Tax Scout Apr-Jun, 2017 1 - Cyril Amarchand Mangaldas · Ÿ Draft rules for valuation of “unquoted shares ... 'tryst with destiny' for India, as the government likes to call it,

We are delighted to present to you, the latest issue of the Tax Scout, our quarterly update on recent developments in the field of direct and indirect tax laws for the quarter ending June 2017.

This time, as part of our cover stories, we have analysed the key features of the notification issued by the CBDT, dealing with changes made pursuant to Finance Act, 2017, to long term capital gains exemption available in case of certain transfers of equity shares. This notification by stating that all transactions shall be eligible for exemption other than certain specified transactions provides the much needed clarity on this issue.

In the context of indirect taxation, we have discussed the impact of newly introduced anti-profiteering provisions under the GST regime, which are aimed at ensuring that fiscal benefits arising from GST implementation are passed on to the final consumers.

© 2017 Cyril Amarchand Mangaldas

FOREWORD

TAX SCOUTA QUARTERLY UPDATE ON RECENT DEVELOPMENTS IN TAXATION LAW

APRIL 2017 - JUNE 2017

Additionally, this issue of Tax Scout analyses the important rulings by the Indian judiciary and the key changes brought about by way of circulars and notifications in the direct and indirect tax regimes during the June quarter.

We hope you find the newsletter informative and insightful. Please do send us your comments and feedback at [email protected].

Regards,

Cyril Shroff Managing Partner Cyril Amarchand Mangaldas Email: [email protected]


Tax Scout | Apr - Jun, 2017

INDEX

02

Cover StoriesŸ Long term capital gains tax exemption on sale of listed shares - a much needed closure by CBDT

notificationŸ Anti-profiteering or anti-profits

Case Law UpdatesDirect Tax Ÿ Expenditure incurred in relation to use of technical know-how for bringing the business into existence is

capital expenditureŸ Word “payable” in section 40(a)(ia) not only covers cases where any amount is payable, but also

instances where amount has actually been paidŸ Royalty income is taxable in India on receipt basis as per India-Italy DTAAŸ Reimbursement of salaries paid under a secondment agreement does not attract with holding tax in

IndiaŸ Payments for Standard Operating Procedure is taxable as royaltyŸ Foreign shipping company not liable to tax in the absence of POEM

Indirect TaxŸ Mandatory pre-deposit of 10% of duty demanded for second appeal shall be over and above the 7.5%

deposited at the time of first appealŸ A proviso leading to variation of prices for retailers when the goods are sold directly and when sold

through oil marketing companies is not arbitrary or discriminatoryŸ Small Scale Exemption shall not be denied to the products using brand name of their ownŸ Chit fund cannot be treated as fund management as generally understood in the common business

parlanceŸ Not for Profit educational Trust providing training or coaching services was liable to service taxŸ Appy Fizz passes the test as fruit juice based drinkŸ Chargers sold with cell phone in composite packs are chargeable to VAT at rate applicable to cell phone

Non Judicial UpdatesDirect TaxŸ CBDT notifies new safe harbour rulesŸ Government notifies the list of specified individuals to whom section 139AA of the IT Act will not applyŸ Clarification on treatment of lease rent from letting out buildings/developed space along with other

amenities in an Industrial Park/SEZ Ÿ Cabinet approves Multilateral Convention to Implement DTAA Related Measures to Prevent Base

Erosion and Profit ShiftingŸ Definition of Start-up amendedŸ CBDT notifies rules for TDS on rent payment by individuals / HUFsŸ Notification of Cost Inflation IndexŸ Rules for method of valuation of accreted income of trust under section 115TD of the IT Act notified on

April 21, 2017Ÿ Draft rules for valuation of “unquoted shares”

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03 © 2017 Cyril Amarchand Mangaldas

COVER STORIES



LONG TERM CAPITAL GAINS TAX EXEMPTION ON SALE OF LISTED SHARES - A MUCH NEEDED CLOSURE BY CBDT NOTIFICATION

Background

Section 10(38) of the IT Act exempts long-term capital gains arising from transfer (after October 1, 2004) of, inter alia, an “equity share” of a company, if such transfer takes place through a recognised stock exchange and Securities Transaction Tax (“STT”) is paid. The Government alleging that the exemption was being misused by the unscrupulous elements to convert unaccounted money into legal money inserted the third proviso to section 10(38) vide Finance Act, 2017 (“FA”). This proviso restricts the entitlement of such exemption only to cases where STT has been paid at the time of acquisition of such equity shares (“Restrictive Provision”) with the exception of certain genuine business transactions where STT has not been paid (yet to be notified by the Government).

CBDT Notification

A number of representations were made to the Government on the grounds that the draft

1 notification lacks clarity on a number of issues and taxpayers were worried about the manner in which it will be interpreted by the tax authorities. Taking note of the representations made, the Government has finally come up with an improvised version of the

2notification (“Notification”) .

The Notification provides that all transactions of acquisition of equity shares that have taken place on or after October 1, 2004 in respect of which no STT was paid, will continue to remain exempt from the application of the Restrictive Provision, except for the specified transactions listed in the said Notification wherein the exemption shall not be available.

The Notification stipulates three types of acquisitions, where the Restrictive Provisions would apply, which are as follows:

3(a) Where shares which are not frequently traded on the recognized stock exchange and were acquired through a preferential issue, except the following:

(i) Acquisition of such shares through a mechanism other than those preferential issues to which Chapter VII of Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 (“ICDR”), (dealing with preferential issues) does not apply;

(ii) such shares were acquired by a non-resident in accordance with the extant foreign direct investment guidelines issued by the Government of India;

(iii) if such acquisition was approved by the Reserve Bank of India (“RBI”), the Securities and Exchange Board of India (“SEBI”), the National Company Law Tribunal (“NCLT”), the SC or any of the HC; and

(iv) such acquis i t ion was made by an investment fund or a venture capital fund.

(b) Acquisition of listed equity shares of a company, otherwise than through a recognized stock exchange, except the following:

(i) Acquisition through a mechanism not covered in (a) above;

(ii) Acquisition of such shares through a mechanism other than those preferential issues to which Chapter VII of the ICDR does not apply;

(iii) such shares were acquired by a non-resident in accordance with the extant foreign direct investment guidelines issued by the Government of India;


1 Press Release dated April 3, 2017 issued by the CBDT.2 Notification No. S.O. 1789(E) dated June 5, 2017.3 “Frequently traded shares” means shares of a company, in which the traded turnover on a recognised stock exchange during the twelve calendar months

preceding the calendar month in which the transfer is made, is at least ten per cent of the total number of shares of such class of the company Provided that where the share capital of a particular class of shares of the company is not identical throughout such period, the weighted average number of

total shares of such class of the company shall represent the total number of shares.

05

(iv) if such acquisition was approved by the RBI, SEBI, NCLT, SC or HCs;

(v) a c q u i s i t i o n b y s c h e d u l e d b a n k s , reconstruction or securitisation companies or public financial institutions during the ordinary course of their business;

(vi) acquisition by the employees under an employee stock option plan (“ESOP”);

(vii) such acquis i t ion was made by an investment fund or a venture capital fund, etc.

(viii) acqu i s i t i on unde r SEB I Takeove r Regulations; and

(ix) acquisition by mode of transfer referred to in sections 47 to 50B, if it is not covered within any of the other mode of acquisition specified in this Notification;

(c) acquisition of the shares of a company during which it was delisted.

From the perusal of the Notification, the following principles emerge:

(i) The Notification does not cover all preferential issues made by the companies whose shares are not frequently traded in the stock exchanges. Instead, it has included within its purview only such preferent ia l issues to which ICDR Regulations apply.

It may be noted that “Preferential issue” has been defined by the ICDR to mean a private placement of shares to a select group of persons by a listed issuer. ICDR specifically excludes certain transactions from the ambit of the term “preferential issue”, such as offer of specified securities made through a public issue, rights issue, bonus issue, employee stock option scheme, employee stock purchase scheme or qualified institutions placement or an issue of sweat equity shares and depository receipts issued in a country outside India. Thus, it can be implied that such transactions have deliberately been excluded from the application of the Restrictive Provision.

(ii) Regulation 70 of the ICDR provides that Chapter VII of the ICDR transactions would not apply in cases of

(i) preferential issue of shares pursuant to conversion of loans or options attached to convertible debt instruments;

(ii) preferential issue of shares pursuant to scheme approved by the HC sections 391-394 of the Companies Act 1956; and

(iii) under a rehabilitation scheme under the Sick Industrial Companies (Special Provisions) Act, 1985.

Thus, acquisition of equity shares pursuant to these transactions has been specifically excluded from the scope of the specified transactions to which the Restrictive Provision will apply.

Unlike the draft notification which did not specify various genuine forms of acquisitions to be covered within its purview, the Notification appears to have made an attempt to clarify that acquisitions of listed shares made on the basis of genuine business transactions shall continue to be entitled to claim exemption. For example, shares acquired under an ESOP, shares acquired by scheduled banks, securitisation and reconstruction companies, acquisitions made by investment funds and venture capital funds, acquisitions made after obtaining approvals from Courts, RBI, SEBI, NCLT, etc., will continue to be entitled to exemption under section 10(38) of the IT Act. It is also pertinent to note that all investments made by foreign investors in accordance with the extant foreign direct investment guidelines will also continue to be entitled to such exemption.

This is a very welcome initiative by the Government wherein most of the concerns expressed by various stakeholders appear to have been addressed through this Notification. This will enable investors and promoters to plan their business transactions in an optimum manner without having any uncertainty regarding their tax treatment.





ANTI-PROFITEERING OR ANTI-PROFITS?

Introduction and Background

Goods and Services Tax (“GST”) is finally a reality as we usher into the GST era with effect from July 01, 2017. The 'Good and Simple Tax' and the second 'tryst with destiny' for India, as the government likes to call it, is expected to bring out a huge change in the manner of doing business in India in ways more than one.

We all would agree that this is a welcome step towards consolidating the indirect tax structure in the country and will go a long way in simplifying the indirect tax regime in India. While it's difficult to question the noble intention of the Government in implementing GST in record time, probably the haste of making GST implementation at the earliest has led to few unanswered questions and lack of clarity for businesses on certain aspects. One of the primary concern areas for the industry has been the introduction of the anti-profiteering provisions.

Anti-profiteering provisions under GST in India

In terms of Section 171 of the Central Goods and Services Tax Act, 2017 (“CGST Act”), every supplier, receiving the benefit of reduction in rate of tax or gain from effective input tax credit, is required to pass on the benefit to the recipient by way of commensurate reduction in price. The said provision has been inserted under the CGST Act with an objective to protect the interest of the ultimate customers and to ensure that the benefits of introduction of GST passes through the supply chain and does not remain limited to businesses.

The aforesaid section further provides for constitution of an authority or empowering any other authority for ensuring compliance with the anti-profiteering provision. However, the lack of clarity or guidance in the implementation of the anti-profiteering provisions has led to a major road block in smooth transition to GST. While the industry hoped that the Anti-Profiteering Rules (“Rules”) to be released by the Government would bring transparency and clarity in the implementation of the anti-profiteering provision, the Rules have only turned out to be a disappointment.

The Rules have only chalked down the administrative hierarchy and framework of the authority which would

redress complaints of anti-profiteering, but have not provided any guidance on how to calculate and determine 'profiteering' and the 'commensurate benefit' to be passed on to the customers.

International Practice

The anti-profiteering provisions introduced in India are not novel and have been tested in other international jurisdictions. While the concept of GST at the international arena can be traced back to approximately 60 years, the anti-profiteering provisions are fairly recent.

In Australia, which is considered as the first country to enact an anti-profiteering law in the year 2000, anti-profiteering policies were bought into public domain a year before the implementation of the GST regime. The Australian government introduced much in advance, pricing guidelines, strategies focused specifically on certain sectors, advice centers for businesses and consumers, etc. The calculation of profits and comparisons were based on the Net Dollar Margin Rule method, which mandated that if the tax and cost fell by $1, then the price of the commodity should also fall by at least $1.

In Malaysia a formula was laid down wherein the net profit margin of the period preceding GST was compared to the post-GST margin to see if the unreasonable gains had gone to the businesses.

Going by the international precedents, ideally, the anti-profiteering and profit control measures should have been in place well before the implementation of GST in India in order to equip the industry to take pricing decisions and ensure preparedness for the new tax regime. International experience also indicates that anti-profiteering provisions are effective only if there is significant lead-in time to allow the relevant authorities to monitor and control prices.

However, under the Indian context, even after the implementation of GST, the authority which is required to implement the anti-profiteering provisions still remains on paper.

Another aspect where the Indian provisions depart from the international practice is that tax authorities have been vested with the role to ensure that price control mechanisms are properly put into place. In



Malaysia, the anti-profiteering provisions were not part of the GST legislation and were enacted separately under the Price Control and Anti-Profiteering Act, 2011. The Authority which was given the power to control and monitor prices was the Malaysian Ministry of Domestic Trade.

Similarly, in Australia, the price monitoring regime was set up under the Trade Practices Act, 1974 (later known as Competition and Consumer Act, 2010) with the task of monitoring anti-profiteering being assigned to the Australian Competition and Consumer Commission (“ACCC”).

The Australian experience of GST implementation is quoted as the smoothest in the world. The Australian government conferred the ACCC with various statutory responsibilities, inter alia including the task of formulating guidelines on what constitutes price exploitation, seek information from businesses to effectively monitor the price movements, etc. The ACCC's price oversight regime, during the transition period resulted in obtaining refunds of around $21 million which benefitted around 2 million consumers, mostly on account of overcharged GST.

The Australian Government also launched dual ticketing norms, wherein both prices- Pre-GST and Post-GST were mentioned on the goods and this was adopted for a month before the implementation of GST. One of the main reasons to implement such a norm was to ensure that the consumers were not misled by businesses.

The Hurdles

O n e o f t h e m a n y p r o b l e m s i n e f f e c t i v e implementation of the anti-profiteering provisions under GST is the absolute lack of clarity regarding computation of 'benefits' by the supplier, which shall trigger the application of anti-profiteering provisions. It is unclear whether the comparison would be on the basis of profits earned at an entity level or each product line. Certain press statements made by Government officers indicate that the comparison would be at an entity level, and if that is actually done, it would make many businesses run out of profits. The anti-profiteering provisions do not factor in any associated events such as increase in operating costs due to increase in extraneous factors such as salary of employees, rents etc., which also influence price determination. Therefore, if by the strict applicability of the anti-profiteering provisions, an

entity is required to pass on the benefit due to reduced tax rate or increased input tax credit in relation to a product which is the major source of its revenue, it may lead to an overall loss at the entity level. It is also uncertain whether the benefits are to be computed on monthly, quarterly or annual basis.

It has been observed from international experience, that introduction of GST leads to temporary inflationary trends, and anti-profiteering provisions are the government's attempt at combating such inflation during the infancy of the new tax regime. Typically these provisions are aimed to deal with domestic inflation, and therefore should not require exporters to comply with the anti-profiteering provisions while making supplies to recipients located abroad. However, no such exclusion for exporters is currently contemplated in the law.

Another aspect which needs attention is the treatment of entities covered under various fiscal incentive schemes under the Foreign Trade Policy. In light of GST implementation, these schemes, are also expected to be reviewed to provide enhanced incentives. It is challenging to determine whether the corresponding increase in profits on the basis of any favorable revision in these schemes would also be deemed as 'profiteering' and would be subject to scrutiny despite the fact that the incentives were meant to promote exports.

Closing Remarks

In a study conducted by Controller and Auditor General of India it has been revealed that post the introduction of the Value Added Tax (VAT) regime in India, manufacturers had illegally retained benefits which otherwise would have benefitted consumers by way of lower prices. It is undoubtedly with this background that the anti-profiteering regime was felt necessary along with GST introduction. However, the law still needs a lot more evolution and clarity in order to effectively achieve the intended target.

At this stage, the only respite is that time and again, the Government has indicated that the anti-profiteering provisions are merely incorporated as a deterrent provision, and misuse of the provisions by officials would be monitored and the provision is not meant to harass honest tax payers.

08

CASE LAW UPDATES

- DIRECT TAX





4In Honda Siel Cars India Ltd. , the SC held that expenditure incurred for use of technical know-how which was crucial in setting up a new business was in the nature of capital expenditure and not revenue expenditure.

FACTS

Honda SIEL Cars Ltd. (“Assessee”), a joint venture company of Honda Motors Company Ltd., Japan (“HMCL”) and M/s. SEIL Ltd. (“SEIL”), a company incorporated in India with shareholding of 99% and 1% held by HMCL and SEIL respectively. HMCL (licensor) entered into a “Technical Collaboration Agreement” (“TCA”) with the Assessee (licensee), wherein the licensor, which was engaged in the business of development, manufacture and sale of automobiles and their parts, agreed to grant a “license” and provide “technical assistance” to the Assessee, for a payment of lump sum fee payable in five continuous equal instalments (commencing from third year after commencement of commercial production) and a royalty of 4%. The Assessee, in its tax return, claimed the said expenditure as a revenue expenditure, however, IRA held it to be a capital expenditure and also alleged that such payment had escaped assessment. The ITAT, while adjudicating on the appeal filed by the Assessee held such expenditure as a revenue expenditure. However, on further appeal by the IRA, the ITAT ruling was reversed by the Allahabad HC. The matter travelled to the SC when the impugned judgment of Allahabad HC was challenged before the SC.

ISSUE

Whether technical fee and royalty payable would be treated as revenue expenditure or capital expenditure.

ARGUMENTS/ANALYSIS

IRA contended that payment of fee for technical know-how and royalty payments were for bringing a

EXPENDITURE INCURRED IN RELATION TO USE OF TECHNICAL KNOW-HOW FOR BRINGING THE BUSINESS INTO EXISTENCE IS CAPITAL EXPENDITURE

new business into existence and thus, the benefits accruing to the Assessee were of enduring nature and ought to have been treated as a capital expenditure. On the other hand, the Assessee submitted that it had acquired mere right to use technical information provided by HMCL, Japan and, thus, it did not lead to creation of any asset of enduring nature and hence, it deserved to be treated as revenue expenditure. Assessee relied on the decision of Delhi HC in Hero

5Honda Motors , wherein on identical facts, it was held that payment of technical know-how fee and royalty was in nature of revenue expenditure.

It was also submitted that the Allahabad HC had erroneously recorded that the payment for technical know-how was made for setting up a new automobile manufacturing plant in India whereas such payment was made to acquire the licence which assisted the Asssessee in the manufacturing of products in India and payment was not made towards setting up of new plant. Under the TCA which was for initial ten years from the date of agreement, Assessee had only acquired the limited right to use technical know-how for manufacture of products and ownership rights in the know-how continued to remain with HMCL.

The ITAT had held that any expenditure incurred under the TCA was a revenue expenditure and it was based on the premise that separate three agreements/ memoranda (for necessary guidance for setting up of plant, supply of parts for manufacture of cars and supply of manufacturing facilities) were executed between the parties which were necessary for setting up the manufacturing facilities. Payments made for such services ought to have been treated as capital expenditure whereas payments under TCA were treated as revenue expenditure and such payments were held to be not in connection with setting up of manufacturing unit. Though the ITAT did nurture a doubt over the connection between technical collaboration under TCA and setting up of new plant, but decided in favour of the taxpayer based

4 Honda Siel Cars India Ltd v. CIT (2017) 82 taxmann.com 212 (SC).5 CIT v. Hero Honda Motors (2015) 327 ITR 481 (Delhi HC).



on the fact that payments under TCA was for use of know-how for limited period as opposed to acquisition of know-how placing reliance on judicial

6precedents.

The Allahabad HC reversed the ITAT ruling, relying on 7the decision of Jonas Woodhead and Sons (India) ,

wherein it was held that whenever a complete new plant with new process and new technology for the manufacture of a product was brought into existence, payment for such technical know-how would be treated as a capital expenditure and accordingly held that payments made under TCA for technical collaboration was for the establishment of plant and machinery, etc. so as to bring into existence new manufacturing unit for automobiles and parts thereof. Therefore, payments made in the instant case, were for the enduring benefit of the business, i.e. for bringing a new business into existence and then for running and sustaining it and hence, such expenditure was capital in nature.

DECISION

The SC noted that the distinction between capital expenditure and revenue expenditure with reference to acquisition of technical information and know how had been spelled out in judicial precedents. The primary test in this regard was noted to be the enduring na ture tes t wh ich means i f the expenditure incurred provided enduring benefit it would be treated as capital expenditure and where expenditure of concurrent and recurring nature is incurred it would be treated as revenue expenditure. The SC referred to its own decision in Alembic

8Chemical Works Co. Ltd. and applied parameters laid down to the instant case.

The SC applying the principle enunciated above held that payment of technical fee/ royalty under TCA amounted to capital expenditure given technical collaboration was to provide complete assistance for acquisition of plant, machinery for setting up of a new manufacturing unit. Thus, a new business was being set-up with the technical know-how provided by HMCL. Though TCA was for the limited period, it was noted that the period for manufacturing of product in the plant under the terms of the joint venture agreement was co-terminus with the TCA and

therefore, TCA was crucial for setting up of the plant project for manufacturing of goods. Based on these reasons, expenditure incurred in relation to technical collaboration under TCA was held to be in the nature of capital expenditure.

The Assessee had relied on the case of Alembic Chemical Works Co. Ltd. (supra) wherein the taxpayer was engaged in the manufacture of antibiotics and pharmaceuticals availed requisite technical know-how for a royalty payment, such expenditure was held as revenue expenditure. The SC stated that the aim and object of the expenditure would determine the character of the expenditure i.e. capital expenditure or revenue expenditure. The Court also observed that expenses incurred to bring into existence an asset or an advantage for the enduring benefit of trade would be construed as a capital expenditure. The decision in Alembic Chemical (supra) was in favour of the taxpayer primarily on the ground that the taxpayer was already engaged in the preparation of antibiotic drug

and, therefore, obtaining know-how from foreign collaboration was for the improvisation of its existing business. The added factors in this regard were the limited rights to use the technical know-how which did not amount to exclusive acquisition. In other words, the SC in Alembic Chemical (supra) held that technical fee/ royalty paid for the right to use know-how for limited period with no

right of acquisition, coupled with the fact that technical know-how was utilised for improvising an existing business, would be treated as revenue expenditure.

However, the SC distinguished it's earlier decision and observed that perusal of the SC decision in case of Alembic Chemical (supra) gave an indication that if technical know-how was for purpose of setting up a new business, the conclusion arrived at may have been different.

The SC, relying on observations made by HC, also distinguished Assessee's reliance on Delhi HC ruling in its own case Hero Honda Motors (supra) and observed that technical know-how therein was obtained for improvising scooter segment, which was already in existence whereas in the instant case, payments under the TCA were made for setting up a new manufacturing plant for manufacturing cars.

6 Shriram Refrigeration Industries v. CIT (1981) 127 ITR 746 (Delhi HC).7 Jonas Woodhead and Sons (India) v. CIT (1979) 117 ITR 55 (Madras HC).8 Alembic Chemical Works Co. Ltd. v. CIT (1989) 177 ITR 377 (SC); CIT v. Ciba India Ltd. (1968) 69 ITR 629 (SC).

“”

Technical know-how fee and royalty for bringing a new

business into existence is capital

expenditure.



SIGNIFICANT TAKEAWAYS

The issue that a particular expenditure incurred by the taxpayer is a capital expenditure or a revenue expenditure has remained contentious for a long time. In certain instances, it was held that expenditure incurred for availing technical know-how was in the nature of revenue expenditure given such technical knowledge was availed to assist in the running of the existing business of the taxpayer. However, the SC in the present case has clarified that expenditure for use of technical know-how aiding in the setting up of new business would be an expenditure which provides “enduring benefit” to the taxpayer and thus, would qualify as a capital expenditure.

The SC has reiterated the long standing position that any expenditure incurred in connection with the formation of a new business is capital in nature. This SC decision is significant in clarifying that term “enduring benefit” is not something with a fixed meaning; while it signifies an element of sufficient degree of durability, it will have to be analysed appropriate to the context. As result of this ruling, cases wherein expenditure incurred by the taxpayer in the form of technical know-how fee and royalty was not for improving the existing business, but for bringing the business into existence, could not be treated as the revenue expenditure. One of the peculiar characteristics of TCA in the instant case which resulted in said decision was that termination of TCA would have resulted in discontinuation of manufacturing of specific products by the Assessee. This indicates that a detailed examination shall have to be carried out based on specific facts and circumstances to ascertain whether an expenditure is revenue or capital in nature.

9 Technical know-how fee and royalty for bringing a new business into existence is capital expenditure.



10In Palam Gas Service the SC while dealing with the scope of business disallowance under section 40(a)(ia), when interest, etc. is paid to a resident without tax deduction at source, decided in favour of the IRA and held that the word “payable” does not deal only with cases where any expense is payable, but also covers cases where the amounts have already been paid.

FACTS

Palam Gas Service (“Assessee”) was engaged in the business of purchase and sale of LPG cylinders. During the course of assessment proceedings, it was noticed by the AO that the main contract of the Assessee for carriage of LPG was with Indian Oil Corporation Ltd. (“IOC”).

The Assessee had received the total freight payments from IOC to the tune of INR 32.04 lakhs. The Assessee had, in turn, got the transportation of LPG done through three persons and paid them INR 20.97 lakhs.

The AO was of the opinion that the Assessee had made a subcontract with the said three persons within the meaning of section 194C and, therefore, it was liable to deduct tax at source from the payment of INR 20.97 lakhs. On account of his failure to do so, said freight expenses were disallowed by the AO as

11per the provisions of section 40(a)(ia) .

The ITAT as well as the HC upheld the order passed by the AO.

ISSUES

Whether the provisions of section 40(a)(ia) would be attracted to instances where the amounts were “payable” to a contractor or sub-contractor but has not actually been paid, given the fact that the word contained in the section is only “payable”?

WORD “PAYABLE” IN SECTION 40(A)(IA) NOT ONLY COVERS CASES WHERE ANY AMOUNT IS PAYABLE, BUT ALSO INSTANCES WHERE AMOUNT HAS ACTUALLY BEEN PAID

DECISION

The SC while dealing with the question whether section 40(a)(ia), which uses the word “payable”, would cover only those contingencies where the amount is due and still payable or it would also cover the situations where the amounts have already been paid and no tax was withheld, held that the word “payable” would also include instances where the concerned amounts had already been paid.

The SC observed that this issue has come up for hearing before various HCs and there have been divergent views on the same. Majority of the HCs have taken the view that the aforesaid provision would cover even those cases where the amount had already been paid. This view had been taken by the

12 13Madras , Calcutta and Gujarat HCs. However, a contrary view was expressed by the Allahabad HC. In a recent judgment, the Punjab & Haryana HC also took note of the above mentioned judgements and concurred with the view taken by the Madras, Calcutta and Gujarat HCs and showed it's reluctance to follow the view taken by the Allahabad HC.

Dealing with the provisions of the IT Act, the SC observed that as per section 194C, it is the statutory obligation of a person, who is making payment to the subcontractor, to deduct tax at source at the rates specified therein. The plain language of the section suggests that such a tax at source is to be deducted at the time of credit of such sum to the account or at the time of payment thereof, whichever is earlier. Thus, tax has to be deducted in both the contingencies, namely, when the amount is credited to the account of the contractor or when the payment is actually made. Section 200 of the IT Act imposes further obligation on the person deducting tax at source, to deposit the same with the Government, within the prescribed time.

10 Palam Gas Service v. CIT [2017] 81 taxmann.com 43 (SC).11 Section provides for the various amounts which shall be disallowed as a deduction in computing the income from business.12 Tube Investment India Ltd v. Asstt. CIT [2010] 325 ITR 610 (Madras HC).13 CIT v. Crescent Export Syndicate [2013] 216 Taxman 258 (Calcutta HC).



A conjoint reading of these two sections would suggest that not only a person, who is paying to the contractor, is supposed to deduct tax at source on the said payment whether credited in the account or actual payment made, but also deposit that amount to the credit of the Central Government within the stipulated time.

In the aforesaid backdrop, the SC dealt with the issue, namely, whether the word “payable” in section 40(a)(ia) would mean only when the amount is payable and not when it is actually paid. The SC stated that grammatically, it may be accepted that the two words, i.e. “payable” and “paid”, denote different meanings. Then, the SC referred to the decision of

14the Punjab & Haryana HC, in P.M.S. Diesels , where it was rightly remarked that the word “payable” is, in fact, an antonym of the word “paid” and it further took the view that it was not significant to the interpretation of section 40(a)(ia).

The SC also held that section 40(a)(ia) covers not only those cases where the amount is payable but also such cases where it has already been paid. In this regard, one has to keep in mind the purpose with which section 40(a)(ia) was enacted, along with the provisions of sections 194C and 200. Once it is found that the aforesaid sections mandate a person to deduct tax at source not only on the amounts payable but also when the sums have been paid to the contractor, any person who does not adhere to this statutory obligation, has to suffer the consequences which are stipulated in the IT Act itself.

Certain consequences of failure to deduct tax at source from the payments made, where tax was to be deducted at source or failure to pay the same to the credit of the Government are stipulated in section 201. This section provides that in that contingency, such a person would be deemed to be an assessee in default in respect of such tax. While stipulating this consequence, section 201 categorically states that the aforesaid sections would be without prejudice to any other consequences which that defaulter may incur. Other consequences are provided under section 40(a)(ia) of the IT Act, namely, payments made by such a person to a contractor shall not be

treated as deductible expenditure. When read in this context, it is clear that section 40(a)(ia) deals with the nature of default and the consequences thereof.

When the entire scheme of obligation to deduct the tax at source and paying it over to the Government is read holistically, it cannot be held that the word “payable” occurring in section 40(a)(ia) refers to only those cases where the amount is yet to be paid and does not cover the cases where the amount is actually paid. If the provision is interpreted in the manner suggested by the Assessee, he would still go scot-free, without suffering the consequences of monetary default in spite of specific provisions laying down these consequences.

15Dealing with the judgement of the Allahabad HC , the SC observed that the HC, after noticing the fact that the amounts had already been paid, concluded, without any discussion that section 40(a)(ia) would apply only when the amount is “payable”. Merely

because the SLP against this decision was dismissed in limine, that would not amount to the SC confirming the view of t he A l l ahabad HC. W i th t hese observat ions, the SC expressly overruled the judgement of the Allahabad HC.


The instant decision, has put to rest the controversy around the applicability of section 40(a)(ia) vis-a-vis amounts paid or payable at the end of the year. The SC has referred and discussed all the relevant judgements of various HCs and has also looked into the intention of introducing section 40(a)(ia) of the IT Act.

The SC had held in the case of Paras Laminates Pvt. 16Ltd. that when a Court acts in ignorance of a previous

decision of its own or of a Court of co-ordinate jurisdiction covering the issue in case before it, the decision is said to be given per incuriam. The decision of the Allahabad HC in the case of Vector Shipping (supra) had dealt with the same issue and held that for disallowance of expenditure on which tax has not been deducted, the amount should be payable and not that has already been paid by end of the year, but what is to be noted here is that the Court did not deal with the decisions of the Calcutta HC or the Madras

“”

“Payable” under section 40(a)(ia)

dealing with business disallowance, includes amount already paid during the relevant

previous year.

14 P.M.S. Diesels v. CIT [2015] 374 ITR 562/232 Taxman 544 (Punjab & Haryana HC).15 CIT v. Vector Shipping Service (P.) Ltd [2013] 357 ITR 642 (Allahabad HC).16 Paras Laminates Pvt. Ltd. [1990] 186 ITR 722 (SC).



HC. Therefore, the Allahabad HC decision seems to be per incuriam and has been rightly overruled by the SC.

This is a very important decision and puts to rest the issue of disallowance of expenses where tax was not withheld by the taxpayer, especially on account of conflicting decisions by the HCs. Moreover, when the SLP filed by the IRA was rejected by the SC in the

17case of Vector Shipping ad limine, certain taxpayers were trying to contend that any violation made by them during the financial year would not result in any disallowance under section 40(a)(ia) of the IT Act so long as no amount was outstanding at the end of the relevant previous year, in spite of explicit requirement under the said provisions to the contrary.

It may also be pertinent to note that the CBDT issued 18a circular to clarify that the disallowance under this

section would also cover amounts payable at any time during the year. It was clarified that the term “payable” shall include “amounts which are paid during the previous year”. While the said circular is binding only on the IRA and not on the taxpayers, it is a reflection of the view of the CBDT/IRA on the issue.

17 Commissioner of Income Tax, Muzaffarnagar v. Vector Shipping Services (P) Ltd. CC No. 8068 / 2014 (SC).18 CBDT Circular No. 10/DV/2013 dated December 16, 2013.



19In Saira Asia Interiors (P.) Ltd. , the ITAT held that merely by crediting the amount of royalty payable to a non-resident does not cause taxability under the DTAA for the non-resident. The income becomes taxable only at the point when actual payment takes place.

FACTS

Saira Asia (“Assessee”) was engaged in the business of owning, operating, and managing hotels. The Assessee was liable to make a payment on account of technical know-how to Saira Europe SPA, Italy. This liability was duly accounted for in the books of account in 2010, though the payment was made, a bit later, in 2011. The tax was duly withheld from the payment so made, and it was deposited at the time of payment.

The AO contended that the due date for depositing the tax was at the time of accounting for the same. Accordingly, the AO raised a demand for interest under section 201(1A) of the IT Act on the Assessee. The CIT(A) upheld the order of the AO. Aggrieved by the order, the Assessee appealed before the ITAT.

ISSUE

What shall be the point of time when withholding tax obligation triggers for an Indian payer of income in relation to a Royalty/Technical Service fee (“Service fee”) proposed to be made to a non-resident entity?

ARGUMENTS/ANALYSIS

The IRA relied on the provisions of section 195 of the IT Act and contended that from a plain reading the said section, it is evident that the Assessee was liable to deduct tax at source at the time of credit of sum to the account of the payee or at the time of payment thereof, whichever was earlier. Further, as the Assessee had applied beneficial tax rate as provided in the IT Act, the Assessee could not take recourse to DTAA to determine the point of withholding tax on royalty payment made to the non-resident.

ROYALTY INCOME IS TAXABLE IN INDIA ON RECEIPT BASIS AS PER INDIA-ITALY DTAA

The Assessee, on the other hand, contended that the withholding tax obligation in relation to the payment made to the non-resident did not arise at the time of accounting for the liability in the books of account, as the same was liable to tax in the hands of the non-resident only at the time of actual payment in terms of section 195(1) of the IT Act read with Article 13 of the India – Italy DTAA.

DECISION

The decision to withhold tax from credit or payment to non-resident is dependent on the tax liability in the hands of the non-resident. Therefore, withholding provisions under the IT Act have to be read in conjunction with the charging provisions of the IT Act

and the relevant DTAA. It will also have to be kept in mind that the relevant DTAA overrides the charging provisions of the IT Act.

As regards the tax liability of the sum in the hands of the non-resident, as per the Article 13 of the India-Italy DTAA, the same is taxable only at the time when actual

payment is made to non-resident. In this regard, the ITAT placed its reliance on the Mumbai ITAT's ruling in the case of National Organic Chemical Industries

20Ltd. , wherein it was observed that so far as the taxability of royalties and fees for technical services are concerned, twin conditions of “accrual” as also the “payment” shall have to be satisfied.

In relation to withholding tax liability in the hands of the Assessee, the ITAT held that when amount credited by the Assessee was not taxable for the non-resident at the time of credit in the books of account, it did not give rise any withholding tax obligations under the provisions of IT Act. In this regard reliance was place on the decision of the SC in the case of GE India

21Technology Center (P.) Ltd. , wherein the SC had held that the obligation to deduct tax at source arises only if there is a sum chargeable to tax under the IT Act (in the hands of the non-resident).

19 Saira Asia Interiors (P.) Ltd. v. ITO (2017) 79 taxmann.com 460 (Ahmedabad ITAT).20 National Organic Chemical Industries Ltd. v. DCIT (2006) 5 SOT 317 (Mumbai ITAT).

“”

Royalty for non-resident

taxable on receipt basis under the

India – Italy DTAA.



Further, the ITAT opined that the adoption of a lower rate under the IT Act does not imply that the payer is required to withhold tax on the amount payable to foreign company at the time of accounting for the same in the books of account in accordance with the provisions of the IT Act.


The Bombay HC in the case o f Siemens Aktiengesellschaft had held that the assessment of royalty or fees for technical services under the India-Germany DTAA has to be made in the year in which amounts are received and not otherwise.

The ITAT in the instant case clarified that the taxability of a particular type of income shall be determined as per the provisions of the DTAA and after interpreting the India-Italy DTAA, held that Service Fees shall be taxable in India only on actual payment basis. Further, it also clarified that even if the applicable tax rate on the Service Fees was determined in accordance with the provisions of the IT Act, the timing of deductibility of tax shall still be determined by as per the provisions of the relevant DTAA.

This provides much need relief to the taxpayers from Italy as the withholding is required to be made only at the time of actual payment of royalty and not at the time of accrual.

21 GE India Technology Center (P.) Ltd. v. CIT (2010) 327 ITR 456 (SC).22 DIT v. Siemens Aktiengesellschaft (ITA No. 124/2010) ( Bombay HC).



23In Burt Hill Design (P.) Ltd. , the ITAT ruled that reimbursement made by an Indian company to a foreign company towards the cost of employees seconded by it to the Indian company does not attract any tax withholding in India.

FACTS

Burt Hill Design (“Assessee”) had entered into a secondment arrangement with its American parent company, Burt Hill Inc. USA (“BHI”). Under the agreement, the parent company placed some of its employees at the disposal and control of the Assessee and the salary cost of such personnel was reimbursed on a cost-to-cost basis without deduction of any tax at source under section 195 of the IT Act. However, the Assessee had deducted tax at source under section 192 of the IT Act for the income of the seconded employees before reimbursing it to BHI.

The Assessee was subject to a survey by the IRA to verify its withholding compliances. Upon perusal of the facts of the case and examination of the relevant documents, the AO held that reimbursements to BHI were for services rendered and could not be termed as mere reimbursements. Furthermore, the officer held that the payments were in the nature of Fees for included services (“FIS”) and that the seconded emp loyees fo rmed a Se rv i ce Pe rmanen t Establishment (“Service PE”) of BHI in India. The entire amount paid to BHI was thus sought to be taxed on a gross basis at 40% in the absence of details of expenditure incurred by the parent company.

ISSUES

1. Whether the payment made to employees of BHI would be considered to be in the nature of payment of services rendered by the employees?

2. Whether the work done by the said employees has resulted in a formation of a Service PE in India?

REIMBURSEMENT OF SALARIES PAID UNDER A SECONDMENT AGREEMENT DOES NOT ATTRACT WITH HOLDING TAX IN INDIA

ARGUMENTS/ANALYSIS

The Assessee contended that these are pure reimbursements, and that these payments did not involve any profit element taxable in the hands of BHI. It was also explained the payments were in the nature of salaries, and that the Assessee had duly discharged his tax withholding obligations from these salaries to the extent the recipients were taxable in India. The details of tax payment by the seconded employees were also furnished. The secondment agreement was examined at length by the AO. He was of the view that the seconded employees continued to be employees of BHI. It was then held that since employees were of BHI, the payment was in fact in the nature of payment for services rendered by these employees.

The IRA also argued that the work done by these employees of BHI has resulted in creation of a Service PE under Article 5(2)(l) of India-USA DTAA, and that the entire amount so paid to BHI, being attributable to the PE, is taxable on gross basis, in the absence of details of expenditure of PE, @ 40% (plus the applicable surcharge and education cess). It was also argued, without prejudice to the other arguments, that in any event, the amount so paid to BHI was taxable as fees for included services under article 12(4) of India-US DTAA and also under section 9(1)(vii) of the IT Act.

DECISION

If payment to a non-resident entity is in the nature of payment consisting of income chargeable under the heading Income from Salaries, the Assessee does not have any tax withholding obligations under section 195 by virtue of the specific exclusion contained in section 195 of the IT Act itself. It is an undisputed fact that payment to BHI consists of income that is chargeable, and has been charged, to tax in India under the heading income from salaries and that payments for all the years under question are of the same nature, under the same agreement and of the

23 Burt Hill Design (P.) Ltd. v. DDIT (2017) 79 taxmann.com 459 (Ahmedabad ITAT).



same character. Thus, what was held to be income in the nature of salaries in one assessment cannot be of any different nature for another assessment, just because the Assessee, rather than deducting tax at source under section 192 of the IT Act, paid the advance tax on behalf of the seconded employees in that particular year.

Whether the seconded employees continue to be in the employment of the foreign entities or not is wholly irrelevant. What is relevant is that the income embedded in the payments in question is taxable in India under the heading Salaries. If that is the case, then there are no withholding obligations on the payer under section 195 of the IT Act.

The existence of a service PE is wholly academic, as whatever the aggregate of receipts is said to be attributable to the PE is exactly the same as the aggregate of expenditure (salary of employees) shall be attributable to the PE. The IRA has not demonstrated that any other receipts, other than on account of reimbursements for salaries, or any other income could be attributed to the so called Service PE. The ITAT also observed that the IRA had failed to demonstrate in any manner how any technical knowledge, skills, knowhow or processes were made available by these services.

Accordingly, the demand raised under section 195 of the Act was held to be devoid of merit and was quashed.


This judgment of the Ahmedabad Tribunal only adds to the plethora of judgments on this contentious issue.

In a recent judgment, the Bombay HC in the case of 24Marks & Spencer had also dealt with the issue of

secondment of employees. The HC upheld the decision of the Mumbai ITAT and observed that if the

payment is only a reimbursement of expenses, the same cannot be regarded as an income in the hands of the payee/recipient under the IT Act. Though the Mumbai ITAT was silent on the issue of Service PE, yet the HC proceeded to hold that payments made to the foreign company under a secondment agreement without transfer of technology would not satisfy the “make available” test under the India-UK DTAA and accordingly, would not be taxable as FTS.

It is pertinent to note that this judgment by the Bombay HC in favour of the taxpayer is at variance with the

25decision of the Delhi HC in the case of Centrica India which was in favour of the IRA, and followed by the

26Bangalore Tribunal in Foodworld Supermarkets making the issue even more controversial.

27While on one hand there are decisions in favour of the assesse, which hold that reimbursement of salary of seconded employees shall not be regarded as FTS and tax must be withheld under Section 195, however

28on the other hand, there exist decisions which hold the contrary view. A careful analysis of the decisions show that there is a greater possibility for the IRA to contend that reimbursement of salary of the seconded employee is FTS when the seconded employee has been sent by the non-resident company to its Indian for rendering managerial services or technical services than when mere ordinary employees are

seconded. Hence, from a planning perspective it all depends on how well the assesse is able to substantiate its position.

In view of the above discussions, it is evident that the last word on this subject has not yet been spoken. The issue of reimbursement of payments, with or without mark-up, towards salaries paid to seconded, deputed or assigned employees may ultimately have to be decided by the SC in lieu of conflicting decisions by various HCs and ITATs.

“”

No withholding on

reimbursement of salary of seconded

employees.

24 DIT v. Marks & Spencer Reliance India (P.) Ltd. (Income tax appeal 893 of 2014) (Bombay HC).25 Centrica India Offshore (P.) Ltd. v. CIT (2014) 364 ITR 336 (Delhi HC).26 Food World Supermarkets Ltd. v. DDIT, [2015] 174 TTJ 859 (Bangalore ITAT).27 IDS Software Solutions India (p.) (Ltd.) v. ITO, (2009) 122 TTJ 410 (Bangalore ITAT); DCIT v MahanagarGas Ltd., (2016) 69 taxmann.com 321(Mum ITAT);

Abbey Business Services (P) Ltd. V. DCIT, (2102) 23 taxmann.com 346 (Bangalore ITAT).28 Temasek Holding Advisors India (P.) Ltd. V. DCIT, (2013) 38 taxmann.com 80 (Mum ITAT); Intel Corporation v. DDIT, (2016) 76 taxmann.com; Flughaten

Zurich AG v. DDIT, (2017) 79 taxmann.com 199 (Bang ITAT).



PAYMENTS FOR STANDARD OPERATING PROCEDURE IS TAXABLE AS ROYALTY

In the case of the Oncology Service India Private 29Ltd. , the Ahmedabad ITAT held that sharing of

Standard Operating Procedure (“SOP”) amounted to sharing of information concerning industrial, commercial or scientific experience, therefore the payments for such SOP would be taxable as royalty under the India-Germany DTAA.

FACTS

Oncology Service India Private Ltd. (“Assessee”), made certain payments to Oncology Service Europe S.a.r.l (“OSE”) in consideration for sharing of SOPs, without deducting any tax at source. The AO held that the payments made by the Assessee were for the purpose of use of technology, patent, trademark and accordingly treated such payments as royalty. The Assessee unsuccessfully appealed before the CIT (A). Being aggrieved of the order of the CIT (A), the Assessee appealed before the ITAT.

ISSUE

Whether payments made for sharing of SOP are in nature of royalty?

ARGUMENTS

It was contended on behalf of the IRA that payments were for the purpose of use of technology, patent, trademark. Therefore, the same were taxable as royalty under the IT Act and the India-Germany DTAA.

The Assessee contended that receipts in hands of OSE were only for the purpose of sharing SOP, access database, email servers, hardware and software. It was argued that these payments were in nature of business profits in the hands of OSE, therefore, in absence of a PE in India the question of taxability of such payments in India did not arise.

DECISION

The ITAT observed that the invoices raised by OSE mentioned that the invoice is for transfer of knowhow, i.e. SOPs. The ITAT also pointed out that even as per

the submissions of the Assessee before the CIT(A), these SOPs are “matured validated standard procedures” which have been developed by OSE over a period of time and the sharing of these SOP amounted to sharing information concerning industrial, commercial or scientific experience. Additionally, it was also noted that the SOPs were non-transferrable and the Assessee was not allowed to make any changes to it. Thus, the ITAT concluded that the consideration was for the sharing of information about the scientific experience of OSE and accordingly, such payments were taxable as royalty under the India-Germany DTAA which defines royalty to include information concerning industrial, commercial or scientific experience.

Additionally, the ITAT also clarified that the access to database and other allied activities are only incidental to the primary objective of sharing the SOP and cannot be viewed in isolation.


The taxability of payments made for transfer of information concerning

industrial, commercial or scientific experience has been a subject of litigation across various fora. The

30Courts in a number of precedents have held that for payments towards transfer of “ information concerning industrial, commercial or scientific experience” to qualify as royalty, there should be certain kind of expertise or skill involved, which render certain kind of special feature to such information or experience.

31In the case of Lanka Hydraulic Institute the AAR dealt with the phrase “information concerning industrial commercial or scientific experience.” The AAR observed that the said term means an accumulated fund of knowledge acquired by years of observation, search, experimentation and experience.

Also various commentaries also provide that this phrase means imparting of knowledge derived from

“”

Consideration received for sharing standard operating procedure is nature

of royalty.

29 Oncology Services India Private Ltd. v. ADIT (2017) 82 taxmann.com 42(Ahmedabad ITAT).30 CIT v. HEG Ltd. (2003)263 ITR 230 (MP).31 Lanka Hydraulic Institute, In re A.A.R. No.874 of 2010.



experience that is more than “general special knowledge” and also to mean specialized knowledge having intrinsic value relating to commercial, industrial or managerial processes conveyed in form of instructions, advices, etc. or use of experience gathered on a particular subject.

In the instant case, the ITAT followed suit with the aforementioned principle and held that the SOP was a matured validated standard procedure which was developed by OSE over the period of time and approved by regulatory bodies, therefore, the payments received for the same was in nature of royalty under the India-Germany DTAA.



FOREIGN SHIPPING COMPANY NOT LIABLE TO TAX IN THE ABSENCE OF POEM

32 In the case of Pearl Logistics & EX-IM Corporationthe Rajkot ITAT has held that the income of a foreign shipping company was not liable to pay any tax in India since its place of effective management (“POEM”) was situated outside India.

FACTS

Pearl Logistics & EX-IM Corporation (“Assessee”) was an agent of Denmark based ship broker, M/s. Faber Ship Brokers APS, Denmark (“Faber”). M/s. CTI Group Inc, Jordan (“CTI Group”) was the charterer of the ship which carried goods to ports in India for which it had paid freight charges to Faber.

The Assessee filed its return of income under section 172 of the IT Act for being the freight beneficiary of Faber in respect of the two voyages and claimed exemption under Article 9 of the India-Denmark DTAA. The AO had initiated scrutiny proceedings under section 172(4) of the IT Act and called for records from Faber.

Not satisfied with the documentary evidences furnished by the Assessee, the AO denied the DTAA benefit to the Assessee by holding that the same was claimed using incriminating and forged documents as the real beneficiary of the freight was CTI Group as well and in the absence of a DTAA with Jordan, no DTAA could be availed and accordingly, raised a tax demand. On appeal, the CIT (A) upheld the order of the AO which was challenged by the Assessee before the Rajkot ITAT.

ISSUES

The main issues raised by the Assessee before the ITAT were as follows:

1. Whether the Assessee was eligible for the benefit under Article 9 of the India-Denmark DTAA?

2. Whether Faber had its POEM in Denmark in accordance with Article 4 of the India-Denmark DTAA?

ARGUMENTS

The Assessee submitted that as per the charter party agreement, Faber was the owner of the ship and CTI was the charterer which carried goods to ports in India. Thus, according to the provisions of section 172 of the IT Act, income of the non-resident owner or charterer was liable to tax in India. In the instant case, freight charges were received by Faber, a tax resident of Denmark and, therefore, the provisions of the India-Denmark DTAA shall have to be examined to determine whether any benefit under the DTAA shall be available to it in view of the decision of the SC in the

33case of Azadi Bachao Andolan .

It was further contended on behalf of Faber that as per Article 9 of the India-Denmark DTAA, profits derived from the operation of ships in international traffic shall be taxable only in the state where the POEM of the enterprise is situated. The Assessee relied on the decisions of various HCs in the cases of Radha Rani

34 35Holdings (P.) Ltd. , Sarawati Holding Corp. Inc , and 36Arabian Express Line Ltd . to contend that the POEM

of the enterprise would be construed to be situated in a country where it's “head and brain” were situated.

The Assessee also submitted copies of tax residency certificate, corporate registration certificate and the passport of the owner of Faber issued by the Government of Denmark to contend that “head and brain” of Faber was situated in Denmark and, therefore, the POEM of Faber was situated in Denmark.

The IRA, on the other hand, contended that the real beneficiary of the freight should not be decided merely based on charter party agreement, tax residency certificate, etc. but should be decided by verifying the copy of bank accounts / bank certificate acknowledging the actual beneficiary of the freight. It further contended that the real beneficiary of the freight could be CTI Group as well and in such a case, the question of availing benefit under the DTAA would

32 Pearl Logistics & EX-IM Corporation v. ITO (2017) 80 taxmann.com 217.33 Azadi Bachao Andolan v. UOI 132 Taxman 373 (SC).34 Radha Rani Holdings (P.) Ltd. v. ADIT (2007) 16 SOT 495 (Delhi HC).35 Saraswati Holding Corp. Inc. v. DDIT (2007) 16 SOT 535 (Delhi HC).36 Arabian Express Line Ltd. v. UOI (1995) 212 ITR 31 (Gujarat HC).



not arise since there is no DTAA with Jordan. In view of the same, the IRA contended that the Assessee should not be given the benefit of India-Denmark DTAA but should be taxed in accordance to the provisions of the IT Act. The IRA also relied on the decision of the Delhi ITAT in the case of SMR

37 Investments Ltd. to contend that tax residency certificate is not a conclusive proof to determine the residential status of a person.

DECISION

The contentions of the IRA that CTI Group could also be the real beneficiary of the freight was rejected by the ITAT by holding that no income was accrued or deemed to have been accrued to CTI Group in India in view of section 5(2) read with section 9 of the IT Act and that the freight was received only by Faber. Therefore, only Faber could be held liable to tax in India and not CTI Group. It relied on the decision of the SC in the case of Azadi Bachao Andolan (supra) to hold that Faber was entitled for the benefits enshrined in India-Denmark DTAA.

The ITAT also referred to Article 9 of the India-Denmark DTAA and held that the income on account of operation of ship in international traffic shall be taxable in the state in which the POEM of the taxpayer is situated and the documents furnished by the Assessee, viz. declaration by the director of the entity, copy of Director's passport, tax residency certificate, etc. sufficiently establish that the Director, Mr. Jens Faber Anderson, was a tax resident of Denmark and had been operating the business of Faber from Denmark only. It further held that all the important decisions were taken from Denmark in the form of board meetings, etc. and, therefore, the POEM of Faber was in Denmark in accordance to Article 4 of the India-Denmark DTAA.

Accordingly, the ITAT overruled the decision of the CIT(A) and held that any income earned by Faber from the operation of ships in the international traffic shall not be liable to tax in India.


While Section 172 of the IT Act is a special provision providing summary mode of assessment for the shipping business of the non-residents, Article 9 of the India-Denmark DTAA provides that the income of a non-resident shipping company shall be taxable only in the country where the POEM of the taxpayer entity is situated. The concept of POEM is recognized internationally and most of the DTAAs executed by India provide POEM as the test to determine residential status of a non-resident entity as a tie-breaker rule.

This aspect of POEM would also gain prominence in the coming days since the IT Act has been revised and foreign corporate entities could be considered as tax residents of India in case their POEM is held to be situated in India. We are sure that taxpayers will welcome any guidance or decision by Indian appellate authorities including ITAT and the Courts

which provide guidance about the concept of POEM.

The CBDT has recently issued certain 38guiding principles through a Circular for

the determination of POEM. While the Circular states that the concept of POEM is based on the principle of substance over form, it also prescribes certain quantitative formula for the determination

of “active business outside India” such as passive income, total asset base, number of employees and payroll expenses inside and outside India. It is worthwhile to note that most of the other countries have not yet recognized any of these indicators as guiding principles to ascertain POEM of a non-resident in the other country. It is also pertinent to note that Circulars issued by the CBDT are not binding on taxpayers as well as Indian Courts.

Hence, it remains to be seen how the international jurisprudence evolves on this important aspect and whether the principles laid down by the ITAT would be construed as guiding factors for the determination of POEM.

“”

Freight income of a non-resident

shipping company not taxable in India in the absence of

POEM.

37 SMR Investments Ltd. v. DDIT (2011) 7 ITR(T) 23 (Delhi ITAT).38 Circular No. 6 of 2017 dated January 24, 2017.

23

CASE LAW UPDATES

- INDIRECT TAX





39In Re: Quantum of Mandatory Deposit , the CESTAT held that the provision for mandatory pre-

40deposit of 10% of the duty demanded (where duty or duty and penalty are in dispute), for preferring an appeal before the CESTAT against the order of first appellate authority, is an independent provision, and such deposit shall be made irrespective of the 7.5% deposited for preferring an appeal before the first appellate authority.

FACTS

The larger Bench of the CESTAT was constituted to examine the issue of quantum of mandatory pre-deposit, as prescribed under Section 35F of the Central Excise Act, 1944 (“CEA”) and Section 129 of the Customs Act, 1962 (“Customs Act”) for preferring an appeal before the CESTAT against the order of the Commissioner (Appeals).

The dispute arose due to conflicting orders of different Benches of the CESTAT. In the case of Balaji

41Structural (India) Pvt. Ltd. , the CESTAT had held that the mandatory deposit of 10% of the duty or duty and penalty imposed, if any, for preferring an appeal before the CESTAT is inclusive of 7.5% deposited at the time of first appeal, whereas in the case of

42Hindalco Industries Ltd and ASR Multimetals Pvt. 43Ltd. , the CESTAT had held that the pre-deposit of

10% of the amount of the duty and penalty, if any, was to be deposited over and above the amount mandated to be deposited before the first appellate authority.

ISSUE

Whether an appellant is required to pay 10% mandatory pre-deposit over and above the 7.5% of

MANDATORY PRE-DEPOSIT OF 10% OF DUTY DEMANDED FOR SECOND APPEAL SHALL BE OVER AND ABOVE THE 7.5% DEPOSITED AT THE TIME OF FIRST APPEAL

the duty liability already deposited for the first appeal, under Section 35F of the CEA and Section 129 of the Customs Act?

ARGUMENTS/ANALYSIS

In this matter, a written submission was filed on behalf of the Bar Association, Chennai. However, no one appeared before the CESTAT for the arguments on the date of hearing. The CESTAT decided to consider the submissions made by the Bar Association, and allowed the Revenue to argue.

The Revenue argued that the provisions for mandatory pre-deposit before the first appellate authority and the second appellate authority, are independent. Therefore, if a person wants to prefer an appeal before the second appellate authority against the order of the first appellate authority, he shall pay a pre-deposit of 10% of the duty demanded over and above the amount of 7.5% deposited at the time of filing the appeal before the first appellate authority. In this regard, the Revenue placed its reliance on the

44decision of ASR Multimetals Pvt. Ltd. and CBEC 45 Circular No. 984/8/2014 dated September 16, 2014

(“Circular”).

DECISION

The CESTAT observed that the Circular only stated that 10% of the duty confirmed and/ or penalty imposed by the first appellate authority, if any, was to be paid for preferring an appeal before the second appellate authority (CESTAT) against order of Commissioner (Appeals). The Circular does not indicate the intention of the legislatures for enacting the aforesaid separate provisions for quantum of mandatory deposit.

39 In Re: Quantum of Mandatory Deposit 2017 (4) TMI 1222 - CESTAT - Del.40 Section 35F of the CEA provides for the deposit of certain percentage of the duty demanded or penalty imposed before filing appeal. Further, Section 129E

of the Customs Act also provides for similar provision for mandatory deposit. 41 Balaji Structural (India) Pvt. Ltd. v. Commissioner of Central Excise 2014 (4) TMI 647 - CESTAT –Del.42 Hindalco Industries Ltd and Ors.. v. Commissioner of Central Excise, Kolkata-II and Ors., 2016-TIOL-3050-CESTAT-Kol.43 ASR Multimetals Pvt. Ltd. and Ors. v. Commissioner of Customs & Ors. 2016-TIOL-3154-CESTAT-Ahm.44 ASR Multimetals Pvt. Ltd. and Ors. v. Commissioner of Customs & Ors. (supra).45 The Circular provides for clarification on issues related to the amendments to the appeal provisions in Customs, Central Excise and Service Tax made by

Finance Act, 2014.



The CESTAT, therefore, looked into the provisions itself and held that for first appeal, an appellant is required to deposit an amount of 7.5% of the duty confirmed by the adjudicating authority and/or penalty imposed, if any. On conclusion of the proceedings before the adjudicating authority, an assessee has the option to go further in appeal before the first appellate authority, and if the appeal is disposed of, amount pre-deposited by him which is equivalent to 7.5% of the duty confirmed or penalty imposed as the case may be, needs to be refunded in accordance with law.

With regards to the quantum of mandatory deposit for second appeal, the CESTAT further held that the provisions for both the proceedings (first appeal and second tribunal) are to be treated as independent provisions, and accordingly, the deposits as prescribed, also needs to be made independently. In other words, the CESTAT held that an appellant needs to deposit 10% of the amount of demand confirmed, irrespective of 7.5% of the said amount deposited by them for preferring an appeal to the first appellate authority. The second appeal, being a statutory right, is to be considered as an independent right. If s u c h r i g h t i s e x e r c i s e d , t h e proceedings, subsequent to pre-deposit of the amount to exercise the first appeal, were to be considered as having come to closure. The appellant may seek legal remedies available such as refund, as regards the mandatory pre-deposit made before the first appellate authority.

In light of the above, the CESTAT upheld the decision of the Division Bench of the CESTAT in the case of

46ASR Multimetals Pvt. Ltd. , and held that an appellant

is required to deposit 10% of the amount of the duty confirmed and penalty imposed, if any, separately, for preferring a second appeal before the Tribunal.


It is significant to note that even when India was on the verge of introduction of GST, the Division Bench of the CESTAT clarified the issue of quantum of mandatory pre-deposit before the second appellate authority. The legislatures, with an intention to settle the disputes with regards to the discretionary power of the CESTAT to decide on the quantum of pre-deposit and to save the time spend to determining the pre-deposit amount by the CESTAT, had introduced an amendment in 2014 to provide a fixed quantum of pre-deposit for preferring an appeal before both the first and the second appellate authority. Despite the said amendment, there has been continuous dispute as to whether the quantum of mandatory pre-deposit for preferring the second appeal before the CESTAT is

exclusive of the 7.5% pre-deposited at the time of first appeal, especially in light of the conflicting decisions of the different Benches of the CESTAT.

It may be noted that this decision of the Division Bench of the CESTAT would have significance even under the GST regime, as the provisions for first appeal and appeal before the CESTAT require mandatory pre-deposit. However,

under the GST regime, the quantum of pre-deposit has been increased from 7.5% and 10% to 10% and 20% respectively. The increase in the quantum of pre-deposit may potentially act as deterrent for the number of appeals filed merely for the sake of filing appeals.

46 ASR Multimetals Pvt. Ltd. and Ors. v. Commissioner of Customs & Ors. (supra).

“”

Appeal to the Tribunal (second

appellate authority) is a statutory right,

independent from the right to appeal before

the first appellate authority.



47In Indian Oil Corporation Limited , the HC upheld the constitutional validity of the second proviso to

48Section 3(2) of Bihar Tax on Entry of Goods into Local Areas for Consumption, Use or Sale Therein Act, 1993 (“Bihar ET Act”) which grants set-off of the entry tax paid by the importer on goods entering the local area, against his VAT liability.

FACTS

Indian Oil Corporation Limited (“Petitioner/ IOCL”) is a government company, inter-alia engaged in manufacture and sale of petroleum products at its oil refinery in Barauni, Bihar. The products (oil) were manufactured from the crude material received from outside (imported) Bihar, and then sent to the Branch in Patna primarily through a pipeline for sale to local retailers through its outlets in Patna. On such products, when they entered into the Barauni local area, the Petitioner paid entry tax at 16%, and thereafter when the product entered the local area of Patna where 24.5% VAT was payable, the Petitioner could claim the set off of entry tax under second proviso to Section 3 (2) of the Bihar ET Act.

The products were also sold directly from Barauni to various other marketing companies (OMCs) such as Bharat Petroleum and Hindustan Petroleum. Such sale was exempt from VAT, vide notification dated May 4, 2006. However, when the products were sold by the OMCs to the retailers, VAT was payable at 24.5%, without any benefit of set off of entry tax paid on the same, as provided under the second proviso to Section 3(2) of the Bihar ET Act.

A notice was served by the commercial tax department (“Respondent”) to the Petitioner demanding payment of Entry tax based on certain

A PROVISION CANNOT BE TERMED AS ARBITRARY OR DISCRIMINATORY MERELY FOR THE REASON THAT IT LEADS TO VARIATION OF PRICES FOR RETAILERS WHEN THE GOODS ARE SOLD DIRECTLY AS AGAINST WHEN SOLD THROUGH OIL MARKETING COMPANIES

audit objections raised by the Accountant and Auditor General of Bihar. The Petitioner replied to the notice explaining the legal position and claimed that by virtue

49of the powers available under Section 33 of the Bihar Value Added Tax Act, 2003 (“BVAT Act”) read with

50Section 8 of the Bihar ET Act, the demand raised was wholly illegal, contrary to certain judgments.

The Respondent, without considering the reply to the notice and representations made by the Petitioner, passed an order against the Petitioner. The Petitioner, filed an appeal against the said order before the HC, wherein the Petitioner inter-alia challenged the order as well as the imposition of interest and penalty, on the grounds of absence of any substantive provision for interest and penalty under the Bihar ET Act.

The Petitioner also challenged the validity of second proviso to Section 3(2) of the Bihar ET Act being ultra vires of the Constitution, and even if it is not ultra vires, to be struck down for being arbitrary and discriminatory in nature.

ISSUES

1. Whether the second proviso to Section 3(2) of the Bihar ET Act is ultra vires to the Constitution, or in the alternate is arbitrary and unreasonable and therefore, liable to be struck down?

2. Whether in the absence of express provisions, can interest be levied on the Petitioner, by aid of provision for interest of the BVAT Act?

3. Whether entry tax is liable to be paid when the goods only enter the local area and after such entry is subjected to sale wi thout any consumption in the local area?

47 Indian Oil Corporation Limited v. the State of Bihar TS-94-HC2017 (PAT)-VAT.48 Second proviso to Section 3(2) reads as: “Provided further that where an importer of Scheduled goods liable to pay tax under the Act, incurs tax liability, at

the rate specified under section-14 of the Bihar Value Added. Tax Act, 2005 (Act 27 of 2005), by virtue of sale of imported Scheduled goods or sale of goods”.49 Section 33 provides for Assessment of tax based on audit objections.50 Section 9 provides for burden of proof.



4. Whether the Respondent has the power to re-open the assessment, on the basis of an audit objection under the BVAT Act?

ARGUMENTS/ANALYSIS

The Petitioner argued that the levy of entry tax under the Bihar ET Act was primarily on the goods and not on the dealer, and if the goods were subjected to entry tax, it could not be subjected to VAT in the same local area. Accordingly, the proviso, to that extent, should be read down or should be declared as ultra vires being discriminatory and arbitrary.

In this regard, the Petitioner substantiated its arguments with an example wherein Motor Spirit worth Rs.100, brought from Barauni to Patna, and sold to a retailer at Patna by the Petitioner. The selling price would be Rs.124.5 (16% entry tax and 24.5% VAT, with a set off of Rs. 16 under the second proviso to Section 3(2) of the Bihar ET Act). However, when the same product was sold through other OMCs, the price to be paid by the retailer comes to Rs.144.42 (with entry tax at 16% charged by the Petitioner and 24.5% VAT charged by the OMCs) without any set off of entry tax against the VAT liability. The retailer had to pay more than Rs.20/- extra for the same product. The Petitioner further argued that product after its sale to the OMCs, was neither consumed nor used within the local area. On the contrary, the product was taken out of the area and sold to the retailers who took it out to another local area for sale, and therefore, there being no use or consumption of the product within the local area of Patna after its sale, no entry tax on the product could be imposed.

Accordingly, the Petitioner argued that denial of the benefit of the said proviso would result in a hostile discrimination, which would be unreasonable, arbitrary and unworkable. Therefore, such provision was un-sustainable and must be declared as ultra vires or read down.

On the second issue of levy of interest, the Petitioner submitted that there was no provision for levy of interest under the Bihar ET Act in the relevant period. The Petitioner argued that until and unless, there was

a specific substantive provision in the Bihar ET Act itself for levy of interest, the same could not have been levied with the aid of another Act. Accordingly, levy of interest was highly illegal and arbitrary. On the same principles, the Petitioner further argued that the once the assessment proceedings were completed and the returns were accepted after assessment of tax, then with the aid of Section 33 of the BVAT Act, based on audit objection, the impugned action taken was unsustainable.

On the other hand, the Respondent argued that the second proviso to Section 3(2) of the Bihar ET Act provided for set off in the matter of payment of entry tax where VAT is already paid. This set off was being availed of by thousands or lakhs of consumers, suppliers, importers. The Respondent argued that if the contentions of the Petitioner were to be accepted and provision declared ultra vires, it would result in disastrous consequences inasmuch the benefit of set

off available to lakhs of assessees would be taken away which could never be the purpose or intention of this Court while considering the constitutional validity of a provision.

The Respondent also questioned the locus standi of the Petitioner as the Petitioner was not aggrieved in any manner in the present case. Further, if at all there were any grievance, then it should have been canvassed by the party incurring the burden of tax and

not the Petitioner.

The Respondent further argued that entry tax and VAT were two entirely different and distinct levies, based on totally different taxable events and covered by distinct entries, namely Entry 52 and 54 to List-II of the Seventh Schedule to the Constitution. In this regard, only the State had the power to grant exemption, relaxation, set off etc. with regard to taxation and merely because exemption or set off was not granted, the provision would not become ultra vires.

The Respondent further argued that the provision of 51interest as contained in Section 39 of the BVAT Act

was incorporated into the Bihar ET Act by virtue of the 52provision of Section 8 of the Bihar ET Act. The

Respondent submitted that the provisions of the Bihar Finance Act had been bodily lifted and incorporated

“”

Merely because a provision provides for set off being granted on the

happening of some eventualities and not

otherwise, such provision cannot be declared

as ultra-vires.

51 Recovery of simple interest. 52 Applicability of the provisions of the Bihar Finance Act, 1981 and rules made thereunder relating to assess, reassess, collect and enforce Payment of tax

and penalty special mode of recovery, maintenance of accounts, inspection, search and seizure liability in representative character, refund, appeal, revision and reviews etc., on the Bihar ET Act.



into Section 8 of the Bihar ET Act and, therefore, all the provisions in the Bihar Finance Act even after its repeal continued to be part of Bihar ET Act as it was a case of legislation by incorporation, therefore, interest could be charged. The Respondent argued that the same principle would apply for the re-opening of assessment on audit objection.

DECISION

The HC held that the purpose of the proviso was to give benefit to a person, who incurs liability VAT as well as entry tax on the imported goods at the same time. The HC observed that in the matter of statutory provision being discriminatory, the burden is on the person complaining of such discrimination to prove not only inequality or unequal treatment, but hostile inequality or unequal treatment between the persons similarly situated.

The HC held that the primary purpose of the proviso was to grant set off to person, who have paid VAT and are required to pay entry tax on entry of goods into the local area. The HC held that merely because the benefit granted by virtue of a proviso was not applicable to the Petitioner, the proviso could not be termed as arbitrary or discriminatory, and same should not be struck down and thereby depriving lakhs of assessees, who were reaping the benefit of the aforesaid provision. This could never be the purpose and intention of the legislature nor appropriate for this Court to make such indulgence. The Petitioner had alleged discrimination only because the price of petrol, which was paid by the consumer, varies, and therefore, this amounted to hostile discrimination. The HC held that this could never be a ground for holding the provision as un-constitutional.

Further, with respect to levy of interest, the HC held that by virtue of Section 8 of the Bihar ET Act, the provisions of the Bihar Finance Act pertaining to assessment, reassessment, col lect ion and enforcement of payment of tax and penalty payable by a dealer will be incorporated into Bihar ET Act. The HC observed that Section 8, in the relevant period, did not mention of recovery or imposition of interest anywhere. The HC further noted that Section 8 was amended with effect from May 6, 2015, and the words, “interest” and “fine” were later incorporated in Section 8 of the Bihar ET Act. The HC, therefore, held that the amendment clearly shows that prior to the amendment, there was no provision for recovery of

interest under the Bihar ET Act. The HC accordingly held that in the absence of there being any specific provision authorizing the revenue to assess interest under the Bihar ET Act, recovery of interest is not permissible, and therefore, interest could not be recovered from the Petitioner.

The HC further held that the provisions of assessment, reassessment, escaped assessment was applicable under the Bihar Finance Act, and therefore, Section 33 of the BVAT Act would apply on Bihar ET Act. Accordingly, the HC held that the assessment carried out by the Respondent was legal and valid. However, the HC observed that whether or not entry tax could be levied and whether the assessment is correct or not, were factual issues and therefore, refrained from deciding the same.

Lastly, the HC were of the view that to attract liability for payment of entry tax, apart from the fact that there is entry of goods into the local area, there has to be sale, use and consumption in the local area. Mere entry or sale of the goods into the local area without its consumption or use in the local area will not make the goods liable for payment of entry tax.

Accordingly, the HC upheld the validity of said proviso to Section 3(2) of the Bihar ET Act, and allowed the petition to the extent of challenge to the order for recovery of interest.


While the lower Benches of the SC are yet to examine the validity of the various State entry tax laws, in the instant case, the HC held that merely a differential treatment in grant of set-off claims does not amount to discrimination, and a provision cannot be struck down merely on this ground. In the landmark case of Jindal

53Steel , the SC held that a ground of discrimination can be a val id ground for chal lenging the constitutional validity of a provision or a legislation itself, and had set certain milestones for considering whether there was a discrimination or not, between goods imported into the State and goods manufactured therein.

However, whether the provision or the legislation itself, is discriminatory, has to be examined very carefully. Given that the GST has already been implemented, it is likely that the new disputes will start arising before the Courts, and therefore, it is important that the SC clears the old issues pertaining to entry tax at the earliest.

53 Jindal Stainless Steel vs. State of Haryana, Civil Appeal No. 3453/2002 (SC).



SMALL SCALE EXEMPTION SHALL NOT BE DENIED TO THE PRODUCTS USING BRAND NAME OF THEIR OWN

54In Rashmi Theatre Pvt. Ltd , the CESTAT held that the Appellant was manufacturing certain products under its own brand name, i.e. 'Calrod', and not the branded products for other brand owners. Therefore, Rashmi Theatre Pvt. Ltd. was eligible for small scale exemption provided under the Central Excise.

FACTS

Rashmi Theatres Pvt. Ltd. (“Appellant”) was a manufacturer of heating elements. The Appellant had executed an agreement with Elpro International Ltd. (“Elpro”) for purchase of machinery and technology to manufacture such heating elements on March 6, 1990. The Appellant had also executed an agreement for appointing Elpro to market the products so manufactured by the Appellant on January 09, 1991. The Agreements clearly mentioned that the Appellant would manufacture the heating element in the brand name 'Calrod' and sell the heating elements to any other person during the pendency of contract.

The Appellant was registered under the CEA and had also declared the trade mark 'Calrod', along with the specific design on the classification list. In 1994, an anti-evasion team, after the investigation of factory, concluded that the Appellant was ineligible to avail the benefit of small scale exemption as the product were affixed with the label “Marketed by Elpro International” and the product label also had a brand name 'Calrod'. Accordingly, a show cause notice was issued to the Appellant for evasion of excise duty. The demand was confirmed by the adjudicating authority, against which an appeal was preferred by the Appellant to the Tribunal. The Tribunal, however, remanded the matter back to the lower authorities to reconsider the issue.

The adjudicating authority held that the brand name 'Calrod' belonged to Elpro and therefore, the Appellant was ineligible to avail the benefit of small scale exemption. The said order was challenged by the Appellant on merits as well as on limitation.

ISSUES

Whether the Appellant was eligible for the benefit of small scale exemption in the relevant period?

ANALYSIS/ ARGUMENTS

The Appellant argued that technical dictionary clearly indicate that Calrod was a generic name, which was nothing but a derivative of calorie and rod wherein calorie referred to a measure of heat and rod is heating element. The Appellant also the submitted that the department (“Respondent”) was not able to produce any evidence to prove that Calrod is a brand name of Elpro.

The Appellant further argued that even assuming that Calrod was the brand name of Elpro and the agreement restricted the sale of the said product to others during the contract period, the Appellant was entitled to sell the product brand Calrod to anyone after the specified period. This also indicated that the brand name was belonging to Appellant. In this regard, the Appellant relied on the case of MTR Foods

55Ltd , wherein the SC had held that the marketing company and the manufacturer are different, and hexagonal design of the marketing company cannot be said to be the brand name of the marketing company.

On the limitation issue, the Appellant submitted that they had intimated the Respondent about using of b rand name by l e t te rs addressed to the Superintendent of Central Excise, Philips India range, and had also filed the classification list declaring the brand name and logo. Therefore, the Appellant argued that there could be no suppression of facts by them.

The Respondent, on the other hand, argued that the products contained a label which had logo of Calrod and specific words “Marketed by Elpro International”. Further, such products with brand name Calrod were supplied to Elpro only and no one else.

54 M/s Rashmi Theatres Pvt. Ltd. v. CCE, Pune 2017-VIL-397-CESTAT-MUM-CE.55 CCE v. MTR Foods Ltd 2012 (282) ELT 196.



The Respondent further submitted that the Appellant had suppressed vital information about restricting the sale of such heating element to any other customer other than Elpro. Therefore, in the absence of this information, Respondent was not aware that Calrod was the brand name of Elpro.

DECISION

The CESTAT observed that it was not disputed that Calrod was a brand name. The CESTAT referred to the findings of the Tribunal which had also concluded that the Appellant was the owner of the brand name Calrod. The CESTAT further observed that the Company Secretary of Elpro had also stated that neither Calrod was their brand name/ trade name/ logo nor had they never use it as a brand name/ trade name.

The CESTAT further noted that the agreement only indicated that the Appellant would manufacture the branded product Calrod and supply to Elpro, and label would contain the words “Marketed by Elpro International”. Further, the classification list filed by the Appellant had clearly mentioned Calrod as their brand name. In addition, the Trade Mark authorities had also accepted Calrod as brand name of the Appellant in 1998.

The CESTAT also noted that the Appellant had categorically stated before the Superintendent of Central Excise on July 12, 1991 that they were not manufacturing any branded goods, but were manufacturing product with trade mark Calrod which was their brand name.

Accordingly, the CESTAT concluded that the Appellant had always considered Calrod as their brand name and not the brand name of Elpro. The

words used on the label “Marketed by Elpro International” was also not a hurdle in the case of the Appellant inasmuch as the said words did not indicate any connection of Elpro to the brand name Calrod due to which Appellant could have got undue benefit in the market. Accordingly, the CESTAT held that the Appellant was using the brand name of their own for the goods manufactured by it, and therefore, cannot be precluded from availing the small scale exemption.

On limitation, the CESTAT held that nothing was brought on record to show that there was suppression from the side of the Appellant as to use of word Calrod as the brand name. The CESTAT further held that inasmuch as appointing selling agent or distributor cannot be held as a brand name owner, non-production of such agreement cannot be considered as a suppression of fact, therefore, the demands were also hit by limitation.


The judgment, even though relates to a very old period, is a very welcoming judgment in relation to the brand name. A clarification that manufacturing goods under a brand name of its own by a company is different than manufacturing branded products. Though the central excise law has been subsumed under the GST, and manufacturing is no more a taxable event, the clarity on term 'brand

name' would still be significant.

Under the GST also, certain exemptions has been provided to the goods bearing a registered brand name. Further, the phrase 'registered brand name' has also been defined in the said Notification.

“”

Manufacturing of product in a

brand name is not the same as

manufacturing of branded goods.

56 Notification No. 2/2017 dated June 28, 2017.



CHIT FUND CANNOT BE TREATED AS FUND MANAGEMENT AS GENERALLY UNDERSTOOD IN THE COMMON BUSINESS PARLANCE

57In Margadarshy Chit Funds , the SC held that cash management deals with optimization of cash as an asset does not amount to cash management. Therefore, it cannot be treated as fund management, and accordingly, would not be covered under Section

5865(12)(v) of the FA , even after the amendment in 2007 by which the terms 'but does not include cash management' was omitted therefrom.

FACTS

The present appeal has been filed by the UOI (“Appellant”) against the order dated July 14, 2008 passed by the HC of Andhra Pradesh in a batch of writ petitions filed by the M/s Margadarshy Chit Funds and many other chit companies (“Respondents”). The Respondents had filed writ petition before the HC challenging the validity of the Circular No. 96/7/2007ST (Circular No. 03404) dated August 23,

592007 (“Circular”) and Proceedings No. HAST 1 4 1 / 2 0 0 7 d a t e d D e c e m b e r 1 8 , 2 0 0 7

6 0( “Proceedings” ) . Vide the C i rcu lar and Proceedings, the Appellant had called upon the Respondents to pay the service tax on the running of chit funds considering it to be a service provided by them under the heading 'banking and other financial services', as defined under Section 65(12) of the FA during the relevant period.

The issue before the HC was whether service tax is leviable on chit fund or not, post the amendment in the definition of the “banking and other financial services”, w.e.f. June 1, 2007. Prior to June 2007, the defini t ion had specifical ly exc luded 'cash management' from 'asset management'. Vide the amendment effective from June 01, 2007, the words 'but does not include cash management' were deleted.

The Appellant had argued before the HC that managing chit fund, which was a fund management service, was a specie of cash management, and post the said amendment, the same was included in 'asset management' as covered under the definition of banking and other financia l serv ices. The Respondent, on the other hand, had argued that even after the deletion of the words 'but does not include cash management' from Section 65(12)(v), chit fund was not covered and for the purpose of coverage, it was to be shown that the chit fund services is 'asset management', while it was not so.

The HC noted that in the absence of specific statutory definition of the terms 'cash management' and 'asset management', the question of its wider interpretation either by seeking to include or exclude any other transactions or business, would not arise or was also not permissible. The HC, therefore, had accepted the plea of the Respondents, and thereby had quashed the Circular and the Proceedings.

ISSUES

1. Whether chit fund activity can be treated as business of cash management?

2. Whether chit fund can be treated as a form of fund management?

ARGUMENTS/ANALYSIS

The SC took note of the arguments placed before the HC of Andhra Pradesh. The Appellant had argued that the business of chit fund was in the nature of cash management. Since, the definition of 'banking and financial services' prior to June 01, 2007 specifically excluded 'cash management', the benefit was extended to the chit fund companies by not levying

57 UOI v. M/s Margadarshy Chit Fund 2017-VIL-23-SC-ST.58 Defines “banking and other financial services”, as stood prior to June 1, 2007, from to mean as– “(a) the following services provided by a banking company or a financial institution including a nonbanking financial company or any other body corporate

or any commercial concern, namely: (I)… (v) asset management including portfolio management, all forms of fund management, pension fund management, custodial, depository and trust

services, but does not include cash management;…”.59 The Circular stated that activity of chit fund is in the nature of cash management.60 The Commissioner vide the Procedure advised the assessees under his jurisdiction to obtain registration and clear service tax liability w.e.f. June 1, 2007 at

applicable rates immediately.



any service tax as they were in the business of cash management. However, post the amendment, the chit fund companies were brought within the purview of the service tax. It was submitted by the Appellant that Section 65(12)(v) specifically covers 'asset management' as 'banking and other financial services'. The Appellant further submitted that 'all forms of fund management' were to be treated as 'asset management', and cash management was one of the forms of 'fund management'.

DECISION

The SC looked into the history of the banking and other financial services covered under the FA, and referred to the paradigm shift post-2012. The SC referred to the judgment of Delhi HC in Delhi Chit

61Fund Association where it was held that chit fund business was not covered within the definition of service, because it was excluded from the definition as 'transaction in money'. The HC had also observed that the Legislature's intention behind the exclusion was to be read from the Explanation 2 to the Section 65B(44), which made an exception only in one case, i.e. activity relating to the use of money or its conversion by cash or any other mode, from one form etc. and where separate considerat ion is charged. Since only one such exception existed, all the other activities in the nature of 'transaction in money' including services of a foreman of chit business were excluded from the definition of 'services'.

Responding to the first question the SC held that in common parlance as well as in banking field, cash management is understood as managing the surplus cash of a person or a company. Even the business management aspect of cash management refers to management of cash balance and bank balance including the short term deposits. In the light of the above as well as the tenets of common parlance, the SC held that the term 'cash management' as

understood in common parlance would not embrace chit fund business.

Responding to the second question, the SC held that cash management is one of the forms of fund management and the Court had already determined that chit fund business did not amount to cash management and hence the question of chit business being an activity in the nature of fund management does not arise. The SC further observed that 'fund' in fund management refers to one which is created by a business or an organization for a specific purpose and hence, chit fund activities cannot amount to fund management.


Given that the 'services by a foreman of a chit fund' was specially included within the gamut of the service tax vide Finance Act, 2015, its taxability was no more a res integra under the FA. However, for the period prior to 2015, the taxability of chit fund had always been a

subject of dispute, especially from the point of classification so as to levy tax on the same. The instant judgment, therefore, settles the aforesaid issue p e r t a i n i n g t o t h e p a s t p e r i o d . Additionally, the instant judgment is also significant to the extent that it discussed the nature of cash management and fund management services.

However, it is significant to note that under the GST regime, 'services' has been defined to include anything except goods, money and securities. Unlike erstwhile regime (Post-2012 but before the specific inclusion of chit fund business under services vide Finance Act, 2015) where the exception was available in respect of 'transactions in money', the definition under CGST Act, provides exception to 'money' only and hence, all other activities are covered within the term services. Further, services of a foreman of a chit fund has been specifically covered within the list of rate of 'services'.

61 Delhi Chit Fund Association v. Union of India 2013 (30) STR 347 (Del).

“”

The terms ‘cash management’ and

‘fund management’ as understood in common

parlance would not embrace chit fund

business.



NOT FOR PROFIT EDUCATIONAL TRUST PROVIDING TRAINING OR COACHING SERVICES WAS LIABLE TO SERVICE TAX

62In Chanakya Mandal , the HC held that coaching or training services provided by an educational trust would be liable to service tax, irrespective of the non-profit motive of the trust.

FACTS

Chanakya Mandal (“Petitioner”) was a Trust registered under the Bombay Public Trust Act, 1950. The Petitioner was engaged in the provision of training and coaching services for various civil services examinations. Since, under the Finance Act 1994 (“FA”), service tax was levied on 'commercial training or coaching', the Petitioner was of the view that the services provided by the Petitioner were not exigible to service tax, as its predominant aim was not 'commercial', i.e., profit generation. However, vide Finance Act, 2010, an 'explanation' was added to the definition of the term 'taxable services' under Section

6365(105)(zzc) of the FA, with retrospective effect from July 1, 2003 (“Amendment”). The Amendment levied tax on 'commercial training or coaching' services irrespective of the predominant non-profit intention. In this regard, the Petitioner was issued a show-case notice by the IRA that required the Petitioner to furnish details of fees collected by it for respective courses from 2005-06. In response, the Petitioner submitted that since it was a non-profit educational public trust imparting education, no service tax was leviable on them. The Petitioner further relied upon various precedents, wherein, institutions like the Petitioner, were held to be outside the purview of service tax net under the FA.

Simultaneously, the Petitioner filed the instant writ petition and sought a declaration from the HC that the Amendment was unconstitutional and ultra vires Article 14 of the Constitution.

ISSUE

Whether the Amendment was unconstitutional and ulta vires Article 14 of the Constitution?

ARGUMENTS/ANALYSIS

The Petitioner had placed its reliance on the definition 64of 'commercial training or coaching' defined under

section 65(26) of the FA and 'commercial training or 65coaching center' under section 65(27) of the FA, and

emphasized on the fact that the predominant intention of the Petitioner was not commercial and therefore they would not get covered within the said definitions. The Petitioner argued that the expression 'hereby declared' added to the explanation to Section 65(105)(zzc) of the FA vide the Amendment, demonstrated the intent of the legislature to give a prospective effect to the Amendment.

It was further submitted by the Petitioner that even if it was cons t rued tha t t he Amendmen t was retrospective, merely because the legislature had inserted the Amendment with retrospective effect, it could not overturn binding precedents on the subject, unless the foundation or basis on which the judgments were delivered had been altered. Accordingly, such overruling of binding decisions was impermissible in law.

The IRA submitted that the Petitioner's insistence that its activities were not for profit was flawed, as the Amendment had made profit intent irrelevant for the purpose of taxability under the FA. The IRA contended that the Petitioner's case fell within the ambit of 'taxable services' because coaching for any examination or imparting skills fall within the purview of 'commercial training or coaching' and/or 'coaching centre',

63 Explanation added to Section 65(105)(zzc) of the FA clarified that the ‘commercial training or coaching center shall include any center or institute, by whatever name called, where training or coaching is imparted for consideration, whether or not such center or institute is registered as trust or a society or similar other organization under any law for time being in force and carrying on its activity with or without profit motive.

64 Section 65(26) defines the term ‘commercial training or coaching’ as any training or coaching provided by a commercial training of coaching center.65 Section 65(27) defines the term ‘commercial training or coaching center’ to mean any institute or establishment providing commercial training or coaching

for imparting skill or knowledge or lessons on any subject or field other than sports, with or without issuance of a certificate and includes coaching or tutorial classes.



The IRA argued that the Petitioner's apprehension about being called to pay the tax liability since inception, i.e. with effect from July 01, 2003, was baseless as the demand of tax could only be made after adjudication of the show-cause notice.

Even though the Amendment was made applicable stwith retrospective effect from 1 July, 2003, as

regards the adjudication pending with respect to one show-case notice, the assessment and recovery could be made only in accordance with the provisions under the CEA which puts a fetter on the power to demand tax. Hence, the apprehension of the Petitioner was baseless.

DECISION

The HC noted that the explanation added vide the Amendment was clear and unambiguous with regards to its retrospective effect. There was no scope of advancing any argument to the contrary. A c c o r d i n g l y, t h e Pe t i t i o n e r ' s contention of being non-profit was irrelevant for the taxability under the FA. In this regard, the HC placed reliance on the case of M/s Bishwanath

66Jhunjhunwala and Anr. and noted that clear and full effect was to be provided where the language of the statute was clear and unambiguous.

The Petitioner's provision of training and coaching services was squarely within the ambit of taxable service as defined under the FA.

The HC also noted that an 'explanation' may be validly added to declare the inclusion or exclusion of something from the principal Act and retrospectively clarify the connotation of some word that appeared in the principal Act. The Legislature acting in its own wisdom, could not be said to have acted unreasonably in taxing the provision of training and coaching services. In the light of the retrospective clarification, the basis or foundation of the law on which the precedents cited by the Petitioner were delivered has been altered. Accordingly, the precedents prior to the Amendment cited by the Petitioner were irrelevant.

The HC clarified that the Petitioner's apprehension that it would be taxed for its services since inception was erroneous. The show-cause notice would be adjudicated in accordance with the existing law. Since, inbuilt safeguards and checks on the power to recover tax are provided under the FA read with CEA, the writ petition was dismissed by the HC.

In light of the above, the HC upheld the validity of the Amendment.


The said ruling will have a significant impact on the not-for-profit educational trusts that were providing taxable services in the pre-negative list regime and which did not pay tax under the impression that service tax would not be levied on their services. The HC has reiterated the principle of law that it is not open to read between the lines where the language of the statute was clear and unambiguous.

Under the GST regime, education starting from pre-school to higher secondary has been made exempt from the levy of GST. However, training or coaching services, which facilitates educa t ion , have been t rea ted

67differently under GST. The training or coaching services provided by any person, including trust, are taxable at the rate of 18% in the GST regime, except in certain cases where such

68services are exempt. Therefore, training and coaching services would be costlier now, pursuant to the 3% increase in the tax liability in transition from service tax to GST. Considering the demographic strength of India, which is majorly young, such tax liability is contrary to the Government's initiative of skill India. A lesser tax burden on students would have gone a long way in encouraging quality education and skill development among the masses.

66 Commercial Tax Officer and Ors. v. M/s. Bishwanath Jhunjhunwala and Ors. AIR 1997 SC 357.67 Notification No. 12/2017- Central Tax (Rate), dated 28/06/2017.68 Exemption provided to training or coaching in recreational activities relating to arts or culture, or sports by charitable entities registered under section 12AA

of the Income-tax Act, Notification No. 12/2017- Central Tax (Rate), dated 28/06/2017.

“”

An explanation may be added

retrospectively to include something within or exclude

something from the ambit of the main

enactment.



APPY FIZZ PASSES THE TEST AS FRUIT JUICE BASED DRINK

69In Parle Agro (P.) Ltd , the SC held that 'Appy Fizz' was to be classified as 'fruit juice based drink' and not as an 'aerated branded soft drink' under the Kerala VAT Act, 2003.

FACTS

M/s Parle Agro (P.) Ltd. (“Appellant”) was a dealer engaged in the manufacturing of fruit juice based drink known as 'Appy Fizz' (“Product”) and had obtained registration under the Kerala Value Added Tax Act, 2003 (“KVAT Act”).

M/s One Trade Lines (“Distributor”) was the distributor of the Appellant in the State of Kerala and was discharging its VAT liability at the rate of 12.5% on the sale of the Product. Demand was raised by the IRA on the Distributor to pay tax at the rate of 20% on the sale of the Product classifying the product was an 'aerated branded soft drink'. In this regard, appeal was filed by the Distributor before the Tribunal, and subsequently before the HC, but the appeals were dismissed. The Distributor then filed a SLP before the SC, however, the SLP met the same fate.

Later, the Appellant was issued assessment notices for AYs 2009-2015 classifying the Product as 'aerated branded soft drink' under the Schedule to Section

706(1)(a) of the KVAT Act that attracted a VAT liability of 20%. The Appellant filed an application before the IRA seeking clarification (“Application”) as to the

71 classification of the Product in terms of Section 94 of the KVAT Act. The Appellant substantiated its Application by placing certificates and expert opinions before the authorities and claimed that the Product should be classified as 'fruit juice based

72drink' under the residuary clause in Entry No. 71 of 73Schedule to Section 6(1)(d) of the KVAT Act

(“Impugned Entry”) and attracted levy of VAT at the rate of 12.5%.

Since the Application filed by the Appellant was not responded by the IRA within a reasonable time, the Appellant preferred a writ petition before the HC to direct the IRA to timely clarify the classification of the Product. The HC directed the IRA to pass clarification order regarding the classification dispute within one month from the date of receipt of the order of the HC. The IRA appealed against the said order of the Single Bench of the HC before the Division Bench of the HC, which was dismissed by the Division Bench.

Accordingly, the IRA clarified on the Application of the Appellant and classified the Product to be an 'aerated branded soft drink' by relying on the HC's order in the Distributor's case. The Appellant filed an appeal against the said order of the IRA before the HC, and subsequently a review application, both of which were dismissed by the HC. (“Impugned Orders”).

ISSUE

Whether the Product was to be classified as an 'aerated branded soft drink' under Section 6(1)(a) of the KVAT Act or under residuary clause to the Impugned Entry as 'fruit juice based drink'?

ARGUMENTS/ANALYSIS

The Appellant submitted that the IRA itself had classified the Product as 'fruit juice based drink' under Impugned Entry till the year 2007 and levied tax at 12.5%. The Appellant contended that prior to amendment made to the Impugned Entry in 2008, the IRA had classified the Product to be fruit juice based drink. Accordingly, there was no reasonable basis for classifying the Product should have been covered under Section 6(1)(a) after the amendment, since there was no addition/modification made to the said section vide the amendment.

69 Parle Agro (P.) Ltd v. Commissioner of Commercial Taxes, Trivandrum [2017] 81 taxmann.com 194 (SC).70 Rate of tax for certain goods.71 Power of authority to issue clarification.72 Entry 71 (Post-amendment): Non-alcoholic beverages…including….(2) Fruit Juice, fruit concentrates, fruit squash, fruit syrup and pulp, and fruit

cordial....(5)Similar other products not specifically mentioned under any other entry in this list or any other schedule. Entry 71 (Pre-Amendment): Non-alcoholic beverages….(4) Fruit pulp or fruit juice based drink. 73 Section 6(1)(d) empowers the Government to notify a list of goods which are taxable at the rate of 12.5%, which does not fall under Section 6(1)(a) or 6(1)(c)

of the KVAT Act.



The Appellant contended that the entries under the KVAT Act were technical and scientific in nature, therefore, the common parlance was incorrectly held to be applicable by the HC. It submitted that the IRA and the HC had not considered the technical evidences and certificates filed by the Appellant. Such evidences substantiated that the Product was a 'fruit drink' and, unlike aerated drinks, the Product contained more than 10% fruit concentrate. Further, it submitted that the Product was thermally processed and aerated with CO2 merely to preserve the Product from perishing. The Appellant lastly contended that Section 6(1)(a) of the KVAT Act covers products that were dangerous to health and environment and therefore subject to a higher rate of VAT at the rate of 20%.

The IRA submitted that the deletion of expression 'fruit pulp or fruit based drinks' from the Impugned Entry vide amendment in 2008 clarified the legislative intent that the fruit based drinks were excluded from the ambit of the Impugned Entry and were brought under Schedule to Section 6(1)(a) of the KVAT Act. The IRA contended that in so far as the Product was aerated by CO2, the Product should be covered under Section 6(1)(a) of the KVAT Act.

The IRA lastly advanced that the common / commercial parlance test was rightly used by HC in absence of specific HSN number provided under the KVAT Act for the Product. Further, in the commercial parlance any product with more than 10% fruit concentrate was referred to as 'soft drink'. Therefore, in so far as the product was 'aerated' and a 'soft drink', it should have been covered under the entry for 'aerated branded soft drink'.

DECISION

The SC noted that the goods listed under the Schedule to Section 6(1)(a) of the KVAT Act were not congenial to health and environment and therefore a higher rate of VAT was intentionally levied on such goods. The SC also observed that the power of the legislature to notify goods under Section 6(1)(d) of

the KVAT Act was restricted to issue notifications only with respect to the goods which were not covered under the ambit of Section 6(1)(a) or 6(1)(c). Therefore, since prior to the Amendment, fruit juice drinks were notified under Entry 71 of Section 6(1)(d) of the KVAT Act, it indicated that the legislature was aware that the fruit juice based drinks were not covered under Section 6(1)(a) of the KVAT Act. The residuary entry inserted in the Impugned Entry vide the Amendment merely subsumed the entry for 'fruit juice based drinks', and did not affect the character and content of the products that were included in the Impugned Entry.

The SC noted that the scientific and technical meaning test was relevant for interpreting scientific and technical words used in the Impugned Entry. Accordingly, the SC held that the usage of carbon dioxide to the extent of 0.6%, merely for the purpose of preservation in packaging, did not make the product

an 'aerated' product under KVAT Act.

The SC applied the doctrine of 74 'noscitur a sociis' and held that the

residuary item under the Impugned Entry should take its colour from other items in the said entry. Accordingly, fruit juice based drink, which was similar to 'fruit juice, fruit concentrate etc.' provided in Item 2 of the Impugned Entry, squarely fell under residuary entry provided in Item 5 to

the Impugned Entry.

On the Clarification issued by IRA, the SC observed that the decision of the HC in Distributor's case did not conclude the issue of classification of the Product and the IRA was not absolved from its duty of determining the classification in accordance with the evidences and certificates brought on the record by the Appellant. The order of Food Safety Authority and expert opinion regarding the process of manufacture relied upon by the Appellant were relevant material and IRA and HC had erred in discarding these materials.

In conclusion the SC declared the Product to be classified under the Impugned Entry as fruit juice based drink.

74 The meaning of the word may be known from the accompanying words.

“”

The order of the Food Safety Authority

and expert opinion regarding the process of manufacturing are

relevant for determining the classification

of a product.




The instant ruling of the SC is a landmark ruling as it brings to rest the issue of classification of fruit juice based drinks which are aerated with CO2 merely for the purpose of preservation and not to carbonate the drink. The SC has also laid down principles on various other aspects, such as weightage of scientific meaning of an expression along with common parlance, relevance of order of Food Safety Authority and other expert opinions for determination of classification of the product.

Even under the GST regime, which adopts HSN codes for classification of products, the ratio decidendi laid down in this judgment of the SC will go a long way in deciding disputes relating to classification of drinks. In the GST regime, 'fruit pulp and fruit juice' based drinks are made taxable at 12%, whereas, the 'aerated drinks' are taxable at 28% with additional cess of 12%. Accordingly, any ambiguity in relation to classification of fruit drinks, aerated merely for preservation, would have led to excessive taxation on such drinks under the category of 'aerated drinks'. Therefore, the ruling of the SC has timely brought the much needed clarity and respite to manufacturers of such drinks.



CHARGERS SOLD WITH CELL PHONE IN COMPOSITE PACKS ARE CHARGEABLE TO VAT AT RATE APPLICABLE TO CELL PHONE

75In Nokia India Sales Pvt. Ltd. , the Himachal Pradesh VAT Tribunal at Shimla held that the cell phone chargers, sold with cell phones in composite packs, were chargeable to VAT at the rate applicable to cell phones under the Himachal Pradesh VAT Act, 2005.

FACTS

M/s Nokia India Sales Pvt. Ltd. (“Appellant”) was engaged in the business of trading cell phones. The Appellant had been discharging its VAT liability on the sale of composite packs of cell phones, including cell phone chargers and other accessories, at the rate of

76 5% under Entry No. 57 of Part II-A of Schedule A(“Impugned Entry”) of the Himachal Pradesh VAT Act, 2005 (“HP VAT Act”).

The IRA contended that although the cell phones were chargeable to VAT at the rate of 5%, the cell phone chargers, even when sold in composite packs of cell, were chargeable to VAT at the rate of 13.75%, under the residuary entry to the Schedule provided under HP VAT Act. In this regard, the IRA sought to levy additional differential rate of VAT at the rate of 8.75% (13.75% less 5%) on the cell phone chargers sold in the composite packs of cell phones and raised a demand of INR 52.15 lacs, inclusive of interest.

Before the IRA, the Appellant submitted that the Appellant's predominant intention was to sell cell phones only, and the price of the accessories, including cell phone chargers, sold in the composite pack of cell phones, was not assigned separately. Therefore, separate rate of VAT was not leviable on such chargers sold along with the cell phone. The IRA dissented with the contention of the Appellant by

77placing reliance on the case of Nokia India Pvt. Ltd , wherein the Apex Court, while examining the provisions of the Punjab VAT Act, had held that the cell phone charger was an accessory to the cell

phone and was not part of the cell phone. Accordingly, the IRA upheld the demand of INR 52.15 lacs against the Appellant.

ISSUES

1. Whether the decision of the SC in Nokia India Pvt. 78Ltd. , decided in relation to Punjab VAT Act, 2005

(“Punjab VAT Act”) was applicable to the provisions of the HP VAT Act?

2. Whether the Impugned Entry of the HP VAT Act could be interpreted basis the rules of interpretation applicable to HSN code and general rules for interpretation of the first schedule to the Customs Tariff Act, 1975?

ARGUMENTS/ANALYSIS

The Appellant contended that the IRA's order was based on the judgment of the SC in Nokia India Pvt.

79Ltd , wherein the Court had decided the issue in relation to the provisions of the Punjab VAT Act, which were distinguishable from the provisions of the HP VAT Act. The relevant entry under the Schedule to the Punjab VAT Act was restricted to the list of products enumerated in the said schedule and the said list did not cover 'cell phones and parts thereof', as it was explicitly listed under the HP VAT Act. The Appellant further submitted that the IRA had not taken into consideration the subsequent decision of the SC in

80Micromax Informatics Ltd , wherein the SC had held that the cell phone charger was not an accessory and had argued that it was an integral part of the cell phone.

The Appellant also submitted that the determination of the notional value of the charger at INR 100/- per charger by the IRA was arbitrary and had no basis since no monetary value had been assigned to the specified charger by the Appellant. Since the chargers were product-specific and could only be

75 M/s Nokia India Sales Pvt. Ltd. v. Excise and Taxation Commissioner and Ors. TS-156-Tribunal-2017-VAT.76 “Telephone, cell phones, tele-printer, wireless equipment and parts thereof….”.77 State of Punjab v. Nokia India Pvt. Ltd. (AIR 2015 SC@ 1068).78 ibid.79 State of Punjab v. Nokia India Pvt. Ltd. (supra.).80 Micromax Informatics Ltd. v. State of Himachal Pradesh SLP (C) No. – 028448-028450 - 2015.



used for specific cell phones, therefore by necessary implication the chargers were sold as a part of the cell phone.

The Appellant also submitted that it was a settled position of law that where goods were sold in a set, the classification of the goods would be determined with reference to the material component which accorded them their essential character. Therefore the composite pack of cell phone should have been classified according to its essential character and usage.

The Appellant contended that the Impugned Entry squarely covered 'cell phones and parts thereof', which included mobile charger. The charger was an integral part of the cell phone, without which cell

81phone could not be used. Reliance was placed by 82 the Appellant on the Circular wherein reference was

made to the Customs (Accessory Conditions) Rules, 1963, which provided that an accessory compulsorily supplied free with an article shall attract the same rate of duty, which was applicable to imported article.

Appellant also placed reliance on Rule 833(a) of the Rules of Interpretation of HSN

and submitted that since the HP VAT Act did not provide a separate entry for the cell phone chargers, it should be classified under the Impugned Entry, which would be specific entry in relation to telephone set, as compared to the residuary entry. Further, it was

84 submitted that in terms of Rule 3(b) of the said Rules, the composite mobile pack, compromising of cell phone and various accessories, had to be classified according to essential character of the material component, i.e. the cell phone.

The IRA argued that the Appellant was discharging VAT liability at 13.75% on the chargers sold separately by the Appellant. Therefore, the chargers sold with the cell phone should also have been chargeable to VAT at the rate of 13.75%. The IRA also

placed reliance on the decision of the SC in Nokia 85India Pvt. Ltd. and argued that the legal position had

been settled by the Hon'ble SC.

DECISION

The VAT Tribunal held that the entries in the HP VAT Act were distinct from the entries under the Punjab VAT Act. The Impugned Entry in HP VAT Act was more specific and clearly mentioned 'cell phones and parts thereof', whereas the relevant entry under Punjab VAT Act was restricted to only the 'telephone and parts thereof'. Therefore, the ruling of the SC in the case of

86Nokia India Pvt. Ltd. was distinguishable. Further, the VAT Tribunal noted that the Apex Court in the case of

87Micromax Informatics Ltd. (supra.) had positively 88 stated that the decision in the Nokia India Pvt. Ltd.

was distinguishable and was not a applicable in relation to the provisions of HP VAT Act.

The VAT Tribunal observed that in terms of General Rules of Interpretation of Import Tariff, in a composite

transaction, the essential character was to be determined with reference to the main component of higher value. The Appellant was engaged in the business of selling cell phones and not chargers and the charger was only an accessory which complements to the product.

The VAT Tribunal also held that it was clear that the MRP was affixed on the retail

packages at the time of sale and that the chargers were sold in a composite pack without any charges separately indicated for the chargers. Therefore, if separate VAT was to be levied on each part then the IRA should also tax the pre-packed batteries separately, which was not an acceptable view. The VAT Tribunal concluded that it was not appropriate to tax an individual component in the case of a composite supply of goods.

Accordingly, the VAT Tribunal set aside the order of the IRA.

“”

It is not appropriate to tax

individual components separately in case

of composite supply of goods.

81 ATCO, Ward-I, Circle-C, Jodhpur v. Industrial Instruments, Jodhpur, S.B. Civil Revision (Sales Tax) No. 331/2005: It was held that UPS and CVT are essential part of the computer because without them the computer cannot be used.

82 Ministry of Finance Department of Revenue (Sales Tax Division) dated November 30, 2015.83 In case the goods are classifiable under two or more headings, heading which provides a specific description has to be preferred.84 Composite goods made up of different components and goods put up in sets for retail sale are to be classified by the component which gives them their

essential character.85 State of Punjab & Ors. v. Nokia India Pvt. Ltd. (supra).86 State of Punjab v. Nokia India Pvt. Ltd. (supra.).87 Micromax Informatics Ltd. v. State of Himachal Pradesh (supra).88 State of Punjab & Ors. v. Nokia India Pvt. Ltd. (supra).



SIGNIFICANT TAKEAWAY

In the newly enforced GST Regime, the concepts of “composite supply” and “mixed supply” and the tax liability on these supplies has been very categorically laid down. Composite supply has been defined to include all those cases where a supply of goods is of two or more taxable supplies of goods which are naturally bundled in the ordinary course of business. In case of a composite supply, the tax liability shall be determined as if the supply was made only of the

89 principal supply of goods.

Whereas, “mixed supply” has been defined as a supply where two or more individual supplies are made in conjunction, for a single price and does not

90constitute composite supply. The tax liability shall be determined as if the supply was solely a supply of the

91goods services which attract highest rate of tax.

In light of the clarity provided under the GST in this regard, it can be said that the position taken by the VAT Tribunal is echoed in the legal provisions under the GST. Since chargers and mobile phones are sold together, they should be considered to be 'naturally bundled' and sold as such.

89 Section 8(a) of CGST Act, 2017.90 Section 2(74) of the CGST Act, 2017.91 Section 8(b) of the CGST Act, 2017.

41

NON-JUDICIAL UPDATES

- DIRECT TAX





CBDT notifies new safe harbour rules

In order to reduce transfer pricing disputes, to provide certainty to taxpayers, to align safe harbour margins with industry standards and to enlarge the scope of safe harbour transactions, the CBDT has notified a new safe harbour regime vide Notification No. 46/ 2017 dated June 07, 2017. The “safe harbour” is meant to provide for circumstances in which a certain category of taxpayers can follow a set of rules, which, if followed, the transfer price (i.e. actual price charged in a transaction between related parties) declared by the taxpayer, in respect of its international transactions with related parties, will be accepted by the Indian tax authorities without undertaking a detailed scrutiny.

The revised safe harbour rules (“SHRs”) apply for the AY 2017-18 and two immediately following AYs, i.e. upto AY 2019-20. The earlier SHRs were applicable from the AY 2013-14 and four immediately following AYs, i.e. upto AY 2017-18. For AY 2017-18, the taxpayer can choose from old or new rules, whichever is more beneficial.

The revised SHRs inter alia provides for:(a) Rationalisation of safe harbour rates. The key

changes amongst others include: (i) Rates for information technology and

information technology enabled services, have been reduced to 17-18% from 20-22%;

(ii) Rates for knowledge process outsourcing (“KPO”) services, which were earlier at 25% have been reduced to 18%, 21% and 24% depending upon the percentage of employee cost to operating cost;

(iii) Rates for R&D serv ices prov iders (information technology and generic pharmaceutical drugs) has been brought down from 29-30% to 24%.

(b) Introduction of upper turnover threshold of INR 2000 Million for all contract service providers (information technology, information technology enabled services, KPO services, R&D for software development and pharmaceutical drugs).

(c) Addition of a new category of transaction, i.e. receipt of low value-adding intra-group services (defined in the revised SHRs) from one or more members of its group.

(d) Staggered safe harbour rates for KPO services, which will be dependent upon the application of employee cost to operating cost ratio.

(e) Safe harbour rates on loans advanced in foreign currency to AE, based on LIBOR. The revised SHRs also provide for prescribed staggered rates depending upon the credit rating of the overseas borrower, subject to such credit rating being approved by CRISIL.

(f) Broad definition of “operating expenses”, to include cost relating to employee stock option provided for by the AE, reimbursement to AE for expenses incurred by AE on behalf of the taxpayer, amounts recovered from AE which related to normal operations of the taxpayer.

The revised SHRs with the moderation of safe harbour rates as opposed to earlier SHRs, will pave the way for more taxpayers opting for safe harbour regime. The introduction of upper threshold limit indicates intention of CBDT to restrict the applicability of SHRs to small and midsized entities. The revision of SHRs is indicative of Indian tax authorities' intent to provide a non-adversarial tax regime.

Government notifies the list of specified individuals to whom section 139AA of the IT Act will not apply

The Finance Act, 2017, through introducing section 139AA of the IT Act mandates quoting of an Aadhaar number or the enrolment ID by individuals for filing income tax return and for making an application for allotment of permanent account number, with effect from July 01, 2017. The press release issued by CBDT dated April 05, 2017 clarified that mandatory quoting of an Aadhaar number shall apply only to a person eligible to obtain an Aadhaar number. Under Aadhaar (Targeted Delivery of Financial and other Subsidies, Benefits and Services) Act, 2016, only a resident individual is entitled to obtain an Aadhaar number.

Accordingly, the Government vide Notification No. 37/ 2017 dated May 11, 2017 stated that provisions of section 139AA of the IT Act shall not apply to an individual who does not possess an Aadhaar number or the enrolment ID and is: (a) residing in the states of Assam, Jammu & Kashmir or Meghalaya; (b) non-resident under the IT Act; (c) of the age of eighty years or more at any time during the previous year; (d) not a citizen of India.



This is a welcome step for expatriate employees and Indians working/ settled abroad who may have a tax filing obligation in India.

Clarification on treatment of lease rent from letting out buildings/developed space along with other amenities in an Industrial Park/SEZ

The CBDT in a circular dated April 25, 2017 has dealt with the litigious issue of whether income arising from letting out of premises/developed space along with other amenities in an Industrial Park/SEZ to be taxed under the head “Income from Business” or “Income from House Property”.

CBDT has clarified that the income from the Industrial Parks/ SEZ established under various schemes framed and notified under section 80IA(4)(iii) of the IT Act is liable to be treated as “income from business”, provided the conditions prescribed under the schemes are met.

The CBDT relied upon and accepted the judgments 92of the Karnataka HC, in which the HC observed that

any other interpretation would defeat the object of section 80IA of the IT Act and government schemes for development of Industrial Parks in the country and

93has also held that since the assessee-company was engaged in the business of developing, operating and maintaining an Industrial Park and providing infrastructure facilities to different companies, the lease rent received by the assessee from letting out buildings along with other amenities in a software technology park would be chargeable to tax under the head “Income from Business”.

Accordingly, henceforth the appeals may not be filed by the IRA on the above settled issue and already filed appeals may be withdrawn/not pressed upon.

Cabinet approves Multilateral Convention to Implement DTAA Related Measures to Prevent Base Erosion and Profit Shifting

The OECD/G20 Base Erosion Profit Shifting (“BEPS”) Project which was aimed at preventing base erosion and profit shifting through tax planning strategies that exploit gaps and mismatches in tax rules, identified 15 action plans to address the menace of BEPS. The implementation of these plans required amendments to more than 3000 DTAAs. To

92 CIT v. Velanki Information Systems Pvt. Ltd. (2013) 35 taxmann.com 1 (Karnataka).93 CIT v. Information Technology Park Ltd. (2014) 46 taxmann.com 239 (Karnataka).94 Government of India Press Release dated June 7, 2017

avoid the burdensome and time consuming task of amending the plethora of DTAAs an Ad-hoc Group (India was a part of this Group) was formed for the development of a multilateral instrument, pursuant to which the Ad- Hoc Group came up with the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (“MLI”). The MLI was adopted by the Ad-hoc Group on November24, 2016 and was opened for signature as on December 31, 2016.

In view of the above the Government through its press release dated May 17, 2017 had informed of the cabinet approval for signing the MLI, which has been

94subsequently signed by India on June 7, 2017 .

Unlike a protocol, which directly amends a DTAA, MLI will be applied concurrently with existing DTAAs, modifying their application in order to implement the BEPS measures.. A DTAA would be subject to MLI only if both parties ratify and include the DTAA for modification. There is no obligation for a jurisdiction (country) to include all existing DTAAs. For the covered DTAAS, the MLI will in effect override the terms of the existing DTAAs. As per the provisional list, India has notified all its 93 DTAAs indicating the intention of applying the selected MLI provisions to all these treaties. MLI also provides flexibility in the form of an option to opt out of provisions or part of provisions through reservations.

The MLI provides for certain minimum standards, relating to prevention of treaty abuse and dispute resolution, which are required to be adhered to by all the participating countries, unless such provisions already exist in the DTAAs. Firstly, the MLI provides for the insertion of a “Principle Purpose Test” (“PPT”) as a minimum standard. The PPT seeks to expressly include language in the Preamble of DTAAs that states the purpose of the DTAA is not to create opportunities for tax evasion, tax avoidance or double non-taxation. As per PPT, the benefit of the DTAA should not be granted if obtaining such benefit was one of the principal purposes of any arrangement or transaction. It may be pertinent to note that India has accepted the inclusion of the PPT in its DTAAs.

Additionally, the MLI requires that the participating countries include an anti-abuse provisions as a minimum standard. The countries have an option of



either opting for the PPT along with a simplified Limitation of Benefit (“LOB”) provision. Alternatively, the countries may negotiate a detailed LOB clause along with other test to satisfy the minimum standard. India has opted to for the PPT along with simplified LOB clause to apply to all the DTAAs to which MLI applies.

Secondly, MLI requires that all covered DTAAs should include Mutual Agreement Procedures (“MAP”) as a minimum standard. MLI provides that the participating countries should allow a tax payer to present its case to a competent authority of either country under the MAP provisions of the DTAA. Alternatively, the participating countries may allow its residents to first raise the dispute before a competent authority of his contracting country. Subsequently, such competent authority would bilaterally negotiate the dispute with its counterpart of the other country. It may be pertinent to note that India has opted for the latter option and has not accepted the MLI provisions relating to arbitration proceedings for dispute resolution.

Additionally, it may also be noted that he India has accepted the provisions under the MLI for the prevention of artificial avoidance of permanent establishment under commissionaire structure, specific activity exemption etc. However, some of India's DTAA partners have not accepted these provisions.

It would be pertinent to note that the participating countries have been granted a certain degree of flexibility with regards to choosing optional provisions, making or withdrawing from reservations, etc. Thus, it would be essential to monitor the changes India and other countries make in order to determine the exact impact of the MLI. Further, various countries like USA, UAE, Malaysia, etc. have not signed the MLI, therefore the existing DTAAs with these would remain unaffected. The signing of the MLI is a pragmatic shift in the applicability of the DTAAs as it is likely to curb revenue loss through treaty abuse and BEPS strategies by ensuring that profits are taxed where substantive economic activities generating the profits are carried out and where value is created. Additionally, under this new regime, India would also be able to ensure that all its DTAA partner countries adopt the BEPS anti abuse outcomes.

Definition of Start-up amended

The Notification No. GSR 501(E) [F.No.5(91)/ 2015-BE-I] dated May 23, 2017 rescinds the Notification dated February 17, 2016, which defined the meaning of the term “start-up” (“Start-up”) and prescribed the procedure for its recognition and obtaining the tax benefits. Acknowledging the long gestation period for Start-ups, the definition has been amended, where an entity shall be considered as a Start-up for up to seven years (from earlier five years) and a Start-up in a biotechnology sector for up to ten years from the date of its incorporation/ registration. Also, scope of definition has been broadened to include scalable business model with high potential of employment generation or wealth creation. Additionally, no letter of recommendation from an incubator/industry association shall be required for either recognition or tax benefits. Under section 80-IAC of the IT Act, hundred percent deduction is provided for three consecutive years out of seven years, to profits of Start-ups.

CBDT notifies rules for TDS on rent payment by individuals / HUFs

CBDT vide Notification No. 48/2017,dated June 8, 2017 has notified the operating rules and forms with respect to section 194IB. Section 194IB was inserted vide Finance Act, 2017 and it provides for TDS on rent payment exceeding INR. 50,000 made by individuals or HUF.

The newly notified rules provide that the TDS under section 194IB should be deposited with government within a period of 30 days, from the end of the month in which the deduction is made. The rules also provide for a new challan-cum-statement in Form No. 26QC to be furnished electronically by the deductor. Additionally, the rules obligate the deductor to furnish a TDS certificate in Form No. 16C to the payee, within 15 days from the due date of furnishing Form No. 26QC.

Notification of Cost Inflation Index

The CBDT in exercise of the powers under clause (v) of the Explanation to section 48 of the IT Act has by way of a circular dated June 5, 2017, notified the Cost Inflation Index as 272 in respect of computing the long term capital gains for the FY 2017-18.



Rules for method of valuation of accreted income of trust under section 115TD of the IT Act notified on April 21, 2017

The Finance Act, 2016 had inserted special provisions to tax the charitable trusts via section 115TD of the IT Act on its accreted income in certain circumstances viz. conversion of charitable trust into a non-charitable trust, merging the charitable trust with a non-charitable trust or failing to transfer the assets of the charitable trust to eligible entities within a period of 12 months.

It is pertinent to note that sections 11 and 12 of the IT Act, exempt the income derived from property held under a trust and voluntary contributions subject to the condition that such income must be applied for charitable purposes and where such income cannot be applied for such purposes, it should be invested or applied in the prescribed modes. Often, these charitable trusts/ institutions carrying on a charitable activity misuse the benefit conferred by the exemption by merging or converting themselves into non-charitable institutions or transferring assets to non-charitable institutions. To curb this practice, section 115TD in the IT Act was inserted into the IT Act to provide for the taxation of accreted income of charitable trusts or institutions that have either converted, merged or transferred assets to a non-charitable institution at maximum marginal rate. Further, section 115TD (2) provides that accreted income is the difference between the aggregate fair market value of the total assets and the total liabilities of the trust or the institution, as on the specified date, computed in accordance with the method of valuation as may be prescribed.

Accordingly, the CBDT has now notified Rule 17CB of the IT Rules vide notification dated April 21, 2017, with effect retrospectively from June 01, 2016, which prescribes the method of valuation of “accreted income” for the purposes of section 115TD (2) of the IT Act.

The Rule prescr ibes the methodology for determining the fair market value for various assets forming part in the balance sheet of the trust viz. quoted equity shares, unquoted equity shares, shares other than equity shares, business

undertakings, immovable properties and other assets.

While the fair market value of the unquoted equity shares and the business undertakings are computed by a specified formula which takes into consideration the book value of the assets and liabilities entities, the fair market value of quoted equity shares and shares other equity shares are computed by taking into consideration the average of the price of such quoted equity shares in the recognized stock exchange and value determined on valuation report prepared by the merchant banker or an accountant respectively. It prescribes that fair market value of the immovable property and other assets shall be the price that the asset shall ordinarily fetch in the open market on the specified date.

The Rule also prescribes that while computing the total liabilities of the trust for the purposes of determining accreted income, the following items should be excluded- a) corpus or capital funds or accumulated funds; b) reserves or surplus or excess of income over expenditure; c) contingent liability; d) provisions for unascertained liabilities; and e) provisions for taxation.

Draft rules for valuation of “unquoted shares”

BackgroundFinance Act, 2017 (“ ”) has introduced section FA 201750CA of the IT Act, with effect from the FY 2017-18, which provides that in case any unquoted share of a company is transferred at a value less than the fair market value of such share, the fair market value shall be deemed to be the full value of consideration for the purposes of computing the income in the hands of the transferor under the head “capital gains”. The section further provides that the fair market value has to be determined in the prescribed manner.

FA 2017 also substituted sections 56(2)(vii) and 95

56(2)(viia) of the IT Act with section 56(2)(x). Section 96

56(2)(x) provides that any taxpayer (i.e. individuals, HUFs, firms, companies, trusts, association of persons, etc.), who receives any “sum of money” or “property” without or for inadequate consideration, 97

the difference between the fair market value of such “sum of money” or “property” and the actual transaction value would have be taken into account

95 Applicable to individuals and HUFs.96 Applicable to closely held companies and firms.97 Property means the following capital assets of the taxpayer, namely, immovable property, shares and securities, jewellery, archaeological collections,

drawings, paintings, sculptures, any work of art or bullion.



for the purposes of computing the taxable income. Thus, this new anti-abuse provision has widened the ambit of taxation and is now applicable to all types of taxpayers. While the scope has been widened through FA 2017, the valuation rules continued to be governed under the erstwhile Rule 11UA of the IT Rules, which valued unquoted equity shares at their book value (subject to some adjustments).

Last week, CBDT has issued draft rules for computing the fair market value of unquoted shares of a company under sections 50CA and 56(2)(x) of the IT Act and had invited public comments from various stakeholders by May 19, 2017.

Draft rules for valuation of unquoted sharesThe draft valuation rule proposes to substitute the existing Rule 11UA(1)(c)(b) (“ ”) of the Valuation RuleIT Rules.

It is pertinent to note that the existing Valuation Rule provided for the valuation of unquoted shares based on the book value of items appearing in the balance sheet of the company. As per the Valuation Rule, book value of liabilities is reduced from the book value of assets to arrive at the net worth of the company. Once the net worth of the entire company is computed, it is divided by the total number of equity shares issued by the company in order to determine the value per equity share.

The draft rule (“ ”) issued by the CBDT Draft Ruleproposes to substitute the Valuation Rule so as to carry out the valuation of specified assets in a more scientific manner:

Jewelry and artistic work – the price which would fetch if sold in the open market on the basis of the valuation report obtained from a registered valuer;

Immovable property – stamp duty reckoner value;

Other assets – at their respective book value.

Shares and securities – the fair market value (“ ”) of listed shares and securities shall be FMVdetermined at the prevailing market value whereas FMV of the unlisted securities shall be determined by deducting the outstanding liabilities from the sum total of the FMV of jewelry and artistic work, FMV shares and securities, stamp duty value of the immovable property and book value of other assets.

In other words, the FMV of unlisted securities shall be determined as per the following formula:

FMV of unquoted share as on valuation date = (A+B+C+D-L) × (PV) / (PE)

Where:

n A = book value of all the assets (other than covered in B, C and D below) as reduced by

(i) any amount of income-tax paid less the amount of income-tax refund claimed, and

(ii) any amount shown as asset including the unamortized amount of deferred expenditure which does not represent the value of the asset;

n B = the price which the jewellery and artistic work would fetch if sold in the open market on the basis of the valuation report obtained from a registered valuer;

98 n C = FMV of shares and securities as

determined in the manner provided in this rule;

n D = stamp duty in respect of the immovable property;

n L= book value of liabilities, but not including the following amounts, namely:-

(i) the paid-up capital in respect of equity shares;

(ii) the amount set apart for payment of dividends on preference shares and equity shares;

(iii) reserves and surplus, by whatever name called, even if negative, other than those set apart towards depreciation;

(iv) any amount representing provision for taxation, other than amount of income tax paid, less the amount of income-tax claimed as refund, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto

98 Securities shall have the meaning as provided under section 2(h) of the Securities Contracts (Regulation) Act, 1956.



(v) any amount representing provisions made for meeting liabilities, other than ascertained liabilities;

(vi) any amount representing contingent l iabi l i t ies other than arrears of dividends payable in respect of cumulative preference shares;

n PE = total amount of paid up equity share capital as shown in the balance-sheet;

n PV= the paid up value of such equity shares

AnalysisAs per the erstwhile Valuation Rule, the FMV of the unlisted shares of a company was determined as per the book values stated in the balance sheet. However, the Draft Valuation Rule proposes to determine the valuation of unlisted securities through a market driven approach and accordingly, provides that the FMV of various types of assets (like, securities, preference shares and jewellery, as discussed above) owned by the company shall be determined separately before adding them up to ascertain the FMV of unlisted shares of the company.

While it is a very good move to link the shares of a company to its FMV based on an internationally accepted valuation methodology, the manner in which the Draft Valuation Rule proposes to determine the FMV, does raise a number of pertinent issues. We have discussed herein below certain specific instances (we would like to clarify the below mentioned list is merely an illustrative list and not an exhaustive list) which may not have been addressed appropriately in the Draft Valuation Rule:

a) in case of inter-company holdings (where two companies hold shares in each other), since the FMV of shares of one company is dependent on the FMV of the other company, it will create a circuitous path leading to a never ending loop.

b) In case one company holds shares in another company which, in turn, holds shares in a third company and so on and so forth, it is not clear whether valuation of each of such entities shall have to be carried out irrespective of the percentage or value of such investments or whether there would be some de minims threshold, either in terms of the percentage of holding or value of holding. It would be extremely useful if the CBDT could clarify how to determine the value in such instances.

c) property holding companies may be impacted since the valuation of the immovable property has to be done on the basis of the stamp duty reckoner value.

d) certain investment holding companies (including banks, non-banking finance companies, etc.) may have to determine FMV of the securities held by them as capital assets (e.g. pass through certificates issued by a securitization trust, etc.) and a valuation report would have to be obtained from a merchant banker or an accountant in this regard.

e) the Draft Valuation Rules provide that contingent liability, if any, cannot be reduced from the FMV. However, it will be appreciated that assets under litigation generally fetch a reduced value from the market because buyers would typically discount the value of an asset in case such asset is the subject matter of any litigation. It will be advisable to allow adjustment to the FMV on account of genuine contingent liabilities.

f) the valuation of certain assets, like self-generated intellectual property (like, patents, copyright, goodwill, etc. which have not been capitalised) which could have a considerable impact of the price of an unquoted share, have been ignored.

It is important to note that the impact of the Draft Rule shall be widespread and significant and hence, taxpayers are well advised to analyse the implications for both the buyer as well as the seller so that the tax optimum structure can be adopted by the transacting parties. As the Draft Rule is still in the draft stage, it is strongly recommended that the CBDT addresses these issues / concerns in the final valuation rule so that unnecessary ambiguity and litigation can be avoided.


GLOSSARY

ABBREVIATION MEANING

AAR Hon’ble Authority for Advance Rulings

ACIT Learned Assistant Commissioner of Income Tax

AE Associated Enterprises

AO Learned Assessing Officer

AY Assessment Year

Customs Act Customs Act, 1962

CBDT Central Board of Direct Taxes

CBEC Central Board of Excise and Customs

CCR CENVAT Credit Rules, 2004

CEA Central Excise Act, 1944

CENVAT Central Value Added Tax

CESTAT Hon’ble Customs, Excise and Service Tax Appellate Tribunal

CETA Central Excise Tariff Act, 1985

CGST Central Goods and Service Tax

CGST Act Central Goods and Service Tax Act, 2017

CIT Learned Commissioner of Income Tax

CIT(A) Learned Commissioner of Income Tax (Appeal)

CONSTITUTION The Constitution of India, 1950

CRISIL Credit Rating Information Services of India Limited

CST Central Sales Tax

CST Act Central Sales Tax Act, 1956

CTA Custom Tariff Act, 1975

DCIT Learned Deputy Commissioner of Income Tax

DRP Dispute Resolution Panel

DTAA Double Taxation Avoidance Agreement

FA The Finance Act, 1994

FPI Foreign Portfolio Investor

FTS Fees for Technical Services

FY Financial Year

GST Goods and Service Tax

GST Compensation Act Goods and Services Tax (Compensation to States) Act, 2017

HC Hon’ble High Court

IGST Integrated Goods and Services Tax

IGST Act Integrated Goods and Services Tax Act, 2017

INR Indian Rupees



ABBREVIATION MEANING

IRA Indian Revenue Authorities

IT Act Income Tax Act, 1961

ITAT Hon’ble Income Tax Appellate ITAT

IT Rules Income Tax Rules, 1962

LIBOR London Interbank Offered Rate

Ltd. Limited

MAT Minimum Alternate Tax

OECD Organization for Economic Co-operation and Development

PE Permanent Establishment

Pvt. Private

R&D Research and Development

SC Hon’ble Supreme Court

SGST State Goods and Services Tax

SGST Act State Goods and Services Tax Act, 2017

ST Rules Service Tax Rules, 1994

TDS Tax Deducted at Source

TPO Transfer Pricing Officer

UK United Kingdom

USA United States of America

UTGST Union Territory Goods and Services Tax

UTGST Act Union Territory Goods and Services Tax Act, 2017

VAT Value Added Tax

VAT Tribunal Hon’ble VAT Tribunal



ACKNOWLEDGMENTS

We acknowledge the contributions received from S. R. Patnaik, Mekhla Anand, Kalpesh Unadkat, Shruti KP, Thangadurai V.P., Kiran Jain, Abhilasha Singh, Rupa Roy, Shiladitya Dash, Darshana Jain, Bipluv Jhingan, Gurkaran Arora and Mehreen Zafar under the overall guidance of Mrs. Vandana Shroff.

We also acknowledge the efforts put in by Madhumita Paul and Avishkar Malekar to bring this publication to its current shape and form.

DISCLAIMER

This Newsletter has been sent to you for informational purposes only and is intended merely to highlight issues. The information and/or observations contained in this Newsletter do not constitute legal advice and should not be acted upon in any specific situation without appropriate legal advice.

The views expressed in this Newsletter do not necessarily constitute the final opinion of Cyril Amarchand Mangaldas on the issues reported herein and should you have any queries in relation to any of the issues reported herein or on other areas of law, please feel free to contact us at the following co-ordinates:

Cyril Shroff Managing Partner Email: [email protected]

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Documents

Tax Scout Apr-Jun, 2017 1 - Cyril Amarchand Mangaldas · Ÿ Draft rules for valuation of “unquoted shares ... 'tryst with destiny' for India, as the government likes to call it,