Cutting Edge

April 2012, Issue 13

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Editorial

Editorial

Dear Readers,

Greetings for the new financial year! I would like to take this opportunity to thank you for your continued trust in PwC‟s A&D practice. Providing you with quality service is my commitment to you. I am pleased to present the thirteenth edition of PwC India‟s Aerospace & Defence (A&D) quarterly newsletter, the key differentiator of deals, news items and regulatory updates during the quarter. Quarterly developments Asia's largest military expo Def Expo India-2012, the 7th Land, Naval and Internal Security Systems Exhibition was held in New Delhi between the 29th of March and 1st of April 2012, displaying its prowess as a weapons manufacturer and also emergence as a lucrative investment destination in the sector. This year, the Expo has witnessed unprecedented growth, both in regard to the company participation and official delegations. More than 567 global defence companies from 32 countries displayed their land and naval warfare systems at the event with 58 official delegations consisting of 18 ministerial delegations attending Def Expo India-2012.

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Defence budget 2012-13 The Union Budget presented in March, increased the allocation for defence by 17.63% in nominal terms and 11.3% in real terms , to $38.68 billion for 2012-13, with capital expenditure pegged at close to $16 billion, increasing from $15 billion during 2011-12. Even though the increase in rupee terms has been higher, the higher value of the dollar in comparison to the rupee has lead to only marginal increase in the defence budget in dollar terms. The budget was followed up with the commitment of the Finance Minister to provide additional funds to the Armed Forces if and when needed. However the Defence Ministry was asked to surrender close to $600 million in un-spent amount to the Ministry of Finance in March 2012 because of the high fiscal deficit. Among the many changes in the tax framework (discussed in detail in the newsletter), one that is likely to affect many A&D companies is the reporting requirement to the Income Tax department by all Liaison offices. JV guidelines In a key policy initiative, the Department of Defence Production of the Ministry of Defence has articulated a set of guidelines for establishing joint venture companies by the Defence Public Sector Undertakings (DPSUs) with companies in India and abroad. The policy effective from 17th February 2012, is in line with the Government's stated aim at encouraging and enhancing self-reliance. I sincerely hope that these JV guidelines act as a catalyst in bringing about the much needed synergy to public private partnerships in the Defence sector in India. The new DPP 2012 has been approved by the Defence Acquisition Council (DAC) and is likely to be introduced soon, with amendments to build in further transparency in procurement and introduction of multipliers and transfer of technology in defence offsets In the MMRCA competition, France‟s Dassault Aviation has been selected as the lowest bidder with the commercial negotiations expected to commence shortly. The Defence Minister has also fast tracked procurements for the Indian Army that were of critical importance. These new initiatives will make this a busy year for the MoD.

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Some good news for the MRO companies and the Aviation sector as import of spares for repair and overhauling of aircraft by MROs has been exempted from custom duty. The DIPP issued a circular on the consolidated policy on FDI. It has no changes affecting the A&D sector With this, I invite you to review our thirteenth quarterly newsletter dedicated to A&D. Your feedback is important and we look forward to it. Sincerely,

Dhiraj Mathur

Executive Director & Head Aerospace & Defence Practice

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In this Issue Glossary 6

Recent Deals 8

Select News Items 9

Regulatory 11

Direct Taxes 14

Personal Tax 21

Indirect Tax 24

Upcoming A&D events 27

Contact Us 28

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Glossary

A&D Aerospace & Defence

AAR Authority for Advance Rulings

BSF Border Security Force

CBDT Central Board of Direct Taxes

CBEC Central Board of Excise and Customs

CENVAT Central Value Added Tax

CISF Central Industrial Security Forces

CRPF Central Reserve Police Force

DPP Defence Procurement Procedure

DRP or the Panel Dispute Resolution Panel

DTC Direct Taxes Code

ECB External Commercial Borrowings

FAQ. Frequently Asked Questions

FBT Fringe Benefit Tax

FDI Foreign Direct Investment

FIPB Foreign Investment Promotion Board

FTP Foreign Trade Policy

GST Goods and Services Tax

HC High Court

IPO Initial Public Offer

JV Joint Ventures

MAT Minimum Alternative Tax

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MHA Ministry of Home Affairs

MTA Multirole Transport Aircraft

NBFC Non Banking Financial Company

NFE Net Foreign Exchange Earnings

NSG National Security Guard

OEM Original Equipment Manufacturer

RBI Reserve Bank of India

RFI Request for Information

RFP Request for Proposal

RIC Resident Indian Citizen

Rules Income Tax Rules, 1962

SEZ Special Economic Zone

SQR Services Qualitative Requirement

the Act The Income-tax Act, 1961

the Tribunal Income Tax Appellate Tribunal

TO Tax Officer

ToT Transfer of Technology

TV Transaction Value

ULFA United Liberation Front of Assam

VAT Value Added Tax

Glossary

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Recent Deal

Mahindra & Mahindra and Telephonics, form a Joint Venture (JV)

India‟s Mahindra & Mahindra (M&M)and Telephonics, a unit of U.S. based Griffon Corp will be forming a Joint Venture (JV) to provide surveillance and communication devices to the Indian defence sector. The venture intends to provide radar and surveillance systems, identification devices and communication systems to India's defence and civil sectors. The two firms have sought India's Foreign Investment Promotion Board (FIPB)'s approval for the planned foreign direct investments (FDI) in the JV.

Mahindra & Mahindra forms a JV with Rafael Advanced Defense Systems

M&M ahas also signed up with Israel's Rafael Advanced Defense Systems to develop and manufacture naval systems for the Indian Navy. The new company will focus on the development and manufacturing of products such as Torpedo Defence Systems, Electronic Warfare Systems, Advanced Armour Solutions and Remotely Operated Weapon Stations for Futuristic Infantry Combat Vehicles (FICV).

Larsen & Toubro & Samsung Techwin form a JV to develop artillery gun systems

India‟s Larsen & Toubro Limited (L&T) and South Korea‟s Samsung Techwin Co. Ltd (STW) have tied up to develop Tracked Self Propelled Artillery systems for the Indian Army (IA).The project involves developing the 155mm/52 calibre tracked, self propelled artillery.

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Select News Items ASSOCHAM estimates India‟s A&D exports to hit $2billion According to Industry association ASSOCHAM, India‟s Aerospace and defence exports are expected to reach $2 billion dollars in the current fiscal. A&D exports witnessed 18% growth during the first three quarters of 2011-12. Export of aircraft parts and components parts stood at about $1.31 billion against $1.11 billion having contributed an overwhelming 96% of the total aerospace exports.

Selex Sistemi to supply naval radars to Cochin Shipyard Italian company Selex Sistemi Integrati, part of the Finmeccanica group- has signed a contract with Cochin Shipyard Limited for the delivery of naval radars for India‟s indigenous aircraft carrier. As per the contract, Selex will deliver the air surveillance naval radar RAN 40L and IFF radar for the 40,0000 tonne warship INS Vikrant. CCS clears the$1.3 billion acquisition of missiles from France for for the Mirage -2000 upgrade The Cabinet Committee on Security (CCS) has cleared the $1.3 billion acquisition of 490 French advanced missile systems to arm the Mirage-2000 fighter jets, which are being upgraded under a separate $2.18 billion programme finalized in July, 2010.The contract for the fire-and-forget MICA (interception and aerial combat missiles) was signed with French armament major MBDA. Interceptor missile successfully test fired On 9th of February 2012, DRDO successfully test fired the indigenously developed interceptor Advanced Air Defence (AAD) missile at wheeler island in the state of Orissa. The missile is capable of destroying any incoming hostile ballistic missile. France‟s Dassault has been declared the lowest bidder in the MMRCA competiion The French firm Dassault Rafale has emerged as the L1 (lowest bidder) for the bid issued in 2007 for supplying 126 Medium Multi Role Combat Aircraft (MMRCA) to the Indian Air Force (IAF). The first 18 aircraft will be bought off the shelf to be supplied within 36 months. Of the contract being signed. The rest 108 will be built by state-owned Hindustan Aeronautics Ltd. (HAL) through technology transfers. Dassault aviation and Reliance Industries Limited sign an MoU in the defence sector According to media reports, Dassault Aviation of France has entered into a Memorandum of Understanding (MoU) with India‟s Reliance Industries Limited (RIL). The MoU is for the strategic opportunities of collaboration in the area of complex manufacturing and support in Indian defence and homeland security sector Bharat Forge to develop indigenous artillery systems of the Indian Army Bharat Forge, part of the Kalyani Group intends to start developing artillery gun systems for the Indian Army. The company has started working on a fully developed artillery gun system integrating all the command and control systems.

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Select News Items CCS approves the acquisition of 6 OPVs for the Indian Coast Guard The Cabinet Committee on Security (CCS) has cleared the acquisition of six Offshore Patrol Vessels (OPVs) for the Indian Coast Guard at an estimated cost of $400 million. The OPVs will be constructed by the Goa Shipyard Limited (GSL). The CCS clears the acquisition of 500 PGMs from Rafael The CCS has also cleared the proposal for acquiring 500 Precision Guided Munitions (PGMs) for the fighter aircraft fleet of the IAF at an estimated cost of $111.11 million from Rafael Advanced Systems of Israel.

TATA and Sikorsky‟s JV applies for a defence license from the MoD The US based company Sikorsky Aircraft Corporation and India‟s Tata Advanced Systems Limited (TASL) have applied for a defence licence to manufacture components and assemble helicopters for use by the Indian Navy. MoD sanctions $84 million to OFB for the manufacture of Bofors The MoD has sanctioned capital expenditure of $ 83.68 million to Ordnance Factory Board (OFB) for the manufacturing of Large Calibre Bofors guns. India had secured the Transfer of Technology (ToT) right from M/s AB Bofors during the purchase of Bofors guns. Though all the technological documents as per the (ToT) contract were received by OFB from M/s AB Bofors, the Transfer of Technology was not carried forward as the dealings with the technology provider (M/s AB Bofors) were suspended L&T aquires UK‟s Thalest Limited Larsen & Toubro‟s Electrical & Automation division has completed all the formalities to acquire Thalest Limited, a UK-based holding company of Servowatch Systems Limited. Thalest is engaged in offering Integrated Platform Management System (IPMS) and Integrated Bridge System (IBS) solutions for naval warships and mercantile marine ships, vessels and floating systems. K-152 Nerpa Nuclear submarine commissioned in the Indian Navy Russia has handed over the K-152 Nerpa nuclear-powered attack submarine to the Indian Navy at a ceremony in Russia on January 23, 2012. The submarine will be on a 10-year lease with Indian Navy till 2022 under a contract that was signed between the two countries worth over $900 million.

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Budget highlights

The Union Budget 2012-13 has raised the defence outlay to Rs. 1,93,407 Crore. This represents growth rate of 17.63% in nominal terms over the previous year‟s allocation of Rs. 1,64,415 Crore. Key Statistics of Defence Budgets, 2011-12 and 2012-13

Civil Aviation

• Direct import of Aviation Turbine Fuel permitted for Indian Carriers as actual users. • ECB to be permitted for working capital requirement of airline industry for a period of one

year, subject to a total ceiling of US $ 1 billion. • Proposal to allow foreign airlines to participate up to 49 per cent in the equity of an air

transport undertaking under active consideration of the government. • Tax concessions proposed for parts of aircraft and testing equipment for third party

maintenance, repair and overhaul of civilian aircraft. Direct Tax Proposals

• Tax rate on interest payments made by Indian company engaged in the business of operation of aircraft for foreign currency loans borrowed between July 1, 2012 and July 1, 2015 reduced from 20% to 5%

• General Anti Avoidance Rule introduced to counter aggressive tax avoidance scheme

2011-12 2012-13

Defence Budget (Rs. in Crore) 1,64,415 1,93,407

Growth of Defence Budget (%) 11.58 17.63

Revenue Expenditure (Rs in Crore) 95,216 1,13,828

Growth of Revenue Expenditure (%) 8.9 19.55

Share of Revenue Expenditure in Defence

Budget (%)

57.91 58.85

Capital Expenditure (Rs. in Crore) 69,199 79,579

Growth of Capital Expenditure (%) 15.33 15

Share of Capital Expenditure in Defence

Budget (%)

42.08 41.14

Share of Defence Budget in GDP (%) 1.96 2.14

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Budget highlights

• Retrospective amendments introduced to tax transactions similar to Vodafone and supply of software

• Weighted deduction for inhouse research and development extended till 31 March 2017. • Tax Residency Certificate to be submitted for claiming Treaty benefits. • Date of furnishing of tax audit report aligned to the date of filing the tax return in case of tax

payers having international transactions. • Definition of international transactions broadened to specifically include business

restructuring, intra-group financing arrangements, etc. • Transfer pricing provisions (reporting/ documentation/penalty) to apply to specified

domestic transactions • Provisions for advance pricing agreements introduced with effect from 1 July 2012. • Arm's length range restricted to upper limit of 3% with effect from 1 April 2013.

Indirect Tax Proposals

• Customs duty exemption for i. Parts and testing equipment for maintenance, repair and overhauling of aircraft

imported by MRO units, ii. New and retreaded aircraft tyres

• Increase in excise duty and service tax rate from 10.3% to 12.36%. Enhanced excise duty rates

to be effective from 17 March 2012, whereas revised service tax rate will be applicable from 1 April 2012.

• Introduction of Negative List under service tax i.e. service tax to be levied on all services except some specified services, to be made effective from a date to be notified.

• Draft Place of Provision of Service Rules, 2012, proposed in lieu of existing Import of Services Rules and Export of Services Rules. In terms of these rules, services shall be taxed in the jurisdiction of its consumption.

• Proposal to introduce both Negative List and Place of Provision of Service Rules together after public debate.

• Liability to pay service tax in some of the specified categories of services shifted both on service providers as well as on service recipients.

• Process for claiming refund of service tax for export of services simplified. • New classification rules have been introduced for determination of service category in case of

bundled services wherein an element of one service is combined with one or more elements of another service.

• Provisions relating to special audit under service tax introduced. • The one year time limit for issuance of Show Cause Notice increased to 18 months. • Rule relating to refund of inputs services used in export services has been amended to provide

specific formula for computation of eligible credit attributable to export services. • GST Network, the IT infrastructure, to be set up as National Information Utility and to be

operationalized by August 2012.

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Regulatory Release of guidelines for establishing joint venture companies by Defence public sector undertakings The Ministry of Defence on 17th February 2012 released the guidelines for establishing Joint Venture (JV) Companies by Defence Public Sector Undertakings (DPSUs).

The salient features of the guidelines are:

• The proposed partnerships could be of various kinds, such as outsourcing, subcontracting, formation of consortia, project – specific special purpose vehicles (SPVs), formation of JVs, etc.

• DPSUs may enter into JVs only in cases where the complimentary capacities, infrastructure, technology or capability available with the partners requires engagement for a longer term and results in achieving either lower costs or better risk management or greater efficiency or shorter timeframes for delivery.

• JV Company should be restricted to specific product(s) or service(s) that are required to achieve the objectives of the JV Company.

• The DPSU should retain the right of prior approval of the key decisions of the JV Company and should clearly be mentioned in the Share Holders‟ Agreement (SHA) of the JV Company.

• The procedure for the formation of a JV company by a DPSU and the exit provisions have been listed in the guidelines.

• The guidelines come into force with immediate effect.

Companies in the Aviation Sector Allowed to Avail of ECBs for Working Capital Requirements

The rapid growth of the Aviation sector in India has generated demand for additional finance for working capital and capacity expansion. High operating costs, particularly on account of high fuel costs, have put additional stress on the Airline Industry.

In order to alleviate the immediate financing concerns of the Civil Aviation sector, Union Finance Minister in his Budget Speech 2012-13, had announced that companies in the aviation sector would be allowed to avail of ECBs for a period of one year for working capital/refinancing of outstanding working capital rupee loan(s).

The ECB made under this provision would have a maximum ceiling of USD 1 billion for the entire Civil Aviation sector. The limit for individual airline companies would be US$ 300 million. This limit can be availed either in a lump sum or in tranches depending upon the utilization of the limit during the 1 year when the facility is available.

Proposals of individual companies would be considered by RBI under the approval route based on the parameters such as cash flows and the capacity of individual companies to repay these loans from their foreign exchange earnings. In order to increase access to ECBs, RBI would consider relaxation in the average maturity period for ECBs above USD 20 million from five to three years.

This policy decision will provide an additional source of capital low cost to the Airline Industry and help them tide over their present financial crunch. RBI is expected to issue relevant circular/notification giving effect to the aforesaid Budget announcement within 7 days.

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Direct Taxes Furnishing of annual statement to tax department in relation to liaison offices of non-residents

The Central Board of Direct Taxes prescribed Form 49C (vide Notification No. 5/2012 dated February 6, 2012) to be submitted by a non-resident having a liaison office (“LO”) in India, as required under section 285 of the Income tax Act, 1961 (“Act”). The annual statement in Form 49C is to be submitted in electronic form within 60 days from the end of financial year, duly verified and digitally signed by a chartered accountant or a person authorized by the non-resident.

The annual statement seeks to collect extensive details about activities of the non-resident from India or their operation in India. The key information required to be supplied in the annual statement have been outlined as under:

• Details of the LO – date of setup, nature of activities undertaken, date of approval with the Reserve Bank of India (“RBI”), etc.

• Date of submitting the annual activity certificate (“AAC”) of the LO to the RBI (along with details of the chartered accountant signing the AAC).

• India specific financial details i.e. receipts, income and expenses for the financial year of the non-resident person (not only of the LO) from, or in, India.

• Details of all purchases, sales and services from, or to, Indian parties during the year by the non- resident person (not limited to transactions made by the LO).

• Details of any salary or compensation of any sort payable outside India to any employee working in India or for services rendered in India.

• The total number of employees working in the LO during the year and particulars of employees drawing salary of INR 50,000 or above per month specifying their name, designation and sitting location.

• Details (with complete addresses including the permanent account number (“PAN”)) of agents/ representatives/ distributors of the non-resident person in India.

• Names and addresses of the top five parties in India with whom the LO has been doing the liaisoning.

• Details of products or services for which liaisoning activity is done by the LO.

• Details of any other entity (including PAN) for which liaisoning activity is done by the LO.

• Details (with addresses and PAN) of group entities present in India as branches or incorporated entities and their business activities.

• Details (with addresses and PAN) of other LO(s) of the group entities.

• Other group entities operating from the same premises as the office of the LO.

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Direct Taxes Royalty

Consideration received for sale of software not royalty The assessee-company, a tax resident of the US, was a leading provider of information solutions. It received consideration from its joint venture (JV) partner, Onward Novell Software (India) Pvt Ltd (NIPL), for the sale of computer software. The software transferred was resold by NIPL to its end customers. In the absence of an Indian permanent establishment (PE), the assessee treated the sale proceeds as business income not chargeable to tax in the country under the terms of Article 5 of the Double Taxation Avoidance Agreement (tax treaty) between India and USA. The tax officer (TO) held that the consideration received by the assessee for the resale was taxable as royalty under Article 12(3) of the India-USA tax treaty as it was payment for the transfer of copyright in the computer programme. The Commissioner of Income-tax (Appeals) (CIT(A)) upheld the TO‟s order. The Income-tax Appellate Tribunal (Tribunal) held that according to section 14 of the Copyright Act, 1957, the copyright of a computer programme means the exclusive right to reproduce it in any material form or copy it. Royalty, according to section 14 of the Copyright Act, 1957, read with section 9(1)(vi) of the Income-tax Act, 1961 (the Act), would mean consideration for the granting the exclusive right to reproduce a work in any material form. The Tribunal observed that where the creator of an intellectual property allows another to exploit it commercially by making copies and selling it, but retains control over the property constitutes a transfer of copyright. However, if the creator exploits the work by converting it into an end product ready for use and transfers the right to use to another (without any further right to copy the product), it will be a transfer case of a copyrighted product. In the former, the consideration would be considered as royalty, but in the latter case it would be considered as a business profit. The Tribunal also observed that neither NIPL nor its end-users were permitted to copy or exploit the assessee‟s products for commercial purposes. The assessee transferred its computer software products to NIPL, for a consideration, to resale without giving any right to duplicate the software in any manner. The Tribunal held that Article 12(3)(a) of the India-USA tax treaty mentions the use of „copyright‟ of a work and not the use of a product derived from that copyright. As Article 12(3)(a) requires the payment for „use of‟ the „right to copy‟ the „work‟ a pre-condition for its being regarded as „royalty‟, it is difficult to hold the payment for the „use of‟ a copyrighted article finally drawn from the work does not qualify for royalty. The Tribunal also observed that there was no disallowance under section 40(a)(i) of the Act in NIPL‟s assessment. It indicates the TO‟s acceptance that the payment by NIPL was a purchase transaction and not a royalty payment. The Tribunal held that once a particular stand has been taken by the Revenue (in one transaction in the hands of the payer), it is not permitted to take a directly contrary stand on the same transaction (in the hands of the payee). It was held that the consideration was for the transfer of copyrighted products and not for the transfer of copyright in the computer software programme. Therefore, the consideration was to be treated as a business income and not as royalty. In the absence of any PE in India, the assessee‟s business income will not be taxable in the country. Novel Inc v. DDIT [TS-719-ITAT-2011 (Mum)]

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Direct Taxes Withholding tax

Commission paid to overseas agents without deduction of tax not allowed as expenditure The assessee paid commission to 29 non-resident agents for services rendered outside India. The payments were remitted through banking channels as per the regulations of the Reserve Bank of India (RBI). The assessee had not deducted tax at source on these payments on the grounds that overseas agents operated in their own country and no part of their income had arisen in India. The commission was also usually remitted directly to the agent by posting cheques or demand drafts in the country. The payments were not received by or on his/her behalf in India. According to the assessee, an overseas agent was not liable to income-tax in India. When the assessment under section 143(3) of the Act was complete the TO added to the total income on disallowance of the commission payment under section 40(a)(ia) of the Act. It also calculated deduction under section 80HHC of the Act. On appeal, the CIT(A) allowed the assessee certain items of relief. Further, the Tribunal set aside the issue for re-examination after considering an agreement (if any) reached between the parties, and after finding out whether there was any intention to make the payment by cheque or draft. Tribunal ruling The overseas agent of the Indian exporter operates in his/her own country and no part of income arises in India. The commission is usually directly remitted by cheque or demand draft in the country. Therefore, the commission is not received by or on his/her behalf in India. The overseas agent is not liable to pay income-tax in the country on the paid commission. It is pertinent to note that section 195 of the Act has to be read along with charging sections of 4, 5 and 9 of the Act. One should not read section 195 of the Act to mean that the obligation to deduct tax at source automatically arises the moment there is a remittance. It is a principle of law that the provisions of the tax treaty will prevail over the provisions of the Act. This principle was not followed by the Karnataka HC while rendering the judgment in the case of Samsung Electronics. The Tribunal opined that the law related to deduction of tax at source under section 195 of the Act has not been changed. Therefore, the provisions of section 40(a)(ia) of the Act for disallowance of expenditure are not applied on payments made to overseas agents by the assessee without deduction of tax at source. DCIT v. Divi Laboratories Ltd. [2011-TII-182-ITAT-HYD-INTL] No TDS on interest paid to a French entity for loan extended on the most favored nation clause The applicant, an Indian company, entered into an agreement for the purchase of an aircraft from a French company. The latter provided an export credit facility to the purchaser. This facility was insured by the Compagnie d‟Assurance pour le Commerce Exterieur (COFACE), a French export credit agency. The applicant executed promissory notes in favour of the seller, later assigned irrevocably and unconditionally (by the seller) to another French entity (BNP Paribas). Consequently, the applicant was required to deposit instalments to the BNP Paribas branch in New York. The Indian company filed an application before the Authority for Advance Rulings (AAR) on whether any tax should be withheld on the interest payment.

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Direct Taxes On whether the India-US tax treaty should be applied since the payments were made in New York, the AAR held that since there was no material proof on the transfer of beneficial ownership from BNP Paribas, France to its USA branch, the tax treaty between India and France would apply. Besides, the AAR was of the opinion that COFACE merely provided insurance cover to the seller and is obliged to pay in the event of certain contingencies. Therefore, the AAR held that this does not fall under the expression „extension or endorsement of a loan‟ and is not exempt under Article 12(3)(b) of the India-France tax treaty. However, in a further submission by the applicant, it contended that it was entitled to the benefit of the most favored nation (MFN) clause under clause 7 of India-France tax treaty. This clause states, „where India enters into a tax treaty with any other member of the OECD and that treaty provides for a lower rate or a more restricted scope, then the same rate or scope would apply to the India-France tax treaty.‟ The applicant also referred to the provisions of India‟s tax treaties with Canada, Hungary and Ireland, which extend the exemption to interest paid on loans insured by their export credit agencies. Since this scope can be applied to Article 12(3)(b) of India-France tax treaty because of clause 7 of the Protocol, the AAR held that the interest payable by the applicant was not taxable in India and would not be subject to tax withholding. Poonawalla Aviation Pvt Ltd, In re [TS-717-AAR2011]

Permanent Establishment

No dependent agent permanent establishment under India-France tax treaty where the transactions are at arm’s length The assessee, a company incorporated in France, was engaged in the business of operation of ships in international traffic. It claimed exemption of its business profits from activities in India under Article 7 of the Double Taxation Avoidance Agreement (tax treaty) between India and France since it did not have a permanent establishment (PE) in India. The tax officer (TO) rejected the claim of exemption on the ground that the assessee was carrying on the business in India from a fixed place through an agent. The TO computed income of the assessee at 10% of the gross receipts in absence of details of profits attributable to the PE. The Dispute Resolution Panel (DRP) upheld the order of the TO. The Income-tax Appellate Tribunal (Tribunal) observed that in terms of Article 5(6) of the India-France tax treaty, where the activities of an agent are wholly, or almost wholly, devoted on behalf of the foreign enterprise, it would be regarded as an agent of independent status if the transactions were at arm‟s length. The Tribunal considered the decision in the case of Set Satellite (Singapore) Pte. Ltd. v. DDIT [2008] 307 ITR 205 (Bom) where it was held that once an agent is paid arm‟s length remuneration for services rendered, no further profits can be attributed to the PE. Furthermore, the onus to prove the existence of a PE was on the Revenue and in this case at none of the stage of the proceedings was the onus discharged by the Revenue. It was observed that none of the lower authorities recorded any findings that the transactions between the assessee and its agent were not at arm‟s length. Therefore, it was held that, the assessee did not have a dependent agent PE in India. Delmas, France v. ADIT [TS-7-ITAT-2012(Mum)]

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Direct Taxes Royalty

Payment to a foreign company to access an online database taxable as royalty The Indian assessee company made a payment to Gartner, a US company, for subscription to a journal or magazine from a foreign publisher which contained commercial, industrial and technical knowledge. It remitted the subscription amount to the foreign company without withholding tax under section 195 of the Income-tax Act, 1961 (the Act) on the grounds that the payment was neither taxable under the Act, nor under the India-US tax treaty. The TO held that the payment was taxable as royalty under Explanation 2 to section 9(1) (vi) of the Act, or as fees for technical services (FTS) according to section 9(1)(vii) of the Act. The payment was also covered by Article 12 of the India-US tax treaty. Hence, tax was required to be withheld under section 195 of the Act. Consequently, the assessee was treated as an assessee-in default. On appeal, the Commissioner of Income-tax (Appeals) (CIT(A)) upheld the order of the TO. However, the Tribunal accepted the appeal of the assessee by holding that the payment made to Gartner did not constitute royalty since it was in the nature of a subscription to a journal or magazine. Also, no part of the copyright was transferred. Hence, the income was not subject to tax in India and not liable for withholding tax under section 195(1) of the Act. The High Court (HC) however held that the right to access a database amounts to a transfer of rights to use the copyright and, as such, it should be treated as royalty. The decision in the case of Samsung Electronics Co Ltd [TS-696-HC-2011 (Kar)], where it was held that the payment made was in the nature of royalty, was identified as a precedent. Hence, the assessee was liable to withhold tax under section 195 of the Act, failing which, the assessee was liable to pay tax and interest under sections 201(1) and 201(1A) of the Act. CIT v. Wipro Ltd [2011-TII-45-HC-KAR-INTL]

Fees for technical services

Payment for operational and support services taxable as fees for technical services The applicant company, a tax resident of the Netherlands, was engaged in the manufacture and sale of sugar confectionery and gum. It had entered into a service agreement (SA) with its Indian group company, Perfetti Van Melle India Pvt Ltd (Perfetti India), to provide various operational and support services without charging any mark-up. The applicant contended that the services provided to Perfetti India were neither technical nor consultative in nature, but rather managerial. Furthermore, the term „make available‟ has not been defined in the India-Netherlands tax treaty. Therefore, an inference may be drawn from the memorandum of understanding (MoU) of the India-US tax treaty. The treaty provides that in order to qualify as “making available”, technical knowledge, skill, etc. the entity acquiring the services should be enabled to independently apply the transferred technology. Since Perfetti India would not be able to apply the knowledge or expertise provided without the applicant, the service will not be taxable as fees for technical services (FTS) under Article 12(5)(b) of the India-Netherlands tax treaty. The Authority for Advance Rulings (AAR) observed that the applicant failed to mention that it had entered into a Trademarks Technology License Agreement (TTLA) with Perfetti India for bestowing the right to use the copyright of artistic work, trademarks, secret formulas or processes, etc. for which it received royalty. The purpose of the SA in providing support services included improving Perfetti India‟s profitability and efficiency by enabling it to give maximum royalty amounts based on the sales turnover. Hence, the two agreements, TTLA and SA, were inextricably linked and complementary to one another.

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Direct Taxes Accordingly, the services provided under the SA must be considered as services „ancillary and subsidiary to the application or enjoyment of the right, property or information‟, under Article 12(5)(b) of the India-Netherlands tax treaty, for which the applicant received the royalty amount. The AAR observed that in cases where expertise in running the industry is provided by group entities to the Indian entity, once the SA comes to an end, the employees of the Indian entity are equipped to carry on that business or service model on their own without referring to the service provider. Therefore, it is not necessary for the recipient to be specifically given the right to continue using the expertise on expiry of the SA.

On application of the MoU to the India-US tax treaty, the AAR observed that no inference or conclusion in relation to the meaning of „make available‟ can be drawn from it. Since a tax treaty is a contract between two sovereign countries, it cannot be used to interpret a separate independent contract with another country.Accordingly, the AAR held that the payment made by Perfetti India towards services rendered under the SA would be taxable as FTS under both Articles 12(5)(a) and 12(5)(b) of the India-Netherland tax treaty. Consequently, the applicant would be liable for withholding tax on payments received from Perfetti India under section 195 of the Act. Perfetti Van Melle Holding B v. In re, [TS-723-AAR-2011] Business expenditure

Withholding tax borne by remitter allowable as business expenditure

The assessee, a Bangkok-based company, was carrying out a hydroelectric power project in India. It paid upfront fees for documentation to Standard Chartered Bank (SCB), Thailand for a loan from SCB, India. The assessee grossed up the payment for tax to be withheld under the direction of the TO. It also paid bank charges for remitting upfront fees.The assessee claimed a deduction for the payment of upfront fees, tax paid on these fees and the amount paid towards bank charges. The TO allowed the deduction of upfront fees but disallowed the tax paid on it as well as bank charges.

The CIT(A) upheld the order of the TO and held that under section 40(a)(ii) of the Act, payment of income tax is not deductible and there is no distinction between the income tax paid by the assessee on its own income or on the income of the payee.The Tribunal held that the assessee was required to pay upfront fees net of tax. The payment of taxes was in pursuance of the order passed by the TO under section 195 of the Act and was an integral part of the consideration paid by the assessee towards upfront fees.

The Tribunal relied on the decision of the Madras HC in the case of CIT v. Standard Polygraph Machines Pvt Ltd [2003-TII-223-HC-MAD-INTL], where it was held that the amount paid as tax by the company was only in discharge of a liability. It had undertaken this under the terms of the agreement entered into between itself and the collaborator. Therefore, it formed a part of the consideration for the agreement relating to know-how. The Tribunal held that the amount withheld towards tax and paid to the government for and on behalf of SCB, Thailand was to be treated as part of the upfront fees for coordinating all relevant documentation for a loan facility from the bank in India. Since the payment of an upfront fee, net of taxes, by the assessee was allowed as a deduction by the TO, the payment of withholding tax, being part of the same consideration, would also be eligible for a deduction.

The Tribunal also held that the payment of bank charges was also allowable as revenue expense.Italian Thai Development Public Company Ltd v. ADIT [2011-TII-199-ITAT-Delhi-INTL]

PwC

Direct Taxes Withholding tax

No withholding tax on foreign exchange fluctuation loss arising at the time of remittance

The assessee claimed loss on foreign exchange fluctuation on payment of an instalment of research and know-how fees to a foreign collaborator. The assessee withheld and paid tax on the entire amount in accordance with the agreement. The TO disallowed the claim as the amount included the exchange loss not pertaining to the year under consideration. On appeal, the CIT(A) returned the matter to the TO. The TO held that the assessee had not withheld tax on the additional amount due to exchange loss. Hence, it was disallowed under section 40(a)(i) of the Act.

The Tribunal observed that under the provisions of section 195(1) of the Act, tax is to be withheld only once, either at the time of credit or at the time of payment, whichever is earlier. Section 195(1) of the Act does not envisage deduction of tax in both instances. Therefore, the assessee was not under any obligation to withhold tax again at the time of payment. The amount remitted was only a part of the total obligation and not in addition to the aforesaid amount.

Since the transaction with the payee was subject to withholding tax on the earlier occasion i.e. at the time of crediting of such income to the account of the payee, it would not again call for withholding tax under section 195(1) of the Act at the time of payment to the payee.

The Tribunal also considered the alternative argument of the assessee that since tax was withheld on the amount credited, it was merely a case of withholding a short amount and not a failure to withhold tax. The Tribunal relied on the decision in the case of DCIT v. Chandabhoy and Jassobhoy, Mumbai [2012] 17 taxmann.com 158 (Mum) and DCIT v. S K Tekriwal [2011] 48 SOT 515 (Kol). It held that disallowance under section 40(a)(i) of the Act cannot be made in the case of short tax withholding. Thus, foreign exchange loss was allowed as a deduction on both counts i.e. allowed as liable to tax only once, and permitted for short tax withholding.

Sandvik Asia Ltd v. JCIT [TS-712-ITAT-2011(Pun)]

PwC

Personal Tax EPF rate for the Year 2010-2011 notified

A foreign national coming on Employment Visa (EV) to work in one company/organization can change his employment to another company/organization within the visa validity period during his stay in India.

It has been clarified by the Ministry of Home Affairs (MHA), through amendment in the FAQs relating to work related visas, that a foreign national can change his employer during the duration of his current EV with prior permission and satisfaction of MHA, if such change of employment is between a registered holding company and its subsidiary and vice-versa or between subsidiaries of a registered holding company, provided following conditions are satisfied: The change of employment permissible at a senior level e.g. managerial or a senior executive position or at a skilled position. The foreign national to fulfill all other conditions stipulated for grant of EV. A certificate from the holding company, that the company, in which the change of employment has been requested, is its subsidiary and justification warranting the change of employment No objection from the company from where the foreigner is seeking change of employment. Change of employment may be permissible only once during the currency of 5 years of Employment Visa. Change of employment would entitle the foreigner to stay in India for a period of 5 years from the date of issue of original EV. Note: For this purpose, the „holding company‟ and „subsidiary‟ shall have the same meaning as provided in Section 4 of the Companies Act 1956. In all other cases, of change in the employment to another company/organization by a foreign national, he/she will have to leave the country and would need to apply for a fresh EV. While computing the capital gains arising on transfer of a capital asset acquired by the assessee under a gift, whether the indexed cost of acquisition has to be computed with reference to the year in which the previous owner first held the asset or the year in which the assessee became the owner of the asset ?

The assessee filed the tax return for the AY 2004-05 including long term capital gains arising from the sale of a residential flat. The said flat was originally purchased by the daughter of the assessee ('previous owner') on 29 Jan, 1993, under a gift deed dated 1 Feb, 2003; the previous owner gifted the flat to the assessee. On 30 June, 2003, the assessee sold the flat and offered the long term capital gains to tax. The assessee contended that the capital gains were to be computed as long term capital gain, by deducting from the total consideration, the amount of indexed cost of acquisition. Further, the indexed cost of acquisition had to be determined with reference to the cost inflation index for the year in which the cost of acquisition was incurred, that is, by the previous owner. Whereas, the AO held that under Explanation (iii) to Section 48 of the Act, the indexed cost of acquisition had to be determined with reference to the cost inflation index for the first year in which the asset was first held by the assessee.

PwC

Personal Tax On appeal filed by the assessee, the CIT (A) allowed the claim of the assessee, which was further allowed by the ITAT. In the HC, the Ld Counsel for the Revenue contended that the deeming fiction under Explanation 1(i)(b) to Section 2(42A) of the Act to consider the period of holding of asset from the date asset was held by the previous owner is limited for determining whether the asset was a short term or long term capital asset. Further, the said fiction cannot be applied in determining the indexed cost of acquisition in view of the express language used in Explanation (iii) to Section 48 of the Act to consider inflation index for the first year when the asset was held by assessee. It was argued that the expression 'held by the assessee' is not defined under Section 48 of the Act and the purpose of indexation is to offset inflation effect. When cost of acquisition of previous owner has to be considered, the indexation shall be for the year in which acquisition happened, as otherwise, the intention of the computational mechanism provided in the Act shall be defeated. Accordingly, the cost inflation index for 1992-93, when the previous owner acquired the asset would be applicable in determining the indexed cost of acquisition. Accordingly, the appeal was decided in favour of the assessee. Manjula J Shah [TS-694-HC-2011(BOM)] The nature of transaction cannot be changed from investment to business only because shares were purchased from borrowed funds

The assessee, an individual was residing in the US and was carrying on his own business. The assessee purchased some shares in India for investment purposes, which were held less than a year before being sold. The assessee filed his tax return claiming the gains as „short term capital gains‟ and consequently taxable at a concessional rate of tax in terms of section 111A of the Act.

The Assessing Officer (AO), referring to the CBDT circular of 2007, held that purchase and sale of securities being allied to the assessee‟s usual trade or business or incidental to it, was not an occasional activity but constituted business of the assessee. Therefore, taxes should be levied at a higher rate as applicable to business income. Further, the assessee has also shown income from share trading and short term capital gain on sale of shares. It was observed that the frequency of transactions were large while the holding period was small and the investment was made from borrowed funds, therefore, it was held that these gains should be taxed as a business income.

The CIT (A) held that these receipts were short term capital gains observing that in the majority of share transactions, the assessee had incurred loss or earned a nominal profit except in the share transactions related to one company. The net profit position in the share transactions was because of the profit earned in this scrip; otherwise the transactions would have resulted in loss. Also, the assessee, being resident of the USA, could not have day to day trading activity in shares in India. The shares had been transferred into the assessee's account and actual delivery had been taken at the time of sale. The shares were sold during the period when the assessee thought the price had reached the peak. This was also established by the share price figures which had substantially reduced after the sale.

PwC

Personal Tax Relying on the precedents from earlier judgements, the CIT(A) held that unlike traders, the assessee did not have dealings in a large number of scripts or large frequency of transactions. The assessee had never treated these shares as stock in trade in its books of account but shown them as investments and profit there from as capital gains. Though money has been borrowed to invest in shares, neither the interest paid on borrowed money nor security transaction tax have been claimed as expense while computing capital gains. Thus, the CIT(A) held that the perception of the tax department was invalid.

In further appeal, the Tribunal upheld the order of CIT(A). The tribunal also relied on the judgement of Gujarat High Court in the case of Niraj Amidhar Surti wherein it was held that “merely because the shares have been purchased from borrowed funds obtained on high rate of interest would not change the nature of the transaction from investment to one in the nature of adventure in the nature of trade” and commented that the assessee had no intention of trading in shares at the time of purchase of the shares and the same is also fortified by the fact that the assessee enjoyed share dividend income on such investments.

ACIT vs Rajesh Patel { 2012-TII-02-ITAT-Ahm- Intl}

PwC

Indirect Taxes Customs:

Notification/ Circulars

The Central Government has introduced On-Site Post Clearance Audit at the Premises of Importers &

Service Tax

Case Laws

In Vigyan Gurukul Vs. CCE (2011-TIOL-1724-CESTAT-DEL), the Tribunal has held that where advance payment for services is received prior to an enhancement in the service tax rate, the rate as applicable at the time of receipt of consideration and not the enhanced rate, would be applicable. The Tribunal in Brij Mohan Surinder Kumar Vs. CCE (2012 (25) S.T.R. 58) has held that the Commissioner‟s powers in revision cannot go beyond the show cause notice originally adjudicated by the subordinate authority. The Tribunal, in CCE Vs. Reid & Taylor (India) Ltd. (2012 (25) S.T.R. 85), has held that extended period of limitation cannot be invoked where divergent views from different Tribunals are available on the same issue. The Tribunal, in Bank of India Vs. CST (2012-TIOL-40-CESTAT-AHM), has held that extended period of limitation cannot be invoked in cases involving interpretation of law. The Tribunal, in Kinetic Engineering Ltd. Vs. CCE (2012 (25) S.T.R. 26), has held that transfer of technical know how against payment of royalty is not liable to service tax under the category of Consulting Engineer‟s Services. The Tribunal, in Punjab Automobiles Vs. CST (2012-TIOL-57-CESTAT-AHM) has held that penalty is not imposable where tax is paid in full with interest before issue of the show cause notice. VAT

Notifications/ Circulars

Pondicherry

VAT rate has been increased from 4% to 5% and 12.50% to 14.50% w.e.f. January 01, 2012 [Notification No 68/F2/2011 dated December 31, 2011]

Sales Tax

The Delhi High Court, in Giesccke & Debrient I.P. Ltd. Vs. Commissioner of Sales Tax. [(2012) 47 VST 343 (Del.)], has held that in order to claim the benefit of sale in the course of import it is essential that import of goods should have direct nexus with the transaction of sale of goods in India. Import of goods in India under back to back contracts is desirable but not a sufficient condition for a sale to qualify as sale in the course of import, unless the domestic sale is backed by legal or contractual obligation to sell the goods to the buyer for whom the goods are imported into India.

PwC

Indirect Taxes The Allahabad High Court, in ITC Limited Vs. State of UP and others [(2012) NTN (Vol. 48) – 1)], has upheld the constitutional validity of U.P. Tax on Entry of Goods into Local Area Act, 2007. The Court held that there are sufficient guidelines and guarantees under the Act for ensuring that the entire amount of entry tax collected and credited to the U.P. State Development Fund is utilized for facilitating the trade, commerce and industry. Hence, the levy of entry tax does not violate the freedom of trade, commerce and intercourse guaranteed under Article 301 of Constitution of India.

Customs

Valuation

In Keihin Fie Pvt. Ltd. Vs CC (2011 (274) ELT 515), the Tribunal has held that fees paid for technical know-how is not includible in the value of imported goods if the payment is in relation to manufacture of finished goods and not related to the imported goods.

Foreign Trade Policy (FTP)

Notifications/Circulars

The Central Government has stated that export permission is not required for the supply of Special Chemicals, Organisms, Materials, Equipment, and Technologies (SCOMET) items from the Domestic Tariff Area (DTA) to the Special Economic Zone (SEZ). However, export permission will continue to be required for the export of SCOMET items outside India from both the SEZ and the DTA (including Export Oriented Units (EOU)).

(Notification No. 93 (RE-2010)/2009-2014 dated 06/01/2012)

Service Tax

Case Laws

The Gujrat High Court, in CCE Vs. Dynaflex Pvt. Ltd. [2012 (25) S.T.R. 277], has held that reversal of CENVAT Credit wrongly availed prior to its utilization amounts to non availment and no interest is payable on such reversal.

The Punjab & Haryana High Court, in CCE Vs. Nahar Industrial Enterprises Ltd. [2012 (25) S.T.R. 129 (P&H)], held that in view of the legal fiction created by Sec. 68 (2) of the Finance Act, 1994 (Act), service tax on Goods Transport Agency Services is permitted to be discharged by utilization of available CENVAT Credit.

The Tribunal in CCE Vs. Novo Petrochemicals Ltd. [2012-TIOL-116-CESTAT-AHM], has held that a recipient of Goods Transport Agency Services, being a deemed output service provider, is permitted to utilize available CENVAT Credit for payment of service tax on reverse charge basis.

The Tribunal, in CST Vs. Suzuki Motor Corp. [2012 (25) S.T.R 266], has held that transfer of technical know how against payment of royalty is not liable to service tax under the category of Consulting Engineer‟s Services.

PwC

Indirect Taxes Sales Tax

Case Laws

The Supreme Court, in M/s Hotel Ashoka Vs. Assistant Commissioner of Commercial Taxes & ANR [(2012) VIL 03 (SC)], has held that sales by duty free shops situated at international airports both to inbound and outbound passengers were made before/after the goods have crossed the customs frontiers of India. Consequently, such sales are not liable to sales tax as the same qualify as sale in the course of imports/exports covered by section 5 of the CST Act, 1956.

Customs

Notifications/Circulars

The Central Government has instructed Customs Authority to strictly follow the guidelines regarding time-bound clearance of goods from ports/Land Customs Stations and Inland Container Depots (ICD), etc. as directed by the Supreme Court. Further, the Customs Authorities must intimate the importer/exporter to keep the goods in the warehouse, in case clearance is not possible due to any unavoidable reason. (F. No. 450/160/2011-STO dated 13/02/2012)

Sales Tax

Case Laws

The Allahabad High Court, in ITC Limited Vs. State of U.P. & Others [(2012) 48 VST 281 (All)], has upheld the constitutional validity of Uttar Pradesh Tax on Entry of Goods into Local Areas Act, 2000 („Act‟) with effect from the date of original law. The High Court observed that the provisions of the Act have sufficient guidelines and guarantees ensuring that the entire amount of entry tax collected and credited to the U.P. State Development Fund are utilized to facilitate the trade, commerce and industry. Hence, the levy of entry tax is not discriminatory, unreasonable or against public interest.

Customs

Others

The Supreme Court, in Hotel Ashoka Vs ACCT (2012 (276) ELT 433), has held that the goods kept in customs bonded warehouse are deemed to be outside the customs frontier of India.

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The report is based on the information available in the Public domain.

Further, the information based on our interaction with the Government

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taken by Toyota Motor Asia Pacific Pte. Ltd., Singapore only after the

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