ITD 292 (Mum).

Hence, Indian courts have had divergent views on this aspect.



• Judgments by foreign courts

The decision on tax treaties by foreign courts or authorities in other Contracting States or third states may serve as a useful aid to interpret treaties. These could be persuasive, though not binding; and may provide important insights8.

Many countries have accepted OECD’s “common interpretative principle” of legal decisions on treaty interpretation. The concept of common interpretation means, where a treaty is considered to have a particular meaning in one state, it is desirable if it has the same meaning in the other state. The approach is that the courts should consider and follow the relevant decision from other states, unless they are convinced that those decisions are incorrect.

In CIT vs. Visakhapatnam Port Trust [1983] 144 ITR 146, the Andhra Pradesh High Court has also acknowledged this concept.

• Parallel treaties

Parallel treaties are treaties on a similar subject matter concluded between third states or between one of the parties and a third state.

— Binding or persuasive?

At times, succession of provisions in subsequent treaties could be an approach by the negotiators of one country. As a result, parallel treaties could be referred to while interpreting tax treaties with same language. However, it should be borne in mind that even same wording may represent different intentions if used in a different context. On the other hand, different wording may represent the same negotiating intentions.

Inferences, even where plausible, should be drawn with caution, as each treaty is a result of separate bilateral negotiations. In spite of such limitation, parallel treaties generally, provide persuasive support.

— India perspective

There are decisions where Indian courts have placed reliance on parallel treaties for interpreting a tax treaty. In the case of CIT vs. Vijay Ship Building Corp [2003] 261 ITR 113 (Guj HC), the interest article under the India-UK tax treaty was sought to be interpreted by reference to the India-Indonesian tax treaty. Also, in Raymond Ltd. vs. CIT [2002] 86 ITD 791 (Mum), the Tribunal while interpreting the term “fees for technical services” which make available knowledge, experience, etc., under the Indian-UK tax treaty, placed reliance on the explanation of this term in the Memorandum of Understanding appended to the India-US tax treaty, which was executed prior to the India-UK tax treaty. This view also finds support in the case of R V Loxdale 97 ER 394 as reported in DCIT vs. Boston Consulting Group Pte Ltd [2005] 93 TTJ 293 (Mum) and DDIT vs. Preroy A.G. [2010] 39 SOT 187 (Mum).

However, there are also Indian cases where reference to the parallel treaties was disregarded e.g. Advance Authority Ruling in the case of Shell India Markets Pvt. Ltd (AAR No.833 of 2009) and Mashreq Bank PSC vs. DDIT (2007) 108 TTJ 554 (Mum).

8 Roy Rohatgi, Basic international taxation: Vol 1 (2005). Examples: Dutch interpretation used in Canada in Hunter Douglas vs. MNR 79 DTC 5340, UK and Canadian decisions applied in Australia in Thiel v. FCT 90 ATC 4717



In the case of Mashreq Bank PSC vs. DDIT, the taxpayer contended that “different phraseology employed in the Indian tax treaties warrant an interpretation in such a manner that a uniform meaning is not given to all these different expressions because differentiation in expression will then be rendered meaningless”. The Tribunal observed as follows :

“Unlike a piece of tax legislation, which is creature of a sovereign state, a tax treaty is a result of bilaterial negotiations. Therefore, the wordings of a tax treaty are essentially dependent on the priorities of, and acceptability by, the Contracting States, parties to such a tax treaty. It is only elementary that these factors vary from one set of Contracting States to another set of Contracting States. The same purpose, therefore, can indeed be intended even by radically different phraseology employed in tax treaties to which a particular country is one of the parties. In the case of tax legislation, however, things are quite different, because…tax legislations are unilateral acts of the law making bodies, and when a law making body makes even slightest departure from the expression it used earlier, the normal inference is that such deviation, being a unilateral act, has some specific intent and purpose. The tax treaties being product of bilateral negotiations, deviation in language of the tax treaties entered into by a country, does not necessarily indicate a deviation in objectives and purpose that these tax treaties seek to achieve. It is also not common that some of the Contracting States are too conservative in their approach and insist on certain provisions as a measure of abundant caution (ex abudanti coutela).”

• Mutual Agreement Procedures

Article 25(3) of the OECD MC, as also a number of tax treaties entered into by India, permit competent authorities to resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the Convention. MAP can be either (i) interpretative - to avoid doubts or difficulties as to interpretation or application of the tax treaty; or (ii) legislative - to eliminate double taxation in cases not provided for in the tax treaty. As subsequent agreements, they may be treated similar to context (Article 31 of VCLT ) or at least as supplementary data (Article 32 of VCLT ). These agreements will generally, not be binding for other cases / matters as the agreement would almost invariably be stated to have been arrived at considering the specific facts and circumstances of the case – also, information of the factual matrix and sometimes even the mutual agreement may not be available in the public domain.

• Notifications assigning meanings to terms in tax treaties

A Contracting State may assign a meaning to a term used but not defined in the tax treaty, which may be specific to the country or otherwise. Such notifications may be indicative of the meaning which was intended to be given to the terms at the time of conclusion of treaties.

For example: Sub-section 3 of section 90 of the Income-tax Act, 1961 (‘the Act’) authorises the Government to notify the meaning of a particular term not defined in the tax treaty. Explanation 3 inserted by the Finance Act, 2012 provides that the meanings assigned in the notification shall be deemed to have been assigned from the date on which the agreement comes into force. The Memorandum explains that the intention is to adopt the same meaning which was considered at the time of treaty negotiation.

However, this could also raise a question as to whether such notifications tantamount to unilateral material / clarification, consequently raising doubts on its binding nature for



the other Contracting State. It is unlikely that Government would maintain all documents summarising the circumstances under which the treaties are negotiated and the meanings understood by the parties over a period of time; or that the respective Government officers involved in treaty negotiations can be called upon to refresh their memories, especially if the treaties in question are old. In absence of concrete documentation regarding the circumstances and understanding at the time of negotiations, the act could possibly be considered unilateral.

Also, if the meanings assigned to terms under the notification are not consistent with what the parties had understood during the negotiation stage, then it may be seen as an attempt to unilaterally change the terms of the treaty.

5 Hierarchy of aids to interpretation A matter to be considered is the hierarchy of the aids to interpretation.

Whether a bilateral material should be given more importance than unilateral; or whether the latter should carry more weight since it is a clear intention of one of the Contracting States to apply the tax treaty in a particular manner? For example, should India’s reservations to OECD commentaries or notifications by the Indian Government in exercise of powers under section 90(3) of the Act, carry more significance than the language and context of the treaties negotiated before such reservations / notifications? Will the answer be different for treaties entered into thereafter? Similarly, what is the hierarchy of multilateral aid to interpretation such as the OECD commentary over unilateral material of a Contracting State?

One approach could be to give most weightage to bilateral material since they are the closest to what was negotiated between and intended by two Contracting parties. This may be followed by multilateral material to achieve consistency of approach in interpreting tax treaties and lastly unilateral material which is neither agreed to nor acknowledged by the other Contracting State. However, the Revenue authorities may be considered to be bound even by unilateral material as for them such material tantamounts to a representation made by the Revenue authorities.

6 Should tax treaties be interpreted like domestic tax laws • Tax treaties are neither drafted by draftsmen who draft the laws to be passed by the

Parliament; nor are tax treaties passed by the Parliament. Tax treaties are negotiated by the Competent Authorities of the two countries. For this reason, the judicial authorities have taken a view that the tax treaties cannot be interpreted in the same manner in which other domestic laws are interpreted9.

• However, it is interesting to note that drafting and negotiating tax treaties entails a lot of preparation. Tax treaties are based on the globally developed models like the OECD, the UN and the US model. These Models are drafted after significant studies, analysis, and debate and are to be read and understood in the context of commentaries on the Models. The Competent Authorities are prepared and trained to negotiate the tax treaties; they also have support and understanding of these commentaries and Models.

Legislation is a representation to the citizens of Government’s intention. Intention of the citizens is not important since legislation is one-sided. On the other hand, tax treaties, are

9 DCIT vs. Boston Consulting Group [2005] 94 ITD 31 (Mum); Union of India vs. Azadi Bachao Andolan [2003] 263 ITR 706 (SC)



bilateral, where two countries are acting together to negotiate the terms which will govern the Contracting States. Once negotiated, the tax treaties are similar to legislation in a way that a tax treaty is a joint representation of the Contracting States to the citizens of both the States. Hence, a view that tax treaties should be interpreted like a domestic tax law (albeit in a more liberal manner) is also likely to hold good. In any case, the discussion appears to be academic and may not have much practical impact as the fundamental rules of interpretation to be applied to tax treaties cannot really be different from the rules of interpretation applied to domestic tax laws and the reference to a more liberal or more conservative approach are “subjective” factors, which are likely to be pressed in service by the concerned “authority” to support an interpretation, which the “authority” otherwise finds satisfactory or equitable.

7 Role of judiciary in interpretation of law

7.1 Court of justice or Court of equity Courts can be categorised as courts of justice and courts of equity. The basic difference being

that the courts of justice follow strict interpretation of the law, while courts of equity decide on what is fair and equitable.

The courts of equity thus follow a broad notion of natural justice, and differ from the common law courts, wherein equity does not have fixed role and courts of equity may also not consider necessary strict application of the doctrine of precedent. Equity is commonly said to “mitigate the rigour of common law”, allowing courts to use their discretion and apply justice in accordance with natural law.

As a common man, we may expect a tax court to be a court of justice to achieve objectivity and certainty in interpretation and application of law. Whilst in practice, judges may sometimes follow the equity approach; such difference in approach at different points of time is dependent on the political, social and economic context, as also the perception thereof, of the judge or “authority” arriving at the interpretation. It is well recognised in the jurisprudential school called legal realism, that the individual approach of the judge is often more decisive in judicial decisions than the law or the facts.

7.2 Role of an arbitrator or an expert In the case of K.K. Modi vs. K.N. Modi & Ors. [1998] 3 SCC 573(SC), the Apex court

has quoted an observation which helps in deriving the meaning of arbitration. As per the observation, an arbitration would entail arriving at a decision on the evidence and submissions of the parties and applying the law or if the parties agree, on other consideration. On the other hand, an expert, unless it is agreed otherwise, makes his own enquiries, applies his own expertise and decides on his own expert opinion.

Tax Courts are meant to act as arbitrators, not as experts.

8 Select issues in interpretation for international tax

8.1 Domestic tax law or tax treaties vs. best of both worlds? • A question arises as to whether a tax payer can at the same time take advantage of

both - the treaty as also domestic tax law. To put it differently, can a tax payer-

• Offer part of his income in accordance with the Act and part of his income in accordance with the tax treaty?; or



• Should both the Act and the tax treaty be treated as complete codes by themselves and the tax payer should be required to select either of them? In case the Act and tax treaty are treated as complete codes, and once tax payer has made the selection of which code he wants to be governed by, should he be required to give up reliance on the beneficial provisions of the other code?

Interestingly, section 90(2) of the Act does not specify what happens when the provisions of the Act are not beneficial or less beneficial. The term “to the extent” used in section 90 of the Act could mean “up to a particular level”. Thus, section 90(2) of the Act creates a situation wherein simultaneously, combination of tax treaty and the Act can apply to the tax payer.

Hence, the matter to be considered is as to whether the language of section 90(2) of the Act allows a “pick and choose” between the provisions of the tax treaty and the Act. The orders of the Mumbai Tribunal in the cases of Sumitomo Mitsui Banking Corpn. vs. DDIT [2012] 136 ITD 66 (Mum SB) and the Prudential Assurance Co. Ltd. vs. ADIT (ITA No. 7353/Mum/2011), provide significant guidance on this issue.

8.2 Treaty shopping - Interpretation of tax treaty vs. Eligibility to tax treaty • Beneficial effect of certain provisions

Tax treaties are concluded to avoid double taxation. However, in practice, tax treaties may be interpreted in a manner so as to lead to double non-taxation. (A classic example of this is the capital gains arising to a Mauritius tax resident from sale of shares of Indian companies).

Corporates often tend to arrange operations in a manner so as to take advantage of the favourable provisions of tax treaties. The matter for consideration is whether denial of beneficial provisions in such cases is a question of eligibility to enjoy the tax treaty or of interpretation of the tax treaty in light of its context and purpose (i.e. avoidance of double tax rather than promoting double non-taxation). This matter assumes more gravity in respect of treaties where measures to avoid “misuse” of double non-taxation do not exist (like limitation on benefits clause, etc.). One view could be that irrespective of the specific concession permitted under the treaty, an abuse of treaty is never intended; but, alternatively it may possibly be intentionally permitted so as to achieve a specified objective considered relevant at the time of treaty negotiations.

• Stand of the Indian judiciary so far

In the case of UOI vs. Azadi Bachai Andolan And Anr.10, the Supreme Court has observed that “Because treaty negotiations are largely a bargaining process with each side seeking concessions from the other, the final agreement will often represent a number of compromises, and it may be uncertain as to whether a full and sufficient quid pro quo is obtained by both sides.” The Court further observed that in developing countries, treaty shopping is often regarded as a tax incentive to attract scarce foreign capital for technology - “There are many principles in fiscal economy which, though at first blush might appear to be evil, are tolerated in a developing economy, in the interest of long-term development. Deficit financing, for example, is one; treaty shopping, in our view, is another”.

10 [2003] 263 ITR 706 (SC)



As per the case of McDowell And Company Ltd. vs. CTO [1985] 3SCC 230 (SC), although tax planning within four corners of law is permitted, usage of colourable devices is not.

In case of Vodafone International Holdings B.V. vs. Union of India [2012] 204 Taxman 408 (SC), Supreme Court has observed that had the intention of India at the time of negotiation been to avoid “treaty shopping” an anti-avoidance measure would have been built into the tax treaty.

Hence, Indian courts have in a way recognised the concept of use of beneficial provisions even if they lead to double non-taxation, where these were found beneficial for the economy and the country at the relevant point of time.

• General Anti Avoidance Rule - interplay with tax treaties

General Anti Avoidance Rule (‘GAAR’) has been recently introduced in the Indian law and is to be effective in respect of income accruing or arising from 1 April 2013 onwards. To implement GAAR, draft guidelines have been released. As per the provisions, an arrangement which is “impermissible” will be subject to GAAR. It is further provided that the GAAR provisions would override the provisions of the tax treaty.

Some of the illustrations provided vide the draft GAAR guidelines include cases of intermediate holding company (‘IHC’) structures where such IHC lacks commercial “substance” (examples hint towards India-Mauritius tax treaty and India-Singapore tax treaty), non-distribution of dividend for a substantially long time followed by a buy-back, transfer of shareholding, etc. The provisions and the illustrations seem to be bringing out the intention of the Government to check on all cases of tax avoidance and bring them under the tax net.

The question is whether this can be regarded as introduction of anti abuse provision in respect of tax treaties, without the consensus of the treaty partners i.e. a unilateral act. However, it needs to be noted that the OECD commentary specifically provides11 that when the provisions of the tax treaty are sought to be abused, the Contracting States are not bound to give benefit of the tax treaty. Such denial could be on the basis of the interpretation of the tax treaty itself, or based on the specific provisions of the domestic tax law. Thus, although, it may appear that India is unilaterally trying to deny tax treaty benefits, it is an accepted practice to deny treaty benefits when the provisions are sought to be misused. Accordingly, in strict sense, consensus with the treaty partner is not required for introduction of GAAR provisions in the domestic tax law, which could override the tax treaties.

In terms of the provisions of section 100 of the Act, GAAR provisions shall apply in addition to, or in lieu of, any other basis of determination of tax liability. This suggests that GAAR could be applied in addition to Specific Anti Avoidance Rules (‘SAAR’). The provisions of tax treaties also contain SAAR. The proposed draft GAAR guidelines gives example12 of how GAAR could be implemented over and above SAAR provisions of tax treaties.

11 Para 7.1 of the OECD commentary on Article 1

12 Example 15



8.3 Static vs. Ambulatory interpretation • Introduction and concept

Tax treaties are entered into on the basis of the economic and legal environment, the provisions of the domestic laws, and such other factors, prevailing at a particular point of time. Whilst some terms and expressions may be assigned a specific meaning in the text of the tax treaty, some may not be defined; or may be expressly intended to bear the same meaning as the domestic tax law of the Contracting States. However, with the passage of time definitions or interpretation under the domestic laws may change. In such a situation which meaning should be adopted for the purpose of interpretation? The one which prevailed at the time when the tax treaty was signed? Or, the one which prevails when it is to be applied? There are two schools of thoughts on this issue, which give rise to two approaches discussed below.

— Static Approach – As per this approach, the provisions of a tax treaty are to be interpreted on the basis of the provisions and interpretation as prevalent at the time of finalisation of the tax treaty. Rationale behind this is that a tax treaty represents an agreement of understanding between two countries at a particular point of time. Accordingly, the interpretation, which was prevalent at the time of entering into the tax treaty, is to be adopted.

— Ambulatory Approach – As per this approach, a tax treaty is to be interpreted on the basis of the meanings prevalent at the time when the provisions of the tax treaty are applied13.

One of the examples of ambulatory approach adopted by the Indian courts is the case of Skycell Communications Ltd. vs. DCIT [2001] 251 ITR 53 (Mad). In this case the High Court made an interesting observation reflecting change in interpretation of the term “fees for technical services” in section 9(i)(vii) of the Act. The Court has observed that - When the Act came into force (in 1961) and the section 9(1)(vii) was inserted (in 1976), the products of technology were not widely used as they are today. Any construction of the provisions of the Act must be in the background of the realities of day-to-day life in which the products of technology play an important role in making life smoother and more convenient. Section 9(1)(vii) of the Act are not intended to cover the charges paid by the average house-holder or consumer for utilising the products of modern technology, such as, use of the telephone fixed or mobile, the cable T.V., the internet, the automobile, the railway, the aeroplane, consumption of electrical energy, etc. Such facilities are not capable of being regarded as technical services in the current day and age. Hence, the court has in a sense, sanctified the ambulatory approach to interpretation of terms used in the Indian domestic tax law.

Even OECD MC and commentary support the Ambulatory Approach. This is based on the specific language of amended paragraph 2 of Article 3 of the Convention.

13 ITO vs. Leonhardt Andra and Partners [1987] 21 ITD 607 (Cal); held reverse in CIT vs. Siemens Aktiongesellschaft [2009] 310 ITR 320 (Bom)



• Amendment to section 90(3) of the Act

— Ambulatory approach guised as static?

In the context of India, it would be relevant to note that section 90(3) of the Act, which provides that any term not defined under the Act or the tax treaty, will have the meaning as assigned to it in a notification issued by the Central Government.

The Finance Act, 2012 has introduced an Explanation to section 90(3) of the Act, with retrospective effect from 1 October 2009, which reads as under:

“Explanation 3 – For the removal of doubts, it is hereby declared that where any term is used in any agreement entered into under sub-section (1) and not defined under the said agreement or the Act, but is assigned a meaning to it in the notification issued under sub-section (3) and the notification issued thereunder being in force, then the meaning assigned to such term shall be deemed to have effect from the date on which the said agreement came into force”

The Explanation (although effective from 1 October 2009), has inbuilt retrospective mechanism according to which, the meaning given in the notification will be deemed to have effect from date of coming into force of the tax treaty. As per the Explanatory Memorandum, the rationale of such inbuilt retrospective mechanism is that the meaning of a term as understood during the negotiation stage is to be adopted and hence, the meaning needs to be adopted from the date the treaty becomes operational.

An interesting situation would arise if a particular meaning is given to a term by way of notification and the tax authorities make an attempt to apply that meaning to an issue in litigation pertaining to period prior to 1 October 2009 (i.e. the date from which the Explanation is operational), say, AY 2005-06.

Explanation 3 appears to be adopting a static approach as the meaning which was understood during the negotiation stage is to be adopted for all subsequent years during which the treaty prevails. However, point to be considered here is, whether the possibility of the Government attempting to adopt a meaning currently desired can be ruled out, thereby, making the approach partly ambulatory and partly static.

Further, interestingly, there is no statutory or other provision which requires the Government to notify a meaning, if any, understood during the negotiating stage. Therefore, it is also possible that the power to notify under section 90(3) is used to notify a meaning which was not really contemplated at the negotiating stage. It would be desirable that a statutory limitation is built into section 90(3) permitting notifications only within a specified time of a treaty entering into force and limiting the notified meaning to a meaning of which it can be demonstrated that at the time when the treaty came into force the meaning was contemplated by the parties or at least by India.

It may also be worthwhile to note that there is no provision under the Act that restricts the Government to re-notify a meaning which was earlier defined by way of a notification. Hence, there is a possibility that the Government may define a term used under a tax treaty by way of a notification, and then, after some years again define the same term differently by issuing a new notification. Although the



Explanatory Memorandum advocates providing a meaning intended at the time of negotiations, the same is not an obligation cast upon the authorities by virtue of the Act. In a situation of re-notification of definition of the same term, it would be interesting to see how the intent of adopting static approach by the Government gets justified.

— Conflict with certain tax treaties

Tax treaties signed by India with certain countries such as Armenia, Hungary, Kazakhistan, Portugal, South Africa, Sudan, etc., specifically adopt ambulatory approach (as per Article 3 of the respective tax treaties) i.e. term not defined under the tax treaty should be given a meaning as per the domestic tax law prevalent at the relevant point of time. Hence, the amendment to section 90(3) may be considered to be in conflict with the provisions of such tax treaties.

— Is it possible that a term remains undefined?

Certain terms such as “liable to tax”, “make available”, “copyright” etc., are generally not defined in all the tax treaties. Also, terms like “managerial services”, “consultancy services”, “technical services”, etc. are not defined in the domestic tax law

As per Article 3(2) definition under the domestic law is to be adopted only if it is in the right context. Thus, it could happen that particular term used in the tax treaty is defined in the Act in a different context and hence, does not pass the test of Article 3(2). As per section 90(3) of the Act, a term not defined under the tax treaty or the Act may be assigned a meaning vide a notification. However, if such a term is defined under the Act, although in a different context, it may not be possible to notify a meaning with regard to such a term.

• Notification issued under section 90(3)

It needs to be noted that the Government has already issued a notification14 clarifying that when a treaty provides that any income of a resident of India “may be taxed” in the other country, such income shall be included in his total income chargeable to tax in India in accordance with the provisions of the Income-tax Act, 1961 and relief shall be granted in accordance with the method of elimination or avoidance of double taxation provided in such treaty. The prima facie objective of this notification is to plug the opportunities arising from the judgements of the Madras High Court analysed in paragraph 8.6.

• Meaning under the domestic law

Paragraph 2 of Article 3 of tax treaties generally provides that meaning under the domestic law pertaining to the taxes to which the treaty applies is to be adopted. Thus, while applying paragraph 2 of Article 3, if meaning is to be given to a word “company”, then the meaning under the Act is to be applied as against the meaning under the Companies Act, 1956. Further, in case a particular term has more than one meaning under the domestic tax law, then the meaning of the domestic law should be adopted depending on the context in which the term is used under the domestic law as well as the tax treaty.

14 Notification number SO 2123 (E), dated 28 August 2008



8.4 Conflict in source rule as per domestic tax law vs. tax treaty• Meaning of “accruing” and “arising” under tax treaties with particular reference to the

Article dealing with “Fees for technical services”

The Article dealing with taxation of “fees for technical services” is a distinctive feature of Indian tax treaties. Most of the tax treaties signed by India contain a specific provision for taxation of fees for technical services or the provisions are included in the Article dealing with royalties. Such a provision is usually found in Article 12 or Article 13 of an Indian tax treaty. (For the purpose of discussion, reference is made to the provisions as Article 12).

The structure of this Article is such that taxation rights are given to both the Contracting States. Paragraph 1 of Article 12 is generally worded as follows:

“Royalties and fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other state.”

— “Income arising in a Contracting State”

With respect to the concept of “income arising in a Contracting State”, the tax treaty does not clarify the situations in which income can be said to be arising in a particular Contracting State. Also, Article 3 of the tax treaties giving definitions of the terms used in the treaty does not define the word “arising”. Furthermore, as per paragraph 2 of Article 3, terms not defined in the tax treaty shall have the meaning given in the domestic law. The Act does not specifically define the word “arise” either. However, the term is used in the charging section and has resulted in significant litigation. Therefore, it may be possible to take guidance of the judicial precedents in interpreting this word.

— “Paid to a resident of other Contracting State”

With respect to the words “paid to a resident of other Contracting State”, the issue arises whether the Article can have application in case the fees are not actually “paid” but are “payable”. Alternatively, will Article 12 get attracted when the income is accrued but not paid. There could be two interpretations to this.

One interpretation could be that paragraph 1 of Article 12 gets attracted only if fees are actually paid. “Paid” is not defined in the Treaty and is defined in section 43(2) of the Act to include payable i.e. incurred according to the method of accounting upon the basis of which the profits or gains are computed. But, often non-residents do not maintain accounts in India (or separately for Indian income) and therefore, the definition in section 43(2) (even if it be considered to apply) does not throw any light. Should the method of accounting adopted internationally be considered relevant? But, it can be argued that, the internationally followed method is not relevant to taxation in India and hence, is not of relevance in applying paragraph 12(1) of the treaty. Under paragraph 1 of Article 12, the terms are cumulatively used i.e. arising and paid. Considering this the more acceptable interpretation could be that Article 12 would not be applicable if there is no actual payment of fees. Taxation of Royalties and Technical Service Fees on cash basis is supported by Mumbai ITAT in the case of National Organic Chemical Industries Ltd. vs. DCIT [2005] 96 TTJ 765, CSC Technology Singapore Pte. Ltd. vs. ADIT [2012] 50 SOT 399 (TDEL) and DCIT vs. Uhde Gmbh [1994] 54 TTJ 355 (TBOM).



Another interpretation could be that the term “paid” could include “payable” as well. The reason for this interpretation is that the objective of the tax treaty is to merely distribute taxing rights between the Contracting States. It is not the purpose of these Articles to lay down a decisive rule on the timing of taxation. This should be as per the domestic law. Such a view is supported by the Authority of Advance Ruling in the case of Flakt (India) Limited [2004] 267 ITR 727, wherein Article 12 on the India-Sweden tax treaty was discussed. The AAR held that Article 12 does not particularise the stage at which tax can be levied in India. Income is to be taxed in accordance with the laws of India and it can be on cash basis or on accrual basis.

• Missing link between the deeming provision and main provision in tax treaty articles

Paragraph 2 of Article 12 is generally worded as follows:

“However, such royalties or fees for technical services may also be taxed in a Contracting State in which they arise and according to the laws of that State,....”

Therefore, this paragraph authorises the source state to levy tax on fees for technical services paid to a resident of other state.

Paragraph 5 of Article 12 of tax treaties signed by India is generally worded on the following lines:

“Royalties or fees for technical services shall be deemed to arise in a Contracting State when the payer is the resident of that State. Where, however, the person paying the royalties or fees for technical services, whether he is a resident of Contracting State or not, has in Contracting State a permanent establishment or a fixed base in connection with which the liability to pay royalties or fees for technical services was incurred, and such fees for technical services are borne by such permanent establishment or fixed base, then such royalties or fees for technical services shall be deemed to arise in the State in which the permanent establishment or fixed base is situated.”

The scheme of Article 12 is that paragraph 2 gives the source state the right to tax the fees for technical services arising in that State. Further, paragraph 5 of Article 12 defines the circumstances in which the fees for technical services can be said to be “deemed to arise” in a Contracting State. However, paragraph 2 of Article 12 does not specifically provide that the source state will have right to tax fees for technical services even when the fees are only deemed to arise in that State. Unlike this, section 5(2)(b) of the Act specifically provides that income accruing or arising or deemed to accrue or arise in India would be subject to tax in India. As a result, there is absence of linkage of paragraph 5 of Article 12 with paragraph 2 of the same Article.

Despite the inadequacy of language, it appears that parties intend paragraph 5 to explain paragraph 2 of the Article 12. This is an example of how treaties are to be interpreted liberally, as agreements, and not as law.

8.5 Certain interpretation issues with relation to distributive rule (classification of income)• Classification of income (fee for technical services taken as an example) Various Articles contain definition of specific class of income, for example, there are

specific Articles relating to income in the nature of interest, dividend, royalties, fees for technical services, etc., and such terms are defined in the respective Articles. An issue arises as to under which Article an income should be classified, when the item of income satisfies the normal meaning of the specified class of income, but is not covered by the



specific definition of the term in the Article. In such a case, can it be said that such an item of income is not “dealt with in the Articles” of the tax treaty.

For example, in case of payment of technical fee to a US / UK tax resident, which does not satisfy the definition of “make available” clause, can the fee be taxed under the tax treaty. If yes, which Article of the tax treaty can be said to be invoked. Two interpretations exists in this regard-

— One interpretation could be that if the definition of “fees for technical services” as contained in Article 12 is not satisfied, the other Articles cannot be considered15. This interpretation is on the basis that Article 12 is a special provision and deals specifically with income in the nature of “fees for technical services”. If this provision does not apply, then other general provisions cannot be applied.

In the tax treaty between India and Switzerland, income from operation of ships in international waters is specifically excluded from Article 7. In Gearbulk Ag, In re. [2009] 318 ITR 66 (AAR), it was held that among the various items of income in the foregoing articles, business profits into which the shipping income falls has been dealt with under Article 7 of India-Switzerland tax treaty. Profits from international operation of ships are only a species of business profits just as the profits from international air transport which is separately dealt in Article 8. A particular species of income which is specifically referred to in Article 7 and deliberately left out of its genus, cannot be said to be an item of income not dealt with under Article 7. The profits from international shipping business have been consciously kept outside the ambit of the treaty and it cannot be brought within the fold of Article 22 on “Other income”.

The other view is that if the definition of “fees for technical services” as contained in Article 12 is not satisfied, the other Articles can be considered.16 This interpretation takes into consideration that the term “fees for technical services” is specifically defined for the purpose of Article 12. Article 12 is applicable only if payment satisfies the definition contained in the Article and not otherwise. Article 12 does not apply to something which may normally be construed as “fees for technical services” in common parlance. In such a case, other Articles of the tax treaty can be considered for an income which does not satisfy the definition of Article 12.

Clue can also be taken from the OECD commentary on Article 11 and Article 21 which says that Article 11 applies only in case of “interest arising in a Contracting State and paid to a resident of another Contracting State”. In case interest arises in a third state then Article 11 is not applicable. This also suggests that each Article has a limited scope and the Article can be applied only if the specific requirements of the Article are met. The OECD commentary seems to be adopting the second interpretation. Thus, it may also be interpreted that if the definition of “fees for technical services” is not met, then such item of income is not dealt with in Article 12 and other Articles can be invoked in such a situation. In Anapharm Inc., Canada

15 Andaman Sea Food Pvt Ltd [TS-440-ITAT-2012(Kol)]

16 Radhakishan Rawal, Taxation of Cross-Border Services, Page 589



vs. Director of Income-tax (International Taxation), Mumbai [2008] 305 ITR 394, the Authority for Advance Rulings held that the services in question cannot be considered “fees for included services”; the consideration received by the applicant would be its business income under Article 7, and such income would be taxed in India only if it has a PE in India.

— Article 7 vs. Article 21 for income not specifically covered

Where the second interpretation as discussed above is adopted, or where there is no specific Article dealing with a class of income in the tax treaty, a question arises as to whether the fee should be considered taxable as per provisions of Article 7 on “Business Profits” or Article 21 “Income not Expressly dealt with” / “Other income”.

Article 21 of the tax treaty is generally worded as “Income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of the Convention shall be taxable only in that State.”

The words “foregoing articles of the Convention” in Article 21 would be applicable to all Articles before Article 21. Of these preceding Articles, Article 6 to Article 20 would be relevant as these typically deal with specific items of income. Accordingly, the issue which arises is, whether the applicability of Article 7 on “Business Profits” needs to be analysed before applying Article 21?

Article 7 as such does not make any reference to the place where income arises; instead it is applicable to the income “attributable to a PE of a resident of a Contracting State in other Contracting State.”

The tax treaty does not have a separate Article dealing with such class of income, say “brokerage” or “fees for technical services”.

— Where technical services are carried on in the course of business

Assuming that the technical services, for which the fees are received as a consideration, are rendered in the course of carrying on business, there could be two interpretations.

One of the interpretations would be that Article 21 is applicable.

This interpretation is based on the reasoning that unlike other Articles of the tax treaty, such as Articles 10, 11, etc., Article 7 does not deal with any specific income. It is a generic provision and once the specific Article is not applicable, it is not appropriate to go back to Article 7.

Further, in a situation where the recipient of the fees does not have a PE in the source state, Article 7 does not even have any application. In this case requirement of Article 21 is met with i.e. income is not dealt with by any other foregoing Article.

Another interpretation would be that Article 7 would be applicable.

This interpretation is based on the reasoning that Article 7 specifically deals with “business profits” and hence, it should prevail over Article 21.

This interpretation is based on the reasoning that merely because the income is of a specific class, it does not cease to be a business profit. Further, it is evident that Article 12 does not apply to every payment which can be treated as “fees for technical services”, in general parlance and something which does not fall in Article 12 should be dealt with in accordance with Article 7 once it is a profit from business of the tax payer.



Even in a situation where there is no PE, it could still be argued that the income being “business income” is dealt with by Article 7. This is because the direction contained in Article 7 is that the source state will tax the business profits, only if there is PE. Further, paragraph 1 of Article 7 also says that the business profits would be subject to tax in State of Residence unless there is PE in other country. Thus, Article 7 “deals with” business profits even in a situation wherein there is no PE in the source state. On the basis that the income is dealt with by Article 7, the provisions of Article 21 cannot be applied.17 This seems to be a more plausible view.

However, it may be interesting to note that, the Chennai Tribunal, in the case of DCIT vs. M/s TVS Electronics Limited (ITA No. 811/Mds/2011), has held that just because the India-Mauritius tax treaty does not provide for a specific article dealing with “fees for technical services”, income in nature of fees for technical services will not be automatically covered under Article 7 – “business profits”. In the opinion of Tribunal, when a tax treaty is silent on an aspect, the provisions of the Act have to be considered and applied.

• Where technical services are not rendered in the course of business

If the services are not rendered in the course of carrying on the business, then it could be argued that Article 7 does not apply and Article 21 is right Article to apply.

8.6 Taxation of PE in the State of tax payer’s residence Paragraph 1 of Article 7 generally reads as follows:

“The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is directly or indirectly attributable to that permanent establishment.”

The issue which arises is, having suffered tax on such income as per the domestic tax law of the foreign country, should tax be levied on such income again in India? In this connection, it would need to be examined as to whether the State of Residence (i.e. India in this case), loses its right to tax the income of the PE, thereby precluding the State of Residence from its right to tax the worldwide income of a tax resident.

Significant litigation has happened on the interpretation of paragraph 1 of Article 7, especially the words “may be taxed” dealt in Article 7 of India-Malaysia tax treaty. The Madras High Court in the case of CIT vs. S. R. M. Firms [1994] 208 ITR 400, took a view that income earned by a Malaysian PE of the Indian company was not subject to tax in India. This judgment of the Madras High Court was subsequently followed in several other cases18 by the Madras High Court. The matter finally reached the Supreme Court in the case of CIT vs. P.V.A.L. Kulandagan Chettiar [2004] 267 ITR 654(SC). However, unfortunately, in this case the Apex Court did not address the issue of interpretation of Article 7. The court ruling was given on the basis that the assessee was a tax resident of Malaysia and it had no PE in India. The decision of the High Court and lower authorities were on the basis that the assessee was a tax resident of India.

17 Viceroy Hotels Ltd. vs. ACIT [2011] 46 SOT 4 (Hyd ITAT)

18 211 ITR 368, 239 ITR 602, 241 ITR 664, 241 ITR 662, 131 ITR 515



Interestingly, the interpretation adopted by the Madras High Court in the case of S. R. M. firms continued to prevail even after the judgement of the Supreme Court in the case of P.V.A.L. Kulandagan Chettiar. For example, in the case of DCIT vs. Mideast India Limited [2009] 28 SOT 395 (Del), it was held that an Indian tax resident, having a PE in a foreign country, should not be taxed in India in respect of income attributable to such PE.

However, in a recent judgment of Telecommunications Consultants India Ltd vs. ACIT (ITA Nos. 1293 & 1294/Del./2009, dated March 29, 2012), where the assessee sought to rely on the decision of the Apex court in the case of P.V.A.L. Kulandagan Chettiar, the Delhi Tribunal distinguished this decision on the basis that the case before the Supreme Court was that of a dual residency; and the assessee was a resident of Malaysia. Hence, it was concluded that the decision of the Supreme Court was not correctly applied. In this case before the Delhi Tribunal, the assessee was resident in India and therefore, India has inherent right to tax global income of its resident.

In this regard, it will not be out of place to take note of paragraph 1 of Article 7 of the India-Bangladesh tax treaty, which provides that profits attributable to a PE shall be taxed only in the country in which the PE exists. The relevant extract of Article 7 of the India-Bangladesh tax treaty is reproduced hereunder:

“Article VII - Business profits -

1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, then so much of the profits of the enterprise as is attributable to that permanent establishment shall be taxable only in that other Contracting State.”

8.7 Whether surcharge and cess should be levied on the rates provided in the tax treaties• Tax treaties typically provide a cap beyond which the tax rate cannot exceed. While

referring to the tax rate, the words “... should / shall not exceed…” are invariably used in the tax treaty indicating that where any income is being taxed under the tax treaty the tax rate cannot be more than what is provided in the tax treaty.

For example, Article 11 of the India-Singapore tax treaty provides for taxation of interest as under:

“2. However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that State, but if the beneficial owner of the interest is a resident of the other Contracting State, the tax so charged shall not exceed:

...(b) 15% of the gross amount of the interest in all other cases...”

However, it needs to be examined whether “Surcharge”, “Education Cess” and “Secondary and Higher Education Cess” are to be levied over and above the tax rates provided under the tax treaty.

• Continuing with the example of India-Singapore tax treaty, the term “tax” is defined in Article 2 of the India-Singapore tax treaty, which reads as under:

“Article 2 – Taxes covered

1. The taxes to which this Agreement shall apply are:

(a) in India : income-tax including any surcharge thereon (hereinafter referred to as “Indian tax”);...”



2. The Agreement shall also apply to any identical or substantially similar taxes which are imposed by either Contracting State after the date of signature of the present Agreement in addition to, or in place of, the taxes referred to in paragraph 1...”

Hence, tax includes surcharge and as per the tax treaty provides that the “tax” (including surcharge) should not exceed the limit provided under the tax treaty.

Futhermore, in relation to education cess, the Indian domestic law states as under:

“The amount of income-tax as specified in the sub-sections (1) to (10) and as increased by a surcharge for purposes of the Union calculated in the manner provided therein, shall be further increased by an additional surcharge for purposes of the Union, to be called the ‘Education Cess on income-tax’ / ‘Secondary and Higher Education Cess’, calculated at the rate of two per cent of such income-tax and surcharge so as to fulfil the commitment of the Government to provide and finance universalised quality basic education.”

Thus, it emanates that education cess is an “additional surcharge” and it shall be levied on the amount of tax and surcharge, and will also be covered by the scope of Article 2 of the tax treaty.

• It may also be noted that Article 2(2) further extends the scope of the “tax” by laying down that it shall also cover “any identical or substantially similar taxes which are imposed by either Contracting State after the date of signature of the present Agreement in addition to, or in place of, the taxes referred to in paragraph 1”. Education Cess was introduced by the Finance Act, 2004, and Secondary and Higher Education Cess was introduced by the Finance Act, 2007, which was much after the signing of major tax treaties. Therefore, the scope of article 2(2) would extend to the Education Cess and Secondary and Higher Education Cess.

Accordingly, the taxability whether in respect of income tax or surcharge or additional surcharge by whatever name called would be restricted at the rates specified in the Article of the tax treaty. This interpretation was recently adopted by Mumbai Tribunal in case of DIC Asia Pacific Pte. Ltd. vs. ADIT (ITS No. 1458/Kol/2011, dated 20 June 2012).

8.8 Most-favoured-nation clause Certain tax treaties include the most-favoured-nation (‘MFN’) clause to ensure that the taxes

paid by the residents of a country in another country are not less favourable than the taxes paid by other foreign investors in that country. The MFN clause is present in India’s tax treaty with Belgium, Hungary, Netherlands, Norway, France, Sweden, Swiss, Finland, Spain, Israel, Kazakhistan, Philippines, Thailand, UK, etc. The formulation of MFN clauses in tax treaties is largely specific to certain set of incomes such as dividend, interest, fees for technical services and royalty. The MFN clause could either have the effect of restricting the scope of taxation or lowering the rate of taxation.

For instance, the Protocol amending the tax treaty between India and Finland provides that if India, in any of its subsequent tax treaties with other OECD countries, exempts from tax or limits the tax charged to a lower rate on dividends, interest, royalties or fees for technical services arising in India then, such exemption or lower rate shall be made applicable to the residents of Finland.



In addition to the lower rate of tax, the Protocol to the India-France tax treaty provides that if India agrees to a restricted scope of the dividend, interest, fees for technical services and royalty income in any of its subsequent tax treaty, such restricted scope would apply. Under the India-France tax treaty, all technical services arising in India ought to be taxed in India; however, under the India-US tax treaty only those technical services that make available any technical knowledge should be taxed in India. Therefore, by virtue of the MFN clause, only those technical services that make available of technical knowledge will be liable to tax in India under the India-France tax treaty (read with the India-US tax treaty) since the scope of fees for technical services is narrower in the India-US tax treaty. This tax position has been upheld by various Indian courts19.

8.9 Exchange of Information Clause This clause imposes an obligation on tax authorities of a country to provide information to the

tax authorities of the other country. Are tax authorities justified in refusing to share information on the ground that the information may not remain confidential, that Indian tax authorities may share the data with other regulators or that it may be leaked because of weak controls. Can tax authorities of the counterpart country question the relevance of the data sought. Can they also object on the ground that the Indian authorities have not exercised the powers available to them to collect in India the information which they are seeking.

Can tax authorities claim that they are prohibited by the injunction of a local court in their country even when the Indian tax authorities were not parties in the matter resulting in the injunction.

To what extent can taxpayers seek protection under the clause. Can they act directly or do they necessarily have to act through the tax authorities of their country.

9 Conclusion Interpretations are and will always be subjective to the interpreter and the circumstances.

Any interpreter will tend to be equitable in the circumstance in which the matter needs to be decided and there will always be a legitimate approach to support the opinion!

The contents and issues covered in the paper are not exhaustive and views presented are personal.

19 Idea Cellular Ltd., In re [343 ITR 381 (AAR)], XYZ, In re [206 Taxman 494 (AAR)], Millennium IT Software Ltd., In re [338 ITR 391 (AAR)], DCIT vs ITC Ltd. [82 ITD 239 (ITAT)], Mersen India Private Limited (AAR No.1074 of 2010)



Annexure 1 EXTRACT FROM THE VIENNA CONVENTION ON THE LAW OF TREATIES

SECTION 3. INTERPRETATION OF TREATIES

Article 31 General rule of interpretation

1. A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.

2. The context for the purpose of the interpretation of a treaty shall comprise, in addition to the text, including its preamble and annexes:

(a) any agreement relating to the treaty which was made between all the parties in connection with the conclusion of the treaty;

(b) any instrument which was made by one or more parties in connection with the conclusion of the treaty and accepted by the other parties as an instrument related to the treaty.

3. There shall be taken into account, together with the context:

(a) any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions;

(b) any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation;

(c) any relevant rules of international law applicable in the relations between the parties.

4. A special meaning shall be given to a term if it is established that the parties so intended.

Article 32 Supplementary means of interpretation

Recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion, in order to confirm the meaning resulting from the application of article 31, or to determine the meaning when the interpretation according to article 31:

(a) leaves the meaning ambiguous or obscure; or

(b) leads to a result which is manifestly absurd or unreasonable.

Article 33 Interpretation of treaties authenticated in two or more languages

1. When a treaty has been authenticated in two or more languages, the text is equally authoritative in each language, unless the treaty provides or the parties agree that, in case of divergence, a particular text shall prevail.

2. A version of the treaty in a language other than one of those in which the text was authenticated shall be considered an authentic text only if the treaty so provides or the parties so agree.

3. The terms of the treaty are presumed to have the same meaning in each authentic text.

4. Except where a particular text prevails in accordance with paragraph 1, when a comparison of the authentic texts discloses a difference of meaning which the application of articles 31 and 32 does not remove, the meaning which best reconciles the texts, having regard to the object and purpose of the treaty, shall be adopted.

qqq


Case Studies

CASE STUDY 1

A Limited, a tax resident of Mauritius, invests in shares of an Indian company and holds the same as a capital asset. A Limited is eligible to benefits of the India-Mauritius DTAA.

In year 1 – A Limited transfers the capital asset and incurs loss on sale of shares of Indian companies.

In year 2 – A Limited earns capital gains on transfer of shares of Indian companies.

Question:

Can A Limited carry forward the losses incurred in year 1? In year 2, can it claim that the capital gains are not taxable in India and carry forward the loss incurred in year 1 for set off to subsequent years?

CASE STUDY 2

A Limited, a tax resident of Mauritius, invests in shares of Indian company.

During the year A Limited had sold the shares of Indian company and also earned dividend income on the shares.

Question:

A Limited proposes to claim that the dividends are not subject to tax as per the provisions of the Act. Simultaneously, it proposes to claim that capital gains are exempt as per the provisions of the India-Mauritius DTAA in the same return of income. Would such a treatment be appropriate?

Case Studiesby CA Gautam Doshi


Case Studies

CASE STUDY 3

Facts:

A Limited is a tax resident of Singapore and provides tax consulting and accounting services to an Indian company. Employees of A Limited were present in India for 100 days during the period of 12 months of the fiscal year.

Questions:

How will the income be taxable in India – on a net income basis or gross income basis and whether under the provisions of the DTAA/Act?

CASE STUDY 4

Paragraph 5 of Article 12 is worded in India-Finland DTAA as follows:

“Royalties or fees for technical services shall be deemed to arise in a Contracting State when the payer is that State itself, a political sub-division, a local authority, or a resident of that State. Where, however, the right or property for which the royalties are paid is used within a Contracting State or the fees for technical services relate to services performed, within a Contracting State, then such royalties or fees for technical services shall be deemed to arise in the State in which the right or property is used or services performed. Where, however, the person paying the royalties or fees for technical services, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the liability to pay the royalties or fees for technical services was incurred, and such royalties or fees for technical services are borne by such permanent establishment or fixed base, then such royalties or fees for technical services shall be deemed to arise in the State in which the permanent establishment or fixed base is situated.”

Questions:

1. F, resident of Finland, provides services to I, resident of India. Such services are performed in Finland and consumed in India. Whether Article 12(5) of India-Finland DTAA applicable in this case?


Case Studies

2. F, a resident of Finland, renders technical services in India to I, a resident in India. I has a permanent establishment (‘PE’) in Canada. The liability of fees is incurred by I in connection with the PE in Canada and the fees are borne by PE.

Whether Article 12(5) of India-Finland DTAA applicable in this case?


Case Studies

3. F, a resident of Finland, renders technical services in India to I, a resident in India. I has a PE in Finland. The liability for the fees is incurred by I in connection with the PE in Finland and the fees are borne by the PE. Whether Article 12(5) of India-Finland DTAA applicable in this case?

CASE STUDY 5

Tax treaty between India and Germany notified on 13 September, 1960 contained no specific provision relating to FTS. Amendments were made to tax treaty to bring FTS arising in India under the tax net. Such protocol was ratified in August 1985.

Question:

Contracts entered into by assessee prior to August 1985, however payments made after the ratification of the protocol. Will such payments be taxable?


Case Studies

CASE STUDY 6

Company A has a wholly owned subsidiary in UK, the shares being held through a SPV in Mauritius. The SPV is also a wholly owned subsidiary of Co. A. The UK subsidiary earned a taxable profit of UK Pounds 100,000 and being liable paid a tax of UK Pounds 30,000 in UK. The UK subsidiary declared a dividend of UK Pounds 50,000 from its after tax profits. No tax or withholding tax is charged by UK on dividends. The dividend constitutes taxable income of the Mauritian SPV. The applicable rate of tax in Mauritius is 15% and accordingly, the SPV is liable to a tax of UK Pounds 7,500 in Mauritian currency. The SPV is entitled to claim underlying tax credit of the tax paid in UK on the profits from which the dividend is declared and accordingly discharged its liability in Mauritius by claiming credit for tax paid in UK. The SPV is entitled to credit of UK Pounds 21,428 (5 by 7 of 30,000) but uses only UK Pounds 7,500 as that is the liability in Mauritius. The SPV in turn declared a dividend of the entire amount of UK Pounds 50,000. Evaluate the tax which would be payable by Co. A in India and the tax credit, if any, to which it would be entitled.

Would the terms of the India-UK treaty be relevant. The treaty does not provide for underlying tax credit presumably as India did not consider that Indian companies were likely to need credit of tax paid by UK subsidiaries though UK allows such credit as this was a relevant consideration for UK investors. On the other hand the India-Mauritius treaty provides for two way underlying tax credit.

nnn


Case Studies

NOTES


Case Studies

NOTES


Case Studies

NOTES


Case Studies On International Tax

CASE STUDY 1 :

Indirect transfer : Directional Saga1 India Fortunes Inc. (IFI) is an US incorporated company, which has global footprint with specific

emphasis on investments in various operating entities of India. The structure below reflects the present group position.

2 US Group is desirous of exiting from India operations, whereas PE investor group has signalled its desire to continue to hold its stake in Mauritian company unchanged. This resulted in USCo Group exiting from the Mauritian company in respect of entirety of its 55% stake in Mauritian company. The transaction is to be consummated by each of the shareholders of Mauritian company divesting its stake in favour of the prospect.

3 Certain further particulars shared by the Group are as under:

a) SACo has strong presence in African countries. For SACo, the value contribution of Indian Companies is in the range of 40% to 45% consistently over last decade.

Case Studies On International Taxby CA. Pinakin Desai



b) UKCo is the sole beneficiary of Bermuda Trust which holds 12% stake in Mauritian company. The trust is not registered in any jurisdiction. UKCo is contemplating assignments of its beneficial interest in the Trust to the buyer.

c) ChinaCo operations have been suspended for a year. There is likelihood of resumption. Had China been operative, the value contribution of ChinaCo to UKCo would have been > 75%. Since the buyer was apprehensive about timing of resumption, the contribution of China to overall value was pegged at 45%.

d) Initially, GermanCo held stake in Mauritian company through its wholly owned subsidiary in Germany. Investment in Mauritian entity was the only asset of WOS. In the year 2009-10, the subsidiary was merged with GermanCo.

e) LuxCo holds optionally convertible debentures of MauCo. These have been acquired by the buyer at fair price resulting in capital gains income for LuxCo.

f ) Enterprise value of OpCo5 is largely attributable to its overseas WOS which has mining licence in its home jurisdiction. The possession of mine is not yet allotted. There is a hope, but, no assurance about success of mining operations. The buyer and the seller are, however, bullish on its success based on expert’s evaluation.

g) Enterprise value of OpCo4 is largely influenced by the income that OpCo4 derives from its service PE operations outside India. The service PE does not involve any major asset base outside India.

h) USCo is paid compensation of $ 5 M for desisting from initiating or carrying on in India any activity competing with the business of any one of the Indian entities for a period of 5 years. The agreement has been signed at US and is subject to the jurisdiction of US Court.

4 The values which are indicated in the fact pattern could be regarded as the value parameter which would emerge either when calculated with reference to book value or with reference to fair value of various enterprises.

5 You have been asked to evaluate tax implications for each entity in USCo Group who is likely to be a party to the exit arrangement. The group also needs clarity on the following:

a) The scope of amendments contained in S. 2(14), S. 2(47), S. 9 of the Act, r.w. Explanations 3 and 4 to Section 9(1)(i).

b) Examine significance of the expressions “substantially”; “direct or indirect”; “derived from assets in India”.

c) Is it possible to suggest that the amendments to Finance Act, 2012 should be restricted in scope to cases where there is transfer of controlling interest in Indian companies?

d) Would the seller be entitled to treaty protection assuming the concerned entity is treaty resident?

The participants may identify and discuss issues on principles without undue emphasis on Maths.





CASE STUDY 2

Dividend Taxation : Act and treaty scenarios 1 Mickey Group is a versatile group having presence and operations across the globe. Mickey

Group has significant presence in diverse sectors in India through sector specific holding companies.

The group is wedded to the philosophy of rewarding shareholders by payout of regular dividend.

The following can be taken as a quick snapshot of its India centric structure to the extent relevant for taxation of dividend income upstreamed from operating companies at the bottom of the vertical structure.

2 The assumptions in the above structure are:

a) There is dividend payout at each level. E.g. ICO pays dividend to its (ICO’s) shareholder entities and the recipient then pays dividend to its shareholders such that dividend is upstreamed.

b) Op Cos in India have paid corporate taxes on profits and have also paid DDT on dividends distributed to ICO’s shareholders.

c) For each of the overseas companies, value of investment depends almost wholly on Indian investments.

d) The entity in the structure from a treaty jurisdiction can be considered as a valid treaty resident entitled to treaty benefit and can also be regarded as a beneficial owner of shares. Each overseas entity also holds valid TRC.

e) Each overseas company pays dividend to its shareholders pursuant to Board resolution passed in its jurisdiction and remits dividend from its own jurisdiction.



3 Mr. Chintamani, President (Tax) of the Group, in keeping with the spirit of his name, is worried on account of retroactive clarificatory amendments to S. 9(1)(i). He is apprehensive that :

a) S. 9(1)(i) r.w. Explanation 5 would, for each holding company, lead to the conclusion that the investment being shares of the underlying foreign company, is its asset / capital asset situated in India.

b) S. 9(1)(i) r.w. Explanation 4, brings to charge income accruing or arising through (i.e., by means of or in consequence of or by reason of ) any property or asset or source of income which is situated in India.

c) For a shareholder, his holding of shares can be considered as a source of income with regard to dividend yield.

d) Once source rule is triggered in terms of S. 9(1)(i), charge may not be frustrated u/s. 9(1)(iv).

4 Mr. Chintamani’s junior, Mr. Singham, is of the strong view that no tax officer of India in his senses would even distantly make any such suggestion having regard to the following:

a) The amendments are restricted in application to tax implications of capital gains income arising from transfer of assets being shares of a foreign company.

b) The amendments to Ss. 2(14), 2(47), S. 119 of Finance Act, 2012 etc. will need to be read along with the insertion of Explanations 4 and 5 to S. 9(1)(i). Reference may also be needed to the Explanatory Memorandum to discern the legislative object.

c) The deeming fictions need to be confined to a reasonable boundary and cannot be extended to provide extra territorial rights of taxation to India. India cannot assert right of taxation at each level of dividend payout.

d) It would be incongruous to expect India to expand scope of S. 9(1)(i) even beyond what is contemplated in terms of specific provisions of S. 9(1)(iv).

e) Assuming that the charge is triggered in terms of IT Act, it would be relieved by the treaty applicable to the dividend paying company or to the recipient.

5 While Mr. Chintamani is at the bar and Mr. Singham at the beach, the BCAS group has been engaged by Mickey Group with following questions:

a) Can India assert right of taxation at the stage of each dividend payout?

b) Was, or is any of the shareholders of CCO, NLCO1, Sing Co1 liable to pay tax in India u/s. 9(1)(i) as amended or otherwise?

c) Does section 9(1)(iv) have any role to play in this behalf?

d) Is it possible to contend that dividends paid by NLCO1 and SingCo1 cannot be taxed in India in view of provisions of Article 10 of the respective treaties?

e) Can any of the shareholders of CCO, NLCO1 and SingCo1 resist liability having regard to treaty provisions as applicable to it?



6 Reference material

a) Amendments to S.9(1)(i) along with Explanatory Memorandum thereto

b) S. 9(1)(i) / (iv) – Legislative history

c) Mrs. Kusumben D. Mahadevia vs. CIT (1963) 47 ITR 214 (Bom.)

d) Pfizer Corporation vs. CIT (2003) 259 ITR 391 (Bom.)

e) Caltex (India) Ltd. vs. CIT (1952) 21 ITR 278 (Bom.)

f ) Provisions of Article 10 / 21 of the respective treaty

g) OECD/UN Commentary on Article 10(5)

h) Hunter Douglas Ltd. vs. The Queen (Federal Court of Canada) (79 DTC 5340) (1979).

i) Decision of Hoge Raad in the context of Netherland–Ireland treaty. (Decision Hoge Raad (SC of Netherlands) dt. 2 Sept. 1992).

j) Vogel Commentary on Article 10(5) and Article 21.



CASE STUDY 3

Computation of capital gains and rate of tax : Indirect transfer, S. 112, Rule 115, etc.1 Tolerant Inc., US headquartered group has made certain investments in Indian operating

companies either directly or through one or more intermediaries.

The structure relevant to the case study under consideration is as follows :

2 The group is likely to exit from India operations and is evaluating options of exit under various scenarios.

3 The assumptions/positions conveyed to you are as under:

a) Shares of each of the foreign companies can be accepted as asset deemed to be situated in India having regard to fiction of Explanation 5 to s. 9(1)(i).

Each entity is a beneficial owner of the shares.

b) Each foreign company made investment by remitting funds in US $. The US $ equivalent of the amount is reflected as cost of investment in the books of each of the foreign company.

c) Sale consideration in respect of transfer of shares of ICO will be fixed in INR while consideration in respect of transfer of shares of an overseas entity is to be fixed in US $.

d) Reference to ‘akin to Private Ltd. Co.’ in the chart above reflects that, in terms of the applicable Articles of Association / Companies Act, there are restrictions on free transferability of shares akin to provisions of s. 3(1)(iii)(a) of Indian Companies Act (ICA). Conversely, reference to ‘akin to Public Ltd. Co’ reflects free transferability of shares of the company.

e) Each of the assets is held as capital asset. Shares/ units are held for more than 12 months while CCDs are held for more than 36 months. Gain is accordingly likely to be long term in each of the case.

CCDs



4 The following alternative transactions are contemplated by the group over the next couple of years.

a) Transfer of India Pvt. Ltd., such that, depending on the negotiations, sale could result with Hong Kong Companies acting as sellers or USCo acting as seller.

b) Transfer of CCDs of India Pvt. Ltd. to the buyer group by USCO.

c) Redemption of the units of Mutual Fund by USCO.

d) Transfer of India Ltd. either at the level of UKCO1 or USCO to achieve tax efficient exit.

5 In the background aforesaid, the group desires to evaluate tax rate matrix applicable to each scenario having regard, in particular, to provisions of S. 112(1)(c)(iii) which, the group is advised, is likely to be the most favourable provision in each and every situation. The group is also advised that, the taxpayer should be able to opt out of S. 112(1)(c)(iii) if, per chance, the provisions are perceived to be onerous.


a) S. 112 as amended by FA 2012.

b) Definition of “securities” in terms of S. 2(h) of SCRA.

c) Decisions in the context of SCRA explaining meaning of the term “security”. Refer illustratively: i) Dahiben Umedbhai Patel and Ors. vs. Norman James Hamilton and Ors. [1982

INDLAW MUM 4387]ii) Norman J. Hamilton and Anr. vs. Umedbhai S. Patel and Ors. [49 Comp Cas 1 Bom]iii) B.K. Holdings Private Limited vs. Premchand Jute Mills and Ors. [1980 INDLAW

CAL 9041]

d) S. 48 and provisos thereto.

e) Rule 115 / 115A of IT Rules.



CASE STUDY 4

Assessment, TDS and representative assessee1 Happy-Go-Lucky Group holds 100% interest in ICO through a vertical structure, such that the

only asset of each foreign company is its investment in the immediate subsidiary. Each such subsidiary has an independent Board of Directors to manage the activities. The structure, together with the change in ownership of the structure over a period is depicted as under:

2 The governing fact pattern is as under:

a) None of the foreign companies nor any of the buyer companies is entitled to treaty benefit.

b) None of the companies has had any other business connection in India and hence, none of them has furnished any return of income in India till date.

c) Based on the legal opinion obtained, Buyer 1 as also Buyer 2 had not deducted tax at source while acquiring shares of FCO 2 or FCO 3. Based on legal advice, it was not considered necessary to obtain any ruling from AAR or NIL TDS certificate from tax department at the time of purchase.

3 The following are the details of transactions impacting the entities:

a) FCO 1 had transferred shares of FCO 2 to Buyer 1 in FY 2003-04 at or for consideration of $ 30 million resulting in considerable capital gain for FCO1.

b) Buyer 1 exited from India operations during F.Y. 2009-10 by FCO2 transferring shares of FCO 3 to Buyer 2. The transfer was effected for $ 40 million. The original cost of investment of FCO 2 in FCO 3 was $ 1 lakh.



4 There was a wave of shock in the offices of the buyers on reading through all that was reported in tax journals on possible implications of Finance Act, 2012 on their structure and transactions. Many of the top executives were reported sick for days together. Their bonus packages have since been withdrawn with retrospective impact and their lawyers have not been able to find a way by which the transactions or structures can be altered with retrospective effect.

5 There has been an assurance to restore pay packages, provided they can obtain clean advice from BCAS participants that the Finance Act, 2012 cannot impact their group adversely. The employees have showed willingness to contribute a decent percentage of the package to BCAS Foundation.

6 In the background aforesaid, with regard to transaction 1, the issues raised for your consideration are as follows:

a) Can FCO 1 be subjected to assessment/reassessment proceedings having regard to extended time line of 16 years as provided in terms of S. 149(1)(c)?

b) Can Buyer 1 be regarded as a representative assessee in terms of S. 163(1) r.w.s. 149(3) as amended by the Finance Act of 2012?

c) Can Buyer 1 be held to be an assessee in default having regard to provisions of S. 195(1) read with Explanation 2 to S. 195(1) as introduced by Finance Act, 2012 w.r.e.f. 1-4-1962.

d) Can ICO be regarded as an agent in terms of S. 163(1)(c)?

e) Would it have made any difference for the parties had they obtained ruling from AAR or Tax Authority at the time of purchase?

f ) Would it be advisable for FCO 1 to furnish return of income on a voluntary basis?

g) Can the seller or buyer company be visited with interest or penalty levy?

7 With regard to transaction 2, similar issues may be debated. Additionally, please also evaluate if the group can expect any relief on the ground that transaction 1 has been (or, had the potential of being) subjected to tax.

8 FCO1 has since distributed major part of its worth as dividend. FCO 2 happened to gift its assets to a group concern in 2011. None of them has any assets available to discharge the demand, if raised.


a) S. 9(1)(i), 2(14), 2(47) as amended by Finance Act, 2012.

b) S. 147, 163, 195, as amended by Finance Act, 2012.

c) S. 119 of FA 2012 captioned ‘Validation of demand, etc.’

d) S. 179 / 281 of IT Act.

e) Explanatory Memorandum and notes on clauses of FA 2012 to the extent relevant.

qqq





Reference Material

Income-tax Act, 1961

Definitions

Sec. 2(14) “capital asset” means property of any kind held by an assessee, whether or not connected with his business or profession, but does not include—

(i) to (vi) not reproduced

Explanation.—For the removal of doubts, it is hereby clarified that “property” includes and shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever;

Sec. 2(47) “transfer”, in relation to a capital asset, includes,—

(i) the sale, exchange or relinquishment of the asset ; or

(ii) the extinguishment of any rights therein ; or

(iii) to (vi) and Explanation 1 not reproduced.

Explanation 2.—For the removal of doubts, it is hereby clarified that “transfer” includes and shall be deemed to have always included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterised as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India;

Income deemed to accrue or arise in India

Sec. 9. (1) The following incomes shall be deemed to accrue or arise in India :—

(i) all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India.

Explanation 1 & 2 not reproduced.

Explanation 3.—Where a business is carried on in India through a person referred to in clause (a) or clause (b) or clause (c) of Explanation 2, only so much of income as is attributable to the operations carried out in India shall be deemed to accrue or arise in India.]

Explanation 4.—For the removal of doubts, it is hereby clarified that the expression “through” shall mean and include and shall be deemed to have always meant and included “by means of ”, “in consequence of” or “by reason of”.

Explanation 5.—For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India;

(iv) a dividend paid by an Indian company outside India;



Mode of computation

Sec. 48. The income chargeable under the head “Capital gains” shall be computed, by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset the following amounts, namely :—

(i) expenditure incurred wholly and exclusively in connection with such transfer;

(ii) the cost of acquisition of the asset and the cost of any improvement thereto:

Provided that in the case of an assessee, who is a non-resident, capital gains arising from the transfer of a capital asset being shares in, or debentures of, an Indian company shall be computed by converting the cost of acquisition, expenditure incurred wholly and exclusively in connection with such transfer and the full value of the consideration received or accruing as a result of the transfer of the capital asset into the same foreign currency as was initially utilised in the purchase of the shares or debentures, and the capital gains so computed in such foreign currency shall be reconverted into Indian currency, so, however, that the aforesaid manner of computation of capital gains shall be applicable in respect of capital gains accruing or arising from every reinvestment thereafter in, and sale of, shares in, or debentures of, an Indian company :

Provided further that where long-term capital gain arises from the transfer of a long-term capital asset, other than capital gain arising to a non-resident from the transfer of shares in, or debentures of, an Indian company referred to in the first proviso, the provisions of clause (ii) shall have effect as if for the words “cost of acquisition” and “cost of any improvement”, the words “indexed cost of acquisition” and “indexed cost of any improvement” had respectively been substituted:

Provided also that nothing contained in the second proviso shall apply to the long-term capital gain arising from the transfer of a long-term capital asset being bond or debenture other than capital indexed bonds issued by the Government:

Provided also that where shares, debentures or warrants referred to in the proviso to clause (iii) of section 47 are transferred under a gift or an irrevocable trust, the market value on the date of such transfer shall be deemed to be the full value of consideration received or accruing as a result of transfer for the purposes of this section:

Provided also that no deduction shall be allowed in computing the income chargeable under the head “Capital gains” in respect of any sum paid on account of securities transaction tax under Chapter VII of the Finance (No. 2) Act, 2004.

Explanation.—For the purposes of this section,—

(i) “foreign currency” and “Indian currency” shall have the meanings respectively assigned to them in section 2 of the Foreign Exchange Regulation Act, 1973 (46 of 1973);

(ii) the conversion of Indian currency into foreign currency and the reconversion of foreign currency into Indian currency shall be at the rate of exchange prescribed in this behalf;

(iii) “indexed cost of acquisition” means an amount which bears to the cost of acquisition the same proportion as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the first year in which the asset was held by the assessee or for the year beginning on the 1st day of April, 1981, whichever is later;



(iv) “indexed cost of any improvement” means an amount which bears to the cost of improvement the same proportion as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the year in which the improvement to the asset took place;

(v) “Cost Inflation Index”, in relation to a previous year, means such Index as the Central Government may, having regard to seventy-five per cent of average rise in the Consumer Price Index for urban non-manual employees for the immediately preceding previous year to such previous year, by notification in the Official Gazette, specify, in this behalf.

Tax on long-term capital gains.

Sec. 112. (1) Where the total income of an assessee includes any income, arising from the transfer of a long-term capital asset, which is chargeable under the head “Capital gains”, the tax payable by the assessee on the total income shall be the aggregate of,—

(a) in the case of an individual or a Hindu undivided family, being a resident,—

(i) the amount of income-tax payable on the total income as reduced by the amount of such long-term capital gains, had the total income as so reduced been his total income ; and

(ii) the amount of income-tax calculated on such long-term capital gains at the rate of twenty per cent :

Provided that where the total income as reduced by such long-term capital gains is below the maximum amount which is not chargeable to income-tax, then, such long-term capital gains shall be reduced by the amount by which the total income as so reduced falls short of the maximum amount which is not chargeable to income-tax and the tax on the balance of such long-term capital gains shall be computed at the rate of twenty per cent ;

(b) in the case of a domestic company,—

(i) the amount of income-tax payable on the total income as reduced by the amount of such long-term capital gains, had the total income as so reduced been its total income ; and

(ii) the amount of income-tax calculated on such long-term capital gains at the rate of twenty per cent :

[(c) in the case of a non-resident (not being a company) or a foreign company,—

(i) the amount of income-tax payable on the total income as reduced by the amount of such long-term capital gains, had the total income as so reduced been its total income ; and

(ii) the amount of income-tax calculated on such long-term capital gains at the rate of twenty per cent;

The following sub-clauses (ii) and (iii) shall be substituted for sub-clause (ii) of clause (c) of sub-section (1) of section 112 by the Finance Act, 2012, w.e.f. 1-4-2013 :

(ii) the amount of income-tax calculated on long-term capital gains [except where such gain arises from transfer of capital asset referred to in sub-clause (iii)] at the rate of twenty per cent; and

(iii) the amount of income-tax on long-term capital gains arising from the transfer of a capital asset, being unlisted securities, calculated at the rate of ten per cent on the capital gains in respect of such asset as computed without giving effect to the first and second proviso to section 48;



[(d)] in any other case of a resident,—

(i) the amount of income-tax payable on the total income as reduced by the amount of long-term capital gains, had the total income as so reduced been its total income ; and

(ii) the amount of income-tax calculated on such long-term capital gains at the rate of twenty per cent.

Provided that where the tax payable in respect of any income arising from the transfer of a long-term capital asset, being listed securities or unit or zero coupon bond], exceeds ten per cent of the amount of capital gains before giving effect to the provisions of the second proviso to section 48, then, such excess shall be ignored for the purpose of computing the tax payable by the assessee.

Explanation.—For the purposes of this sub-section,—

(a) “listed securities” means the securities—

(i) as defined in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (32 of 1956); and

(ii) listed in any recognised stock exchange in India;

The following clauses (a), (aa) and (ab) shall be substituted for clause (a) of Explanation to section 112 by the Finance Act, 2012, w.e.f. 1-4-2013 :

(a) the expression “securities” shall have the meaning assigned to it in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (32 of 1956);

(aa) “listed securities” means the securities which are listed on any recognised stock exchange in India;

(ab) “unlisted securities” means securities other than listed securities;

(b) “unit” shall have the meaning assigned to it in clause (b) of Explanation to section 115AB.]]

(2) Where the gross total income of an assessee includes any income arising from the transfer of a long-term capital asset, the gross total income shall be reduced by the amount of such income and the deduction under Chapter VI-A shall be allowed as if the gross total income as so reduced were the gross total income of the assessee.

(3) Where the total income of an assessee includes any income arising from the transfer of a long-term capital asset, the total income shall be reduced by the amount of such income and the rebate under section 88 shall be allowed from the income-tax on the total income as so reduced.

Income escaping assessment147. If the Assessing Officer has reason to believe that any income chargeable to tax has escaped

assessment for any assessment year, he may, subject to the provisions of sections 148 to 153, assess or reassess such income and also any other income chargeable to tax which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under this section, or recompute the loss or the depreciation allowance or any other allowance, as the case may be, for the assessment year concerned (hereafter in this section and in sections 148 to 153 referred to as the relevant assessment year) :



Provided that where an assessment under sub-section (3) of section 143 or this section has been made for the relevant assessment year, no action shall be taken under this section after the expiry of four years from the end of the relevant assessment year, unless any income chargeable to tax has escaped assessment for such assessment year by reason of the failure on the part of the assessee to make a return under section 139 or in response to a notice issued under sub-section (1) of section 142 or section 148 or to disclose fully and truly all material facts necessary for his assessment, for that assessment year:

Provided further that nothing contained in the first proviso shall apply in a case where any income in relation to any asset (including financial interest in any entity) located outside India, chargeable to tax, has escaped assessment for any assessment year:

Provided also that the Assessing Officer may assess or reassess such income, other than the income involving matters which are the subject matters of any appeal, reference or revision, which is chargeable to tax and has escaped assessment.

Explanation 1.—Production before the Assessing Officer of account books or other evidence from which material evidence could with due diligence have been discovered by the Assessing Officer will not necessarily amount to disclosure within the meaning of the foregoing proviso.

Explanation 2.—For the purposes of this section, the following shall also be deemed to be cases where income chargeable to tax has escaped assessment, namely :—

(a) where no return of income has been furnished by the assessee although his total income or the total income of any other person in respect of which he is assessable under this Act during the previous year exceeded the maximum amount which is not chargeable to income-tax ;

(b) where a return of income has been furnished by the assessee but no assessment has been made and it is noticed by the Assessing Officer that the assessee has understated the income or has claimed excessive loss, deduction, allowance or relief in the return ;

(ba) where the assessee has failed to furnish a report in respect of any international transaction which he was so required under section 92E;

(c) where an assessment has been made, but—

(i) income chargeable to tax has been underassessed ; or

(ii) such income has been assessed at too low a rate ; or

(iii) such income has been made the subject of excessive relief under this Act ; or

(iv) excessive loss or depreciation allowance or any other allowance under this Act has been computed;

(d) where a person is found to have any asset (including financial interest in any entity) located outside India.

Explanation 3.—For the purpose of assessment or reassessment under this section, the Assessing Officer may assess or reassess the income in respect of any issue, which has escaped assessment, and such issue comes to his notice subsequently in the course of the proceedings under this section, notwithstanding that the reasons for such issue have not been included in the reasons recorded under sub-section (2) of section 148.



Explanation 4.—For the removal of doubts, it is hereby clarified that the provisions of this section, as amended by the Finance Act, 2012, shall also be applicable for any assessment year beginning on or before the 1st day of April, 2012.

Time limit for notice.

149. (1) No notice under section 148 shall be issued for the relevant assessment year,—

(a) if four years have elapsed from the end of the relevant assessment year, unless the case falls under clause (b) [or clause (c)];

(b) if four years, but not more than six years, have elapsed from the end of the relevant assessment year unless the income chargeable to tax which has escaped assessment amounts to or is likely to amount to one lakh rupees or more for that year;

[(c) if four years, but not more than sixteen years, have elapsed from the end of the relevant assessment year unless the income in relation to any asset (including financial interest in any entity) located outside India, chargeable to tax, has escaped assessment.]

Explanation.—In determining income chargeable to tax which has escaped assessment for the purposes of this sub-section, the provisions of Explanation 2 of section 147 shall apply as they apply for the purposes of that section.

(2) The provisions of sub-section (1) as to the issue of notice shall be subject to the provisions of section 151.

(3) If the person on whom a notice under section 148 is to be served is a person treated as the agent of a non-resident under section 163 and the assessment, reassessment or recomputation to be made in pursuance of the notice is to be made on him as the agent of such non-resident, the notice shall not be issued after the expiry of a period of [six] years from the end of the relevant assessment year.

[Explanation.— For the removal of doubts, it is hereby clarified that the provisions of sub-sections (1) and (3), as amended by the Finance Act, 2012, shall also be applicable for any assessment year beginning on or before the 1st day of April, 2012.]

Who may be regarded as agent.

163. (1) For the purposes of this Act, “agent”, in relation to a non-resident, includes any person in India—

(a) who is employed by or on behalf of the non-resident; or

(b) who has any business connection with the non-resident; or

(c) from or through whom the non-resident is in receipt of any income, whether directly or indirectly; or

(d) who is the trustee of the non-resident;

and includes also any other person who, whether a resident or non-resident, has acquired by means of a transfer, a capital asset in India :



Provided that a broker in India who, in respect of any transactions, does not deal directly with or on behalf of a non-resident principal but deals with or through a non-resident broker shall not be deemed to be an agent under this section in respect of such transactions, if the following conditions are fulfilled, namely:—

(i) the transactions are carried on in the ordinary course of business through the first-mentioned broker; and

(ii) the non-resident broker is carrying on such transactions in the ordinary course of his business and not as a principal.

Explanation.—For the purposes of this sub-section, the expression “business connection” shall have the meaning assigned to it in Explanation 2 to clause (i) of sub-section (1) of section 9 of this Act.

(2) No person shall be treated as the agent of a non-resident unless he has had an opportunity of being heard by the Assessing Officer as to his liability to be treated as such.

Other sums.

195. (1) Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest referred to in section 194LB or section 194LC) or any other sum chargeable under the provisions of this Act (not being income chargeable under the head “Salaries”) shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force:

Provided that in the case of interest payable by the Government or a public sector bank within the meaning of clause (23D) of section 10 or a public financial institution within the meaning of that clause, deduction of tax shall be made only at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode:

Provided further that no such deduction shall be made in respect of any dividends referred to in section 115-O.

Explanation 1—For the purposes of this section, where any interest or other sum as aforesaid is credited to any account, whether called “Interest payable account” or “Suspense account” or by any other name, in the books of account of the person liable to pay such income, such crediting shall be deemed to be credit of such income to the account of the payee and the provisions of this section shall apply accordingly.

Explanation 2.—For the removal of doubts, it is hereby clarified that the obligation to comply with sub-section

(1) and to make deduction thereunder applies and shall be deemed to have always applied and extends and shall be deemed to have always extended to all persons, resident or non-resident, whether or not the non-resident person has—

(i) a residence or place of business or business connection in India; or

(ii) any other presence in any manner whatsoever in India.



(2) Where the person responsible for paying any such sum chargeable under this Act (other than salary) to a non-resident considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make an application to the Assessing Officer to determine, by general or special order, the appropriate proportion of such sum so chargeable, and upon such determination, tax shall be deducted under sub-section (1) only on that proportion of the sum which is so chargeable.

(3) Subject to rules made under sub-section (5), any person entitled to receive any interest or other sum on which income-tax has to be deducted under sub-section (1) may make an application in the prescribed form to the Assessing Officer for the grant of a certificate authorising him to receive such interest or other sum without deduction of tax under that sub-section, and where any such certificate is granted, every person responsible for paying such interest or other sum to the person to whom such certificate is granted shall, so long as the certificate is in force, make payment of such interest or other sum without deducting tax thereon under sub-section (1).

(4) A certificate granted under sub-section (3) shall remain in force till the expiry of the period specified therein or, if it is cancelled by the Assessing Officer before the expiry of such period, till such cancellation.

(5) The Board may, having regard to the convenience of assessees and the interests of revenue, by notification in the Official Gazette, make rules specifying the cases in which, and the circumstances under which, an application may be made for the grant of a certificate under sub-section (3) and the conditions subject to which such certificate may be granted and providing for all other matters connected therewith.]

(6) The person referred to in sub-section (1) shall furnish the information relating to payment of any sum in such form and manner as may be prescribed by the Board.]

(7) Notwithstanding anything contained in sub-section (1) and sub-section (2), the Board may, by notification in the Official Gazette, specify a class of persons or cases, where the person responsible for paying to a non-resident, not being a company, or to a foreign company, any sum, whether or not chargeable under the provisions of this Act, shall make an application to the Assessing Officer to determine, by general or special order, the appropriate proportion of sum chargeable, and upon such determination, tax shall be deducted under sub-section (1) on that proportion of the sum which is so chargeable.

Liability of directors of private company in liquidation.

Sec. 179. (1)] Notwithstanding anything contained in the Companies Act, 1956 (1 of 1956), where any tax due from a private company in respect of any income of any previous year or from any other company in respect of any income of any previous year during which such other company was a private company cannot be recovered, then, every person who was a director of the private company at any time during the relevant previous year shall be jointly and severally liable for the payment of such tax unless he proves that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.

(2) Where a private company is converted into a public company and the tax assessed in respect of any income of any previous year during which such company was a private company cannot be recovered, then, nothing contained in sub-section (1) shall apply to any person who was a director of such private company in relation to any tax due in respect of any income of such private company assessable for any assessment year commencing before the 1st day of April, 1962.



Certain transfers to be void

Sec. 281. (1) Where, during the pendency of any proceeding under this Act or after the completion thereof, but before the service of notice under rule 2 of the Second Schedule, any assessee creates a charge on, or parts with the possession (by way of sale, mortgage, gift, exchange or any other mode of transfer whatsoever) of, any of his assets in favour of any other person, such charge or transfer shall be void as against any claim in respect of any tax or any other sum payable by the assessee as a result of the completion of the said proceeding or otherwise :

Provided that such charge or transfer shall not be void if it is made—

(i) for adequate consideration and without notice of the pendency of such proceeding or, as the case may be, without notice of such tax or other sum payable by the assessee ; or

(ii) with the previous permission of the Assessing Officer.

(2) This section applies to cases where the amount of tax or other sum payable or likely to be payable exceeds five thousand rupees and the assets charged or transferred exceed ten thousand rupees in value.

Explanation.—In this section, “assets” means land, building, machinery, plant, shares, securities and fixed deposits in banks, to the extent to which any of the assets aforesaid does not form part of the stock-in-trade of the business of the assessee.

Finance Act, 2012Validation of demands, etc., under Income-tax Act, 1961 in certain cases.

Sec. 119. Notwithstanding anything contained in any judgment, decree or order of any Court or Tribunal or any authority, all notices sent or purporting to have been sent, or taxes levied, demanded, assessed, imposed, collected or recovered or purporting to have been levied, demanded, assessed, imposed, collected or recovered under the provisions of Income-tax Act, 1961 (43 of 1961), in respect of income accruing or arising through or from the transfer of a capital asset situate in India in consequence of the transfer of a share or shares of a company registered or incorporated outside India or in consequence of an agreement, or otherwise, outside India, shall be deemed to have been validly made, and the notice, levy, demand, assessment, imposition, collection or recovery of tax shall be valid and shall be deemed always to have been valid and shall not be called in question on the ground that the tax was not chargeable or any ground including that it is a tax on capital gains arising out of transactions which have taken place outside India, and accordingly, any tax levied, demanded, assessed, imposed or deposited before the commencement of this Act and chargeable for a period prior to such commencement but not collected or recovered before such commencement, may be collected or recovered and appropriated in accordance with the provisions of the Income-tax Act, 1961 as amended by this Act, and the rules made thereunder and there shall be no liability or obligation to make any refund whatsoever.

Income-tax Rules, 1962

Rate of exchange for conversion into rupees of income expressed in foreign currency.

Rule 115. (1) The rate of exchange for the calculation of the value in rupees of any income accruing or arising or deemed to accrue or arise to the assessee in foreign currency or received or deemed to be received by him or on his behalf in foreign currency shall be the telegraphic transfer buying rate of such currency as on the specified date.



Explanation : For the purposes of this rule,—

(1) “telegraphic transfer buying rate” shall have the same meaning as in the Explanation to rule 26;

(2) “specified date” means—

(a) in respect of income chargeable under the head “Salaries”, the last day of the month immediately preceding the month in which the salary is due, or is paid in advance or in arrears;

(b) in respect of income by way of “interest on securities”, the last day of the month immediately preceding the month in which the income is due;

(c) in respect of income chargeable under the heads “Income from house property”, “Profits and gains of business or profession” [not being income referred to in clause (d)] and “Income from other sources” (not being income by way of dividends and “Interest on securities”), the last day of the previous year of the assessee;

(d) in respect of income chargeable under the head “Profits and gains of business or profession” in the case of a non-resident engaged in the business of operation of ships, the last day of the month immediately preceding the month in which such income is deemed to accrue or arise in India ;

(e) in respect of income by way of dividends, the last day of the month immediately preceding the month in which the dividend is declared, distributed or paid by the company;

(f ) in respect of income chargeable under the head “Capital gains”, the last day of the month immediately preceding the month in which the capital asset is transferred :]

Provided that the specified date, in respect of income referred to in sub-clauses (a) to (f ) payable in foreign currency and from which tax has been deducted at source under rule 26, shall be the date on which the tax was required to be deducted] under the provisions of the Chapter XVII-B.

[(2) Nothing contained in sub-rule (1) shall apply in respect of income referred to in clause (c) of the Explanation to sub-rule (1) where such income is received in, or brought into India by the assessee or on his behalf before the specified date in accordance with the provisions of the Foreign Exchange Regulation Act, 1973 (46 of 1973).

Rate of exchange for conversion of rupees into foreign currency and reconversion of foreign currency into rupees for the purpose of computation of capital gains under the proviso to clause (a) of sub-section (1) of section 48 of the Income-tax Act, 1961.

Rule 115A. For the purpose of computing capital gains arising from the transfer of a capital asset being shares in, or debentures of, an Indian company, in the case of an assessee who is a non-resident Indian, the rate of exchange shall be :—

(a) for converting the cost of acquisition of the capital asset, the average of the telegraphic transfer buying rate and telegraphic transfer selling rate of the foreign currency initially utilised in the purchase of the said asset, as on the date of its acquisition;

(b) for converting expenditure incurred wholly and exclusively in connection with the transfer of the capital asset referred to in clause (a), the average of the telegraphic transfer buying rate and telegraphic transfer selling rate of the foreign currency initially utilised in the purchase of the said asset, as on the date of transfer of the capital asset;



(c) for converting the full value of consideration received or accruing as a result of the transfer of the capital asset referred to in clause (a), the average of the telegraphic transfer buying rate and telegraphic transfer selling rate of the foreign currency initially utilised in the purchase of the said asset, as on the date of transfer of the capital asset;

(d) for reconverting capital gains computed in the foreign currency initially utilised in the purchase of the capital asset into rupees, the telegraphic transfer buying rate of such currency, as on the date of transfer of the capital asset.

Explanation : For the purposes of this rule—

(i) “telegraphic transfer buying rate” shall have the same meaning as in the Explanation to rule 26;

(ii) “telegraphic transfer selling rate”, in relation to a foreign currency, means the rate of exchange adopted by the State Bank of India constituted under the State Bank of India Act, 1955 (23 of 1955), for selling such currency where such currency is made available by that bank through telegraphic transfer.]

Securities Contracts (Regulation) Act, 1956Sec. 2(h) “securities” include—

(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;

(ia) derivative;

(ib) units or any other instrument issued by any collective investment scheme to the investors in such schemes;

(ic) security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;

(id) units or any other such instrument issued to the investors under any mutual fund scheme;

(ii) Government securities;

(iia) such other instruments as may be declared by the Central Government to be securities; and

(iii) rights or interest in securities;

Extracts from Tax Treaties

India-Netherlands DTAA

ARTICLE 10 - Dividends 1. Dividends paid by a company which is a resident of one of the States to a resident of the

other State may be taxed in that other State.

[2. However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the recipient is the beneficial owner of the dividends, the tax so charged shall not exceed 10 per cent of the gross amount of the dividends.]

3. The competent authorities of the States shall by mutual agreement settle the mode of application of paragraph 2.

4. The provisions of paragraph 2 shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.



5. The term “dividend” as used in this Article means income from shares, “jouissance” shares or “jouissance” rights, mining shares, founders’ shares or other rights participating in profits, as well as income from debt-claims participating in profits and income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident.

6. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the dividends, being a resident of one of the States, carries on business in the other State of which the company paying the dividends is a resident, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the holding in respect of which the dividends are paid is effectively connected with such permanent establishment or fixed base. In such case, the provisions of Article 7 or Article 14, as the case may be, shall apply.

7. Where a company which is a resident of one of the States derives profits or income from the other State, that other State may not impose any tax on the dividends paid by the company, except in so far as such dividends are paid to a resident of that other State or in so far as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment or a fixed base situated in that other State, nor subject the company’s undistributed profits to a tax on the company’s undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State.

India-Singapore DTAA

ARTICLE 10 : Dividends

1. Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.

2. However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the recipient is the beneficial owner of the dividends, the tax so charged shall not exceed :

(a) 10 per cent of the gross amount of the dividends if the beneficial owner is a company which owns at least 25 per cent of the shares of the company paying the dividends;

(b) 15 per cent of the gross amount of the dividends in all other cases.

This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.

3. Notwithstanding the provisions of paragraph 2 of this Article, as long as Singapore does not impose a tax on dividends in addition to the tax chargeable on the profits or income of a company, dividends paid by a company which is a resident of Singapore to a resident of India shall be exempt from any tax in Singapore which may be chargeable on dividends in addition to the tax chargeable on the profits or income of the company.

4. The term “dividends” as used in this Article means income from shares or other rights not being debt-claims, participating in profits, as well as income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident.



5. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the dividends, being a resident of a Contracting State, carries on business in the other Contracting State of which the company paying the dividends is a resident through a permanent establishment situated therein or performs in that other State independent personal services from a fixed base situated therein, and the holding in respect of which the dividends are paid is effectively connected with such permanent establishment or fixed base. In such case, the provisions of Article 7 or Article 14, as the case may be, shall apply.

6. Where a company which is a resident of a Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the dividends paid by the company except insofar as such dividends are paid to a resident of that other State or so far as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment or a fixed base situated in that other State, nor subject the company’s undistributed profits to a tax on the company’s undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State.

7. (a) Dividends shall be deemed to arise in India if they are paid by a company which is a resident of India;

(b) Dividends shall be deemed to arise in Singapore:

(i) if they are paid by a company which is a resident of Singapore; or

(ii) if they are paid by a company which is a resident of Malaysia out of profits arising in Singapore and qualifying as dividends arising in Singapore under Article VII of the Agreement for the Avoidance of Double Taxation between Singapore and Malaysia signed on 26th December, 1968.

ARTICLE 23 : INCOME NOT EXPRESSLY MENTIONED - Items of income which are not expressly mentioned in the foregoing Articles of this Agreement may be taxed in accordance with the taxation laws of the respective Contracting States.

India-Mauritius DTAA

ARTICLE 10 - Dividends


2. However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the recipient is the beneficial owner of the dividends the tax so charged shall not exceed—

(a) five per cent of the gross amount of the dividends if the beneficial owner is a company which holds directly at least 10 per cent of the capital of the company paying the dividends;

(b) fifteen per cent of the gross amount of the dividends in all other cases.

This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.



3. Notwithstanding the provisions of paragraph (2), dividends paid by a company which is a resident of Mauritius to a resident of India may be taxed in Mauritius and according to the laws of Mauritius, as long as dividends paid by companies which are residents of Mauritius are allowed as deductible expenses for determining their taxable profits. However, the tax charged shall not exceed the rate of the Mauritius tax on profit of the company paying the dividends.

4. The term “dividends” as used in this Article means income from shares or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the Contracting State of which the company making the distribution is a resident.

5. The provisions of paragraphs (1), (2) and (3) shall not apply if the beneficial owner of the dividends, being a resident of the Contracting State, carries on business in the other Contracting State of which the company paying the dividends is a resident, through a permanent establishment situated therein or performs in that other State independent personal services from a fixed base situated therein and the holding in respect of which the dividends are paid is effectively connected with such permanent establishment or fixed base. In such a case, the provisions of article 7 or article 14, as the case may be, shall apply.

6. Where a company which is a resident of a Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the dividends paid by the company, except in so far as such dividends are paid to a resident of that other State or in so far as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment or a fixed base situated in that other State nor subject the company’s undistributed profits to a tax on the company’s undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State.

ARTICLE 13 - Capital gains

1. Gains from the alienation of immovable property, as defined in paragraph (2) of article 6, may be taxed in the Contracting State in which such property is situated.

2. Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or together with the whole enterprise) or of such a fixed base, may be taxed in that other State.

3. Notwithstanding the provisions of paragraph (2) of this article, gains from the alienation of ships and aircraft operated in international traffic and movable property pertaining to the operation of such ships and aircraft, shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.

4. Gains derived by a resident of a Contracting State from the alienation of any property other than those mentioned in paragraphs (1), (2) and (3) of this article shall be taxable only in that State.

5. For the purposes of this article, the term “alienation” means the sale, exchange, transfer, or relinquishment of the property or the extinguishment of any rights therein or the compulsory acquisition thereof under any law in force in the respective Contracting States.



ARTICLE 22 - Other income1. Subject to the provisions of paragraph (2) of this article, items of income of a resident of a

Contracting State, wherever arising, which are not expressly dealt with in the foregoing articles of this Convention, shall be taxable only in that Contracting State.

2. The provisions of paragraph (1) shall not apply to income, other than income from immovable property as defined in paragraph (2) of article 6, if the recipient of such income, being a resident of a Contracting State, carries on business in the other Contracting State through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein and the right or property in respect of which the income is paid is effectively connected with such permanent establishment or fixed base. In such case, the provisions of article 7 or article 14, as the case may be, shall apply.

India-USA DTAA

ARTICLE 10 - Dividends


2. However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident, and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed:

(a) 15 per cent of the gross amount of the dividends if the beneficial owner is a company which owns at least 10 per cent of the voting stock of the company paying the dividends.

(b) 25 per cent of the gross amount of the dividends in all other cases.

Sub-paragraph (b) and not sub-paragraph (a) shall apply in the case of dividends paid by a United States person which is a Regulated Investment Company. Sub-paragraph (a) shall not apply to dividends paid by a United States person which is a Real Estate Investment Trust, and sub-paragraph (b) shall only apply if the dividend is beneficially owned by an individual holding less than 10 per cent interest in the Real Estate Investment Trust. This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.

3. The term “dividends” as used in this Article means income from shares or other rights, not being debt-claims, participating in profits, income from other corporate rights which are subjected to the same taxation treatment as income from shares by the taxation laws of the State of which the company making the distribution is a resident; and income from arrangements, including debt obligations, carrying the right to participate in profits, to the extent so characterised under the laws of the Contracting State in which the income arises.

4. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the dividends, being a resident of a Contracting State, carries on business in the other Contracting State, of which the company paying the dividends is a resident, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the dividends are attributable to such permanent establishment or fixed base. In such case the provisions of Article 7 (Business Profits) or Article 15 (Independent Personal Services), as the case may be, shall apply.



5. Where a company which is a resident of a Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the dividends paid by the company except insofar as such dividends are paid to a resident of that other State or insofar as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment or a fixed base situated in that other State, nor subject the company’s undistributed profits to a tax on the company’s undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State.

ARTICLE 13 — Gains — Except as provided in Article 8 (Shipping and Air Transport) of this Convention, each Contracting State may tax capital gains in accordance with the provisions of its domestic law.

ARTICLE 23 — Other income

1. Subject to the provisions of paragraph 2, items of income of a resident of a Contracting State, wherever arising, which are not expressly dealt with in the foregoing Articles of this Convention shall be taxable only in that Contracting State.

2. The provisions of paragraph 1 shall not apply to income, other than income from immovable property as defined in paragraph 2 of Article 6 [Income from Immovable Property (Real Property)], if the beneficial owner of the income, being a resident of a Contracting State, carries on business in the other Contracting State through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the income is attributable to such permanent establishment or fixed base. In such case the provisions of Article 7 (Business Profits) or Article 15 (Independent Personal Services), as the case may be, shall apply.

3. Notwithstanding the provisions of paragraphs 1 and 2, items of income of a resident of a Contracting State not dealt with in the foregoing articles of this Convention and arising in the other Contracting State may also be taxed in that other State.

India-Germany DTAA

ARTICLE 13 — Capital gains

1. Gains derived by a resident of a Contracting State from the alienation of immovable property situated in the other Contracting State may be taxed in that other State.

2. Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or with the whole enterprise) or of such fixed base, may be taxed in that other State.

3. Gains from the alienation of ships or aircraft operated in international traffic or movable property pertaining to the operation of such ships or aircraft shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.

4. Gains from the alienation of shares in a company which is a resident of a Contracting State may be taxed in that State.



5. Gains from the alienation of any property other than that referred to in paragraphs 1 to 4 shall be taxable only in the Contracting State of which the alienator is a resident.

India–South Africa DTAA

ARTICLE 13 Capital gains

1. Gains derived by a resident of a Contracting State from the alienation of immovable property referred to in Article 6 and situated in the other Contracting State may be taxed in that other State.

2. Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or with the whole enterprise) or of such fixed base, may be taxed in that other State.

3. Gains of an enterprise of a Contracting State from the alienation of a ship or aircraft operated in international traffic or movable property pertaining to the operation of such ships or aircraft, shall be taxable only in that State.

4. Gains from the alienation of shares or similar rights in a company, or of an interest in a partnership, trust or estate, the assets of which consist principally of immovable property situated in a Contracting State, may be taxed in that State.

5. Gains derived by a resident of a Contracting State from the sale, exchange or other disposition, directly or indirectly, of shares or similar rights in a company, other than those mentioned in paragraph 4, which is a resident of the other Contracting State, may be taxed in that other State.

6. Gains from the alienation of any property other than that referred to in the preceding paragraphs, shall be taxable only in the Contracting State of which the alienator is a resident.

India-China DTAA

ARTICLE 13 — Capital gains

1. Gains derived by a resident of a Contracting State from the alienation of immovable property referred to in Article 6 and situated in the other Contracting State may be taxed in that other Contracting State.

2. Gains from the alienation of movable property forming part of business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or together with the whole enterprise) or of such a fixed base, may be taxed in that other Contracting State.

3. Gains from the alienation of ships or aircraft operated in international traffic or movable property pertaining to the operation of such ships or aircraft shall be taxable only in the Contracting State of which the alienator is a resident.



4. Gains from the alienation of shares of the capital stock of a company the property of which consists directly or indirectly principally of immovable property situated in a Contracting State may be taxed in that Contracting State.

5. Gains from the alienation of any property other than that referred to in the preceding paragraphs of this Article, arising in a Contracting State, may be taxed in that Contracting State.

India-United Kingdom DTAA

ARTICLE 14 — Capital Gains

1. Except as provided in Article 8 (Air Transport) and 9 (Shipping) of this Convention, each Contracting State may tax capital gains in accordance with the provisions of its domestic law.

qqq



Notes



Notes



Notes


General Anti Avoidance Rules with Case Studies

Case Study 1 Inbound investment from Mauritius

Facts• US Co is a company incorporated in the United States of America (‘USA’) and a tax resident

of USA

• US Co is a global conglomerate having subsidiaries in various jurisdictions across the world

• US Co has set-up 100 per cent subsidiary in Mauritius, M Co

• M Co is a tax resident of Mauritius, holding a tax residency certificate issued by the Mauritius Revenue Authorities

• M Co was set up to act as a holding company for investments into India and other Asia Pacific countries

• M Co has two full time employees and has taken office premises on rent in Mauritius

• Board meetings of M Co are held in Mauritius once a quarter for taking business decisions

• M Co has set up 100 per cent subsidiaries in India, I Co 1 and I Co 2

• I Co 1 and I Co 2 are operating companies

• This structure has been in place since the year 2003

• M Co sells the shares of I Co 1 in Financial Year (‘FY’) 2013-14

Structure

General Anti Avoidance Rules with Case Studiesby Pranav Sayta



Issues for consideration1. Whether M Co or US Co could be subject to Income-tax in India on gains from sale of shares

of I Co 1?

2. On what grounds could the tax authorities invoke GAAR to assert taxability on US Co or M Co for gains from sale of shares of I Co 1?

3. What could be the consequences/ Income-tax implications in the hands of US Co/ M Co in case GAAR is invoked by the tax authorities?

4. Whether there could be any tax implications for the buyer wherein GAAR is invoked on the seller for the above sale of shares of I Co 1?

Reference material• GAAR - Chapter X-A of the Income-tax Act, 1961 (‘Act’) — [Sections 95 to 102 of the Act]

• Explanatory memorandum to the Finance Bill, 2012 — GAAR

• Extract of Finance Minister’s budget speech on 16th March, 2012 and extract of Finance Minister’s speech on 7th May, 2012 and 15th May, 2012 on the floors of the Parliament

• Draft guidelines for implementation of GAAR

• Double Taxation Avoidance Agreement (‘DTAA’) between India and USA

• DTAA between India and Mauritius

• Circular No. 789, dated 13th April, 2000 — Clarification regarding taxation of income from dividends and capital gains under the Indo-Mauritius Double Tax Avoidance Convention (DTAC)

• Circular No. 682, dated 30th March, 1994 – Clarification regarding agreement for avoidance of double taxation with Mauritius

• Circular No. 1/2003, dated 10th February, 2003

• Azadi Bachao Andolan (263 ITR 706) (Supreme Court)

• Vodafone International Holdings B.V. (341 ITR 1) (Supreme Court)





Case Study 2 Intra group reorganization

Facts• US Co is a company incorporated in USA and a tax resident of USA

• US Co has a 100 per cent subsidiary in Mauritius, M Co


• M Co has a 100 per cent subsidiary in India, I Co

— I Co is an operating company

• As part of the group reorganization, M Co sells shares of I Co to S Hold Co, a Singapore company in December 2012 at fair market value

— M Co had purchased the shares for ` 10 in the year 2002

— M Co sells the shares in December 2012 for ` 100

• S Hold Co is also a 100 per cent subsidiary of US Co and is set up to act as a holding company for Asia Pacific region

• Group has its regional headquarter in Singapore and also has significant operations in Singapore through S Op Co

• S Hold Co and S Op Co are tax residents of Singapore, holding tax residency certificates issued by the Singapore Revenue Authorities

• S Hold Co’s expenditure in the previous 2 years have been USD 225,000 per annum

• S Hold Co sells the shares of I Co in FY 2014-15

Structure



Issues for consideration1. Whether US Co or M Co or S Hold Co could be subject to Income-tax in India on gains from

sale of shares of I Co by S Hold Co in FY 2014-15?

2. On what grounds could the tax authorities invoke GAAR to assert taxability on US Co or M Co or S Hold Co for gains from sale of shares of I Co?

3. What would be the cost of acquisition for the transferor in respect of the transaction of sale of shares in FY 2014-15?

4. Can the intra-group reorganization of December 2012 and subsequent sale of shares in FY 2014-15 be considered as “pre-ordained” and subject to GAAR?

5. Can the tax authorities invoke GAAR in the above case, even though S Hold Co meets the “limitation of benefit” test under the India-Singapore tax treaty?

6. What could be the consequences/ Income-tax implications in the hands of US Co/M Co/S Hold Co in case GAAR is invoked by the tax authorities?

Reference material• GAAR — Chapter X-A of the Act — [Sections 95 to 102 of the Act]




• DTAA between India and USA


• DTAA between India and Singapore

• Protocol to the India – Singapore DTAA










Case study 3 Singapore based group

Facts• S Co is the ultimate parent company of a Singapore based group and is an operating company

— Group has significant business operations in Singapore

• S Co 1 is the group’s holding company for overseas business interests

• S Co and S Co 1 are tax residents of Singapore holding a tax residency certificate issued by the Singapore Revenue Authorities

• S Co 1 has a subsidiary, M Co which has invested into India


• M Co holds 100% shares of an Indian company I Co since January 2005

• Negotiations are in progress with potential buyers which could result in:

— M Co selling the shares of I Co in FY 2013-14; or

— S Co 1 selling the shares of M Co in FY 2013-14

Structure

Issues for consideration



1. Whether any entity in the structure could be subject to Income-tax in India on gains from sale of shares of I Co?

2. On what grounds could the tax authorities invoke GAAR to assert taxability on any entity in the structure for gains from sale of shares of I Co?

3. What could be the consequences/ Income-tax implications in the hands of the entities in the structure in case GAAR is invoked by the tax authorities?

4. Is there any tax avoidance arising due to the above structure?

5. Whether tax avoidance motive has to be looked at point of investment or divestment?






• DTAA between India and Singapore








Case Study 4 Private Equity Investment

Facts• US based fund manager launches a Private Equity (PE) fund to raise capital from foreign

investors for investment in India. The investors are likely to be in various different jurisdictions.

• Due to regulatory reasons and commercial considerations, it may not be feasible for the foreign investors to individually invest directly into Indian companies (I Cos)

• The fund manager has set up an offshore vehicle, M Co, for pooling funds & investment into I Cos


• M Co has engaged US based fund manager as its investment manager

• The fund manager in turn has engaged an Indian company to act as an investment advisor in India

• All investment decisions are taken in the board meetings of M Co chaired from/held in Mauritius after considering the recommendations of US based fund manager

• Board of directors of M Co comprises representatives from US based fund manager, a couple of Mauritius residents and some independent (non-Indian) directors

• M Co is likely to earn capital gains on sale of shares of I Cos

Structure



Issues for consideration 1. Whether M Co or private equity investors could be subject to Income-tax in India on gains

from sale of shares of I Cos?

2. On what grounds could the tax authorities invoke GAAR to assert taxability on M Co or private equity investors for gains from sale of shares of I Cos?

3. What could be the consequences/ Income-tax implications in the hands of M Co/ private equity investors in case GAAR is invoked by the tax authorities?

Reference material• GAAR-Chapter X-A of the Income-tax Act, 1961 (‘Act’) — [Sections 95 to 102 of the Act]

• Explanatory memorandum to the Finance Bill, 2012 - GAAR




• Circular No. 789, dated 13th April, 2000 - Clarification regarding taxation of income from dividends and capital gains under the Indo-Mauritius Double Tax Avoidance Convention (DTAC)




• AIG [Advance Ruling P.No.10 of 1996, In re] (224 ITR 473) (AAR)

• DLJMB Mauritius Investment Company (228 ITR 268) (AAR)



Case Study 5 Buyback of shares

Facts• US Co is a tax resident of USA

• US Co has a 100 per cent subsidiary in Mauritius, M Co


• M Co holds 90 per cent of the shares of company in India, I Co and balance 10 per cent is held by unrelated parties

• I Co has been paying 10 per cent dividend regularly for the last several years

• I Co has significant accumulated profits

• Board of directors of I Co believes inter alia that :

— Idle cash is available with I Co

— There is a lack of good/convincing opportunities available for investment of idle cash

— Buyback seems a worthwhile option as per current share valuation (i.e., currently, shares of I Co are valued at less than their potential)

• While it is uncertain whether or not in the buyback offer shares will be tendered by the unrelated parties, M Co is likely to tender shares in the buyback offer

Structure



Issues for consideration1. Whether any of the entities in the structure could be subject to Income-tax in India on buyback

of shares of I Co?

2. On what grounds could the tax authorities invoke GAAR and raise a tax demand in respect of the transaction of buyback of shares of I Co?

3. On which entity in the structure could the tax authorities invoke GAAR for the transaction of buyback of shares of I Co?

4. What could be the consequences/ Income-tax implications in the hands of each party, in case GAAR is invoked by the tax authorities?





• DTAA between India and USA


• Circular No. 789, dated 13th April, 2000 - Clarification regarding taxation of income from dividends and capital gains under the Indo-Mauritius Double Tax Avoidance Convention (DTAC)




• Section 46A of the Act – Capital gains on purchase by company of its own shares or other specified securities

• Otis Elevators (AAR) (20 Taxmann 52)



Case Study 6 Funding by Compulsorily Convertible Debentures (‘CCDs’) and

External Commercial Borrowings (‘ECBs’)

Facts• UK Co is a company incorporated in UK

• UK Co is a tax resident of UK, holding a tax residency certificate issued by the UK Revenue Authorities

• UK Co has a 100 per cent subsidiary in Netherlands, N Co

• N Co is a tax resident of Netherlands, holding a tax residency certificate issued by the Netherlands Revenue Authorities

• N Co has a 100 per cent subsidiary in India, I Co

• I Co had issued CCDs to N Co at a coupon rate of 10 per cent

• CCDs were issued on 1st January, 2010

• CCDs are compulsorily convertible into equity shares of I Co on 31st December, 2019

• I Co had also borrowed (ECBs) on 1st January, 2009 from N Co, repayable on 31st December, 2013

• I Co has been paying and will continue to pay interest on 31st December every year in respect of the ECBs and the CCDs (assume that the interest rate is at arm's length & is compliant with exchange control regulations)

• Interest is claimed as an expense deduction and is also subjected to withholding tax

• Capital structure of I Co is as follows:

— Equity – 10

— Debt – 100 (CCDs of 60 and ECBs of 40)

• I Co requires further funds for business purposes and has accordingly, approached N Co

• I Co would be:

— Issuing additional CCDs on 1st July, 2013 of 20

— Availing ECBs of 10 on 1st July, 2013



Structure

Issues for consideration1. What could be the Income-tax implications in the hands of N Co/ I Co/ UK Co in respect of

interest payout by I Co?

2. Whether GAAR could be invoked in respect of past transactions of CCDs and ECBs?

3. On what grounds could the tax authorities invoke GAAR in respect of CCDs as well as ECBs in spite of interest payout being at arm’s length?

4. In whose hands can GAAR be invoked in respect of CCDs and ECBs?

5. What could be the consequences/ Income-tax implications in the hands of N Co/ I Co/ UK Co in case GAAR is invoked by the tax authorities?

Reference material• GAAR — Chapter X-A of the Act - [Sections 95 to 102 of the Act]



• Draft guidelines regarding implementation of GAAR

• DTAA between India and UK

• DTAA between India and Netherlands



• LMN India Limited (307 ITR 40) (AAR)

• Besix Kier Dabhol, SA (134 TTJ 513) (Mumbai ITAT)



Case Study 7 Right to Choose?

Facts• S has acquired shares in an unlisted Indian company as follows:

Year Particulars No. of shares Cost per share (in `)

2007 Purchase 25 10

2009 Bonus 25 -

2010 Rights 50 100

• Above shares in unlisted Indian company are held in dematerialized form in a demat account

• S is contemplating sale of 40 shares

• S transfers 50 shares from the above demat account 1, into a new demat account 2

• S thereafter sells 40 shares for ` 125 per share & transfers/delivers 40 shares to the buyer’s demat account from his old demat account 1

Structure

Issues for consideration1. Is the taxpayer entitled to exercise a choice so as to mitigate his taxes?

2. On what grounds could the tax authorities invoke GAAR to assert taxability on S?

3. What could be the consequences/ Income-tax implications in the hands of S in case GAAR is invoked by the tax authorities?

4. In case GAAR is invoked in respect of the present transaction, what would be the cost of acquisition when the balance 60 shares are sold by S?



Reference Material• GAAR — Chapter X-A of the Act — [Sections 95 to 102 of the Act]




• Section 45(2A) of the Act

• Circular 768 dated 24th June, 1998 – Determination of ‘date of transfer’ and the ‘period of holding of securities’ held in dematerialized form under Section 45(2A) qua transactions in securities



Case Study 8 Transfer of capital asset at loss

Facts• F Co is a foreign company

• F Co has two 100 per cent subsidiaries in India – A Co and B Co

• During the year, A Co has divested its shareholding in X Co to an unrelated party

— A Co has earned substantial long term capital gains (on the above)

— A Co proposes to sell shares of Y Co to B Co at fair market value

• A Co would incur a substantial loss (long term) on account of the above

• A Co proposes to set-off the long term capital loss on sale of shares of Y Co against the long term capital gains earned on sale of shares of X Co

Structure

Issues for consideration1. On what grounds could the tax authorities invoke GAAR on the above transaction of sale of

shares of Y Co?

2. What could be the Income-tax implications in the hands of A Co on the above transaction of sale of shares of Y Co?

3. What could be the Income-tax implications in the hands of B Co if they were to divest these shares eventually?




• Explanatory memorandum to the Finance Bill, 2012 - GAAR





Case study 9A Merger

Facts• F Co holds shares in A Co and B Co

• A Co and B Co are Indian companies

• A Co has huge carried forward tax losses

• B Co is highly profitable company in a mature business which consistently earns cash surplus

• A Co is likely to continue incurring losses for the next few years and will need cash investments and support till its business matures

• It is contemplated to merge B Co with A Co

— Objective of merger is to simplify the holding structure and reduce the number of companies and utilize the cash profit of B Co to support the investment requirements of A Co

• The merger satisfies the conditions of Section 2(1B) of the Act

Structure

Issues for consideration1. On what grounds could the tax authorities invoke GAAR in respect of the above transaction

of merger of B Co to A Co?

2. What would be the impact on:

2.1 Set-off of carried forward losses of A Co

2.2 Set-off of future losses of A Co against profits of B Co

3. What could be the consequences/ Income-tax implications and in the hands of which entity in case GAAR is invoked by the tax authorities?





Case Study 9B Demerger

Facts• F Co holds shares in A Co and B Co

• A Co and B Co are Indian companies and F Co is a foreign company

• A Co has 2 business units – X and Y

• B Co has 1 business unit – Z

• A Co has huge carried forward tax losses

— X and Y are loss making units

• B Co (Unit Z) is highly profitable company in a mature business which consistently earns cash surplus

• It is contemplated to demerge Unit X into B Co

— Objective of demerger is business synergies – Unit X and Unit Z are in similar business activities

• The demerger satisfies conditions of Section 2(19AA) of the Act

Structure

Issues for consideration1. On what grounds could the tax authorities invoke GAAR in respect of the above transaction

of demerger of Unit X into B Co?

2. What would be the impact on:

2.1 Set-off of carried forward losses of Unit X

2.2 Set-off of future losses of Unit X against profits of B Co

3. What could be the consequences/ Income-tax implications and in the hands of which entity in case GAAR is invoked by the tax authorities?







• Vodafone Essar Gujarat, Limited (342 ITR 135) (Gujarat High Court)



Case Study 10A Change in shareholding of holding company

Facts• F Hold Co 1 has a 100 per cent subsidiary, F Hold Co 2

• F Hold Co 2 has a 100 per cent subsidiary in India, Op Co

• Op Co has significant carried forward business losses (tax)

• F Hold Co 1 sells the shares of F Hold Co 2 to Acquirer Co in FY 2013-14

• Subsequent to above sale of shares of F Hold Co 2, Acquirer Co holds 100 per cent shares of F Hold Co 2 which, in turn, holds 100 per cent shares of Op Co

Structure

Issues for consideration

1. On what grounds could the tax authorities invoke GAAR in respect of the above transaction of sale of shares of F Hold Co 2?

2. What would be the impact on set-off of carried forward losses of Op Co?

3. What could be the consequences/ Income-tax implications in case GAAR is invoked by the tax authorities?





• Extract of Finance Minister’s budget speech on 16th March, 2012 and extract of Finance Minister’s speech on 7th May, 2012 and 15 May 2012 on the floors of the Parliament


• Section 79 of the Act



Case Study 10B Change in shareholding of JV Co

Facts• F Co 1 and F Co 2 are foreign companies

• F Co 1 and F Co 2 hold 50 per cent shareholding each in an Indian company, Op Co

• OpCohas significant carried forwardbusiness losses (tax)

• F Co 1 sells 49 per cent of the shares held in Op Co to F Co 2

• Subsequent toabovesaleof sharesofOpCo,FCo2holds99per centof the sharesofOpCoand thebalance1per cent of the sharesareheld byFCo1

• The share purchase agreement betweenFCo 1 andFCo 2 also provides for a call optionforFCo2 to purchase thebalance1 per cent shareholdingofOpCowithin 2 to 5 years ofthedateof the sharepurchaseagreement

Structure

Issues for consideration1. Onwhat grounds could the tax authorities invokeGAAR in respect of the above transaction

of sale of shares of Op Co?

2. Whatwould be the impact on set-off of carried forward lossesofOpCo?

3. What couldbe theconsequences/ Income-tax implications in caseGAAR is invokedby the taxauthorities?

4. Whether the call option to purchase the balance1 per cent shareholdingofOpComakesadifference fromaGAARperspective?



Reference material• GAAR—ChapterX-Aof theAct - [Sections95 to 102of theAct]

• Explanatorymemorandum to theFinanceBill, 2012—GAAR

• Extract of FinanceMinister’s budget speech on 16thMarch, 2012 and extract of FinanceMinister’s speechon7thMay, 2012and15thMay, 2012on the floorsof theParliament

• Draft guidelines regarding implementationofGAAR

• Section79of theAct

qqq



NOTES



Reference Material

Annexure A — Chapter X-A of the Income Tax Act, 1961 (‘Act’)- [Section 95 to 102 of Act]95. Applicability of General Anti-Avoidance Rule.—Notwithstanding anything contained in the Act, an arrangement entered into

by an assessee may be declared to be an impermissible avoidance arrangement and the consequence in relation to tax arising therefrom may be determined subject to the provisions of this Chapter.

Explanation.—For the removal of doubts, it is hereby declared that the provisions of this Chapter may be applied to any step in, or a part of, the arrangement as they are applicable to the arrangement.

Impermissible avoidance arrangement.

96. (1) An impermissible avoidance arrangement means an arrangement, the main purpose or one of the main purposes of which is to obtain a tax benefit and it—

(a) creates rights, or obligations, which are not ordinarily created between persons dealing at arm’s length;

(b) results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act;

(c) lacks commercial substance or is deemed to lack commercial substance under, in whole or in part; or

(d) is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes.

(2) An arrangement shall be presumed to have been entered into, or carried out, for the main purpose of obtaining a tax benefit, if the main purpose of a step in, or a part of, the arrangement is to obtain a tax benefit, notwithstanding the fact that the main purpose of the whole arrangement is not to obtain a tax benefit.

Arrangement to lack commercial substance.

97. (1) An arrangement shall be deemed to lack commercial substance if—

(a) the substance or effect of the arrangement as a whole, is inconsistent with, or differs significantly from, the form of its individual steps or a part; or

(b) it involves or includes—

(i) round trip financing;

(ii) an accommodating party;

(iii) elements that have effect of offsetting or cancelling each other; or

(iv) a transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of funds which is the subject matter of such transaction; or

(c) it involves the location of an asset or of a transaction or of the place of residence of any party which is without any substantial commercial purpose other than obtaining a tax benefit (but for the provisions of this Chapter) for a party.

(2) For the purposes of sub-section (1), round trip financing includes any arrangement in which, through a series of transactions—

(a) funds are transferred among the parties to the arrangement; and

(b) such transactions do not have any substantial commercial purpose other than obtaining the tax benefit (but for the provisions of this Chapter),

without having any regard to—

(A) whether or not the funds involved in the round trip financing can be traced to any funds transferred to, or received by, any party in connection with the arrangement;

(B) the time, or sequence, in which the funds involved in the round trip financing are transferred or received; or



(C) the means by, or manner in, or mode through, which funds involved in the round trip financing are transferred or received.

(3) For the purposes of this Chapter, a party to an arrangement shall be an accommodating party, if the main purpose of the direct or indirect participation of that party in the arrangement, in whole or in part, is to obtain, directly or indirectly, a tax benefit (but for the provisions of this Chapter) for the assessee whether or not the party is a connected person in relation to any party to the arrangement.

(4) The following shall not be taken into account while determining whether an arrangement lacks commercial substance or not, namely:—

(i) the period or time for which the arrangement (including operations therein) exists;

(ii) the fact of payment of taxes, directly or indirectly, under the arrangement;

(iii) the fact that an exit route (including transfer of any activity or business or operations) is provided by the arrangement

Consequence of impermissible avoidance arrangement.

98. (1) If an arrangement is declared to be an impermissible avoidance arrangement, then the consequences, in relation to tax, of the arrangement, including denial of tax benefit or a benefit under a tax treaty, shall be determined, in such manner as is deemed appropriate,| in the circumstances of the case, including by way of but not limited to the| following, namely:—

(a) disregarding, combining or recharacterising any step in, or a part or whole of, the impermissible avoidance arrangement;

(b) treating the impermissible avoidance arrangement as if it had not been entered into or carried out;

(c) disregarding any accommodating party or treating any accommodating party and any other party as one and the same person;

(d) deeming persons who are connected persons in relation to each other to be one and the same person for the purposes of determining tax treatment of any amount;

(e) reallocating amongst the parties to the arrangement—

(i) any accrual, or receipt, of a capital or revenue nature; or

(ii) any expenditure, deduction, relief or rebate;

(f ) treating—

(i) the place of residence of any party to the arrangement; or

(ii) the situs of an asset or of a transaction,

at a place other than the place of residence, location of the asset or location of the transaction as provided under the arrangement; or

(g) considering or looking through any arrangement by disregarding any corporate structure.

(2) For the purposes of sub-section (1),—

(i) any equity may be treated as debt or vice versa;

(ii) any accrual, or receipt, of a capital nature may be treated as of revenue nature or vice versa; or

(iii) any expenditure, deduction, relief or rebate may be recharacterised.

Treatment of connected person and accommodating party.

99. For the purposes of this Chapter, in determining whether a tax benefit exists—

(i) the parties who are connected persons in relation to each other may be treated as one and the same person;



(ii) any accommodating party may be disregarded;

(iii) such accommodating party and any other party may be treated as one and the same person;

(iv) the arrangement may be considered or looked through by disregarding any corporate structure

Application of Chapter.

100. The provisions of this Chapter shall apply in addition to, or in lieu of, any other basis for determination of tax liability

Framing of guidelines.

101. The provisions of this Chapter shall be applied in accordance with such guidelines and subject to such conditions and the manner as may be prescribed.

Definitions.

102. In this Chapter, unless the context otherwise requires,—

(1) “arrangement” means any step in, or a part or whole of, any transaction, operation, scheme, agreement or understanding, whether enforceable or not, and includes the alienation of any property in such transaction, operation, scheme, agreement or understanding;

(2) “asset” includes property, or right, of any kind;

(3) “associated person”, in relation to a person, means—

(a) any relative of the person, if the person is an individual;

(b) any director of the company or any relative of such director, if the person is a company;

(c) any partner or member of a firm or association of persons or body of individuals or any relative of such partner or member if the person is a firm or association of persons or body of individuals;

(d) any member of the Hindu undivided family or any relative of such member, if the person is a Hindu undivided family;

(e) any individual who has a substantial interest in the business of the person or any relative of such individual;

(f ) a company, firm or an association of persons or a body of individuals, whether incorporated or not, or a Hindu undivided family having a substantial interest in the business of the person or any director, partner, or member of the company, firm or association of persons or body of individuals or family, or any relative of such director, partner or member;

(g) a company, firm or association of persons or body of individuals, whether incorporated or not, or a Hindu undivided family, whose director, partner, or member have a substantial interest in the business of the person, or family or any relative of such director, partner or member;

(h) any other person who carries on a business, if—

(i) the person being an individual, or any relative of such person, has a substantial interest in the business of that other person; or

(ii) the person being a company, firm, association of persons, body of individuals, whether incorporated or not, or a Hindu undivided family, or any director, partner or member of such company, firm or association of persons or body of individuals or family, or any relative of such director, partner or member, has a substantial interest in the business of that other person;

(4) “benefit” includes a payment of any kind whether in tangible or intangible form;

(5) “connected person” means any person who is connected directly or indirectly to another person and includes associated person;

(6) “fund” includes—



(a) any cash;

(b) cash equivalents; and

(c) any right, or obligation, to receive, or pay, the cash or cash equivalent;

(7) “party” means any person including a permanent establishment which participates or takes part in an arrangement;

(8) “relative” shall have the meaning assigned to it in the Explanation to clause (vi) of sub-section (2) of;

(9) a person shall be deemed to have a substantial interest in the business, if—

(a) in a case where the business is carried on by a company, such person is, at any time during the financial year, the beneficial owner of equity shares carrying twenty per cent or more, of the voting power; or

(b) in any other case, such person is, at any time during the financial year, beneficially entitled to twenty per cent or more, of the profits of such business;

(10) “step” includes a measure or an action, particularly one of a series taken in order to deal with or achieve a particular thing or object in the arrangement;

(11) “tax benefit” means—

(a) a reduction or avoidance or deferral of tax or other amount payable under this Act; or

(b) an increase in a refund of tax or other amount under this Act; or

(c) a reduction or avoidance or deferral of tax or other amount that would be payable under this Act, as a result of a tax treaty; or

(d) an increase in a refund of tax or other amount under this Act as a result of a tax treaty; or

(e) a reduction in total income including increase in loss, in the relevant previous year or any other previous year.

(12) “tax treaty” means an agreement referred to in sub-section (1) of or sub-section (1) of.

Annexure B — Explanatory memorandum to the Finance Bill, 2012 in respect of GAAR The question of substance over form has consistently arisen in the implementation of taxation laws. In the Indian

context, judicial decisions have varied. While some courts in certain circumstances had held that legal form of transactions can be dispensed with and the real substance of transaction can be considered while applying the taxation laws, others have held that the form is to be given sanctity. The existence of anti-avoidance principles are based on various judicial pronouncements. There are some specific anti-avoidance provisions but general anti-avoidance has been dealt only through judicial decisions in specific cases.

In an environment of moderate rates of tax, it is necessary that the correct tax base be subject to tax in the face of aggressive tax planning and use of opaque low tax jurisdictions for residence as well as for sourcing capital. Most countries have codified the “substance over form” doctrine in the form of General Anti Avoidance Rule (GAAR).

In the above background and keeping in view the aggressive tax planning with the use of sophisticated structures, there is a need for statutory provisions so as to codify the doctrine of “substance over form” where the real intention of the parties and effect of transactions and purpose of an arrangement is taken into account for determining the tax consequences, irrespective of the legal structure that has been superimposed to camouflage the real intent and purpose. Internationally several countries have introduced, and are administering statutory General Anti Avoidance Provisions. It is, therefore, important that Indian taxation law also incorporate a statutory General Anti Avoidance Provisions to deal with aggressive tax planning. The basic criticism of statutory GAAR which is raised worldwide is that it provides a wide discretion and authority to the tax administration which at times is prone to be misused. This vital aspect, therefore, needs to be kept in mind while formulating any GAAR regime.

It is accordingly proposed to provide General Anti Avoidance Rule in the Income Tax Act to deal with aggressive tax planning.



A. The main feature of such a regime are

(i) An arrangement whose main purpose or one of the main purposes is to obtain a tax benefit and which also satisfies at least one of the four tests, can be declared as an “impermissible avoidance arrangements”.

(ii) The four tests referred to in (i) are—

(a) The arrangement creates rights and obligations, which are not normally created between parties dealing at arm’s length.

(b) It results in misuse or abuse of provisions of tax laws.

(c) It lacks commercial substance or is deemed to lack commercial substance.

(d) Is carried out in a manner, which is normally not employed for bona fide purpose.

(iii) It shall be presumed that obtaining of tax benefit is the main purpose of an arrangement unless otherwise proved by the taxpayer.

(iv) An arrangement will be deemed to lack commercial substance if -

(a) the substance or effect of the arrangement as a whole, is inconsistent with, or differs significantly from, the form of its individual steps or a part; or

(b) it involves or includes -

(i) round trip financing;

(ii) an accommodating party ;

(iii) elements that have effect of offsetting or cancelling each other; or

(iv) a transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of fund which is subject matter of such transaction; or

(c) it involves the location of an asset or of a transaction or of the place of residence of any party which would not have been so located for any substantial commercial purpose other than obtaining tax benefit for a party.

(v) It is also provided that certain circumstances like period of existence of arrangement, taxes arising from arrangement, exit route, shall not be taken into account while determining ‘lack of commercial substance’ test for an arrangement.

(vi) Once the arrangement is held to be an impermissible avoidance arrangement then the consequences of the arrangement in relation to tax or benefit under a tax treaty can be determined by keeping in view the circumstances of the case, however, some of the illustrative steps are:-

(a) disregarding or combining any step of the arrangement.

(b) ignoring the arrangement for the purpose of taxation law.

(c) disregarding or combining any party to the arrangement.

(d) reallocating expenses and income between the parties to the arrangement.

(e) relocating place of residence of a party, or location of a transaction or situs of an asset to a place other than provided in the arrangement.

(f ) considering or looking through the arrangement by disregarding any corporate structure.

(g) re-characterizing equity into debt, capital into revenue etc.

(vii) These provisions can be used in addition to or in conjunction with other anti avoidance provisions or provisions for determination of tax liability, which are provided in the taxation law.

(viii) For effective application in cross border transaction and to prevent treaty abuse a limited treaty override is also provided.



B. The procedure for invoking GAAR is proposed as under:—

(i) It is proposed that the Assessing Officer shall make a reference to the Commissioner for invoking GAAR and on receipt of reference the Commissioner shall hear the taxpayer and if he is not satisfied by the reply of taxpayer and is of the opinion that GAAR provisions are to be invoked, he shall refer the matter to an Approving Panel. In case the assessee does not object or reply, the Commissioner shall make determination as to whether the arrangement is an impermissible avoidance arrangement or not.

(ii) The Approving Panel has to dispose of the reference within a period of six months from the end of the month in which the reference was received from the Commissioner.

(iii) The Approving Panel shall either declare an arrangement to be impermissible or declare it not to be so after examining material and getting further inquiry to be made.

(iv) The Assessing Officer (AO) will determine consequences of such a positive declaration of arrangement as impermissible avoidance arrangement.

(v) The final order in case any consequence of GAAR is determined shall be passed by AO only after approval by Commissioner and, thereafter, first appeal against such order shall lie to the Appellate Tribunal.

(vi) The period taken by the proceedings before Commissioner and Approving Panel shall be excluded from time limitation for completion of assessment.

(vii) The Approving Panel shall be set up by the Board and would comprise of officers of rank of Commissioner and above. The panel will have a minimum of three members. The procedure and working of Panel shall be administered through subordinate legislation.

In addition to the above, it is provided that the Board shall prescribe a scheme for regulating the condition and manner of application of these provisions.

These amendments will take effect from 1st April, 2013 and will, accordingly, apply in relation to the assessment year 2013-14 and subsequent assessment years

Annexure C — Extract of finance minister’s speech on 7th May 2012 on the floors of Parliament Para 4. In addition, certain provisions relating to a General Anti-Avoidance Rules (GAAR) have also been proposed

in the Finance Bill, 2012. After examining the recommendations of the Standing Committee on GAAR provisions in the DTC Bill 2010, I propose to amend the GAAR provisions as follows:

(i) Remove the onus of proof entirely from the taxpayer to the Revenue Department before any action can be initiated under GAAR.

(ii) Introduce an independent member in the GAAR approving panel to ensure objectivity and transparency. One member of the panel now would be an officer of the level of Joint Secretary or above from the Ministry of Law.

(iii) Provide that any taxpayer (resident or non-resident) can approach the Authority for Advance Ruling (AAR) for a ruling as to whether an arrangement to be undertaken by her is permissible or not under the GAAR provisions.

5. To provide greater clarity and certainty in the matters relating to GAAR, a Committee has been constituted under the Chairmanship of the Director General of Income Tax (International Taxation) to give recommendations for formulating the rules and guidelines for implementation of the GAAR provisions and to suggest safeguards so that these provisions are not applied indiscriminately. The Committee has already held several rounds of discussion with various stakeholders including the Foreign Institutional Investors. The Committee will submit its recommendations by 31st May 2012.

6. To provide more time to both taxpayers and the tax administration to address all related issues, I propose to defer the applicability of the GAAR provisions by one year. The GAAR provisions will now apply to income of Financial Year 2013-14 and subsequent years.

D. Draft guidelines regarding implementation of General Anti Avoidance Rules (GAAR ) in terms of section 101 of the Income Tax Act, 1961

PRESS RELEASE, DATED 28-6-2012

Background



The Chairman, CBDT, Vide OM F.NO. 500/111/2009-FTD-1 Dated 27 February, 2012 constituted a Committee under the Chairmanship of the Director General of the Income Tax (International Taxation) to give recommendations for formulating the guidelines for proper implementation of GAAR. Provisions under the Direct Tax Code Bill, 2010 and to suggest safeguards to these provisions to curb the abuse thereof. The Committee comprised of the following officers :-

1. Director General of Income Tax (International Taxation)- Chairperson

2. Joint Secretary (FT& TR-I)

3. Joint Secretary (FT& TR-II)

4. Joint Secretary (TPL-I)

5. Director of International Taxation, Ahmedabad

6. Director, FT & TR-III

7. Addl. Director on Income Tax, Range-I (IT), New Delhi, Member Secretary.

The terms of reference of the Committee was as under :-

1. Recommendations for formulating guidelines to implement the provisions of General Anti-Avoidance Rules(GAAR) as per section 123 of the Direct Tax Code Bill, 2010; and

2. Draft a circular as a safeguard so that the GAAR provisions are not applied indiscriminately in every case.

The Committee met for the first time on 6th March, 2012 and felt that the existing provisions of the Direct Tax Code Bill 2010(DTC) needed certain modifications and therefore various specific suggestions were made in this regard. These included suggestions on defining various terms as appearing in the DTC, changing the procedure of invoking the provisions of GAAR, prescribing time limits etc.

Subsequent to the first meeting, the Finance Bill 2012 was presented before the Parliament and it was gathered that most of the suggestions given in the first meeting were addressed in the Finance Bill 2012. The Committee thereafter examined the provisions related to GAAR in the Finance Bill 2012 as modified through Government amendments during the passage of the Bill in Parliament. The recommendations regarding guidelines/circulars have been made in light of the final provisions relating to GAAR in the Finance Act, 2012.

The Committee held several meetings between 06.03.2012 to 28.05.2012.

After exhaustive deliberations and broad based discussions with the officers, representatives of FII’s, members of the advisory committee and others stake holders, the Committee makes the following recommendations which would need to be split between Circulars and the Rules.

Proposals for inclusion in the guidelines

1. Guidelines u/s 101

Section 101 of the Finance Act, 2012, provides that “the provisions of this Chapter shall be applied in accordance with such guidelines and subject to such conditions and the manner as may be prescribed”. The Committee makes the following recommendations to be incorporated in the guidelines.

1. Monetary threshold

The committee feels that in order to avoid the indiscriminate application of the GAAR provisions and to provide relief to small taxpayers, there should be monetary threshold for invoking the GAAR provisions. In this regard, the following recommendation is made by the committee.

Only an arrangement or arrangements where the tax benefit through the arrangement(s) in a year to an assessee is above Rs. ___ lacs will be covered by GAAR provisions.

2. Prescription of statutory forms

The committee feels that consistency of approach is essential in the procedures for invoking the GAAR provisions. It also feels that adequate safeguards should be provided to ensure that principles of natural justice were not violated



and there is transparency in the procedures. Therefore, the committee is of the opinion that there should be prescribed statutory forms for the following:-

1. For the Assessing Officer to make a reference to the Commissioner u/s 144BA(1) (Annexure-A)

2. For the Commissioner to make a reference to the Approving Panel u/s 144BA(4) (Annexure-B)

3. For the Commissioner to return the reference to the Assessing Officer u/s 144BA(5) (Annexure-C)

(The drafts thereof not enclosed)

3. Prescribing the time limits

The committee feels that there should be absolute certainty about the time limits during which the various actions under the GAAR provisions are to be completed. Some of these time lines have been prescribed under the act under sections 144BA(1) and 144BA(13). For the remaining actions the following time lines are suggested by the committee:-

It may be prescribed that in terms of section 144BA(4), the CIT should make a reference to the Approving Panel within 60 days of the receipt of the objection from the assessee and in case of the CIT accepting the assessee’s objection and being satisfied that provision of chapter X-A are not applicable, the CIT shall communicate his decision to the AO within 60 days of the receipt of the assessee’s objection as prescribed under section 144BA(4) r.w.s. 144BA(5). No action u/s 144BA(4) or (5) shall be taken by the Commissioner after the period of six months from the end of the month in which the reference under sub-section 144BA(1) was received by the Commissioner.

2. Recommendations regarding setting up of the Approving Panel u/s 144(BA)

Section 144BA(14) has empowered the CBDT to constitute Approving Panel consisting of not less than 3 members, out of which one member of the panel would be an officer of the level of Joint Secretary or above from the Ministry of Law and the others being the Income Tax Authorities of the rank of Commissioner and above. The committee deliberated on the constitution of this committee for efficient output and has made the following recommendations :-

1. To begin with, there should be one Approving Panel, which shall be situated at Delhi. Subsequently, the CBDT should review the number of Approving Panels required on the basis of the workload in the FY 2014-15.

2. The Approving Panel should comprise of three members, out of which, two members should be of the level of Chief Commissioners of Income Tax and the third member should be an officer of the level of Joint Secretary or above from the Ministry of Law. All the members should be full time members.

3. The Approving Panel should be provided the secretariat staff along with appropriate budgetary and infrastructure support by the CBDT. The secretariat should be headed by an officer of the level of Joint/Additional Commissioner of Income Tax.

3. Recommendations for the Circular on GAAR

1. Explaining the provisions of GAAR

For the purpose of explaining the provisions of GAAR and better understanding thereof, the Committee suggests a detailed note to be included in the circular, which is enclosed as Annexure- D.

2. Special provisions for Foreign Institutional Investors (FII’s)

Foreign Institutional Investors have expressed certain concerns regarding GAAR provisions. The committee met the representatives of Asia Securities Industry & Finance Markets Association and Capital Markets Tax Committee of Asia. After discussions, the representatives of these bodies gave following suggestions to resolve their apprehensions.

1. To exempt Capital Market transactions entirely from the GAAR provisions

2. A flat tax on FII’s gains without any distinction between various transactions could be considered.

3. The tax authorities could attempt to clarify the details of each provision in the GAAR. For this, they gave comments on how the relevant provision may be clarified.



The committee considered the suggestions of the representatives. Option No. (1) & (2) above are not viable options as it is not permitted under the provisions of the Income Tax Act. However option (3) could be considered. For this purpose, safe harbour could be provided to the FII’s subject to the payment of taxes as per domestic law. Accordingly, the committee recommends the following.

Where a Foreign Institutional Investor (FII) chooses not to take any benefit under an agreement entered into by India under section 90 or 90A of the Act and subjects itself to tax in accordance with the domestic law provisions, then, the provisions of Chapter X-A shall not apply to such FII or to the non-resident investors of the FII.

Where an FII chooses to take a treaty benefit, GAAR provisions may be invoked in the case of the FII, but would not in any case be invoked in the case of the non-resident investors of the FII.

3. Clarity regarding retrospective/prospective operations of the GAAR provisions.

Certain apprehensions have been raised regarding the retrospective/prospective operation of the GAAR provisions. It may therefore be clarified that:-

The provisions of GAAR will apply to the income accruing or arising to the taxpayers on or after 01.04.2013.

4. Interplay between Specific Anti-Avoidance Rules (SAAR) and General Anti-Avoidance Rules (GAAR).

Concerns have been raised that there could be interplay between the SAAR and GAAR. The committee examined this issue and the recommendation of the committee is as below:-

While SAARs are promulgated to counter a specific abusive behavior, GAARs are used to support SAARs and to cover transactions that are not covered by SAARs. Under normal circumstances, where specific SAAR is applicable, GAAR will not be invoked. However, in an exceptional case of abusive behavior on the part of a taxpayer that might defeat a SAAR, as illustrated in example no. 16 in Annexure E (or similar cases), GAAR could also be invoked.

5. Definition of “connected person”.

Concerns have been raised that the definition of “connected person” u/s 102 (5) is too broad and ambiguous. The committee recommends that it may be clarified that:-

“Connected person” would include the definition of “associated enterprise” given in section 92A, the definition of ‘relative’ in section 56 and the “persons” covered u/s 40A(2)(b).

6. Concern regarding application of section 96(2).

Concerns have been raised in various fora that section 96(2) provides that an arrangement shall be presumed to have been entered into, or carried out, for the main purpose of obtaining a tax benefit, if the main purpose of a step in, or a part of the arrangement is to obtain a tax benefit, notwithstanding the fact that the main purpose of the whole arrangement is not to obtain a tax benefit. In view of this provision where only a part of the arrangement is to obtain a tax benefit, the tax authorities will treat the whole arrangement as an impermissible arrangement.

In order to allay the apprehensions of the taxpayers in this regard, the committee recommends that it must be clarified in the Rules that:-

Where only a part of the arrangement is impermissible, the tax consequences of “Impermissible Avoidance Arrangement” will be limited to only that part of the arrangement.

7. Illustrative cases under GAAR

The committee felt that terms like, “Misuse or abuse”, “bona fide purpose” and “lacks commercial substance” may be explained by illustrations. However it may be clarified that it should be only an indicative list and not an exhaustive list. The committee has recommended a few illustrative cases, which are given in Annexure-E. The guidelines provided through examples are based on specific facts in the particular example. Whether GAAR may be invoked in any particular case would depend on the specific facts of that case.



Annexure-D GAAR – Note for Guidelines1.0 While introducing the provisions of General Anti Avoidance Rule (GAAR) in the Income-tax Act, it was mentioned in

the Explanatory Memorandum to the Finance Bill, 2012 that the question of substance over form has consistently arisen in the implementation of taxation laws. In the Indian context, judicial decisions have varied. While some courts in certain circumstances had held that legal form of transactions can be dispensed with and the real substance of transaction can be considered while applying the taxation laws, others have held that the form is to be given sanctity. There are some specific anti-avoidance provisions, but, prior to introduction of GAAR, general anti-avoidance has been dealt in specific cases only through judicial decisions. In an environment of moderate rates of tax, it is necessary that the correct tax base be subject to tax in the face of aggressive tax planning. Internationally, several countries have codified the “substance over form” doctrine in the form of General Anti Avoidance Rule (GAAR) and are administering statutory GAAR provisions.

1.1 The General Anti Avoidance Rule (GAAR) is a codification of the proposition that while interpreting the tax legislation, substance should be preferred over the legal form. Transactions have to be real and are not to be looked at in isolation. The fact that they are legal does not mean that they are acceptable with reference to the meaning in the fiscal statute. Where there is no business purpose, except to obtain a tax benefit, the GAAR provisions would not allow such a tax benefit to be availed through the tax statute. These propositions have otherwise been part of jurisprudence in direct tax laws as reflected in various judicial decisions. The GAAR provisions codify this ‘substance’ over ‘form’ rule.

1.2 The basic criticism of a statutory GAAR which is raised worldwide is that it provides a wide discretion and authority to the tax administration which can cast an excessive tax and compliance burden on the taxpayer without commensurate remedies. One of the methods by which this can be addressed is to provide guidance on what the provisions entail and how they would be administered. These guidelines are meant to provide explanations and clarity regarding the GAAR provisions.

2. Tax avoidance vs. Tax evasion

2.1 Tax evasion is generally the result of illegality, suppression, misrepresentation and fraud. Tax avoidance is the result of actions taken by the assessee, none of which or no combination of which is illegal or forbidden by the law itself. The GAAR provisions do not deal with cases of tax evasion. Tax evasion is clearly distinct from tax avoidance and is already prohibited under the current provisions of the Income-tax Act.

3. Tax avoidance vs. Tax mitigation

3.1 ‘Tax mitigation’ is a situation where the taxpayer takes advantage of a fiscal incentive afforded to him by the tax legislation by actually submitting to the conditions and economic consequences that the particular tax legislation entails. An example of tax mitigation is the setting up of a business undertaking by a taxpayer in a specified area such as a Special Economic Zone (SEZ). In such a case the taxpayer is taking advantage of a fiscal incentive offered to him by submitting to the conditions and economic consequences of the SEZ provisions in the Income-tax Act e.g., setting up the business only in the SEZ areas and export from the SEZ area. Tax mitigation, as distinct from tax avoidance, is allowed under the tax statute. The GAAR provisions also do not deal with case of tax mitigation.

4. Analysis of the GAAR provisions

4.1 The provisions relating to GAAR appear in Chapter X-A (sections 95 to 102) of the Act. The provisions allow the tax authority to, notwithstanding anything contained in the Act, declare an ‘arrangement’ which the assessee has entered into, as an ‘impermissible avoidance arrangement’. Once an ‘arrangement’ has been declared as an ‘impermissible avoidance arrangement’, the consequence as regards the tax liability would also be determined.

4.2 The provisions give a wide definition of the term ‘arrangement’. An ‘arrangement’ means any step in or a part or whole of any transaction, operation, scheme, agreement or understanding, whether enforceable or not. It also includes the alienation of any property in such a transaction etc. The onus of proving that there is an impermissible avoidance arrangement is on the Revenue.

4.3 An ‘arrangement’ would be an ‘impermissible avoidance arrangement’ if,

(a) its main purpose is to obtain a ‘tax benefit’, and,

(b) it also has one of the following characteristics:

(i) it creates rights and obligations, which are not normally created between parties dealing at arm’s length;



(ii) it results in misuse or abuse of the provisions of the tax law;

(iii) it lacks commercial substance;

(iv) it is carried out by means or in a manner which is normally not employed for an authentic (bona fide) purpose.

A ‘tax benefit’ has been defined to mean

(i) a reduction or avoidance or deferral of tax or other amount payable under the Act or as a result of a tax treaty;

(ii) an increase in a refund of tax or other amount that would be payable under the Act or as a result of tax treaty; or

(iii) a reduction in total income including an increase in loss.

The term “tax benefit” would be the benefit, quantified in terms of tax liability, arising to any party to the arrangement on account of such arrangement.

4.4 The onus of proving that

(A) there is an arrangement,

(B) the arrangement leads to a ‘tax benefit’,

(C) the main purpose or one of the main purposes of the ‘arrangement’ is to obtain a ‘tax benefit’, and

(D) the arrangement has one of the characteristics listed at (i) to (iv) at (b) of 4.3 above is on the revenue.

5. Flow chart of GAAR provisions?

Not reproduced

Annexure-E Illustrative cases where GAAR provisions will be considered applicable or not applicableExample 1:

Facts:

A business sets up an undertaking in an under developed area by putting in substantial investment of capital, carries out manufacturing activities therein and claims a tax deduction on sale of such production/manufacturing. Is GAAR applicable in such a case ?

Interpretation:

There is an arrangement and one of the main purposes is a tax benefit. However, this is a case of tax mitigation where the tax payer is taking advantage of a fiscal incentive offered to him by submitting to the conditions and economic consequences of the provisions in the legislation e.g., setting up the business only in the under developed area. Revenue would not invoke GAAR as regards this arrangement.

Example 2:

Facts:

A business sets up a factory for manufacturing in an under developed tax exempt area. It then diverts its production from other connected manufacturing units and shows the same as manufactured in the tax exempt unit (while doing only process of packaging there). Is GAAR applicable in such a case ?

Interpretation:

There is an arrangement and there is a tax benefit, the main purpose or one of the main purposes of this arrangement is to obtain a tax benefit. The transaction lacks commercial substance and there is misuse of the tax provisions. Revenue would invoke GAAR as regards this arrangement.



Example -3 :

Facts:

A foreign investor has invested in India through a holding company situated in a low tax jurisdiction ‘X’. The holding company is doing business in the country of incorporation, i.e. ‘X’, has a Board of Directors that meets in that country and carries out business with adequate manpower, capital and infrastructure of its own and therefore, has substantial commercial substance in the said country ‘X’. Would GAAR be invocable or would the arrangement be permissible ?

Interpretation:

In view of the factual substantive commercial substance of the arrangement, Revenue would not invoke the GAAR provisions.

Example -4:

Facts:

An Indian company has set up a holding company in a low tax jurisdiction outside India which has set up further subsidiary companies which pay dividends to the holding company and such dividends are not repatriated to the Indian company. Would the deemed dividend be treated as income using GAAR ?

Interpretation:

Declaration/repatriation of dividend is a business choice of the companies and GAAR provisions would not apply. Based on further facts such as the degree of Indian Ownership, the location of the subsidiaries (in low tax jurisdictions) and the nature of income (most of the income being passive income like interest, dividend etc.), many jurisdictions have anti-deferral and avoidance provisions in the form of Controlled Foreign Company (CFC) provisions. Specific anti-deferral/anti-avoidance provisions is proposed in the Direct Taxes Code Bill, 2010. Accordingly, GAAR would not be invoked in such a case.

Example -5:

Facts:

The merger of a loss making company into a profit making one results in losses off setting profits, a lower net profit and lower tax liability for the merged company. Would the losses be disallowed under GAAR ?

Interpretation:

As regards setting off of losses, the provisions relating to merger and amalgamation already contain specific anti-avoidance safeguards and therefore, GAAR would not be invoked.

Example -6:

Facts:

A choice made by a company between leasing an asset and purchasing the same asset. The company would claim deduction for leasing rentals rather than depreciation if it had their own asset. Would the lease rent payment be disallowed as expense under GAAR ?

Interpretation:

GAAR provisions, would not, prima facie, apply to a decision of leasing (as against purchase of an asset). However, if it is a case of circular leasing, i.e. the taxpayer leases out an asset and through various sub-leases, takes it back on lease, thus creating a tax benefit without any change in economic substance, Revenue would examine the matter for invoking GAAR provisions.

Example -7:

Facts:

A company has raised funds from an unconnected party through borrowings, when it could have issued equity. Would the interest be denied as an expense deduction under GAAR ?



Interpretation:

A number of jurisdictions have specific thin capitalization rules to deter erosion of the tax base through excessive interest payments. There is no specific provision dealing with this (thin-capitalization) in the I.T. Act. An evaluation of whether a business should have raised funds through equity instead of as a loan should generally be left to commercial judgment and GAAR would not be attracted. Interest payments to connected parties would be subject to transfer pricing provisions. However, based on whether the payments are made to connected parties, the source of funds in the case of the connected parties and the location of these connected parties in low tax jurisdictions, the arrangement could be examined under GAAR provisions.

Example -8:

Facts:

A large corporate group has created a service company to manage all its non core activities. The service company then charges each company for the services rendered on a cost plus basis. Can the mark up in the cost of services be questioned using GAAR.

Interpretation:

There are specific anti avoidance provisions through transfer pricing as regards transactions among related parties. GAAR will not be invoked.

Example -9:

Facts:

A company sets off losses in the stock market against gains which is aimed at balancing the portfolio.

Interpretation:

Sale/purchase through stock market transactions where the buyer and seller are anonymous to each other would not come under GAAR provisions. GAAR provisions could be invoked based on specific facts where transactions are not anonymous i.e. parties are related to each other or a transaction has been entered into through a pre-arrangement between unrelated parties who have been brought together by an intermediary like a broker in order to adjust profit and losses between themselves.

Example -10:

Facts

‘Y’ company, a non-resident, and ‘Z’ company, a resident of India, form a joint venture company ‘X’ in India. ‘Y’, incorporates a 100% subsidiary ‘A’ in country ABC of which ‘Y’ is not a resident. The India-ABC tax treaty provides for non-taxation of capital gains in the source country and country ABC charges a minimal capital gains tax in its domestic law. ‘A’ is also designated as a “permitted transferee” of Y. “Permitted transferee” means that though shares are held by ‘A’, all rights of voting, management, right to sell etc., are vested in ‘Y’. As provided by the joint venture agreement, 49% of X`s equity is allotted to company ‘A’ (being 100% subsidiary and “permitted transferee” of ‘Y’) and the remaining 51% is allotted to the ‘Z’ company. Thereafter, the shares of ‘X’ held by ‘A’ are sold by ‘A’ to ‘C’ (connected to the ‘Z’ group).

Interpretation

The controlling rights of company ‘A’ were with ‘Y’. A direct transfer of these shares by company ‘Y’ to company ‘C’ would have attracted capital gains tax in India read with the relevant treaty of Y’s country of residence. The company ‘A’ was interposed with main purpose of taking advantage of India-ABC treaty. The arrangement results in misuse or abuse of tax provisions. Revenue would invoke GAAR as regards this arrangement.

Example -11:

Facts:

Company ‘A’, is incorporated in country ABC as a wholly owned subsidiary of company ‘B’ which is not a resident of ABC or of India. The India-ABC tax treaty provides for non-taxation of capital gains in the source country and country ABC charges a minimal capital gains tax in its domestic law. Some shares of an Indian Company ‘C’ were acquired by ‘A’. The entire funding for investment by ‘A’ in ‘C’ was done by ‘B’. ‘A’ has not made any other transaction. These shares were subsequently disposed of by ‘A’, thus resulting in capital gains which ‘A’ claims as not being taxable in India by virtue of the India- ABC tax treaty.



Interpretation:

The beneficial ownership vests with the connected company ‘B’ which had played a crucial role in the transaction conducted by ‘A’. Though the legal ownership ostensibly resides with the ‘A’, the real and beneficial owner of the capital gains is the ‘B’ Company which controls the connected company ‘A’. This is an arrangement which has been created with the main purpose of avoiding capital gains tax in India through misuse or abuse of tax provisions. Hence it is impermissible arrangement. Revenue would invoke GAAR as regards this arrangement.

Example -12:

Facts:

An Indian Company ‘A’, is a closely held company and its major shareholders are connected companies ‘B’ ,’C’ and ‘D’. ‘A’ was regularly distributing dividends but stopped distributing dividends from 1.4.2003, the date when Dividend Distribution Tax (DDT) was introduced in India. ‘A’ allowed its reserves to grow by not paying out dividends. As a result no DDT was paid by the company. Subsequently, all its shareholders buyback of shares was offered by the Indian Company ‘A’ to its shareholder company ‘B’ based in country ABC and the other shareholders C and D who are not resident of ABC. The India-ABC tax treaty provides for non-taxation of capital gains in the source country and country ABC charges very low capital gains tax in its domestic law. The buyback offer was only accepted by the entity B. The accumulated reserves of A were used to buyback the shares from the B entity.

Interpretation:

The arrangement is a colourable device designed to avoid tax in India. No dividends were distributed by A since 1.4.2003, the day the Dividend Distribution Tax was implemented for non bona fide purpose. Thus ‘A’ obtained tax benefit by not declaring dividend and passing this on as exempt capital gain in the hands of connected company B. The buyback of shares was accepted onlyby connected company B and not by the connected companies C and D as they would have invited capital gains tax by accepting such offer. Revenue would invoke GAAR as regards this arrangement.

Example -13:

Facts:

The Shares of ‘V’, an asset owning Indian company, was held by an Indian Company ‘X’. ‘X’ was in turn held by two companies ‘E’ and ‘C’, incorporated in country ABC. The India-ABC tax treaty provides for non-taxation of capital gains in the source country and country ABC charges very low capital gains tax in its domestic law. The Company ‘X’ was liquidated by consent and without any Court Decree. This resulted in transfer of the asset/shares from company ‘X’, to companies ‘E’ and ‘C’. Subsequently companies ‘E’ and ‘C’ sold the shares to ‘A’ which was incorporated in country ABC. The companies ‘E’ and ‘C’ claimed benefit of tax treaty and the resultant gain of the transaction was claimed not to be taxable.

Interpretation:

The chain of events bring out the fact that the asset that was situated in India and held by an Indian Company was transferred by liquidation of the Indian Company by an arrangement so as to misuse or abuse the tax provisions . Revenue would invoke GAAR as regards this arrangement.

Example -14:

Facts

A foreign bank ‘F’s branch in India arranges loan for Indian borrower from ‘F’ bank’s branch located in a third country. The loan is later assigned to ‘F’ bank’s branch in XYZ country to take benefit of withholding provisions of India-XYZ treaty (India-XYZ Treaty provides no source based withholding tax on interest to a bank carrying out bona-fide business.)

Interpretation:

Since there is no withholding provision on interest earned by XYZ residents under the India-XYZ treaty, the above arrangement of finalizing the loan from one country and assigning it to another country has been made to avoid withholding provisions. This is a misuse of tax treaty and thus will be treated as an “impermissible avoidance arrangement”. Revenue would invoke GAAR with regard to this arrangement.

Example -15:

Facts

Under the provisions of a tax treaty between India and country XYZ, any capital gains arising from the sale of shares of an Indian company would be taxable only in XYZ, if the transferor is a resident of XYZ. There is further provision condition



under the treaty that gains from alienation of shares issued by an Indian company wherein for more than an interest of XYZ in the capital stock of that Indian company can be taxed in India. A company resident in XYZ owns more than X % shareholding in an Indian Company. It sells shares of that Indian Company (being less than X % interest each at short intervals thus, cumulatively transferring more than “X”%. It thus escapes liability for capital gains tax in India even though it owns more than X% interest in the Indian company.

Interpretation

The above arrangement of splitting the same transaction into many transactions at short intervals below the threshold limit could amount to abuse of tax laws and deemed to be lacking commercial substance and hence would be an “impermissible avoidance arrangement”. Revenue would invoke GAAR with regard to this arrangement.

Example -16:

Facts:

Company ‘A’ is a non resident company in country R and is wholly owned by company ‘X’ in country T. Company ‘X’ is a financial company with substantial reserves and looking for investments in India. Company ‘X uses its subsidiary company ‘A’ to route its investment in an Indian company ‘B’ whereby company ‘A’ purchases the shares of company ‘B’. After sometime, company ‘A’ sells the shares of company ‘B’ to another company ‘C’ and realizes capital gains. As per the provisions of relevant DTAA Protocol between country R and India, a shell/conduit company is not eligible for capital gains exemption in India. However, a company shall not be deemed to a shell/conduit company if its total annual expenditure on operations in country R is equal to or more than Rs. 1,00,00,000/- in the immediately preceding period of 24 months from the date the gains arise. Company ‘A’ claims that capital gains are not taxable in India as it is not a shell company as per the relevant DTAA Protocol and that it incurred Rs. 1,20,00,000/- (Rs. 40,00,000/- as license fees and local office expenses, Rs. 80,00,000/- as interest payments to ‘X’ company, its parent holding company) as business expenses as per P&L A/C to show its economic presence in country ‘R’ as it claimed expenditure exceeding the limit prescribed therein and for it not to be shell/conduit company.

Interpretation:

Company ‘A’ has incurred only Rs. 40,00,000/- on operations in country ‘R’. Interest payments of Rs. 80,00,000/- outside country ‘R’ cannot be taken into account for the purposes of computation of Rs. 1,00,00,000/- limit of expenses incurred on operations in country ‘R’. Company ‘A’ will be deemed to be a shell/conduit company. The treaty benefit may be denied under LOB clause of the treaty itself. As it is an arrangement for claiming benefits of DTAA and it lacks economic substance, therefore, Revenue may also invoke GAAR with regard to this arrangement.

Example -17:

Facts:

An Indian company is in the business of import and export of certain goods. It purchases goods from Country A and sells the same in country B. It sets up a subsidiary in Country X - a zero/ low tax jurisdiction. The director of the Indian company finalizes the contracts in India but shows the documentation of the purchase and sale in Country X. The day to day management operations are carried out in India. The goods move from A directly to B. The transactions are recorded in the books of subsidiary in country X, where the profits are tax exempt.

Interpretation:

A company is camouflaging the sale and purchase transactions as X country based transactions. By this arrangement, the Indian company has obtained a tax benefit. The substance or effect of the arrangement as a whole is inconsistent with, or differs significantly from, the forms of its individual steps and hence, lacks commercial substance. Revenue would invoke GAAR with regard to this arrangement.

Example -18:

Facts:

A company ‘A’ in country ‘X’ invests in a company ‘B’ situated in country ‘R’. Country ‘R’ has a provision of residence based taxation of capital gains in its tax treaty with India. ‘B’ further invests the funds in equities in India and earns capital gains. ‘B’ does not have substantive commercial substance in country ‘R’.

Interpretation:

If ‘A’ invests directly in India, it does not get benefit of treaty and has to pay capital gains tax in India. By routing the funds through ‘B’ in country ‘R’, the payment of capital gains tax in India has been avoided. This is an impermissible avoidance arrangement and revenue would invoke GAAR with regard to this arrangement.



Example -19:

Facts

An employee of a private limited company ‘A’ is to receive a bonus or salary. The employee subscribes for preferential shares of the employer. The preferential shares are purchased by a connected company of ‘A’, or are redeemable at a premium that reflects a portion of the employee’s annual salary or bonus, after a period of one year. In this manner, the employee receives the income as capital gain.

Interpretation

The acquisition of the preferential shares is part of an arrangement designed to avoid the tax that would have been required to be paid on salary. By this arrangement, there is a tax benefit and there is a misuse of the tax provisions. The Revenue would invoke GAAR with regard to this arrangement.

Example -20:

Facts:

‘A’ company had a disputed claim with ‘Z’ company. ‘A’ transferred its actionable claims against ‘Z’ for an amount which was low, say, for example 10 % of the value of the actionable claim against ‘Z’ to a connected concern ‘B’ by way of a transfer instrument. ‘B’ transferred such claim to ‘C’ company and ‘C’ further gifted it to ‘D’ company, another connected concern of ‘A’. Upon redemption of such actionable claims, ‘D’ showed it as a capital receipt and claimed exemption.

Interpretation:

The transfer of actionable claims in the manner as detailed above to a connected concern is a colourable device which lacks commercial substance. The income in the instant case belongs to A. Revenue would invoke GAAR as regards this arrangement.

Example -21:

Facts:

‘A’ company borrowed money from a company ‘B’ and used that to buy shares in three 100% subsidiary companies of ‘A’. Though the fair market value of the shares was Rs. Y, ‘A’ paid Rs. 6Y for each share. The amount received by the said subsidiary companies was transferred back to another company connected to ‘B’. The said shares were sold by ‘A’ for Rs. Y/5 each and a short-term capital loss was claimed and this was set-off against other long-term capital gains.

Interpretation:

By the above arrangement, the tax payer has obtained a tax benefit and created rights or obligations which are not ordinarily created between persons dealing at arm’s length. Revenue would invoke GAAR with regard to this arrangement.

Annexure D — CIRCULARS

Clarification regarding agreement for avoidance of double taxation with Mauritius

1. A Convention for the avoidance of double taxation and preven tion of fiscal evasion with respect to taxes of income and capi tal gains was entered into between the Government of India and the Government of Mauritius and was notified on 6-12-1983. In respect of India, the Convention applies from the assessment year 1983-84 and onwards.

2. Article 13 of the convention deals with taxation of capital gains and it has five paragraphs. The first paragraph gives the right of taxation of capital gains on the alienation of immovable property to the country in which the property is situated. The second and third paragraphs deal with right of taxation of capi tal gains on the alienation of movable property linked with business or professional enterprises and ships and aircrafts.

3. Paragraph 4 deals with taxation of capital gains arising from the alienation of any property other than those mentioned in the preceding paragraphs and gives the right of taxation of capital gains only to that State of which the person deriving the capital gains is a resident. In terms of paragraph 4, capital gains derived by a resident of Mauritius by alienation of shares of companies shall be taxable only in Mauritius according to Mauri tius tax law. Therefore, any resident of Mauritius deriving income from alienation of shares of Indian companies will be liable to capital gains tax only in Mauritius as per Mauritius tax law and will not have any capital gains tax liability in India.



4. Paragraph 5 defines ‘alienation’ to mean the sale, exchange, transfer or relinquishment of the property or the extinguishment of any rights in it or its compulsory acquisition under any law in force in India or in Mauritius.

Circular : No. 682, dated 30-3-1994.

Clarification regarding taxation of income from dividends and capital gains under indo –Mauritius Double Tax Avoidance Convention (DTAC)

1. The provisions of the Indo-Mauritius DTAC of 1983 apply to ‘residents’ of both India and Mauritius. Article 4 of the DTAC defines a resident of one State to mean “any person who, under the laws of that State is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature.” Foreign Institutional Investors and other investment funds, etc., which are operating from Mauritius are invariably incorporated in that country. These entities are ‘liable to tax’ under the Mauritius Tax law and are, therefore, to be considered as residents of Mauritius in accordance with the DTAC.

2. Prior to 1-6-1997, dividends distributed by domestic companies were taxable in the hands of the shareholder and tax was deductible at source under the Income-tax Act, 1961. Under the DTAC, tax was deductible at source on the gross dividend paid out at the rate of 5% or 15% depending upon the extent of shareholding of the Mauritius resident. Under the Income-tax Act, 1961, tax was deductible at source at the rates specified under section 115A, etc. Doubts have been raised regarding the taxation of dividends in the hands of investors from Mauritius. It is hereby clarified that wherever a Certificate of Residence is issued by the Mauritian Authorities, such Certificate will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the DTAC accordingly.

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


Clarification regarding residential status under Indo-Mauritius Double Taxation Avoidance Convention (DTAC)

Reference is invited to the Circular No. 789, dated 13-4-2000 issued by the board where it was clarified that “wherever the certificate of residence is issued by the Mauritian authorities, such certificate will constitute sufficient evidence for accepting the status of residence, as well as beneficial ownership for applying DTAC accordingly.” The said circular specified the mode of proof of residence of an entity in Mauritius.

Certain doubts have been raised regarding the effect of the aforesaid circular, particularly whether the said circular would also apply to entities which are resident of both India and Mauritius. In order to remove all doubts on the subject, it is hereby clarified that where an assessee is a resident of both the Contracting States, in accordance with Para 1 of Article 4 of Indo-Mauritius DTAC, then, his residence is to be determined in accordance with Para 3 of the said article, which reads as under:—

“3. Where, by reason of the provisions of paragraph 1, a person other than an individual is resident of both the Contracting States, then it shall be deemed to be a resident of the Contracting State in which the place of effective management is situated.”

In view of the above, where an Assessing Officer finds and is satisfied that a company or an entity is resident of both India and Mauritius, he would be free to proceed to determine the residential status under Para 3 of Article 4 of DTAC. Where it is found as a fact that the company has its place of effective management in India, then notwithstanding its being incorporated in Mauritius, it would be taxed under the DTAC in India.

Circular : No. 1/2003, dated 10-2-2003.

Determination of ‘date of transfer’ and period of holding securities ‘held in dematerialized form under section 45(2A) qua transaction in securities.

1. At present trading in securities is done through the physical movement of the scrips. Transactions are settled through the endorsement and delivery of the certificates which are also the proof of ownership of the security mentioned therein. This system is fought with many difficulties caused due to bad deliveries and loss of share certificates. In order to remove these difficulties faced by the investors, a system of holding securities in the electronic mode at the option of an investor has now been introduced in India. The object of this system is to eliminate problems which are normally associated with settlement through physical certificates, like tearing/mutilation of share certificates due to careless handling, loss of certificates by postal authorities or registrars or investors, problems of bad delivery, forgery of certificates, etc. The new system is devised to ensure faster and hasslefree settlement of trade with shorter settlement cycles.



2. Under the new system, the movement of the scrips physically from one person to another is totally done away with by introducing certain intermediaries, chief among them being a Depository and a Participant. In order to implement the system of holding and transferring securities through the electronic media, firstly the Depositories Act, 1996, has been enacted. The object of this Act is to regulate the working of the depositories in securities and matters incidental thereto. A depository is an organisation where the securities of a shareholder are held in the electronic form on the request of the shareholder, through the medium of a Depository Participant. The depository is comparable to a bank where an investor who desires to utilise its services can open an account with it through a Depository Participant. However, a Depository is not merely a custodian but is in fact the registered owner of the security and it is the Depository whose name is entered as such in the register of the issuer. The person actually entitled to the security becomes the beneficial owner, whose name is recorded as such in the books of the Depository.

3. The salient feature of this new system is that it is optional and would operate in inconjunction with the existing system of holding securities in physical form. Where an investor opts to hold a security with a Depository, i.e., not in physical possession of a certificate, the Depository shall be intimated of the details of allotment of securities and, accordingly, the depository shall enter in its records the name of the allottee as the beneficial owner of that security. Under this system, physical share certificates are surrendered to the issuing agency and the account maintained with the depository is the only evidence of the ownership of the securities. This conversion of physical certificates into the electronic holdings at the request is called dematerialisation. Whenever purchase/sale, i.e., any transfer of such securities held in dematerialised form is effected, delivery is given or taken by making adjustments in the accounts maintained with the Depository by the two parties. The significant feature of the dematerialised securities is that they are fungible, i.e., all the holdings of a particular security will be identical and inter-changeable and they will have no unique characteristic such as distinctive number, certificate number, folio number, etc. As the holdings of any securities in dematerialised form is represented only by the account with the depository and all transfers are effected through book entries in the accounts maintained by the depository, under this system it is not possible to link the purchase of a security with its sale by means of its distinctive number, etc. It is for this reason that sub-section (2A) has been inserted in section 45 to provide for the computation of capital gains in respect of securities held in dematerialised form. This sub-section provides that for the purposes of calculating the date of transfer and period of holding in respect of shares held in dematerialised form, the FIFO method would apply. Clarifications have been sought on the manner of application of the FIFO system for the determination of the date of transfer and the period of holding.

4. The primary issue under the Income-tax Act in the case of securities whether held in physical form or in the dematerialised form remains the determination of cost of acquisition and the period of holding. The Board had earlier issued Circular No. 704, dated 28-4-1995, which explains the manner in which the ‘date of transfer’ and ‘period of holding’ may be determined. This primary position as regards the ‘date of transfer’ and ‘period of holding’ does not change even when the securities are held in the dematerialised form. The only problem when securities are held in dematerialised form is that the distinct trail linking every share to a certificate and its unique distinctive number linking it with its subsequent sale is not available.

5. Section 45(2A) stipulates that in the case of securities held in dematerialised form, for determining ‘date of transfer’ and ‘period of holding’, the FIFO method would be applicable. FIFO method is generally used to determine the value of any item moving out of a stock account and those remaining in stock at any point of time. When applied to an account holding dematerialised stock, it implies that, out of the existing holdings, the item that first entered into the account is deemed to be the first to be sold out. However, once a sale is linked with an earlier purchase, for determination of their ‘date of transfer’ and ‘period of holdings’, Board’s Circular No. 704 would be applicable. That is to say that the relevant contract notes as explained in Circular No. 704 will have to be referred to, for ascertaining the cost of the security sold and the date of transfer.

When actually operating an account of dematerialised stock by applying FIFO system, certain other issues can arise. For instance, an investor can hold part of his holdings of a security in physical form and the remaining in dematerialised form. Further, he may hold his dematerialised holdings in more than one account with one or more depositories. In such a situation, there can be doubts whether the FIFO system is to be applied globally on the entire holdings of physical and dematerialised holdings or not. In this connection, it is clarified that :

(a) FIFO method will be applied only in respect of the dematerialised holdings because in case of sale of dematerialised securities, the securities held in physical form cannot be construed to have been sold as they continue to remain in possession of the investor and are identified separately.

(b) In the depository system, the investor can open and hold multiple accounts. In such a case, where an investor has more than one security account, FIFO method will be applied accountwise. This is because in case where a particular account of an investor is debited for sale of securities, the securities lying in his other account cannot be construed to have been sold as they continue to remain in that account.



(c) If in an existing account of dematerialised stock, old physical stock is dematerialised and entered at a later date, under the FIFO method, the basis for determining the movement out of the account is the date of entry into the account. This is illustrated by the following examples :

Date of Credit Particulars Quantity

1-6-1997 Purchased directly in Dematerialised form on 25-5-1997 2000

5-6-1997 Dematerialised Shares originally purchased in Nov. 1985 5000

10-6-1997 Purchased directly in Dematerialised form on 10-6-1997 4000

15-6-1997 Dematerialised Shares originally purchased in May 1962 3000

If say, 2500 shares were sold from out of this account, then the period of holding and the cost of acquisition of the first 2000 shares should be as from 25-5-1997 and the cost thereof, whereas the balance 500 shares will be treated as having been acquired in November 1985, at the relevant cost. This is the effect of the FIFO method.


Annexure E — Income-tax Act, 1961 Extracts

Section 45 (2A) of the Act

(2A) Where any person has had at any time during previous year any beneficial interest in any securities, then, any profits or gains arising from transfer made by the depository or participant of such beneficial interest in respect of securities shall be chargeable to income-tax as the income of the beneficial owner of the previous year in which such transfer took place and shall not be regarded as income of the depository who is deemed to be the registered owner of securities by virtue of sub-section (1) of section 10 of the Depositories Act, 1996, and for the purposes of—

(i); and

(ii) proviso to clause (42A) of,

the cost of acquisition and the period of holding of any securities shall be determined on the basis of the first-in-first-out method.

[Explanation.—For the purposes of this sub-section, the expressions “beneficial owner”, “depository” and “security” shall have the meanings respectively assigned to them in clauses (a), (e) and (l) of sub-section (1) of section 2 of the Depositories Act, 1996.]

Capital gains on purchase by company of its own shares or other specified securities.

46A. Where a shareholder or a holder of other specified securities receives any consideration from any company for purchase of its own shares or other specified securities held by such shareholder or holder of other specified securities, then, subject to the provisions of, the difference between the cost of acquisition and the value of consideration received by the shareholder or the holder of other specified securities, as the case may be, shall be deemed to be the capital gains arising to such shareholder or the holder of other specified securities, as the case may be, in the year in which such shares or other specified securities were purchased by the company.

[Explanation.—For the purposes of this section, “specified securities” shall have the meaning assigned to it in Explanation to section 77A of the Companies Act, 1956 (1 of 1956).]

Section 79 of Act

Carry forward and set of losses in the case of certain companies.

79. Notwithstanding anything contained in this Chapter, where a change in shareholding has taken place in a previous year in the case of a company, not being a company in which the public are substantially interested, no loss incurred in any year prior to the previous year shall be carried forward and set off against the income of the previous year unless—

(a) on the last day of the previous year the shares of the company carrying not less than fifty-one per cent of the voting power were beneficially held by persons who beneficially held shares of the company carrying not less than fifty-one per cent of the voting power on the last day of the year or years in which the loss was incurred [* * *] :



[Provided that nothing contained in this section shall apply to a case where a change in the said voting power takes place in a previous year consequent upon the death of a shareholder or on account of transfer of shares by way of gift to any relative of the shareholder making such gift :]

[Provided further that nothing contained in this section shall apply to any change in the shareholding of an Indian company which is a subsidiary of a foreign company as a result of amalgamation or demerger of a foreign company subject to the condition that fifty-one per cent shareholders of the amalgamating or demerged foreign company continue to be the shareholders of the amalgamated or the resulting foreign company.]

qqq


Investment Protection Treaties / Bilateral Investment Treaties (BITs)

Investment Protection Treaties / Bilateral Investment Treaties (BITs) by Rohan Shah

Introduction to BITs


Tax Disputes and BITs

The Vodafone Case and BITs

gRecent Proceedings under BITs

concerning India

Dispute Resolution Mechanism under BITs

Index E L P

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What is a BITA BIT is an agreement for the reciprocal promotion and

protection of investments in each other’s territories byindividuals and companies situated in either StatesBITs do not give a right to make an investment; Investments made must be established or acquired in accordance

with the national laws of the State;

4


Key Elements / Clauses of BITs Applicability:

Applicable to nationals and companies Applicable in respect of existing and future investmentsCertain BITs have limited applicability only to future investments

India’s BITs with Egypt, Sweden;

Where SPV is in a State having a BIT with India, SPV can avail the benefit inrelation to investments in IndiaCertain BITs incorporate condition of substantive business operations

India’s BIT with Switzerland;

Certain BITs incorporate condition that the entity / natural personexercising ownership or control should be of the contracting state India’s BIT with Australia – “Ownership or control” is defined as decisive influence,

specifically demonstrated by – 51% or more share or voting rights, or, decisionmaking ability over selection of majority of board members

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INTERNATIONAL TAX & FINANCE CONFERENCE 2012

Key Elements / Clauses of BITs … Fair and Equitable Treatment (FET):

The FET clause assures that foreign investors shall be protected against arbitrary, unfair or inequitable treatment by the host State

The FET principle mandates States to have a stable and predictable legal framework regulating investments which meets reasonable expectations of the investors

CMS Gas Transmission Company v. Republic of Argentina [ICSID Case No. ARB/01/8) – challenge to Arbitral Award dated 12 May 2005] Argentina had given guarantees to gas transportation companies in

relation to price adjustments. The price was to be calculated in dollars, converted to pesos at time of billing. Tariffs were to be adjusted every 6 months as per US Product Price Index (PPI) Subsequently, public emergency was declared. Right to adjust tariffs as

per USPPI and to calculate the price in dollars were terminated. Tariffs were redenominated in pesos (@1 peso + 1 dollar)

contd…

6


Key Elements / Clauses of BITs … Fair and Equitable Treatment (FET):

CMS Gas Transmission Company case..Arbitral Tribunal concluded that the measures that are complained of did

in fact entirely transform and alter the legal and business environment under which the investment was decided and made. The guarantees given in this connection under the legal framework were crucial for the investment decision”Committee observed that the Tribunal proceeded on a detailed analysis

of the “reality of the Argentine economy” at the time of the crisis, of the measures then taken and of their consequences, before concluding that the fair and equitable standard had been violatedCommittee observed that Tribunal decision on this aspect was

adequately founded

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Key Elements / Clauses of BITs … Full Protection and Security (FPS):

The FPS clause assures protection from physical violence, which might beagainst the investmentsViolence may be by host State or third parties

The host State only has an obligation of due diligence to prevent physicalviolence against the assets of the investments

The clause may vary to bring in different degrees of protection Asian Agricultural Products Ltd. (AAPL) v. Republic of Sri Lanka, [ICSID Case

No. ARB/87/3, Final Award, June 27, 1990]Sri Lankan security forces on 28 January, 1987 destroyed the installations of AAPL

while routing Tamil rebel forces.APPL sought compensation under the Sri Lanka-UK BITWhen compensation was not paid, AAPL requested arbitration before the ICSID

under the Sri Lanka - UK BITOn the basis of the FPS clause the Tribunal held that Sri Lanka had violated its

obligation by not taking all possible measures to prevent the destruction ofinvestment. The Tribunal found that there was no need to establish malice or evennegligence, but that ‘the mere lack or want of diligence’ would be sufficient

8


Key Elements / Clauses of BITs … Non-Discrimination:

BITs generally assure National Treatment and Most-Favoured Nation (MFN) treatment to foreign investorsNational Treatment: Principle under which a State is required to accord

equal benefits / privileges to foreigners and citizens National Treatment clause found in all the three important WTO documents: Art. 3 of GATT (General Agreement on Tariffs and Trade) Art. 17 of GATS (General Agreement on Trade in Services) Art. 3 of TRIPS (Agreement on Trade Related Aspects of IPRs) In a decision of WTO Appellate Body on Taxes levied by Japan on Alcoholic

Beverages it was observed – “national treatment obligation is a general prohibition on the use of internal taxes and other internal regulatory measures so as to afford protection to domestic production”

MFN Treatment: The clause enables the investor to claim any favourable right that is available to any other State having BIT with host State In Emilio Agustin Maffezini v. The Kingdom of Spain [ICSID Case No.

ARB/97/7], the Argentine claimant was allowed to follow a lesser waiting period contained in Chile – Spain BIT before referring dispute to international arbitration, compared to the 8 months waiting period under Argentina – Spain BIT 9


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Key Elements / Clauses of BITs … No Expropriation without Due Process and Compensation:

Legality of expropriation of investments tested on following parameters:It must be for public purpose; It should not be discriminatory or arbitrary;It must be conducted in accordance with due process;It must be accompanied by adequate compensation;

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Key Elements / Clauses of BITs … Dispute Resolution:

BITs provide mechanisms for resolution of disputes between:Contracting Parties (State-State disputes): Such disputes primarily deal

with interpretation of the clauses of the BITInvestor –State Dispute: Covers disputes between a foreign investor and

the host State pertaining to the investment in the host State The dispute resolution mechanisms contain negotiations, conciliation and

arbitration;[Dispute Resolution Mechanisms in BITs have been discussed later]

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A WIN-WIN SITUATION

For Investors For Host States

Secure, stable, and predictable environment for investment

Promotes in-bound investments

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What constitutes an “investment” Every BIT has a definition of “investment” The India-Netherlands BIT defines “investment” as under:

“investments” means every kind of asset invested in accordance with the national laws and regulations of the Contracting Party in the territory of which the investment is made and in particular, though not exclusively, includes:

i. Movable and immovable property as well as other property rights such as mortgages, leases, liens, or pledges;

ii. Rights derived from share, bonds and other kinds of interest in companies;

iii. Rights to money or to any performance having valueiv. Intellectual property rights, technical processes, goodwill and know how

in accordance with the relevant laws of the respective parties;v. Rights granted under law or under contract such as business

concessions to search for and extract oil, natural gas and other minerals.

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What constitutes “investment” The Arbitral Tribunal in Salini Costruttori SpA and Italstrade SpA v.

Morocco identified the following elements as being indicative of an ‘investment’ for the purposes of the International Convention for the Settlement of Investment Disputes (ICSID) [ICSID Case No. ARB/00/4; 42 ILM 609 (2003), 23 July 2001, at para. 53]: Contributions; or Certain duration of performance of the contract; or Participation in the risks of the transaction; or Contribution to the economic development of the host State

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India’s tryst with BITs India has BITs with 82 countries There is Bilateral Investment Promotion and Protection Agreement

(BIPA) with the Russian Federation and Mauritius; There is a Comprehensive Economic Co-operation Agreement with

Singapore, a Comprehensive Co-operation Partnership Agreement with Japan

Presently, the India- U.S BIT is in the process of being negotiated

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Tax Disputes and BITs

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Tax disputes and BITs

Whether tax disputes covered under BITs? Conflict between:

The primary question of tax disputes being subjected to arbitration ispremised on the Nation’s legal system having monopoly on litigationtouching this vital sovereign prerogative Several Nation’s arbitration laws do not cover tax disputesIndian Arbitration and Conciliation Act 1996 does not cover tax

disputes 16

Tax measures by Statesamounting to breach of FET,

National Treatment, MFN, etc. or amounting to expropriation

Sovereign Right of the State to Tax

Vs

Tax disputes and BITs

17

Under several BITs, clauses in relation to MFN and National treatment are not madeapplicable to taxation matters: India – Netherlands BIT (Art. 4)

“4. The provisions of paragraphs 1 and 2 in respect of the grant of nationaltreatment and most favoured nation treatment shall also not apply in respect ofany international agreement or arrangement relating wholly or mainly to taxationor any domestic legislation or arrangements consequent to such legislation relatingwholly or mainly to taxation.”

India – UK BIT (Art. 4) “3. The provisions of this Agreement relating to the grant of treatment not lessfavourable than that accorded to the investors of either Contracting Party or of anythird State shall not be construed so as to oblige one Contracting Party to extend tothe investors of the other the benefit of any treatment, preference or privilegeresulting from:

(b) any international agreement or arrangement relating wholly or mainlyto taxation or any domestic legislation relating wholly or mainly to taxation.”

Similar clauses in BITs with Australia and Switzerland

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Tax disputes and Expropriation

18

Whether tax disputes are subject matter of BITs would depend upon whether suchtax measures have resulted in breach of FET, FPS (where such protection available)or where such tax measures tantamount to expropriation (which protection isgenerally available)

“Expropriation” Black’s Law Dictionary:

“A governmental taking or modification of an individual’s property rights,esp. by eminent domain.”

International Commentary on Trade Laws: ““state measures, prima facie a lawful exercise of powers of governments,may affect foreign interests considerably without amounting toexpropriation. Thus, foreign assets and their use may be subjected totaxation, trade restrictions involving licenses and quotas, or measures ofdevaluation. While special facts may alter cases, in principle such measuresare not unlawful and do not constitute expropriation”


19

International Commentary on Trade Laws: “A state is responsible as for an expropriation of property when it subjectsalien property to taxation, regulation, or other action that is confiscatory,or that prevents, unreasonably interferes with, or unduly delays, effectiveenjoyment of an alien’s property or its removal from the state’s territory… Astate is not responsible for loss of property or for other economicdisadvantage resulting from bona fide general taxation, regulation,forfeiture for crime, or other action of the kind that is commonly acceptedas within the police power of states, if it is not discriminatory…”

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Taxation measures that could tantamount to expropriation: Confiscatory taxes that either alone or in combination with other taxes are

excessive or destructive; Taxes designed to force abandonment of property or its sale at a distress

price; Taxes that violate or repudiate and explicit commitment given to the

investors by the host State; Discriminatory taxes; Arbitrary taxes, when it is manifestly clear that there is no taxable event

according to the tax code or if the application of the tax to the facts isunfounded;

Reasonable expectation:From investors From host States

Deemed to have invested expecting topay taxes properly under thelegislations of the host State

In amending a law with respect to a foreigninvestor is to do so in a manner which meetsinternational principles of due process anddomestic principles of legality

Tax disputes under BIT

Occidental Exploration and Production Co. v. Republic of Ecuador Facts:

Case under US - Ecuador BIT Issue was whether Occidental was entitled to obtain VAT refunds on

payments made for goods and services purchased for its oil operations;Occidental was engaged in exploration and production of oil in Ecuador

under contract with State owned corporation; In 2000-2001, reimbursements were regularly given of VAT paid on

purchases; In 2001 Ecuadorian tax authorities issued resolutions denying further

refunds and requiring the return of the amounts previously disbursed; In 2002, Occidental instituted arbitral proceedings under the BIT claiming

multiple violations of BIT provisions, including those on NationalTreatment, FET, FPS, prohibition of arbitrary and discriminatory measuresand expropriation;

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Decision of the Tribunal: Treatment by Ecuadorian authorities in breach of National Treatment

obligation and in FET and FPS obligation; Ecuador was ordered to reimburse the VAT amounting to $ 71 million plus

interest. Ecuador sought to have the Award set aside by the English courts under

the terms of the United Kingdom Arbitration Act. The Court of Appeal concluded that an arbitral tribunal constituted

pursuant to the BIT between the United States and Ecuador had jurisdiction to determine claims relating to the refunding of value added tax (VAT) payments

22


On the Other Side EnCana v. Republic of Ecuador [6 February, 2006]

The EnCana case was similar to the case of Occidental The case was under Canada- Ecuador BIT However, in the case of EnCana the treaty had a restrictive clause, which

applied only certain provision mentioned under Article 12 to tax policies andthere was no provision which made obligatory on the part of host nation toaccord FET with respect to tax policies

The Tribunal held that it had no jurisdiction over tax claims unless theyconstituted an expropriation

Kugele v. Polish State Poland imposed a levy under the label of ‘license fee’ on a brewery owned by

a German which according to the owner was forced to cease businessbecause of the tax.

The issue was whether the license fee levied was an expropriatory measure? The Arbitral Tribunal rejected the claim of the German brewery owner by

holding that taxation by definition cannot give rise to expropriation23


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On what tax measures would amount to expropriation, reference canbe made to Political Risk Insurance cases which also dealt with“expropriation” clauses: Revere Copper and Brass, Inc. v. OPIC

A Jamaican subsidiary of Revere made an agreement with the Jamaicangovernment regarding the construction and operation of a mining plant inJamaica, which agreement provided for tax stability

Newly elected Government issued a series of measures that strippedRevere of some of its investment guarantees, and, increased taxes androyalties ignoring the tax stability agreement

On OPIC (Overseas Private Investment Corporation) having denied theclaim, Revere filed for Arbitration:Arbitral Tribunal concluded that: The Government’s repudiation of the

tax stability agreement directly prevented Revere from exercisingeffective control over the use or disposition of its property – whichresulted in expropriation under the Insurance Policy

24


Political Risk Insurance case: Reynolds -Guyana Mines Ltd.

Reynold’s owned a bauxite mining facility in Guayana The Guyana Government announced its intent to acquire a meaningful

participation in the mining facility - Reynolds refused to acceded to thegovernments plan

The Guayana Government found a USD 2.7 million tax deficiency andpassed a tax requiring a minimum payment of USD 7 million

On Reynold’s refusal to pay the tax, the Government placed a ban onshipments of chemical and calcined bauxite

OPIC and Reynolds agreed to USD 10 million compensation for Reynoldsclaim against OPIC

Later, Guayana, OPIC and Reynolds signed an agreement in which theGovernment agreed to pay USD 14.5 million for the nationalized assets andUSD 10 million to offset the tax refund and levy claims between itself andReynolds

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The Vodafone Case and BITs

A Quick Overview

Finance Act 2012 Before After

Indirect transfer

of Capital Assets

Retrospective Amendments

•Relevant explanations added to Section 2(14), 2(47), 9(1)(i) and 195 of the Act

•Aforesaid amendments are ‘clarificatory’

•Validation clause validates all the pending demand Notices

Open Issues

•Constitutional Validity of Retrospective Amendment

•What happens to the transactions –routed through treaty countries

•Penalties

SC Decision

•Vodafone transaction was a valid structure

•Azadi Bachao Andolan – No reconsideration required

•No “Look through” allowed

•Genuine tax planning permitted

•Transfer of shares by two offshore entities is not taxable in India

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The ‘Clarificatory’ Amendments…

Held by the SC ‘Clarificatory’ Amendments introduced w.r.e.f 1.4.1962

‘Controlling interest’ is not a separate capital asset

Section 2(14) – Capital Asset•Explanation inserted to clarify that ‘rights in or in relation to an Indian Company, including management rights and control’ were always deemed to fall within the ambit of the term “Capital Asset”

Situs of the sale of shares would be where the company is incorporated and where its shares can be transferred

Section 2(47) – Transfer•Explanation inserted to clarify that ‘disposal of, or parting with, an asset or any interest therein, or creating any interest in any asset, whether directly or indirectly’ was always deemed to fall within the ambit of the term “transfer”’

Important for the tax administration, as well as the Courts, to “look at” the legal nature of the transaction

Section 9(1)(i)•Explanation 5 has been inserted to clarify that an asset or a capital asset being any share or interest in an entity incorporated/located outside India, shall be deemed to have always been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India

…The ‘Clarificatory’ Amendments

Held by the SC ‘Clarificatory’ Amendments introduced w.r.e.f1.4.1962

No liability to tax arises in the event of a transfer of shares by one non-resident to another (Justice Radhakrishnan)

Section 195 – Withholding of tax•Explanation inserted to clarify that ‘the obligation to comply with the provisions of Section 195 of the Act shall be deemed to have always applied and extended to all persons, whether a resident or a non-resident’

-

Validation Clause•Seeks to validate all the proceedings initiated, and demands raised, by the Tax Authorities, prior to the decision of the Hon’ble Supreme Court in Vodafone

Each of the aforesaid amendment, clearly seeks to nullify the principles qua taxability of indirect transfer of shares, laid down by the Hon’ble Supreme Court

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The Vodafone Case

Vodafone (through its Dutch subsidiary) has in April 2012served the Indian government with a Notice of Dispute (“Notice”)regarding proposals in the Finance Bill 2012 The Dutch subsidiary is a company constituted under the laws of

the Netherlands and therefore an investor as defined under Article1(d) of the BIT

Notice is the first step required prior to commencement ofInternational arbitration

Vodafone believes that the retrospective tax proposals amountto a denial of justice and a breach of the Government’sobligations under the BIT to accord FET

30

The Vodafone Case

31

Would the proceedings initiated by Vodafone under the BIT be sustainable?

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Dispute Resolution Mechanism under BITs

Resolution of Disputes under BITs

BITs provide mechanisms for resolution of disputes between: Contracting Parties (State-State disputes):

Such disputes primarily deal with interpretation of the clauses of the BIT Dispute resolution mechanism generally available under BITs:

1st Step: negotiation (if possible)2nd Step: Arbitration

Investor –State Dispute: Covers disputes between a foreign investor and the host State pertaining to

the investment in the host State Dispute resolution mechanism generally available under BITs:

1st Step: amicable settlement through negotiation (as far as possible)2nd Step: Reference of dispute to Conciliation (if parties agree)

BITs with Netherlands and UK provide for conciliation as per UNCITRAL Rules of Conciliation;

contd…

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Resolution of Disputes under BITs

Investor –State Dispute: …Dispute resolution mechanism generally available under BITs:

3rd Step: Reference of dispute to Arbitration as follows: Reference to ICSID (International Centre for the Settlement of Investment

Disputes) – Possible only where Contracting party of investor and the other Contracting party are both parties to convention on the Settlement of Investment Disputes between States and Nationals of other States, 1965; or- India is not a member to the convention

Reference of dispute under Additional Facility for the Administration of Conciliation, Arbitration and Fact-Finding Proceedings; or

Reference to Ad hoc Arbitral Tribunal in accordance with UNCITRAL Arbitration Rules and as provided in BITs

Enforceability of arbitral awards in the contracting State would depend upon the Convention under which award passed and the co-relating enforcement provision under the domestic laws of the State; Where the award has been passed under the New York convention/ Geneva

Convention, it would be enforceable under the Arbitration and Conciliation Act, 1996

The dispute resolution mechanisms vary under different BITs

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gRecent Proceedings under BITs

concerning India

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BIT Arbitral Award against IndiaFacts:

White Industries Australia Ltd. (WIAL) and Coal India Ltd. (CIL) enteredinto a contract in 1989 for the supply of equipment and development ofa coal mine

Disputes arose in 1999 and WIAL claimed payment of its performancebonus under the contract and CIL claimed penalty based on poor qualityproduction and encashed WIAL’s bank guarantee

International Court of Arbitration issued an award of AU$ 4 million infavour of WIAL In 2002, CIL challenged the award in the Calcutta High Court, while at the

same time WIAL moved the Delhi High Court for the enforcement of theaward;

Due to the judicial delay in the enforcement of the arbitral award, WIALinvoked the arbitration clause in the India-Australia BIT and argued thatthe judicial delay resulted in violation of FET obligation

The Arbitral Tribunal held that the inability of the Indian judicialsystem to provide WIAL effective means to enforce its rights is abreach of India’s obligations under the India-Australia BIT 36

Cancellation of 2G Licenses

India-Russia BIT Following the Supreme Court’s decision cancelling 2G licenses of all the

new telecom operators, Sistema, the majority shareholder (56.68%) inSistema Shyam Teleservices Ltd (SSTL) invoked its right under Article9.1 of the India-Russia BIT for the loss of 21 of its 2G licenses Sistema in accordance with Article 9.1 of the BIT has sent a formal letter to

the Republic of India notifying India of the existence of the dispute andproposing to settle the dispute in an amicable way within 6 months, i.e. by28th August 2012

India-Singapore Comprehensive Economic Cooperation Agreement Norwegian telecom operator Telenor who lost 22 2G licenses has filed a

notice of dispute against the Republic of India under the India-SingaporeBIT seeking damages to the tune of USD 14 billion

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The Vodafone Case

Vodafone has issued a Notice of Dispute (“Notice”) to the IndianGovernment regarding proposals in the Finance Bill 2012 Vodafone believes that the retrospective tax proposals amount to

a denial of justice and a breach of the Government’s obligationsunder the BIT to accord FET[Discussed earlier]

38

Thank You!

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NOTES


Domestic Transfer Pricing — Navigating New Challenges

Domestic Transfer Pricing — Navigating New Challenges by CA Sanjay Tolia

The purpose of this paper is to discuss the basic concepts, key issues, recent judicial and other landmark judicial precedents relevant to domestic transfer pricing.

The paper has been organized as under:

1. Presentation

• Overview of the provisions and key challenges

• Case studies

• Thoughts on way forward

2. Extracts of relevant amendments in Finance Act 2012 relating to domestic transfer pricing

3. Summary of recent judicial precedents

4. Snapshot of landmark judicial precedents



Agenda

3Way Forward

1Domestic TP Transactions

2Case Study

Slide 2August 2012Domestic Transfer Pricing

Domestic Transfer Pricing Transactions


3Way Forward

1Domestic TP Transactions 2

Case Study

3


INTERNATIONAL TAX & FINANCE CONFERENCE 2012

Intent of Indian Transfer Pricing (TP) Regulations

Shifting of Losses

India

(Tax @ 33%)

Overseas

(Tax at lower rates, say 10%)

Shifting of Profits

IndianCo.

AssociatedEnterprise

(AE Co.)

Tax savings for the group -> Indian Govt. loses


Intent of Domestic TP–Domestic Tariff Area (DTA)

Particulars Co.A Co.B

Taxed in India @ 33% 33%

Income from RP 100 -

Other Income 200 400

Expense to RP - 100

Other Expenses 400 200

Profit/Loss (100) 100

Tax - 33

Total Tax for the Group

Particulars Co.A Co.BTaxed in India @ 33% 33%



Expense to RP -


Profit/Loss (50) 50

Tax - 17


Scenario 1 Scenario 2

33 17

By shifting of expenses from a loss making company to a profit making company, the group could reduce its tax liability by 16 for the current year, though the impact will be reversed in future years given carry forward of losses.

To avoid such cases and even though there is no erosion of tax base, Domestic TP has been introduced.

100 150



Particulars Power DTA

Taxed in India@ 0% 33%



Expense to RP -


Profit/Loss 150 150

Tax - 50


Particulars Power DTATaxed in India@ 0% 33%



Expense to RP -


Profit/Loss 225 75

Tax - 25


Scenario 1 Scenario 2

50 25

By shifting of expenses from a tax holiday unit(Power ) to a unit in the Domestic Tariff Area, the group could reduce its tax liability by 25.

To avoid such cases, Domestic TP has been introduced.

150 225

Intent of Domestic TP–DTA & Tax Holiday Unit


Scope – Domestic Transactions

Aggregatetransaction value

exceedsRs 50 million in a

financial year(Applicable for

FY 2012-13)

Tax holiday undertakings covering:• inter-unit transfer of goods and

services• transactions with entities

having close connection

Expenditure incurred between related parties defined u/s 40A

Any other transaction that may be specified




Scope of Domestic TP

1. Section 40A(2)

• Disallowance of expenditure in excess of arm's length price for transactions

between related parties.

2. Section 10AA (SEZ Units)

• Any Transfer of goods and services between ‘eligible unit’ and ‘non-eligible

unit’ - whether at market value?

• Transactions with entities having close connection – whether earning

ordinary profits ?

Explainedlater

Explainedlater


40A(2)(b) Transactions - Persons covered

Company X’s payments to the following persons are covered:

- Company Z having 20% or more voting power in X; - any other company in which Company Z has 20% or more voting power;

- a company in which X has 20% or more voting power; - any company of which a director has 20% or more voting power in X; - any company in which a director of X has 20% or more voting power;

- any director of X or of Company Z, or to any relative of such director; &- any individual having 20% or more voting power in X or any relative of such individual.

Relationship can exist at any time during the year




Section 40A(2) – Transactions covered

• Mapping to be done for the company’s transactions with domestic RPs

• Primary reliance on disclosures u/s 40A(2)(b) and Related Party Schedule

• Different divisions enter into different transactions with various group

companies

• Broad categories of transactions likely to be covered :

1.• Purchase of goods and services

2.• Payment of interest

3.• Payment of royalty charges


Illustration – Section 40A(2)(b)

A

B C

D E

A & B

A & C

A & D

A & E

B & C

D & E

Transactions covered ?

*Post Budget 2012 amendment under section 40A

Yes

Yes

Yes*

No

No

No




Issues and Challenges – 40A(2)(b)

• Scope- Direct vs Indirect ownership- Capital vs Revenue expenditure; Is depreciation an expenditure?

• Applies to which head of income? - Income from business or profession; and - Income from other sources

• Director remuneration

• Corresponding adjustments [Second proviso to Section 92C(4)]

• Availability of APA


Illustration – Tax holiday undertakings

A ZX & Y Yes

Y & Z No

X & Z Yes, if Z is closely

connectedto A

X Y

• Requirement to justify that goods and services transactions are at arm’s length price (ALP)

• Requirement that profits of undertaking are ‘ordinary profits’ having regard to ALP

Tax holiday undertaking

DTAundertaking

Transactions covered ?




Issues and Challenges – Sec 80-IA

• Overlap with Sec 80A(6); of no material consequence

• No guidance on meaning of Close connection?

• Aligning Ordinary profits with ALP

• Significant impact on non-charging of services/costs to undertaking

• Relevant to consider Existing judicial precedents

Sec 80 IA (8) Sec 80- IA (10)

• Inter unit transaction of goods or services

• Business transacted with any other person generates more than ordinary profits

• Owing to either close connection or any other reason

• Transfer at market value • Ordinary profit

• Onus of tax payer • Primary onus on taxpayer• Onus on tax authorities


Penalty

Sr.No. Type of penalty Section Penalty quantified

1

(a) Failure to maintain prescribed information/ documents

271AA

2% of transaction value

(b) Failure to report any such transaction or

(c) Furnish incorrect information

2% of transaction value

2Failure to furnish information/ documents during assessment u/s 92D

271G 2% of transaction value

3 Adjustment to taxpayer’s income during assessment 271(1)(c) 100% to 300% of tax on

adjustment amount

4 Failure to furnish accountant’s report u/s 92E 271BA INR 100,000




Comprehensive Compliance

Addressing the Transfer Pricing requirements helps you manage other compliances as well!

• Transfer Pricing

• Section 301 of the Companies Act

• Clause 49 of Listing Agreement

• Corporate Governance

• Proposed Companies Bill


Other developments - Proposed Companies Bill, 2011

Requires Board or, in some cases, shareholder’s consent (by special resolution), if transactions not at arm’s length

What does the Bill say ?

All companies – no threshold prescribedWhich companies qualify?

Reporting in the Board’s report to the shareholders, along with justification

What are the reportingrequirements?

• Contract/ arrangement can be rendered void by the Board• Director to indemnify company against any loss for transactions

with Director’s related party or authorized by him• Company can recover loss from director or employee• Company personnel involved can be imprisoned (in case of listed

company) or fined (in case of listed / unlisted company)

What are the implications of non-adherence?




Case Study


Case Study – ABC India Ltd.

ABC Ltd.(Head Office)

UNITP

UNITQ

Unit R

XYZLtd.

• ABC Ltd. is a diversified group.

• Unit P is a power generation unit which is claiming deduction u/s 80-IA.

• Unit Q (in Baddi) is involved in the manufacture of pharmaceutical goods. It is claiming deduction u/s 80 -IC.

• Unit R sells medical equipment to XYZ Ltd. (associate) and third party customers in India. It is not a Tax Holiday Unit.

• HO incurs expenses in the nature of research and development (R&D), corporate, marketing and interest expenses.




# 1 – Payments to Directors

FactsABC Ltd’s board of directors include:

• Independent directors who receive sitting fee.

• Promoter (directors) who receive salary, commission and sitting fee.

1. Are the payments to Directors ‘Specified Domestic Transactions’? 2. If yes, discuss the approach to comply with the transfer pricing rules?


UNITP

UNITQ

Unit R

XYZLtd.


# 2–Unit P (Power)


UNITQ

Unit R

UNIT P

XYZ Ltd.

Thirdparty

customers

1. Identify the transactions which qualify as ‘Specified Domestic Transactions’. 2. What is the comparable uncontrolled price for sale of power by Unit P to related

parties?3. While calculating eligible profits for Unit P,Q and R, the management expenses

have not been allocated. Is this a likely challenge from tax authorities?

Facts• Unit P provides power supply to

Unit Q, Unit R, XYZ Ltd and third party customers in India.

• State Board supplies power to customers @ Rs. 4 per unit

• Rate charged to Unit Q , Unit R and XYZ - Rs. 3 per unit

• Average rate charged from third party customers– Rs. 2 per unit




# 3– Unit Q (Baddi)

UNITQ

Thirdparty

customers

1. Can higher profit earned by Unit Q be considered as ‘more than ordinary profits’ u/s 80-IA(10)? Consequently, can the tax authorities restrict the tax holiday claim to the extent of the average profits earned by comparable companies in the light of amendments in Finance Act 2012 related to domestic transactions?

2. What is the appropriate approach for Unit Q to demonstrate that section 80- IA(10) should not apply?

Facts

• Unit Q is involved in selling pharma products to its AEs, which is covered under TP provision.

• Taxpayer carried out a TP Study. Unit Q earned a margin (OP/TC) of 65% vis-à-vis the mean margin earned by comparable companies (41%). Refer Annexure -1 for details.

• No adjustment made by the TPO.

• Unit Q has earned higher profits than average profits earned by comparable companies.

AEs(outsideIndia)


#3 – Unit Q contd…

Annexure -1

• Unit Q has earned a margin of 65% (OP/TC) .

• Arithmetic mean of the margins earned by comparables is as under :

• TP documentation concludes that the international transactions with AEs are at arm’s length.

ComparableCompanies

Operating profits/Total cost(OP/TC)

Company A 58%

Company B -8%

Company C 45%

Company D 72%

Company E 38%

Arithmetic Mean 41%




#4 – Unit Q (Baddi Unit)

ABC Ltd.(HeadOffice)

UNIT P

UNIT Q

Unit R

XYZLtd.

Facts

• Unit Q claimed deduction on the profit earned by selling goods to third party.

• Unit Q had earned higher profits than profits earned by other units.

• Earlier Unit Q was selling goods which were purchased from third party contract manufacturers and earned a profit of 59%. After manufacturing its own products, Unit Q has started earning 65%.

• The AO contended that Unit Q carried out manufacturing activity and transferred the goods to the marketing division in the head office and therefore should be entitled only to manufacturing profits of 6% (65% minus 59%) .

In the light of amendments in the Finance Act 2012 relating to domestic transactions, is the AO justified in restricting the profits to the extent ofmanufacturing profits alone?


Way forward




Way forward

• Transaction mapping

• “Pricing” documentation – real time basis

• Robust documentation – ‘ordinary profits’

• Apply learning for FY 2011-12


Glossary


APA Advance Pricing Agreements

ALP Arm’s Length Price

DTA Domestic Tariff Area

FY Financial Year

RP Related Party

SEZ Special Economic Zone

TP Transfer Pricing



Thank You



Notes



Extracts of relevant amendments in Finance Act 2012 relating to domestic transfer pricing

Section 92 - Computation of income from international transaction having regard to arm’s length price.

92. (1) Any income arising from an international transaction shall be computed having regard to the arm’s length price.

Explanation— For the removal of doubts, it is hereby clarified that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arm’s length price.

(2) Where in an international transaction [or specified domestic transaction], two or more associated enterprises enter into a mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises, the cost or expense allocated or apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard to the arm’s length price of such benefit, service or facility, as the case may be.

The following sub-section (2A) shall be inserted after sub-section (2) of section 92 by the Finance Act, 2012, w.e.f. 1-4-2013:

(2A) Any allowance for an expenditure or interest or allocation of any cost or expense or any income in relation to the specified domestic transaction shall be computed having regard to the arm’s length price.

(3) The provisions of this section shall not apply in a case where the computation of income under sub-section (1) [or sub-section (2A)] or the determination of the allowance for any expense or interest under [that sub-section], or the determination of any cost or expense allocated or apportioned, or, as the case may be, contributed under sub-section (2) [or sub-section (2A)], has the effect of reducing the income chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the books of account in respect of the previous year in which the international transaction [or specified domestic transaction] was entered into.]

Sec 92BA - Meaning of specified domestic transaction

92BA. For the purposes of this section and sections 92, 92C, 92D and 92E, “specified domestic transaction” in case of an assessee means any of the following transactions, not being an international transaction, namely:—

(i) any expenditure in respect of which payment has been made or is to be made to a person referred to in clause (b) of sub-section (2) of section 40A;

(ii) any transaction referred to in section 80A;

(iii) any transfer of goods or services referred to in sub-section (8) of section 80-IA;

(iv) any business transacted between the assessee and other person as referred to in sub-section (10) of section 80-IA;



(v) any transaction, referred to in any other section under Chapter VI-A or section 10AA, to which provisions of sub-section (8) or sub-section (10) of section 80-IA are applicable; or

(vi) any other transaction as may be prescribed,

and where the aggregate of such transactions entered into by the assessee in the previous year exceeds a sum of five crore rupees.

Section 92C – Computation of arm’s length price

Sec 92C(4)

Where an arm’s length price is determined by the Assessing Officer under sub-section (3), the Assessing Officer may compute the total income of the assessee having regard to the arm’s length price so determined :

Provided that no deduction under section 10A or section 10AA or section 10B or under Chapter VI-A shall be allowed in respect of the amount of income by which the total income of the assessee is enhanced after computation of income under this sub-section :

Provided further that where the total income of an associated enterprise is computed under this sub-section on determination of the arm’s length price paid to another associated enterprise from which tax has been deducted or was deductible under the provisions of Chapter XVIIB, the income of the other associated enterprise shall not be recomputed by reason of such determination of arm’s length price in the case of the first mentioned enterprise.

Section 40A - Expenses or payments not deductible in certain circumstances

40A. (1) The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provision of this Act relating to the computation of income under the head “Profits and gains of business or profession”.

(2)(a) Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and the [Assessing] Officer is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction.

The following proviso shall be inserted in sub-section (2)(a) of section 40A by the Finance Act, 2012, w.e.f. 1-4-2013

Provided that no disallowance, on account of any expenditure being excessive or unreasonable having regard to the fair market value, shall be made in respect of a specified domestic transaction referred to in section 92BA, if such transaction is at arm’s length price as defined in clause (ii) of section 92F.

(b) The persons referred to in clause (a) are the following, namely :—

(i) where the assessee is an individual — any relative of the assessee;

(ii) where the assessee is a company, firm, association of persons or Hindu undivided family any director of the company, partner of the firm, or member of the association or family, or any relative of such director, partner or member;



(iii) any individual who has a substantial interest in the business or profession of the assessee, or any relative of such individual;

(iv) a company, firm, association of persons or Hindu undivided family having a substantial interest in the business or profession of the assessee or any director, partner or member of such company, firm, association or family, or any relative of such director, partner or member or any other company carrying on business or profession in which the first mentioned company has substantial interest;

(v) a company, firm, association of persons or Hindu undivided family of which a director, partner or member, as the case may be, has a substantial interest in the business or profession of the assessee; or any director, partner or member of such company, firm, association or family or any relative of such director, partner or member;

(vi) any person who carries on a business or profession—

(A) where the assessee being an individual, or any relative of such assessee, has a substantial interest in the business or profession of that person; or

(B) where the assessee being a company, firm, association of persons or Hindu undivided family, or any director of such company, partner of such firm or member of the association or family, or any relative of such director, partner or member, has a substantial interest in the business or profession of that person.

Explanation— For the purposes of this sub-section, a person shall be deemed to have a substantial interest in a business or profession, if

(a) in a case where the business or profession is carried on by a company, such person is, at any time during the previous year, the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) carrying not less than twenty per cent of the voting power; and

(b) in any other case, such person is, at any time during the previous year, beneficially entitled to not less than twenty per cent of the profits of such business or profession.

In section 40A of the Income-tax Act, in sub-section (2), with effect from the 1st day of April, 2013—

(i) in clause (a), the following proviso shall be inserted, namely:—

“Provided that no disallowance, on account of any expenditure being excessive or unreasonable having regard to the fair market value, shall be made in respect of a specified domestic transaction referred to in section 92BA, if such transaction is at arm’s length price as defined in clause (ii) of section 92F”;

(ii) in clause (b), in sub-clause (iv), after the words “or any relative of such director, partner or member”, the words “or any other company carrying on business or profession in which the first mentioned company has substantial interest” shall be inserted.

Section 80A(6)

Sec 80 A (6) Notwithstanding anything to the contrary contained in section 10A or section 10AA or section 10B or section 10BA or in any provisions of this Chapter under the heading “C—Deductions in respect of certain incomes”, where any goods or services held for the purposes



of the undertaking or unit or enterprise or eligible business are transferred to any other business carried on by the assessee or where any goods or services held for the purposes of any other business carried on by the assessee are transferred to the undertaking or unit or enterprise or eligible business and, the consideration, if any, for such transfer as recorded in the accounts of the undertaking or unit or enterprise or eligible business does not correspond to the market value of such goods or services as on the date of the transfer, then, for the purposes of any deduction under this Chapter, the profits and gains of such undertaking or unit or enterprise or eligible business shall be computed as if the transfer, in either case, had been made at the market value of such goods or services as on that date.

Explanation— For the purposes of this sub-section, the expression “market value”—

(i) in relation to any goods or services sold or supplied, means the price that such goods or services would fetch if these were sold by the undertaking or unit or enterprise or eligible business in the open market, subject to statutory or regulatory restrictions, if any;

(ii) in relation to any goods or services acquired, means the price that such goods or services would cost if these were acquired by the undertaking or unit or enterprise or eligible business from the open market, subject to statutory or regulatory restrictions, if any.

The following clause (iii) shall be inserted after clause (ii) in Explanation to sub-section (6) of section 80A by the Finance Act, 2012, w.e.f. 1-4-2013 :

(iii) in relation to any goods or services sold, supplied or acquired means the arm’s length price as defined in clause (ii) of section 92F of such goods or services, if it is a specified domestic transaction referred to in section 92BA.

Sec 80-IA- Deductions in respect of profits and gains from industrial undertakings or enterprises engaged in infrastructure development, etc.

Section 80-IA(8)

Where any goods [or services] held for the purposes of the eligible business are transferred to any other business carried on by the assessee, or where any goods [or services] held for the purposes of any other business carried on by the assessee are transferred to the eligible business and, in either case, the consideration, if any, for such transfer as recorded in the accounts of the eligible business does not correspond to the market value of such goods [or services] as on the date of the transfer, then, for the purposes of the deduction under this section, the profits and gains of such eligible business shall be computed as if the transfer, in either case, had been made at the market value of such goods [or services] as on that date:

Provided that where, in the opinion of the Assessing Officer, the computation of the profits and gains of the eligible business in the manner hereinbefore specified presents exceptional difficulties, the Assessing Officer may compute such profits and gains on such reasonable basis as he may deem fit.

[Explanation — For the purposes of this sub-section, “market value”, in relation to any goods or services, means the price that such goods or services would ordinarily fetch in the open market.]



The following Explanation shall be substituted for the existing Explanation to sub-section (8) of section 80-IA by the Finance Act, 2012, w.e.f. 1-4-2013 :

Explanation—For the purposes of this sub-section, “market value”, in relation to any goods or services, means—

(i) the price that such goods or services would ordinarily fetch in the open market; or

(ii) the arm’s length price as defined in clause (ii) of section 92F, where the transfer of such goods or services is a specified domestic transaction referred to in section 92BA.

80-IA(10)

Where it appears to the Assessing Officer that, owing to the close connection between the assessee carrying on the eligible business to which this section applies and any other person, or for any other reason, the course of business between them is so arranged that the business transacted between them produces to the assessee more than the ordinary profits which might be expected to arise in such eligible business, the Assessing Officer shall, in computing the profits and gains of such eligible business for the purposes of the deduction under this section, take the amount of profits as may be reasonably deemed to have been derived therefrom.

The following proviso shall be inserted in sub-section (10) of section 80-IA by the Finance Act, 2012, w.e.f. 1-4-2013 :

Provided that in case the aforesaid arrangement involves a specified domestic transaction referred to in section 92BA, the amount of profits from such transaction shall be determined having regard to arm’s length price as defined in clause (ii) of section 92F.

Section 271 - Penalty provisions

In section 271 of the Income-tax Act, in sub-section (1), in Explanation 7, for the words “international transaction”, the words “international transaction or specified domestic transaction” shall be substituted with effect from the 1st day of April, 2013.

For section 271AA of the Income-tax Act, the following section shall be substituted with effect from the 1st day of July, 2012, namely:—

“271AA- Penalty for failure to keep and maintain information and document, etc., in respect of certain transactions—Without prejudice to the provisions of section 271 or section 271BA, if any person in respect of an international transaction or specified domestic transaction—

(i) fails to keep and maintain any such information and document as required by subsection (1) or sub-section (2) of section 92D;

(ii) fails to report such transaction which he is required to do so; or

(iii) maintains or furnishes an incorrect information or document,

the Assessing Officer or Commissioner (Appeals) may direct that such person shall pay, by way of penalty, a sum equal to two per cent of the value of each international transaction or specified domestic transaction entered into by such person”.



Summary of Recent Judicial Precedents1. Visual Graphics Computing Services (India) Pvt. Ltd1 and Weston Knowledge Systems

& Solutions India Pvt. Ltd.2

“Ordinary profits” v. “Arm’s length price” for tax holiday units: Recent Tribunal decisions and Impact of Budget 2012 proposals.

In briefIn two recent rulings favourable to taxpayers, the Income-tax Appellate Tribunal (the Tribunal) reversed the action of the revenue authorities to apply the provisions of section 80-IA(10) of the Income-tax Act, 1961 (the Act) to deny tax holiday benefits in excess of the arm’s length price (ALP).

Existing provisions of section 80-IA(10) of the Act provide that where the revenue authorities believe that the tax holiday unit produces more than ordinary profits due to a close connection with any person, only a reasonable level of profits will be eligible for the tax holiday benefit.

Budget 2012 amendments to section 80-IA(10) of the Act require ordinary profits for tax holiday units to be determined having regard to the ALP determined as per the transfer pricing (TP) provisions, with effect from assessment year (AY) 2013-14. Taxpayers with tax holiday units need to consider the impact of the Budget 2012 amendments to demonstrate and document the ordinary profits eligible for the tax holiday and the continued relevance of these rulings.

Facts

1. Visual Graphics is engaged in preparing power-point presentations and also in developing the software necessary for preparing such presentations. It also started offering finance and accounting services to its associate enterprises (AE).

Weston Knowledge is engaged in the business of providing software development services to its parent company.

2. The Assessing Officers (AOs) contended that the taxpayer’s margins were substantially higher than the ordinary profit expected to arise in such business by comparing the taxpayer’s profits with the profits earned by comparables determined under the TP provisions. The AOs thus invoked the provisions of section 10A(7) read with section 80-IA(10) of the Act and reduced the tax holiday claim.

Assessee’s contentions

Visual Graphics

1. It had not been established that the business transacted between the taxpayer and its AE are “arranged” so as to yield more than ordinary profits with a scheme in mind to inflate the profits of the eligible unit.

1 Visual Graphics Computing Services (India) Pvt. Ltd. v. ACIT [TS-274-ITAT-2012 (Chny)] ;2 Weston Knowledge Systems & Solutions India Pvt. Ltd. v. ITO [TS-269-ITAT-2012 (Hyd)]



2. Section 10A of the Act was introduced much before the introduction of the TP provisions, and therefore, ALP could never have been envisaged to be the basis for determination of ordinary profits for the purposes of section 10A(7)/ 80-IA(10) of the Act. Provisions of law stated in section 10A(7) and 80-IA(10) of the Act do not refer to ALP computed under section 92 of the Act to be treated as “ordinary profits” for the purpose of deduction under section 10A of the Act.

3. The revenue authorities would not be adversely affected even if the eligible unit in India charges a higher price to the unit outside India in case of international transactions. Accordingly, section 10A(7) read with section 80-IA(10) of the Act would not be applicable to such transactions.

4. ALP has to be computed by adopting the most appropriate method which may be a profit based or a price based method. In the latter case, the determination of ALP does not involve determination of profit at all. In such cases, the profit would only be a derived figure. Therefore, there is no linkage between ALP and “ordinary profits”. ALP is a concept determined as per the rules and procedures laid down in the statute. “Ordinary profits” on the other hand, is a commercial concept to be understood as excluding super profit. It would not be correct to incorporate the concept of ALP to determine “ordinary profits”.

Weston Knowledge

1. The taxpayer’s mark-up is within the inter-quartile range which fairly represents the ordinary profits generally earned by companies.

2. The industry profit rate could not be treated as ‘ordinary profits’ since the profit margin of a particular company depends upon the cost efficiency, offshore-onshore mix and other advantages enjoyed by the company like locational advantages and quality of human resources.

Tribunal Ruling

Visual Graphics

1. The TP regime is different from regular computation of income. Section 10A of the Act relates to computation of income and it should be independent of TP regulations and the TP orders. It is not therefore, permissible for the AO to calculate the deduction under section 10A of the Act on the basis of arm’s length profit determined by the transfer pricing officer (TPO).

2. The AO was not justified to invoke the provisions of section 80-IA(10) read with section 10B(7) of the Act so as to reduce the eligible profits on the basis of the ALP computed by the TPO without showing how he determined that the taxpayer had shown more than “ordinary profits”.

Weston Knowledge

1. The phrase ‘more than ordinary profits’ referred in section 80-IA(10) of the Act is different from ‘arm’s length price’ as referred in section 92C of the Act.

2. The provisions of section 80-IA(10) of the Act do not give an arbitrary power to the AO to fix the profits of the taxpayer. In cases where the TPO has confirmed that no adjustment on account of transfer pricing is required to be made, then any reduction of eligible profits by the AO is not sustainable unless the AO can show that the taxpayer has earned more than ordinary profits.



Our observations and Impact of Budget 2012 proposals

1. The two rulings clearly bring out the principle that the provisions of section 80-IA(10) of the Act do not give an arbitrary power to the AO to fix the profits of the taxpayer. In cases where the TPO has confirmed that no adjustment on account of transfer pricing is required to be made, then any reduction of eligible profits by the AO is not sustainable unless the AO can show that the taxpayer has earned more than ordinary profits based on the conditions specified in section 80-IA(10) of the Act.

2. With effect from AY 2013-14, Budget 2012 proposes that the ordinary profits with respect to transactions under section 80-IA(10) of the Act should be determined having regard to the ALP. In light of the proposed amendments, a question arises as to whether the ratio of the above rulings will continue to be applicable in the future given that the amended provisions of section 80-IA(10) of the Act require ordinary profits to be referenced to the ALP as per the TP provisions. Furthermore, even though the amendment is prospective, the revenue authorities may refer to the amended provisions to argue that their position to use ALP as per TP provisions to determine the ordinary profits was not arbitrary and that the amendment merely seeks to formalise the transfer pricing documentation requirement to demonstrate ordinary profits.

3. The challenges likely to be faced by taxpayers have been illustrated below:

• A taxpayer (say ABC Ltd., a tax holiday unit) has earned a margin of 30% while arithmetic mean of the margins earned by comparables is 15%. OP/TC of 30% considered to be at ALP by the TPO.

Particulars Profit level indicator

Total Income 150

Cost (TC) 105

Profits (OP) 45

OP/TC 30%

Comparable Companies Operating profits/Total cost (OP/TC)

Company A 35%

Company B 10%

Company C 25%

Company D 14%

Company E -8%

Arithmetic Mean 15%

In the above case, if price based method has been applied to benchmark the transaction between ABC Ltd. and a person closely connected with it, the derived profits should be considered as ordinary profits till the AO can substantiate that the taxpayer’s transaction is so arranged that it has earned more than ordinary profits under section 80-IA(10) of the Act.



• However, where ABC Ltd’s ALP was determined using profit based methods (such as net margins of comparable companies), a question arises as to whether tax holiday benefits will be denied when the ABC Ltd., has earned profits (30%) similar to that earned by other industry players (say Company A – 35% and Company C-25%), though in excess of ALP (15%).

4. Taxpayers with tax holiday units need to consider the impact of these rulings and the Budget 2012 amendments to demonstrate and document the ordinary profits eligible for the tax holiday.

2. OPG Energy Pvt. Ltd. vs. DCIT3

More profit from related than unrelated parties does not itself make it ‘more than ordinary’ (SEB rates also used as support); profit comparison to be done for ‘individual’ related parties.

In brief OPG Energy Pvt. Ltd. (the taxpayer) claimed deduction under section 80-IA of the Income-tax

Act, 1961 (the Act), which was restricted by the Assessing Officer (AO), who alleged that the taxpayer had earned more than ordinary profits by selling to related parties at a higher price than that charged from unrelated parties. The Chennai bench of the Income-tax Appellate Tribunal (the Tribunal), while deciding the case in favour of the taxpayer, laid down the following principles:

• If taxpayer earns more profit from related parties in comparison to unrelated parties, that does not by itself make the profit from related parties ‘more than ordinary’.

• Profit realised by the taxpayer by charging rates to related parties which are lower than the rate charged by a government undertaking (a State Electricity Board or ‘SEB’), cannot be said to be ‘more than ordinary’.

• Comparison of profit realised from one or more related parties must be undertaken for each party separately.

Facts

• The taxpayer was engaged in the business of generation and distribution of power, and sold power to related parties as well as unrelated customers. The taxpayer was eligible for deduction under section 80-IA of the Act in respect of the profit derived from the said undertaking, and claimed such deduction.

• The (AO reduced the deduction claimed by the taxpayer to the extent of the excessive receipts earned from sale to related parties vis-a-vis sale to unrelated customers, as the AO claimed that the taxpayer had earned more than ordinary profits by selling power to related parties at a higher price (at INR 3.364 per unit) than to unrelated parties (at INR 3.266 per unit).

• The Commissioner of Income-tax (Appeals) upheld the AO’s actions. Aggrieved, the taxpayer appealed before the Tribunal.

3 OPG Energy Pvt. Ltd. v DCIT, Chennai [TS-382-ITAT-2012 (CHYN)]



Taxpayer’s contentions

• Prices charged by the Tamil Nadu Electricity Board (TNEB) were higher than the prices charged by the taxpayer from its related parties.

• The taxpayer had charged a higher rate of Rs. 3.40 per unit from most unrelated parties, except one party (Meridian Industries) which had been charged a lower rate due to a different pricing basis. Since the rate charged to this party lowered the average, this party should not be considered.

Revenue’s contentions

• Meridian Industries cannot be excluded, as claimed by the taxpayer, because maximum sale has been made to this unrelated party and ignoring the same would distort the picture. Further, no documentary evidence has been furnished by the taxpayer with regard to exclusion of Meridian Industries. There may be various reasons for contracting different sale rates with different customers but the onus is on the taxpayer to evidence the same, which in the instant case, the taxpayer has failed to do.

Tribunal ruling

The Tribunal ruled in favour of the taxpayer on account of the following:

• Section 80-IA of the Act does not provide that if the taxpayer earns more profit from related parties in comparison to unrelated parties, then the allowance of deduction is to be restricted to the profits derived from unrelated parties.

• The average rate charged by the taxpayer from related parties was less than the rate at which power was sold by TNEB. Thus, profit realised by charging rates which are lower than the rate which is charged by a government undertaking, cannot be said to be ‘more than ordinary’.

• Comparison of profits realised from one or more related parties must be undertaken for each party separately.

In the absence of rates charged from individual related parties, the Tribunal held that it was not in a position to adjudicate the issue completely. Thus, the Tribunal restored the matter back to the AO for fresh adjudication in light of the above observations.

Our observations

• While comparing profit of the taxpayer, the Tribunal has considered profits derived from rates charged to unrelated parties and those charged by a State Electricity Board. Profit of the taxpayer lies in between, i.e., higher than the former and lower than the latter. The Tribunal has, therefore, in essence considered a ‘range’ of profits to conclude that the taxpayer was not earning ‘more than ordinary profits’.

Notably, the terminology used in Section 80-IA(10) of the Act is also ‘ordinary profits’ (in plural) rather than just ‘ordinary profit’ (in singular), thereby implying the use of a ‘range’ rather than a single reference point. Hence, it may be inferred that the legislation itself endorses the use of the ‘range’.

However, in light of the recent amendments made vide Finance Act, 2012, the existing transfer pricing regulations have been made applicable to determination of profits from



transactions of tax holiday units with closely connected person/s. The regulations provide for a concept of ‘arithmetic mean’ with a very narrow tolerance band. In fact, it could have been detrimental for the taxpayer, had the ‘arithmetic mean’ concept been applied in the instant case, instead of the approach actually adopted by the Tribunal.

Accordingly, from a taxpayer’s perspective, one would expect a liberal interpretation of the transfer pricing regulations when applied to determine the ‘more than ordinary profits’ earned by tax holiday units.

• Comparison of profits realised from ‘individual’ related parties as has been contemplated by the Tribunal in the instant case, may pose practical difficulties and may not always be feasible or even required to be undertaken.

3. Durga Rice & Gen Mills4

Income from a domestic related party cannot be adjusted by applying transfer pricing provisions under section 40A(2) of the Act.

In brief

In a recent ruling in case of Durga Rice & Gen Mills (the taxpayer), the Chandigarh Bench of the Income-tax Appellate Tribunal (the Tribunal), held that provisions of section 40A(2) of the Income-tax Act, 1961 (the Act) cannot be applied to adjust sale value realised by a taxpayer from its domestic related party.

Facts

The taxpayer is in the business of running a rice mill and selling the rice bran. During the year, the taxpayer sold rice bran to its domestic related party. The assessing officer (AO) challenged the rate and was of the view that the rate was lower than the rate charged by other independent third parties for sale of similar product. The AO accordingly, proposed to adopt a higher rate based on available comparable price.

The taxpayer contended that the sale value of rice bran depends on its quality and that the sales made to the domestic related party were at comparable rates. The AO rejected the taxpayer’s arguments and made an adjustment on the profit of the taxpayer by considering the average sale price realised by independent parties. Aggrieved, the taxpayer appealed to the CIT(A), who upheld the findings of the AO.

Aggrieved, the taxpayer appealed before the Tribunal.


The sale price of rice bran realised by independent third parties is higher than the sale price charged by the taxpayer to its domestic related party. Thus, there has been under reporting of profits and an adjustment is warranted under section 40A(2) of the Act.

4 Durga Rice & Gen Mills v. AO [TS-446-ITAT-2012(Chandi)]



Taxpayer’s contentions

The taxpayer argued that sale value of rice bran was based on its quality which depends on the content of oil. In addition the taxpayer contended that –

• The law does not oblige any business entity to sell goods at the maximum available rates;

• No addition should be made on account of difference in sale price under section 40A(2) of the Act as this provision deals with expenditure and not revenue5;

• Suitable amendments are required in section 40A(2) of the Act to make addition on account of difference in sales value6.

Tribunal ruling

• It is settled law that section 40A(2) of the Act cannot be applied for making addition for the difference in value of sales made to domestic related party; section 40A(2) of the Act is restricted to disallowance of expenditure value.

• Relying on the findings of Supreme Court in case of Glaxo Smithkline Asia (P) Ltd. the Tribunal held that the Central Board of Direct Taxes (Revenue) also acknowledges that suitable amendments are required to be made in section 40A(2) of the Act, if transfer pricing provisions were required to be applied to domestic transactions between related parties and undertaking adjustments on account of difference in sale value effected by the taxpayer in comparison of the fair market value7. Given this, provisions of section 40A(2) of the Act cannot be attracted in the taxpayers case.

Our observations

• The ruling of the Tribunal clearly brings out the principle that the provisions of section 40A(2) of the Act do not grant powers to the AO to adjust income reported by a taxpayer from domestic related parties.

• Following the observations of the Supreme Court in the case of Glaxo Smithkline Asia Pvt Ltd., Finance Act, 2012 has amended section 40A(2) of the Act to provide that transfer pricing provisions will apply to determine the reasonableness of expenditure incurred towards domestic related parties and related transfer pricing compliances would have to be undertaken, with effect from 1 April 2012.

• It is relevant to note that the above amendments have not extended the scope of section 40A(2) of the Act, to income earned from domestic related parties. In fact, the Memorandum to the Finance Bill, 2012 explaining the amendments noted that extending the transfer pricing requirements to all domestic transactions will lead to increase in compliance burden on all assessees which may not be desirable.

Taxpayers earning income from related parties should, however be cognizant of an adverse impact to the group where a related party making payment to the taxpayer faces a disallowance of the payment under section 40A(2) of the Act but a corresponding reduction in income is not available to the taxpayer. A holistic review of the pricing policy of transactions between domestic related parties and a coordinated effort towards robust transfer pricing documentation needs paramount consideration.

5 CIT vs. A.K. Subbaraya Chetty & Sons [1980] 123 ITR 592 (Mad)6 CIT vs. Glaxo Smithkline Asia (P) Ltd [2010] 195 Taxman 35 (SC)7 Relying on the findings of the Supreme Court in the case of Glaxo Smithkline (above)



4. Cadila Healthcare Ltd8

Profit of tax holiday unit computed by considering ‘actual’ sale price and cost attributable thereof, including HO cost allocation.

In brief

In a recent ruling in the case of Cadila Healthcare Ltd. (assessee or company), the Ahmedabad Income-tax Appellate Tribunal (the Tribunal) has held, among other things, the following:

• Deduction under section 80-IB and section 80-IC of the Act is available on the profit earned by the eligible unit from the overall activity, and the assessing officer (AO) cannot segregate manufacturing and sale activity for the purpose of computing deduction under respective sections.

Facts

• The assessee was engaged in the business of manufacturing and trading of pharmaceuticals goods, diagnostic kits, medical instruments etc. The assessee was having a unit at Baddi, Himachal Pradesh, for which it was claiming a deduction under section 80-IC of the Act. Further, the assessee also has a unit at Goa, for which the assessee was claiming deduction under section 80-IB of the Act.

• During the course of assessment proceedings, the AO inter alia proposed the following adjustments to the total income in his draft assessment order passed under section 143(3) of the Act read with 144C of the Act:

- Curtailment of amount of deduction claimed by the company under sections 80-IC and 80-IB of the Act with respect to its Goa and Baddi units respectively.

• The disallowances proposed by the AO were upheld by the Dispute Resolution Panel (DRP). Aggrieved with the order of the DRP, the assessee preferred an appeal before the Tribunal.

Contentions and ruling

Issue

• Whether deduction under sections 80-IB and 80-IC of the Act is available on the activities of the Baddi and Goa units, being units enjoying tax holiday.

Assessee’s contentions

• The assessee contended that the AO should not disturb the computation of deduction of the eligible unit on the ground that the profit earned by other units is lower than the profits earned by the eligible unit. In this regard, the decision of Delhi Press Patra Prakashan9 was relied upon.

8 Cadila Healthcare Ltd [2012]21 Taxman.com 483 (AHD ITAT)9 ACIT v. Delhi Press Patra Prakashan [2006] 103 TTJ 578 (Del)



• Section 80-IA(5) of the Act requires computation of profits of the undertaking on the assumption that the eligible business is the only source of income for the assessee. Eligible business means the overall activity, i.e., the manufacturing of a product along with the marketing activity.

• There are no provisions in the Act that provide for the segregation of profits of the eligible unit with regard to various operations like manufacturing, marketing, etc.

• As per the provisions of section 80-IC of the Act, profits and gains derived by an eligible undertaking are eligible for deduction. Accordingly, the profits and gains of an eligible undertaking include not only the manufacturing gains but also ancillary gains having direct nexus with manufacturing activity.

• Sourcing of raw materials by the Baddi unit from other plants was at arm’s length price as required by section 80IA(8) of the Act.

• In light of the above, the entire profits of the Baddi and Goa units were eligible for deduction under sections 80-IC of the Act and 80-IB of the Act, respectively.


• The AO contended that the Baddi unit of the company was earning abnormally high profits. Deduction under section 80-IC of the Act was claimed on such abnormally high profits.

• The profit of Baddi unit was computed after deducting manufacturing expenses and depreciation. No indirect costs such as marketing expenses, research and development expenses, corporate expenses and interest were allocated. Accordingly, the profit of the unit is inflated.

• As per the provisions of section 80-IC(7) read with section 80IA(5) of the Act, profits of eligible business are to be computed on the assumption that the said business is the only source of business.

• According to the AO, the Baddi unit carried out manufacturing activity and transferred the goods to the marketing division in the head office, and therefore should have been entitled to remuneration of its cost and a reasonable profit.

• The AO therefore proposed to compute profits attributable to the manufacturing activity alone.

• Earlier, from the sale of products which were purchased from third party contract manufacturers, the assessee was earning gross margin of 80%. However, after the manufacture of these products commenced in Baddi unit, the gross margin of the assessee increased up to 86%. Accordingly, the AO contended that it is only the additional profits of 6% which represented profits from manufacturing activity. The balance profit was earned by exploiting the brand and marketing network.

• Accordingly, the deduction for Baddi unit was restricted to 6% of its turnover10.

10 The AO relied on the decision of Rolls Royce PLC v. DDIT, Delhi 19 SOT 42



• Following the same analogy, the deduction for Goa unit was restricted to 6% of its turnover.

Tribunal’s ruling

• Profit is the difference between sale price and the cost of production along with cost of bringing the product to market such as marketing expenses, corporate expenses and interest.

• The Baddi unit has computed profit as per the above accounting principle (i.e., after allocating head office expenses).

• As separate books of accounts were maintained and no defect in working of the profit with respect to Baddi unit has been pointed out, the AO cannot disturb the computation of profit of Baddi unit.

• The decision of Rolls Royce PLC relied upon by the revenue authorities can be distinguished as in the case of the assessee, the segregation between 80% and 6% is not on account of any evidence through which it could be established that the major portion of the profit could be attributed to the assessee company and rest of the profit could only be attributed to the Baddi unit.

• Section 80-IA of the Act does not suggest that the eligible profit should be computed first by transferring the product at an imaginary sale price to the head office and then the head office should sell the product in the open market. There is no such concept of segregation of profit.

• Profit of an undertaking is always computed by taking into account the sale price of the product in the market.

• In light of the above, deduction under sections 80-IB and 80-IC of the Act is required to be computed on the entire profit of the unit including marketing activities.

Our Comments

In relation to tax holiday claim, the following principles have been laid out:

• To compute a price for transfer of goods or services from a unit enjoying tax holiday to the non-eligible unit of the assessee, an “actual” transfer is a pre-condition.

• Where the sale from the unit enjoying tax holiday is the only source of income, the profit of the unit should be computed by considering the sale price of goods or services and costs attributable to effect such sale (including allocation of head office costs).

Effective from financial year 2012-13, transfer pricing provisions will apply to transactions of transfer of goods and services undertaken by units enjoying tax holiday with non-eligible units of the assessee. Accordingly, the above principles laid down by the Tribunal would need to be followed in consonance with the transfer pricing regulations.

qqq



Snapshot of landmark Judicial Precedents

Case law Sanghvi Jewellery MFG Co. Ltd. vs ITO (2012-TI I -22-ITAT-MUM-TP)

DCW Ltd. vs ACIT (132 TTJ 442)

Assam Carbon products Ltd. vs ACIT (100 TTJ 224)

Reliance Infrastructure Ltd. vs ACIT (9 ITR 84)

National Thermal Power Corpn Ltd vs ACIT (91 ITD 101)

Key Takeaways

• Onus is on revenue to show that assessee has earned more than ordinary profits. However, once AO demonstrates abnormal increase in GP, the onus shifts on the assessee.

• If electricity was purchased from electricity board, whether price would include electricity tax?

• Held that assessee was justified in including the electricity tax (levied by State Govt.) for pricing electricity generated by one of its unit to another.

• Price at which assessee was exporting NH Coke to the foreign

collaborator was to fulfill the conditions imposed by the Indian Government and cannot be considered as market value.

• Accordingly, assessee was justified in valuing inter-unit transfer of NH Coke at notional cost by obtaining quotations from foreign suppliers.

• Purchase price of power from Tata Power Company rather than

price determined based on orders of the Maharashtra Energy Regulatory Commission is more appropriate to computing the profit of the internal power generation u/s 80-IA.

• No expenditure could be deducted for computing tax holiday

profits on a notional basis where the assessee had not incurred actual expenditure for use of any material or service.

qqq

1

Dear Delegate,

Re : International Tax & Finance Conference 2012 Holiday Inn, Goa from 17 to20 August 2012 Travel and other useful information

We have great pleasure in welcoming you to the International Tax and Finance Conference, 2012.

1 In the enclosed Attachment (Annexure 1) we have given our suggestions / information that you may find useful. Needless to say, these are merely for your guidance and you may make your own inquiries and confirm.

2 In case you are not in a position to arrive at the venue on 17th August 2012 by 3 pm, and intend to join the Conference at a later date, please inform by 14th August 2012 by mail to all the following persons, AND by phone to at least one of them, clearly mentioning the date when you would be arriving. This would assist in making appropriate arrangements. Please appreciate that in case we do not receive such an intimation and you do not report on 17th August, 2012, we may presume that you would not be attending the Conference.

Rajesh Kothari 99690 03722 [email protected]

Ganesh Rajgopalan 98202 01951 [email protected]

Nitin Shingala 98200 57694 [email protected]

Chetan Shah 9820223402 [email protected]

Gaurang Gandhi 9820033802 [email protected]

3 In case of your inability to attend the Conference for any reason, please inform us by email [[email protected]] with a copy marked to all the e-mail ids mentioned in 2 above and by phone to any of them. Please do not substitute any other person to attend the Conference in your place. The substituted person shall not be admitted in the Conference.

4 Transport arrangements:

We have arranged for airport transfer for delegates arriving at Goa Airport between 1 pm and 3 pm. Taxis are also available at the Airport.

For those who are arriving by train, we regret that we will not be able to provide Group transfer due to inadequate number of delegates. We request you to make your own arrangements to reach the Hotel.

5 In the following pages, you will find:

• Tentative Conference Programme from 17 to 20 August 2012.

• List of delegates together with details of the groups allotted for group discussions for the three discussion papers. As a mark of courtesy and appreciation towards the Group Leaders who are putting in considerable time, efforts & hard work, we request you to be present only in the Group mentioned against your name.

6 Should you need any clarification, please contact any of the persons mentioned in 2 above.

Looking forward to welcoming you at the Conference Venue,

Sincerely,

Ganesh Rajgopalan Conference Coordinator

International Tax & Finance Conference 2012

Annexures

1 Travel and other useful information with Location Map2 Tentative Conference Programme3 List of Delegates with allotted Groups4 List of Group Leaders

2

3

Documents

Service Tax On Cross-Border Transactions Material... · Service Tax On Cross-Border Transactions (iv) determination of place of provision of service for both import and export of