Cutting Edge

October 2012, Issue 15

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Editorial

Editorial

Dear readers,

Greetings for the new quarter!

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I am pleased to present the 15th edition of PwC India’s Aerospace and Defence (A&D) quarterly newsletter, the key differentiator of deals, news items and regulatory updates.

The Ministry of Defence on 31 July 2012 released the revised Defence Offset guidelines (Appendix D of the Defence Procurement Procedure). The guidelines aim to bring clarity in the defence offset procedure and will go a long way in easing many of the problems faced by foreign OEMs as well as assist in the absorption of offsets by the Indian industry. This is the most significant and comprehensive overhaul of the offset policy since the first draft was released in 2008. The changes indicate that the government has been listening and has intelligently addressed most of the pain points of OEMs as well as the domestic defence industry. PwC hosted an event with CII on the new guidelines in which Mr. VivekRae, the Director General (Acquisitions) along with his team explained the new provisions as well as their rationale. There is a clear attempt to streamline and make the offset policy more transparent and the MoD must be congratulated for revising the policy to promote the growth of a domestic industrial base in the A&D sector.

The government of India has recently allowed foreign airlines to invest in the capital of Indian companies operating scheduled and non-scheduled air transport services, up to 49% of their paid-up capital, under the government approval route. The 49% limit will subsume FDI and FII investment. This decision is welcome, though much delayed. Moreover, subsuming FII investment into FDI is legally, theoretically and practically not correct.

The armed forces are looking to induct 900 helicopters in the coming decade, including

384 light-utility and observation, 90 naval multi-role, 65 light combat, 22 heavy-duty attack, 139 medium-lift and 15 heavy-lift, among others. The Ministry approved a 12,000-crore INR project to acquire 56 transport aircraft for the Indian Air Force to replace itsageing fleet of Avro planes. What is significant about this decision is the fact that this is the first time the Government has stated that the foreign OEM will have to choose an Indian private sector company as its partner. India’s heavy-lift C-17 militarytransport aircraft has got its shape and is likely to arrive by 2013.

In a major development, Larsen and Toubro and Pipavav Defence signed two separate joint venture agreements with the country's biggest naval shipyard, Mazagaon Dock in order to source equipment for the defence sector. Mazagaon will partner with L&T to manufacture submarines for the Navy while the venture with Pipavav will make frigates, destroyers and aircraft carriers. It may be noted that these are the first JV finalized under the new joint venture policy announced by the Government earlier this year.The Ordnance Factory Board (OFB) signed an MoU for a joint venture with Russian Rosoboronexport and Splav 'Spa' to manufacture five versions of 80 km-range Smerch rockets based

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export and Splav 'Spa' to manufacture five versions of 80 km-range Smerch rockets based on the transfer of technology from Russia.

With this, I invite you to review our 15th quarterly newsletter dedicated to A&D.

Your feedback is important and we look forward to it.

Sincerely,

Dhiraj Mathur

Executive Director and Leader, Aerospace and Defence

In this Issue

Glossary 5

Recent Deals 7

Select News Items 8

Regulatory 10

Direct Taxes 14

Personal Tax 21

Transfer Pricing 26

Indirect Tax 31

Upcoming A&D events 38

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Contact Us 39

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

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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

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

Glossary

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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

Recent Deals

BEL, Thales to form JV for civilian, defence radars

State-run Bharat Electronics Limited (BEL) and French major Thales have agreed to form a joint venture company in India to design, develop, market and supply civilian and defence radars in local and global markets. BEL, a defence PSU, has been making radars for the Indian Armed Forces, including the Indra-II and the Rajendra radars. It also provides support to the armed forces in maintaining their radars procured from foreign sources. Thales has also been a major player in the Indian defence sector and recently won a 2.3 billion USD contract with Dassault Aviation from India for upgrading IAF's Mirage-2000 aircraft fleet.

L&T, Pipavav Defenceform JV with Mazagon

Larsen and Toubro and Pipavav Defence signed two separate deals with the country's biggest naval shipyard, Mazagaon Dock, to produce equipment for the defence sector. According to the new joint venture, Mazagaon will partner with L&T to

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new joint venture, Mazagaon will partner with L&T to manufacture submarines for the navy while the venture with Pipavav will make frigates, destroyers and aircraft carriers.

India, Russia sign agreement for Smerchrockets

The Ordnance Factory Board (OFB) signed an MoU for a joint venture with Russian Rosoboron export and Splav 'Spa' to manufacture five versions of 80 km-range Smerch rockets based on the transfer of technology from Russia.

Select News Items

Defence Ministry clears 12,000 crore INR project to acquire 56 transport aircraft for IAFThe Defence Ministry cleared a 12,000-crore INR project to acquire 56 transport aircraft for the IAF to replace its ageing fleet of Avro planes. Interestingly, the project is likely to see a private sector company, instead of Hindustan Aeronautics Ltd (HAL), tie up with a foreign vendor to supply the aircraft.

India successfully test-fires BrahMos cruise missile with new subsystems The 32nd flight test of the BrahMosmissile, jointly designed and manufactured by India and Russia, was carried out from Integrated Test Range (ITR) at Chandipur off the Odisha coast. The objective of the mission was to evaluate some of the newer subsystems produced by the Indian industry as part of production stabilisation.

India successfully develops submarine-launched ballistic missile for INS ArihantIIndia has successfully developed its first submarine-launched ballistic missile (SLBM) for the indigenous nuclear submarine INS Arihant, joining an elite club of nations possessing such weaponry. The development of the underwater-launched ballistic missile will help India complete its nuclear triad under which it will now have the option to strike from air, land and under the sea.

US-made India's first C-17 aircraft will arrive in 2013The first of India's 10 ordered Boeing heavy-lift military transport aircraft has got its shape at an

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exclusive ’major join’ ceremony attended by top Indian diplomats of the region and IAF officials. The global aerospace giant Boeing integrated the forward, centre and aft (rear) fuselages and the wing assembly of India's first C-17 Globemaster during the airlifter's ceremony.

Navy will buy 56 utility helicopters for 1 billion USDIndia's first home-built nuclear submarine was set for sea trials, as it detailed billion-dollar projects to arm its Navy with warships, aircraft and modern weaponry. The indigenous 6,000-ton INS Arihant (Destroyer of Enemies) was unveiled in 2009 as part of a project to construct five such vessels which would be armed with nuclear-tipped missiles and torpedoes.

India's first nuclear submarine is set for sea trialsIndia has set the ball rolling for another mega defence deal, worth close to 1 billion USD, for the acquisition of 56 naval utility helicopters customised for surveillance, anti-submarine warfare, anti-terror, electronic intelligence gathering and search-and-rescue operations. The new tender for the 56 naval helicopters was issued to all top global aviation majors, ranging from Boeing, Bell and Sikorsky to Kamov, Eurocopter and AgustaWestland.

India test-fires nuclear-capable Prithvi-II missileThe tri-service Strategic Forces Command (SFC) conducted another successful test-firing of the nuclear-capable Prithvi-II ballistic missile, capable of a strike range of 350 km, from the integrated test range at Balasore in Odisha. The Armed Forces have so far inducted the Prithvimissiles as well as the higher range Agni-I (700-km), Agni-II (2,000-km) and Agni-III (3,000-km) missiles.

Select News Items

India and Russia are to sign biggest-ever defence deal worth 35 billion USDIndia's quest for a futuristic stealth fifth-generation fighter, which will see the country spend around 35 billion USD over the next 20 years in its biggest-ever defence project, has zoomed into the decisive phase now. India and Russia are all set to ink the full and final design or the R&D phase contract for the 5th Gen fighter by this year-end or early-2013. India had inked the 295-million USD PDC with Russia in December, 2010. The R&D contract on the anvil is pegged at 11 billion USD, with India and Russia chipping in with 5.5 billion USD each.

India plans to establish two more missile testing rangesIndia is planning to set up two more missile testing ranges with a number of missions coming up in the next few years. Each of the upcoming facilities will be a full-fledged testing range to support both short-range and long-range missions. It will have a launch control centre, a few launch pads, a blockhouse and a state-of-the-art communication network, besides permanent monitoring stations such as telemetry and electro-optical tracking.

India gears up to order 22 Apache helicopters for 1.4 billion USDIndia is getting ready to order 22 heavy-duty Apache helicopters for around 1.4 billion USD. The impending 1.4-billion USD deal for the 22 Apaches will also include the supply of 812 AGM-114 L-3 Hellfire Longbow missiles, 542 AGM-114 R-3 Hellfire-II missiles, 245 Stinger Block I-92 H missiles and 12 AN/APG-78 fire-control radars. Among the other military aviation deals already

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bagged by the US are the 4.1-billion USD contract for 10 C-17 Globemaster-III strategic airlift aircraft, 2.1-billion USD for eight P-8 I maritime patrol aircraft and 962 million USD for six C-130 J 'Super Hercules' planes.

IAF unveils 2 lakh crore INR procurement planThe Indian Air Force is planning to spend over two lakh crore INR in the next 10 years on modernisation including the procurement of fighter jets such as the 126 multi-role combat aircraft. The IAF is planning to sign a number of big-ticket deals in the near future including the 126 MMRCA expected to be worth over 50,000 crore, the fifth generation fighter aircraft deal with Russia expected to cross the one lakh crore INR mark and a number of other projects above the range of 5,000 crore INR.

IAF aims to induct 15 airborne warning, control systemsThe Indian Air Force will be aiming to induct and operate as many as 15 airborne warning and control systems in the next decade including the soon-to-be-initiated programme of the India Airborne Warning and Control System. India is already developing Airborne Warning and Control System aircraft using the Russian IL-76 platform and the Israeli Phalcon Radar and has proposed an indigenously developed programme India AWACS.

Regulatory

Revised Defence Offset Guidelines

The Ministry of Defence on 31 July 2012 released the revised defence offset guidelines. The guidelines aim to bring clarity in the defence offset procedure. This is the most significant and comprehensive overhaul of the offset policy since the first draft released in 2008.

• The key objectives of the defence policy are to leverage capital acquisitions to develop the Indian defence industry by:a) Fostering development of internationally competitive enterprisesb) Augmenting capacity for research, design and development related to defence products and

servicesc) Encouraging development of synergistic sectors like civil aerospace and internal security

• Avenues for the discharge of offset obligations have been enlarged to include the following:

a) Direct purchase of or executing export orders for eligible products manufactured by, or services provided by Indian enterprises, i.e. defence public sector undertakings, the Ordnance Factory Board and private and public sector Indian enterprises.

b) Foreign direct investment in joint ventures with Indian enterprises for the manufacture and maintenance of eligible products and provision of eligible services, subject to the guidelines

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maintenance of eligible products and provision of eligible services, subject to the guidelines and licensing requirements stipulated by the DIPP.

c) Investment in ‘kind’ in terms of transfer of technology (TOT) to Indian enterprises for the manufacture and maintenance of eligible products and provision of eligible services. However, the offset credit shall be 10% of the value of buyback.

d) Investment in ‘kind’ in Indian enterprises in terms of provision of equipment through the non-equity route for the manufacture and maintenance of eligible products and provision of eligible services (excluding TOT, civil infrastructure and secondhand equipment). However, the vendor will be required to buy back minimum 40% of the eligible product and service.

e) Provision of equipment and TOT to government institutions and establishments engaged in the manufacture and maintenance of eligible products and provision of eligible services, including DRDO

f) Technology acquisition by the DRDO in areas of high technology

Note: Minimum 70% of the offset obligation shall be discharged by (a) to (d)

• Multiplier of 1.5 permitted where MSMEs are the Indian offset partner and multiplier of up to three permitted for high technology acquisition by DRDO

• Indian enterprises, institutions and establishments engaged in the manufacture of eligible products and provision of eligible services, including the DRDO, are referred to as the Indian offset partner (IOP). The IOP to comply with all guidelines of DIPP

Regulatory

• Timeframe for the discharge of offset obligations to extend beyond the period of the main procurement contract by a maximum of two years

• Defence Offset Management Wing (DOMW) to replace DOFA to be responsible for all the matters related to offset management, monitoring, policy formulation and banking

• Banked offset credits to be valid for a period of seven years from the date of acceptance by the DOMW

• Transfer of credits allowed between an OEM and its Tier I supplier within the same programme, with a 50% cap on using banked credits

• List of products eligible for discharge of offset obligations including defence, internal security, civil aerospace products and services related to eligible products

• Offset implementation reports to be submitted every six months during the implementation stage

• Overall penalty capped at 20% of total offset obligation

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• ToT and supply of equipment to private industry eligible for the discharge of offset obligations subject to buyback by the OEM. ToT should be provided without licence fee and there should be no restriction on domestic production, sale or export.

• ToT and supply of equipment to government institutions and establishments engaged in the manufacture and maintenance of eligible products. The provision of services does not have a buyback condition.

Regulatory

Press note for FDI in civil aviation sector

The government of India has recently issued a press note permitting foreign airlines to invest in the capital of Indian companies, operating scheduled and non-scheduled air transport services, up to the limit of 49% of their paid-up capital.

Until now, foreign airlines were allowed to participate in the equity of companies operating cargo airlines, helicopter and seaplane services, but not in the equity of an air transport undertaking operating scheduled and non-scheduled air transport services. The government has now permitted foreign airlines to invest, under the government approval route, in the capital of Indian companies operating scheduled and non-scheduled air transport services, up to the limit of 49% of their paid-up capital.

Such investment would further be subject to conditions:

• It would be made under the government approval route.

• The 49% limit will subsume FDI and FII investment.

• The investments so made would need to comply with the relevant regulations of SEBI, such as the Issue of Capital and Disclosure Requirements (ICDR) Regulations/ Substantial Acquisition of Shares and Takeovers (SAST) Regulations, as well as other applicable rules and regulations.

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of Shares and Takeovers (SAST) Regulations, as well as other applicable rules and regulations.

• A Scheduled Operator's Permit can be granted only to a company:

a) Registered with its principal place of business within India

b) The chairman and at least two-thirds of the directors of which are citizens of India and

c) The substantial ownership and effective control of which is vested in Indian nationals.

• All foreign nationals likely to be associated with Indian scheduled and non-scheduled air transport services, as a result of such investment shall be cleared from the security view point before deployment.

• All technical equipment that might be imported into India as a result of such investment shall require clearance from the relevant authority in the Ministry of Civil Aviation.

The above revised policy is not applicable to Air India.

Regulatory

Liaison office/branch office/project office in India - additional reporting requirement

Currently, foreign companies with their office in India viz. liaison, branch or project office are required to annually submit annual activity certificate (AAC) and annual report (AR) to the Reserve Bank of India (RBI). Additionally, as per the recent amendment under the tax laws, liaison offices are required to submit details of their activities in form 49C to the Income-tax department.

Now, the RBI has notified additional reporting to be done to the Director General of Police (DGP) by all Indian offices of foreign companies. The report requires providing various information viz. details of personnel employed, activities undertaken, dealing with government departments, public sector units and NGOs, etc.

The guidelines notified are summarised as below:

Initial filing by new Indian offices

• Report needs to be submitted to the DGP of the State concerned in which the office is established within five working days of the Indian office becoming functional.

• In case, the foreign entity has set up more than one office in India, such report needs to be

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• In case, the foreign entity has set up more than one office in India, such report needs to be submitted to each DGP having jurisdiction on the state where the office is established.

Annual filing by all Indian offices (new and existing both)

• The above report also needs to be filed with the DGP concerned on an annual basis along with a copy of the AAC/AR, as the case may be.

• A copy of the above report also needs to be filed with the authorised dealer (AD) bank by the Indian office concerned.

Direct Taxes

Reimbursement of salary and other administration costs under secondment

agreement not fees for technical services and not liable to tax withholding

The assessee is a subsidiary of a group company of Abbey National Plc, (Abbey Plc), a foreign company resident in the UK. Abbey Plc entered into a consultancy agreement with the assessee for rendering specified services for consideration on a cost-plus arrangement. Furthermore, in order to facilitate the outsourcing agreement, Abbey Plc entered into an agreement with the assessee for secondment of staff. As per the secondment agreement, the employees remained on Abbey Plc’s payroll in order to protect employee pension and social security contributions in the UK. However, the employees were under the supervision and control of the assessee during the term of secondment. Abbey Plc incurred salary costs for the employees on secondment, on which tax was deducted at source under section 192 of the Act, and paid to the Indian government. In addition to salary costs, Abbey Plc incurred other administrative costs related to the employees seconded. The assessee, in accordance with the terms of the secondment agreement, reimbursed Abbey Plc for salary and other administrative costs and claimed these reimbursements as deductible expense.

The revenue authorities did not accept the assessee’s contention and concluded that since Abbey Plc was the employer of the secondees and was providing managerial services to the assessee, the payment constituted fee for technical services (FTS) under the Income tax Act, 1961 (the Act) and tax was deductible under section 195 of the Act.

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In an appeal before the Tribunal, the following was observed:

• Since supervision, control over the secondees and the right to instruct them was with the assessee. Though Abbey Plc was the legal employer, the assessee would be considered as the employer of the seconded employees.

• On the issue whether reimbursement of expenses can be regarded as income chargeable in the hands of the non-resident, the Tribunal relying on various decisions, held that since there is no income element, it cannot be regarded as income chargeable under the Act.

• On the issue of whether there was any provision of services of technical or other personnel, the Tribunal held that the use of the words ’services of’ in the expression mandated the rendering of some sort of work through the act of services of technical or other personnel. Since Abbey Plc had only seconded employees and not rendered any services, the requirement of provisions of services was not satisfied. Accordingly, the reimbursement would not constitute FTS under the Act. The Tribunal held that as the payments do not constitute FTS under the Act nor constitute income chargeable to tax, there is no need to examine the India-UK tax treaty.

• In any case, under the India-UK tax treaty, the term ‘managerial service’ is not present in Article 13(4). Further, such services also do not satisfy the condition of ‘making available’ technology, process, skills, etc. Accordingly, such payments will also not constitute FTS under the tax treaty.

• The payments were not liable for withholding tax under section 195 of the Act. Consequently, no disallowance under section 40(a)(i) of the Act is warranted.

Abbey Business Services (India) P. Ltd [TS-532-ITAT-2012(Bang)]

Direct Taxes

Goodwill arising on amalgamation an ‘asset’ eligible for depreciation

YSN Shares and Securities Pvt Ltd (YSN) amalgamated with the assessee in accordance with a scheme sanctioned by the Bombay and Calcutta High Courts. The excess consideration paid over the value of net assets acquired from YSN was considered as goodwill arising on amalgamation. Depreciation was claimed on it. The revenue authorities disallowed the assessee’s claim on the ground that goodwill was not an asset under explanation 3 to section 32(1)(b) of the Act.

The Tribunal and high court rejected the revenue department’s contention and held that the difference between the cost of an asset and the amount paid constituted goodwill, an intangible asset in terms of explanation 3 to section 32 (1)(b) of the Act.

The matter was argued before the Supreme Court, which observed that the following:

• The principle of ejusdem generis should strictly apply while interpreting the expression ‘any other business or commercial rights of similar nature’.

• Goodwill is covered by the expression ‘any other business or commercial rights of a similar nature'. Hence, goodwill is an asset in terms of explanation 3(b) to section 32(1) of the Act

Smifs Securities Ltd. [TS-639-SC-2012]

Transfer of shares to parent company at book value not to be treated as a sham

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Transfer of shares to parent company at book value not to be treated as a sham

Euro RSCG Advertising Pvt. Ltd. (the assessee) is engaged in the rendering of communication services, including advertising, sales promotion, direct marketing, corporate communications and public relations. The assessee during the assessment year 2007-08 transferred 10,400 shares held in Euro RSCG Target Media Pvt Ltd (Euro TM) to its parent company, Havas International ‘at cost’. In 2002, 2400 shares in Euro TM were purchased and in 2006, 8000 shares were allotted at a premium towards the discharge of consideration for the sale of the media business. The price at which the allotment was made was greater than the fair market value determined by an independent valuer.

The assessee computed short-term capital gains at ‘nil’ for 8000 shares and long-term capital loss (due to indexation) for the balance 2400 shares.

In an appeal before the Tribunal, the assessee raised the following issue:

• Whether cost of acquisition of shares should be taken as per books, i.e. actual cost or (lower) fair market value as on the date of acquisition for the purpose of determining capital gains

The Tribunal observed that once the cost of acquisition as shown in the books of account had been accepted earlier by the assessing officer and also evidenced by the terms of agreement between the parties, it cannot be held that the cost shown by the assessee is fictitious. The transaction, between related parties, cannot be treated as a sham as the shares have been transferred purely on the basis of the value recorded in the books. Hence, it cannot be held as a makebelieve arrangement or colorable transaction.

Euro RSCG Advertising Pvt. Ltd. [TS-496-ITAT-2012(Mum)]

Direct Taxes

No capital gains tax on transfer of shares held in Indian companies

Dynamic India Fund (the applicant), a wholly owned subsidiary of Dynamic India Fund II (DIF II), is a company incorporated in Mauritius with the intention to invest in growing sectors in India. It is registered with the Securities Exchange Board of India (SEBI) as a foreign venture capital. The applicant holds a valid tax residency (TRC) from Mauritius and does not have a permanent establishment (PE) in India. The control of affairs of the applicant lies in Mauritius and decisions are taken by the board of directors from there.

The applicant invested funds in the shares of Indian companies and units in India. It holds shares, reflected as investment in books, with the intention to generate long-term capital appreciation.

The issue before the Authority of Advance Ruling (AAR) was to determine whether capital gains arising from the transfer of shares of an Indian company by a Mauritian company are liable to capital gains tax under the India-Mauritius tax treaty.

The AAR held that a Mauritian resident holding a valid TRC and not having a PE in India would not be liable to tax in India in respect of gains arising on the transfer of shares held in Indian companies under the tax treaty. It is important to note that the AAR observed that since the implementation of General Anti-Avoidance Rule (GAAR) provisions has been deferred with effect from 1 April 2013, it has no relevance at present and can be dealt with by the revenue authorities as and when it comes into force.

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as and when it comes into force.

Dynamic India fund I, In re [TS-513-AAR-2012]

Tax planning permissible within the legal framework of the law

Five companies (transferor companies) were being merged into Unichem Laboratories Ltd (Unichem Labs), a listed company under a scheme of arrangement (scheme). The assets of the transferor companies predominantly consisted of shares in Unichem Labs. All the companies filed petitions before the high court for the sanction of the scheme which amongst others, provided for the cancellation of shares held by the transferor companies in Unichem Labs and the allotment of shares to the shareholders of the transferor companies, i.e. promoters.

Minority shareholders of Unichem Labs objected to the scheme on the ground that the objective of the scheme was to avoid capital gains tax on the transfer of shares held by the transferor companies in Unichem Labs to the promoters.

The issue before the court was whether the transaction was a colourable device to avoid capital gains tax on the transfer of shares held by the transferor companies in Unichem Labs to the promoters.

The high court observed that the following:

• The object of the scheme is legitimate and provides long-term stability and transparency. Also, it is permissible under the law and not a colourable device to avoid tax.

• It relied on the Supreme Court’s decision, in the case of Azadi Bachao Andolan, that every transaction or arrangement permissible under the law having an impact of reducing the tax burden of the assessee is not to be treated as a tax avoidance device.

Direct Taxes

It held that the implementation of a transaction under one of the alternative options available, which does not lead to any tax outflow, is not illegal or unlawful. Further, it was held that such a transaction is permissible, provided it is within the framework of the law.

AVM Capital Services Pvt. Ltd. [TS-512-HC-2012(Bom)]

Installation services inextricably linked to the supply of equipment not taxable under the India-Canada tax treaty though can be taxed under the Act

The assessee is a company engaged in the business of engineering and general contracting. It entered into two separate contracts for the purchase, installation and commissioning of the supervisory control and data acquisition (SCADA) system and application computer programmesin object code and binary format for the CCKPL project. Both the contracts were issued under one letter of intent. The assessee had offered for a disallowance amount paid towards the installation charges in relation to the supply of plant and machinery under section 40(a)(i) of the Act as no tax was withheld. It later filed a revised return claiming the amount on the grounds that it was not taxable in India in terms of Explanation 2 to section 9(1)(vii) of the Act. The revenue authorities disallowed the claim made by the assessee under section 40(a)(i) of the Act.

The Tribunal observed the following:

• The services of the non-resident company cannot be regarded as consideration for any

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construction, assembly, mining or similar project as under Explanation 2 to section 9(1)(vii) of the Act.

• By virtue of Article 12(5)(a) of the tax treaty, installation and commissioning services rendered by the non-resident company were ancillary and subsidiary as well as inextricably and essentially linked to the supply and sale of the plant and machinery. Thus, the amount paid for the services by the assessee company was not taxable in India.

• On the basis of the tax treaty, the assessee was not liable to withhold tax from the payment made towards the installation and commissioning work to the non-resident company. The disallowance made under section 40(a)(i) of the Act was not sustainable.

Dodsal Pvt. Ltd. [TS-675-ITAT-2012(Mum)]

Supreme Court on admissibility of SLP against rulings delivered by AAR

Issue : Whether the ruling pronounced by the AAR can be challenged by the petitioner or the tax department before the Supreme Court or the high court

Supreme Court views:

• The AAR is a body exercising judicial power conferred on it by Chapter XIX-B of the Act and is a Tribunal within the meaning of the expression in Articles 136 and 227.

• The binding nature of AAR decisions cannot affect the jurisdiction of the Supreme Court and the high courts to ’challenge’ a ruling of the AAR.

Direct Taxes

• To hold that an AAR ruling cannot be challenged before the high court would ‘negate a part of the basic structure of the Constitution’.

• A writ petition against the AAR ruling will be heard ’directly’ by the division bench of high courts and to be decided by courts as ’expeditiously as possible’.

Columbia Sportswear Company (SLP (C) No. 31543 of 2011)

Retrospective amendment in domestic law to not be read into tax treaty – payment for supply of software embedded in hardware not taxable as ‘royalty’ even after retrospective amendment

Nokia Networks OY (Nokia), a company based in Finland, was a leading manufacturer of advanced telecommunication systems and equipment (GSM equipment) used in fixed and mobile phone networks. Nokia, in March 1994, opened a liaison office (LO) in India and subsequently, in May 1995, incorporated Nokia India Pvt Ltd (NIPL).

The company supplied GSM equipment to various Indian telecom operators from outside the country on a principal-to-principal basis. Installation of the equipment supplied by Nokia was undertaken by its subsidiary NIPL under independent contracts with Indian telecom operators. The LO was carrying out advertising and other preparatory and auxiliary activities permitted by the RBI.

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The issues before the high court were as follows:

• Whether payment of embedded software is ‘royalty’

• Whether LO constitutes PE

• Treatment of supply and installation contracts as composite agreement

• Whether NIPL constitutes a PE and attribution of profit

The court relied on the judgements of the Bombay and Delhi High Courts for Siemens Aktiongesellschaft and Ericsson AB respectively and held that the amendment cannot be read into the treaty and that sale of a copyrighted article does not fall within the purview of royalty. Furthermore, the high court on the basis of the facts concluded that the LO does not constitute a PE of Nokia in India. The high court quashed the revenue authorities’ attempt to club different contracts, which was clearly impermissible. By relying on the Supreme Court’s decision in the case of Hyundai Heavy Industries, it held that in composite contracts, offshore supply should be segregated. Lastly, the high court remanded back to the Tribunal for fresh consideration the matter for considering whether NIPL constitutes a PE of Nokia.

DIT v. Nokia Networks OY [TS-700-HC-2012(Del)]

Expert Committee report on GAAR

GAAR was incorporated in the Act providing a basic framework and structure for its application and consequences. It was prescribed in the Act that the GAAR provisions would be applied in accordance with such guidelines and subject to such conditions and the manner as may be prescribed.

Direct Taxes

For the purpose of formulating these guidelines, a committee was constituted under the chairmanship of the Director General of the Income Tax (International Taxation) which published draft guidelines on 28 June 2012.

Subsequently, the Prime Minister constituted an expert committee on GAAR under the chairmanship of Dr Parthasarathi Shome to undertake stakeholder consultations and finalise the guidelines in order to bring more clarity. The committee analysed the GAAR provisions, discussed the inputs of various stakeholders and presented its draft report on 1 September 2012.

Some of the significant recommendations of the expert committee are outlined as under:

• Implementation of GAAR should be deferred by three years on administrative grounds.

• A monetary threshold of 30 million INR of tax benefit (excluding interest) to a taxpayer in a year should be used for the applicability of the provisions.

• The following illustrative list of tax mitigation arrangements or negative list should be used for not invoking GAAR:

� Selection of one of the options offered in law

• Payment of dividend or buyback of shares by a company

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• Setting-up of a branch or subsidiary

• Setting-up of a unit in a Special Economic Zone or any other place

• Funding through debt or equity

• Purchase or lease of a capital asset

� Timing of a transaction (for example, sale of property in loss while having profit in other transactions)

� High court approved merger and demerger schemes

� Intra-group transactions (i.e. transactions between associated persons or enterprises) which may result in tax benefit to one person without affecting the overall tax revenue either by actual loss of revenue or deferral

• Arrangements wherein the main purpose (and not one of the main purposes) was to obtain a tax benefit should be covered under GAAR.

• Tax on gains arising from the transfer of listed securities (both capital gains and business income) in the hands of residents as well as non-residents should be abolished.

• Investments (though not arrangements) made by residents or non-residents and existing as on the date of commencement of the GAAR provisions should be grandfathered so that they are not invoked for examination or denial of tax benefit on subsequent sale.

Direct Taxes

• The provisions should not be applied to examine the genuineness of the residency of an entity set up in Mauritius, where Circular no 789 of 2000 is applicable i.e. furnishing of tax residency certificate should be sufficient for accepting the status of residence of a person.

• The provisions should not be invoked to look into an aspect or element, where specific anti-avoidance rules are applicable to that particular aspect or element or where anti-avoidance provisions are already present in the tax treaty (for example, limitation of the benefit clause in the case of the India-Singapore tax treaty).

• The provisions should not be applied to a foreign institutional investor in case it chooses not to take the tax treaty benefit and subjects itself to tax in accordance with domestic law provisions.

• While processing an application for nil or lower tax withholding under sections 195(2) or 197 of the Act, GAAR may be invoked (with the prior approval of the commissioner) in case the taxpayer does not submit a satisfactory undertaking to pay taxes along with interest if the GAAR provisions are subsequently found to be applicable in relation to the remittance.

• The tax officers should be able to seek an expert opinion from the transfer pricing officer to ascertain whether rights, or obligations, created in an arrangement (not covered by existing transfer pricing regulations) are the same as ordinarily created between persons dealing at arm's length.

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• In instances where only a part of the arrangement is impermissible, the tax consequences of an ‘impermissible avoidance arrangement’ should be limited to that portion of the arrangement only.

• The GAAR provisions should be applicable to income of the taxpayers on or after the date they come into force.

• While determining tax consequences of an impermissible avoidance arrangement, a corresponding adjustment should be allowed in the case of the same taxpayer in the same year as well as in different years, as the case may be.

• Section 97 of the Act should be amended to provide that the following factors are relevant but may not be sufficient. These factors will be taken into account in forming a holistic view as to whether an arrangement lacks commercial substance or not:

� The period of time for which the arrangement (including operations therein) exists

� The fact of payment of taxes, directly or indirectly, under the arrangement

� The fact that an exit route (including transfer of any activity or business or operations) is provided by the arrangement.

In addition to the aforesaid significant recommendations, the expert committee report has also provided an indicative list of examples to illustrate the scenarios wherein the GAAR provisions would be applicable.

Personal Tax

Asset held for 12 months qualifies as long-term capital asset

The assessee, an individual, had income from salary and other sources. During the financial year 2005-06, the assessee sold two mutual fund instruments on 29 September 2005 and 14 October 2005 respectively, and had shown the income earned as long-term capital gains in the tax return. The mutual fund instruments and units were purchased by the assessee on 29 September 2004 and 14 October 2004 respectively. In the tax return filed by the assessee on 31 July 2006, the assessee treated the capital gains as exempt under section 10(38) of the Income Tax Act, 1961 (Act) as STT was paid on such transaction.

The assessing officer treated the above as short-term capital gains as it was not held for more than 12 months and considered it as short-term gain.

The assessee filed an appeal before the CIT (Appeals) where it was held that since the instruments were held for 12 months, the gains were not short-term capital gains. The Tribunal restored the findings of the AO.

Aggrieved by the ITAT order, the assessee filed an appeal to the Delhi High Court. The HC examined the provisions of Section 2(42A) of the Act which defined ‘short-term capital asset’ as an asset held by an assessee for not more than 36 or 12 months immediately preceding the date of its transfer. It was held that the first part of section 2(42A) stipulates that if an asset is held for 36 or 12 months, it will be a long-term capital asset. The term ’month’ has not been defined in the Act

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12 months, it will be a long-term capital asset. The term ’month’ has not been defined in the Act and therefore the court relied upon the term ’calendar month’ as defined in the General Clauses Act, 1897. Accordingly, the period of 12 calendar months would begin on the specified day when the asset was transferred and the assessee became the holder of the asset and end one day before in the relevant calendar month, the following year.

The expression ’not more than’ clearly in that case would refer to and include the date on which the asset was first held or acquired.

In view of the aforesaid reasoning, the appeal was decided in favour of the assessee.

[ITA No. 1234/Del/2011, order dated 12, April, 2012 Delhi HC]

Foreign income received in overseas bank account at first place not considered as ‘received in India’ on further remittance to Indian bank account

The assessee, an individual, lived in the UK for several years. She returned to India in financial year 2005-06 and sold her home in the UK through an agent. The sale proceeds were transferred to her bank account in the UK and subsequently remitted to India. The assessee qualified as ‘resident but not ordinarily resident’ (RNOR) during the relevant tax year. Her assessment for the assessment year 2006-07 under section 143(3) of the Act was completed on 23 December 2008.

After the completion of the assessment proceedings, the assessment was reopened by the Commissioner of Income Tax (CIT) under section 263 of the Act who considered that the income on the sale of the property in the UK was ‘received in India’ and hence was taxable even in the case of the RNOR assessee.

Personal Tax

Aggrieved by the CIT order, the assessee filed an appeal to the Kolkata ITAT where it was held that section 5(1)(a) of the Act states that in case of RNOR, only such income accruing or arising outside India can be brought to tax in their hands in India if (i) received or deemed to be received in India in such year by or on behalf of such person; or (ii) derived from a business controlled in or a profession set up in India. According to the Commissioner, the assessee had received the income in India. However, he had not considered that it is the place of first receipt of income which is material for the purposes of applying the test provided in section 5(1)(i) of the Act. The place of receipt of an income is the place where it is received by the assessee in its character of income. A mere transfer of money from one bank account to another cannot be considered a receipt of income. In the assessee’s case, the income was received in the UK and only subsequent remittance, wholly irrelevant for taxability purposes, was received in India.

In view of the above discussions, the appeal was allowed in assessee’s favour.

[SarmishthaMukherjee [TS-377-ITAT-2012(Kol)]

PAN not mandatory for person below taxable limit

In response to a writ petition filed by an assessee , the Karnataka High Court held that section 206AA of the Income Tax Act, 1961 (the Act) is not applicable to persons whose income is below the taxable limit.

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The petitioners were small investors with income not exceeding the maximum limit chargeable to income tax. They invested their small savings and filed form 15G to enable respondents not to deduct taxes. However, the respondents insisted that they furnish PAN in view of the provisions of section 206 AA of the Act. The grievance of the petitioners was that they were not assessees and therefore not assessed to income tax. Section 139A(1)(i) of the Act mandates persons having income exceeding the maximum amount not chargeable to tax to apply and obtain PAN.

But section 206AA of Act overrides all the provisions of the Act and is hence arbitrary and violates Article 14 of the Constitution of India.

It was observed by the high court that section 206AA of the Act is contrary to section 139A of the Act and appears to be discriminatory and overriding section 139A of the Act introduced earlier. In view of the specific provisions of section 139A of the Act, section 206AA of the Act is made inapplicable to persons whose income is less than the taxable limit. However, section 206AA of the Act would still be applicable to persons whose income is above the taxable limit. Accordingly, it was directed that banking and financial institutions will not insist upon PAN from small investors having income less than the taxable limit.

A Kowsalya [TS-416-HC-2012(KAR)]

Deduction under section 54F of the Act also applicable in case of belated tax return

In a recent decision, the Chennai Bench of the ITAT held that the amount utilised or invested under section 54F of the Act for a new residential house till the filing of belated tax return as per section 139(4) of the Act is eligible for deduction under section 54F of the Act.

Personal Tax

In this case, the assessee, derived long-term capital gains from the sale of shares during assessment year 2008-09. He invested capital gains in acquiring a residential flat and claimed relief under section 54F of the Act. During the assessment proceedings, the AO noted that the due date for the filing of return of income by the assessee was 31 July 2008. The agreement to acquire new property was executed on 9 September 2008 i.e. after the due date for filing of return of income. Hence, he was denied the deduction under section 54F of the Act. On first appeal, the CIT (A) granted only part deduction of 3 lakh INR paid before the due date of filing return of income.

Before the ITAT, the assessee argued that he had not filed his return of income for assessment year 2008-09 within the time as allowed under section 139(1) of the Act. However, he was eligible to file belated tax return till 31 March 2009 which was the extended time under section 139(4) of the Act. Accordingly, he filed the return on 9 January 2009. The assessee contended that he was entitled to exemption under section 54F of the Act, to the extent of the amount paid to the builder for acquiring the property on 31 March 2009 (i.e. 15 lakh INR).

The Tribunal observed that deduction under section 54F of the Act can be claimed if the net consideration not utilised by him for the purchase or construction of new assets before the date of furnishing the return of income under section 139 of the Act is deposited in an account in any such bank or institution as may be specified in, and utilised in accordance with any scheme the central government may frame in this behalf. Accordingly, the Tribunal held that the amount utilised by the assessee for the purchase of a new residential house before the actual date of filing of tax returns (i.e. 9 January 2009) qualified for relief under section 54F(1) of the Act.

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January 2009) qualified for relief under section 54F(1) of the Act.

[R.K.P.ELAYARAJAN [TS-422-ITAT-2012(CHNY)]

NOR status absolves tax on foreign salary in India

In a recent decision, the Delhi High Court held that there will be no tax liability on foreign salary received by a Japanese resident if he qualifies as a ’not ordinary resident’ (NOR) in India.

The assessee was a permanent resident of Japan. During the year under consideration, he was employed by M/s Suzuki Motors Corporation, Japan (Suzuki). By virtue of a collaboration agreement between Suzuki and M/s Maruti Udyog Ltd, India (Maruti), the assessee was deputed to India for a period of 273 days to offer guidance and technical assistance in accordance with the terms and conditions of that agreement. The salary for this period was paid to him by Suzuki in Japan. In addition, the assessee was also provided hotel accommodation in India by Maruti.

During assessment proceedings, it was contended by the assessee that the hotel accommodation was provided to him in accordance with the terms of the collaboration agreement. There was no employer-employee relationship between him and Maruti. It was also stated that the rent paid was exempt by virtue of section 10(14) of the Income Tax Act, 1961 (the Act). However, the assessing officer (AO) rejected the contentions of the assessee and considered rent paid by Maruti, daily allowance and other monetary benefits taxable in the hands of the assessee in India as per Article 15 of the India-Japan tax treaty (treaty) on the contention that the provisions of the treaty override the provisions of the Act. The CIT(A) partly allowed the assessee’s appeal.

Aggrieved, both the tax authorities as well as the assessee approached the Delhi Bench of the ITAT which ruled in favour of the assessee and held that he was a NOR in India. Therefore, salary earned in Japan for employment with Suzuki in Japan cannot be taxed in his hands in India by virtue of the

Personal Tax

provisions of section 5(1)(c ) read with section 6(6) of the Act. Further, it also held that section 90(2) of the Act clearly states that the provisions of the Act shall be applicable to the extent that they are more beneficial to the assessee to whom the relevant DTAA applies. Since, in this case, the provisions of section 6(6) read with section 5(1)© and section 9(1)(i) were beneficial to the assessee, they should have been preferred over the DTAA and the income earned by the assessee outside India during the year under consideration is not taxable in India.

The Delhi High Court, by relying on the apex court ruling in Morgenstern Werner (2003) 259 ITR 486 (SC), affirmed the view taken by the ITAT and held that the assessee was clearly a NOR in India for tax purposes and hence not liable to tax in India in respect of salary earned outside India.

CIT Vs Sakakibara Yutaka [High Court of Delhi – ITA No. 111/2006]

Duration of stay in India decisive criteria for determining residential status

In a recent decision, the Delhi Bench of the ITAT held that while determining the residential status of an individual, the duration of stay in India is the only decisive factor and other factors such as the existence of a dwelling house and social ties are not relevant.

The assessee was regularly assessed to tax in India as a non resident (NR) since several years by way of assessments under section 143(3) of the Act. In February 2007, certain search-and-seizure operations were carried out in the premises of the assessee. During the proceedings, the AO held that the assesseeshould be treated as a ‘resident’ and not an ‘NR’ as he was not ‘outside India’ but was living within

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should be treated as a ‘resident’ and not an ‘NR’ as he was not ‘outside India’ but was living within India and went abroad on visits. Thus, he was not eligible for the relaxation provided by clause (b) of the Explanation to section 6(1)(c) of the Act. To support his contentions, the AO also referred to the renovation carried out by the assessee in his farmhouse in India as well as his social ties in India. Accordingly, the AO brought his entire global income to tax in India. On further appeal, the CIT(A) confirmed the order of the AO.

Aggrieved by the findings of the lower appellate authorities, the assessee approached the ITAT which observed that for the last 25 years, the assessee’s residential status was accepted as NR and the number of days spent in India was not disputed by the revenue authorities. It further observed that the AO’s interpretation of the residential status was based on section 6(1)(b) of the Act which was omitted with effect from 1 April 1983. Referring to the CBDT Circular no 684, dated 10 June 1994, the ITAT held that when the law intends to give the benefit of 182 days to an Indian citizen who leaves India for taking up employment or business outside India, it does not put any restriction on the number of days spent abroad. All it mandates is to look at the ‘number of days stayed in India’. Since this is a settled position, factors other than stay criteria such as larger presence, business investment, family ties are of no relevance while determining the residential status of an individual assessee. Accordingly, by relying on the findings of the Kerala High Court in the case of Abdul Razaq [337 ITR 350 (Ker)] and the AAR ruling in the case of Dr Virendra Kumar and Canoro Resources, the ITAT concluded that the residential status of the assessee was that of an NR and thereby taxable only on incomes accrued in India.

Suresh Nanda Vs. ACIT [ITA No. 1428, 1429 & 1430/Del/2012]

Adjustment of excess contributions made to the pension fund of Indian employees holding certificate of coverage and deputed to a country with which India has a social security agreement is allowed

In October 2008, the Indian Ministry of Labour and Employment (MLE), made it compulsory for

Personal Tax

international workers (IWs) to contribute to the country's social security schemes. In September 2010, the MLE further amended the scheme and withdrew the salary cap of 6,500 INR per month, applicable for allocating a part of the employer's contribution towards the pension fund of the IWs. This resulted in higher contribution (i.e. 8.33% of the entire salary) to the pension fund of the IWs.

On 25 May 2012, the Employees Provident Fund Organisation (EPFO) clarified in the form of frequently asked questions that Indian employees who avail exemption from contributing in the host country by obtaining a certificate of coverage (COC) from India, will not fall under the category of IWs and the pension contribution of such employees should be limited to the wage ceiling of 6,500 INR per month.

Prior to the above clarification, in the absence of clear guidelines, a number of Indian companies considered their Indian employees (holding a COC issued by the relevant authorities), sent on assignment to a country with which India has a social security agreement (SSA), as IWs and allocated a higher amount towards their pension fund calculated on their full salary rather than limiting the contribution to the wage ceiling of 6,500 INR per month. The EPFO has now issued a clarification allowing adjustment of excess contributions made to the pension fund from the provident fund, provided the concerned Indian employee holds a valid COC and is deputed to a country with which India has an SSA.

This is a welcome step by the government as it will minimise the hardship faced by Indian companies. Now, they can adjust the excess pension contribution made earlier to their provident fund

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Now, they can adjust the excess pension contribution made earlier to their provident fund contributions. For this purpose, the employer is required to file a request letter to the respective Regional Provident Fund Commissioner for adjustment of excess amount from pension to provident fund.

Definition of excluded employee expanded for special provisions applicable to international workers under the Indian social security regulation

In 2008, the Indian MLE, made it compulsory for IWs to contribute to the country's social security schemes. However, IWs from a country with which India has an SSA in force and holding the COC are termed as 'excluded employees' and are exempt from contributing to the Indian social security schemes for the period and terms as specified in the respective SSA.

The MLE has recently issued a notification) and amended the term 'excluded employee' to also include IWs who are deputed from a country with which India has entered into a bilateral comprehensive economic agreement prior to 1 October 2008. Such IWs will now qualify as excluded employee, if the following conditions are met:

• The IW is contributing to the social security programme of his or her home country, either as a citizen or resident.

• The relevant comprehensive economic agreement contains a clause on social security which specifically exempts natural persons of either country to contribute to the social security fund of the host country.

Transfer Pricing

Advance Pricing Agreement rules notified

The Advance Pricing Agreement (APA) is an arrangement between taxpayer and tax authority covering future transactions, with a view to solve potential transfer pricing disputes in a cooperative manner. APA provisions were introduced in India with effect from 1 July 2012 by the Finance Minister in the Union Budget 2012. The Central Board of Direct Taxes (CBDT), by notification in the official gazette, has introduced the detailed rules providing the procedures and necessary forms for the application and administration of APAs.

The rules provide for the constitution of an APA team (team) which shall consist of income tax authorities and experts from economics, statistics, law and other necessary fields. APAs can be applied for existing as well proposed transactions.

In line with the expectation, the rules have provided for both the unilateral as well as bilateral and multilateral APAs. This is a welcome step since a unilateral APA may not be able to assure relief from double taxation to multinational enterprises (MNEs). The government has shown an inclination towards bilateral APAs by questioning the taxpayer on reasons for filing a unilateral APA application in cases where a double taxation avoidance agreement exists. However, in case the bilateral APA negotiated between competent authorities is not acceptable to the taxpayer, the taxpayer may at its option continue with the process of entering into a unilateral APA without the benefit of a mutual agreement process.

A comparison of the key features of Indian APA rules with global best practices along with our

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A comparison of the key features of Indian APA rules with global best practices along with our observations is provided below:

Feature Global Best Practice

India Observation

Pre-filing meeting

� � The pre-filing consultation meeting will play a vital role in the entire process. This will be an appropriate forum for taxpayers to test the waters. Expectations from both sides can be clearly spelled out. By permitting anonymous pre-filing meetings without any charge, the government has also comforted taxpayers. This will act as an enabler for taxpayers to get on board, despite any scepticism from past experiences on the transfer pricing audit.

Flexibility –amendment /withdrawal /revision

� � The APA rules have provided significant flexibility in the overall process by allowing the taxpayer to amend the APA application, provide further information and documents for consideration of the APA team and allowing for revision of APA in case of change in critical assumptions and the law under which the agreement is covered, etc. The taxpayer is also permitted

Transfer Pricing

Feature Global Best Practice

India Observation

to withdraw the APA application at any time before finalisation. Therefore, the taxpayer is not under an obligation to complete the APA process or accept the outcome. Furthermore, the APA rules also provide flexibility in terms of agreeing upon a transfer pricing methodology or arm’s length price. Accordingly, the taxpayer should have the option of agreeing to a transfer pricing methodology instead of a single point arm’s length price in case of complex transactions.

Team

composition –

experts in

economics,

statistics, law etc.

� � The rules provide for the constitution of an APA team consisting of experts in economics, statistics, law, etc. The government, through its intention to form such a team, has clearly showed its dedication and seriousness towards the

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APA programme.

Documentation

simplification

� � The ACR would reduce the compliance

burden of taxpayers.

Roll back � X Though not expressly provided in the rules,

as per the experience in other countries, the

resolution reached in unilateral and

bilateral APAs should be helpful in

resolving open years.

Timeline X X The rules do not prescribe any indicative

timeline for concluding the APAs.

Taking a clue from timelines provided for in

the rules (e.g. serving deficiency letter,

removal of the deficiency or modification of

the application, etc.), the government has

shown its inclination towards the early

processing of APA applications.

Transfer pricing has been a significant source of tax controversy in India and the lack of clarity in matters relating to it has pushed back several large investment proposals of foreign MNEs in India. However, after reviewing the detailed rules notified by the government, one can reckon that the government has demonstrated its sincere commitment towards implementing a successful APA programme. While clarification on certain aspects will be required, the government has provided constructive rules primarily in line with the mature jurisdictions which will surely encourage MNEs to opt for the APA process.

Transfer PricingThe salient features of the procedure laid down for APA are described below:

Pre-filing consultation

The process for APAs starts with the pre-filing consultation meeting. The taxpayer can request for a pre-filing consultation meeting to determine the scope of the agreement, understand the transfer pricing issues involved and examine the suitability of international transactions for an APA. The taxpayer also has the option of applying for a pre-filing consultation on an anonymous basis. The pre-filing consultation shall neither bind the board nor the taxpayer to initiate or enter into an APA.

Application for an APA

After the pre-filing meeting, if the taxpayer is desirous of applying for an APA, an application will be required to be made in specified form. For continuing transactions, the APA can be applied for the period starting 1 April 2013. For proposed transactions, the APA can be applied at any time before undertaking the actual transaction.

Apart from the basic details, the taxpayer will be required to provide the international transactions to be covered, the type of APA applied for, the reason for not applying for bilateral or multilateral APAs, the proposed transfer pricing methodology, a detailed functional analysis, standalone and consolidated financial statements for the last five years, etc.

Procedurally, the application for unilateral APAs will be made to the Director General of Income Tax (International Taxation) [DGIT], and for bilateral and multilateral APAs to the competent authority in

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(International Taxation) [DGIT], and for bilateral and multilateral APAs to the competent authority in India.

The application will be required to be filed along with the requisite fee. The fee for an APA is linked to the value of the transaction undertaken or proposed to be undertaken.

Amount of international transaction Fee

Amount not exceeding 100 crore INR (approx 20

million USD)

1 million INR (approx 20,000 USD)

Amount exceeding 100 crore INR (approx 20

million USD) but not exceeding 200 crore INR

(approx 40 million USD)

1.5 million INR (approx 30,000 USD)

Amount exceeding 200 crore INR (approx 40

million USD)

2 million INR (approx 40,000 USD)

Withdrawal of APA application

The taxpayer has the option to withdraw the application anytime before the finalisation of the terms and conditions of the agreement. However, the filing fee shall not be refunded in case of withdrawal.

Defective application

If there is any defect in the application, the taxpayer shall be served a deficiency letter within one month from the date of receipt of application. The taxpayer shall be provided a period of 15 days

Transfer Pricingfrom the date of service of the letter to make good the deficiency. A defective application, if not corrected within 15 days (extendable to 30 days) will be rejected, in which case the filing fee shall be refunded to the taxpayer.

Procedure

Once the application is accepted, the APA team shall hold meetings with the applicant and undertake necessary inquiries for the case. Post the discussion and inquiries, the APA team shall prepare a draft report to be provided to the competent authority or DGIT, as the case may be. Based on the same, the DGIT or the competent authority shall prepare a draft agreement, which post the approval of the central government shall be entered into between the board and the applicant. The agreement shall mainly include international transactions covered, the agreed methodology, determination of the arm’s length price as well as critical assumptions for the agreement.

Compliances post an APA

The taxpayer shall be required to file an annual compliance report (ACR) to the DGIT within 30 days of filing the return of income or 90 days of entering into the APA, whichever is later. In the ACR, apart from the basic details, the taxpayer shall provide information such as details of change in business model, functional or risk profile, critical assumptions vis-a-vis those agreed in the APA. The transfer pricing officer (TPO) shall conduct the compliance audit based on the details provided in the ACR in order to ensure that the terms as agreed in the APA have been met by the taxpayer. The TPO shall furnish its report within six months from the end of the month in which the ACR was submitted, to the DGIT or competent authority.

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DGIT or competent authority.

Cancellation of an APA

The board may cancel the APA, in case the taxpayer fails to furnish the ACR, there are material errors in the ACR, the TPO finds that there is a failure on the part of the taxpayer to comply with the terms and conditions of the APA, or on account of fraud or misrepresentation of facts by the taxpayer.

Revisions and renewal of an APA

An APA may be revised in case there is a change in the critical assumptions, law under which the agreement is covered, or in case of a request from the competent authority in another country in case of a bilateral or multilateral APA. After completion of the APA term, the taxpayer also has the option to apply for renewal of the APA using the same procedure as provided for original application.

Transfer pricing methodology preferred over Rule 10 for attribution of profits to permanent establishment

In a recent judgment, the Delhi ITAT held that for the purpose of attributing profits to a PE, the methodology provided under transfer pricing regulations is preferred over the procedure provided under Rule 10 of the Income-tax Rules, 1962, read with section 9 of the Income-tax Act, 1961. Rule 10 can be applied in cases where the income of the PE cannot be definitely ascertained, and the assessing officer (AO) has to demonstrate this. The AO cannot simply proceed to apply Rule 10 without rejecting the transfer pricing (TP) study.

Facts of the case

The taxpayer was a project office (PO) of Hyundai Rotem Company in India and was engaged in providing liaisoning, co-ordination, and administrative support services to its head office (HO) in

Transfer Pricingconnection with a contract being executed in India. The taxpayer undertook a detailed transfer pricing study including functional, assets and risk (FAR) analysis and computed the income of the PO on a cost plus 9% basis.

The years under consideration were assessment years 2002-03, 2003-04 and 2004-05. A transfer pricing study was conducted for each of the years under consideration. For assessment year 2004-05, the TPO accepted the TP study carried out by the taxpayer. However, for assessment years 2002-03 and 2003-04, the case was not referred by the AO to the TPO. For these years, the AO rejected the cost plus methodology and adopted Rule 10 to determine the profits attributable to the functions of the PO. Aggrieved, the taxpayer appealed to the Commissioner of Income-Tax Appeals (CIT (A)) who upheld the AO’s approach.

The taxpayer’s primary contention was that as per Article 7(2) of the India-Korea tax treaty, the income of a PE has to be determined on an arm’s length basis and as if it was a distinct and separate enterprise. Determination of income based on Rule 10 is totally unscientific and contrary to the procedure provided in the TP regulations.

The Tribunal held that, for the purpose of computing a PE’s income, if one weighs the procedure provided in Rule 10 read with section 9, vis-à-vis the procedure provided in the TP regulations, in light of the TP study carried out by the taxpayer and its consistent position of showing income under a particular method, then the scale would tilt towards the detailed method provided under the TP regulations. Considering this, the Tribunal held that, given the facts and circumstance of the case, for the purpose of attributing profits to a PE, the methodology provided under TP regulations is preferred

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the purpose of attributing profits to a PE, the methodology provided under TP regulations is preferred over the procedure provided under Rule 10 of the Income Tax Rules, 1962.

Further, the Tribunal relied on Article 7(5) of the double taxation avoidance agreement between India and Korea that profits attributable to a PE shall be determined by the same method each year unless there is sufficient reason to not do so. As the revenue authorities themselves had accepted the TP methodology in subsequent assessment years, there is no reason to reject them for the past years.

Indirect TaxesCustoms:

Notification and Circulars

• The central government has amended the existing exemption notifications providing exemption to capital goods imported under the Export Promotion Capital Goods (EPCG) Scheme and the Status Holder Incentive Scheme (SHIS) in order to synchronise with changes made in these schemes by the Annual Supplement 2012-13 to the Foreign Trade Policy (FTP).

(Notification No. 42/2012 dated 22 June, 2012)

• The central government has clarified the following regarding the Served From India Scheme (SFIS):

� Vehicles in the nature of professional equipment such as airfield fire fighting and rescue vehicles, heavy-duty modulator trailer combination, reach stackers, ambulances, sewage disposal trucks, refuse disposal vehicles, etc. can be imported against SFIS scrips.

� Personal vehicles such as motor cars and sports utility vehicles (SUVs), etc are not permitted to be imported against SFIS scrips.

(Circular No. 18/2012 dated 05 July, 2012)

• The central government has introduced 24X7 customs clearance facility from 1 September 2012 for the following categories of imports and exports:

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following categories of imports and exports:

� Bills of entry where no examination and assessment is required

� Factory stuffed export containers and export consignment covered by free shipping bills

(Circular No. 22/2012 dated 7 August, 2012)

• The central government has mandated e-payment of customs duty with effect from 17 September 2012 for the following importers:

� Importer paying customs duty of 100,000 INR or more per bill of entry.

� Importer registered under accredited client programme (ACP)

(Circular No. 24/2012 dated 5 September, 2012)

• The central government has exempted customs duty on the import of parts, components of aircraft replaced or removed during the course of maintenance, repair or overhaul of the aircraft in a special economic zone. The exemption is available subject to the condition that goods replaced or removed are returned to the owner of the aircraft without any sale.

(Notification No. 52/2012 dated 13 September, 2012)

Case laws - Valuation:

• In CC vs Hitachi Koki India Pvt Ltd (2012 (281) ELT 465), the Tribunal held that refund of extra duty deposit (EDD) loaded on invoice value paid by the importer cannot be held time-barred under section 27 of the Customs Act, 1962 as the amount was not customs duty.

Indirect Taxes• The Tribunal, in Vasco Da Gama Distilleries Pvt Ltd vs CC (2012-TIOL-831-MUM), held that the

transaction value of imported goods cannot be rejected merely on the basis of the price list of the foreign supplier in the absence of any evidence of payment over and above transaction value.

• In CC vs Nath International (2012-TIOL-798-DEL), the Tribunal held that redetermination of the value of imported goods cannot be made unless transaction value of the imported goods has been rejected on legally permissible grounds prescribed under the erstwhile Customs Valuation Rules, 1988.

• The Tribunal, in Tata Yutaka Autocomp Ltd vs CC (2012-TIOL-778-MUM), held that royalty paid on the manufacture of goods is not includible in the assessable value of the imported goods in case it is not a condition of sale of imported goods.

• The Tribunal, in CC vs Windia Power Ltd. (2012 -TIOL- 888-CESTAT-MUM), has held that royalty and know-how fees are not includible in the value of imported goods in case they are related to the goods manufactured in India and have no nexus with the imported goods.

• The Madras High Court, in Unit Traders vs CC (2012 (281) ELT 659), has held that the customs authorities can reject the transaction value declared by the importer based on documentary evidence of contemporaneous import unless rebutted by the importer.

Others:

• The Tribunal, in CC vs Mangalam Alloys Ltd (2012-TIOL-737-AHM) held that where there are two

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• The Tribunal, in CC vs Mangalam Alloys Ltd (2012-TIOL-737-AHM) held that where there are two exemption notifications that cover the goods, the importer is entitled to the benefit of the exemption notification which may give him or her higher relief.

• The Tribunal, in Anupam Products Ltd vs CC (2012 (282) ELT 451), held that the importer can file an application for the refund of the excess duty paid inadvertently even in the absence of challenging the assessment order, in case there is no dispute between the importer and the customs authority at the time of clearance of goods.

• In a revision petition filed before the Department of Revenue in the matter of Mahindra and Mahindra Ltd (2012 (283) ELT 313), the government of India held that the duty drawback is not eligible on the export of finished goods when there was unconditional exemption notification on the raw material required for the manufacture of finished goods but the exemption is voluntarily not availed by the exporter.

• In CC vs Palletainer Transport Pvt Ltd (2012-TIOL-1204-CESTAT-BANG), the Tribunal held that splitting the value of equipment artificially into hardware and software in order to claim the benefit of exemption notification amounts to misdeclaration, therefore, liable for confiscation of goods and penal action.

Foreign Trade Policy:

News

• The Central Government may impose restrictions on the import of used capital goods to protect domestic manufacturers.

(Source: Business Standard, New Delhi, dated 9 August, 2012)

Indirect TaxesNotifications/Circulars

• The central government has amended the EPCG Scheme to provide that post export the Scheme shall be available to the exporter only on full payment of applicable duties in cash. Earlier, the payment of applicable duties in cash was not mandatory.

(Notification No. 8/(RE-2012)/2009-14 dated 26 July, 2012)

• The central government has clarified that clubbing of advance authorisation (AA) issued before 31 March 2001 shall be permitted in cases where the application for it is filed by an exporter on or before 31 March 2012 and all applications filed thereafter will not be entertained in terms of the provisions of FTP.

(Circular No. 5 (RE-2012)/2009-14 dated 21 September, 2012)

Case Law

• The government of India, in FCI OEN Connectors Ltd (2012 (281) ELT 750), has held that duty drawback cannot be denied in case goods imported under the EPCG Scheme are re-exported on payment of differential customs duty along with interest.

• In CCE vs Matrix Laboratories Ltd (2012 (281) ELT 569), the Tribunal has held that the duty levied on clearances of goods by the EOU unit to the DTA can be paid through the Cenvat credit account as it is an excise duty and not a customs duty.

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it is an excise duty and not a customs duty.

• The Tribunal, in Shanthi Alloys Pvt Ltd vs CC (2012-TIOL-1016-CESTAT-BANG), has held that the benefits under the duty exemption entitlement certificate (DEEC) scheme is available to a person other than the licensee, only if the transferability of the licence has been endorsed in his or her name by the licensing authority.

• In Vikram Jain vs CC (2012-TIOL-1080-CESTAT-BANG), the Tribunal held that penalty under any specific penal provision cannot be levied in case offence under such provision is not alleged in the show cause notice (SCN).

Foreign Trade Agreements (FTA)

• The central government has amended the rates of customs duty for goods imported under the South Asian Free Trade Agreement (SAFTA) and has also reduced the number of tariff lines in the sensitive list for non-least developed countries.

(Customs Notification No. 48/2012 dated 6 September, 2012)

CENVAT:

Case Laws

Valuation

• In Otis Elevator Co (I) Ltd vs CCE (2012 (280) ELT 531), the Tribunal held that royalty charges for technical assistance in manufacture is includible in the assessable value of excisable goods cleared for captive consumption.

Indirect Taxes• The Supreme Court, in M/s Fiat India Private Limited (2012-TIOL-58-SC-CX), held that selling cars

at a wholesale price less than the cost of production, even if it is to counter the competition in the market, cannot be considered as sale at a normal price. Since, here the ‘transaction value’ is not the sole consideration and the assessing authority was not able to derive value for the extra consideration, there is nothing wrong in their resorting to best judgment assessment and arriving at a value basis cost accountant’s report.

• In CCE vs Indus Fabricons Pvt Ltd (2012 (282) ELT 417), the Tribunal held that two companies cannot be said to be related parties merely because of common shareholders and directors when similar goods are sold to an independent buyer at a comparable price.

• In Oswal Woolen Mills Ltd vs CCE (2012 (282) ELT 547), the Tribunal held that Rule 8 and Rule 9 of the Valuation Rules will not be applicable when goods are sold at the same price to related and unrelated parties.

CENVAT/MODVAT

• In Rana Sugar Ltd vs CCE (2012 (281) ELT 617), the Tribunal held that credit on capital goods cannot be denied on the ground that 98% of the total production is exempted from duty.

• In JSW Steel Ltd vs CCE (2012 (281) ELT 582), the Tribunal held that service tax paid on clearing charges, commission on export sales, material handling charges, terminal handling charges, bank commission charges and aviation charges are eligible for input service credit.

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Others

• In Shri Bajrang Power and Ispat Ltd vs CCE (2012 (282) ELT 108), the Tribunal held that clearance to an SEZ unit shall be treated at par with physical export under Rule 19(2) of the Central Excise Rules, 2002.

Service Tax:

Notification and Circulars

• The Central Board of Excise and Customs (CBEC) has clarified that there is no service tax per se on the amount of foreign currency remitted to India from overseas as this is merely a transaction in money excluded from the definition of ‘service’ effective from 1 July 2012.

(Circular No. 163/14/2012 – ST dated 10 July, 2012)

• The CBEC has clarified on issues emerging post ‘negative list’ regime, regarding the point of taxation and applicable rate of tax in case of the following:

� Continuous supply of services

� Works contract post introduction of new valuation rules

� New reverse charge scheme

(Circular No. 162/13/2012 – ST dated 6 July, 2012)

Indirect Taxes• The CBEC has exempted the services received by the exporter of goods from a foreign commission

agent from so much of service tax as is in excess of the service tax calculated on a value up to 10% of the free on-board value of export goods for which the services were used.

(Notification No. 42/2012 – ST dated 29 June, 2012)

• The CBEC has inserted an explanation to section 66B to replace reference from the erstwhile charging section 66 to new section 66B, an enabling measure to effectively implement the new charging section for levy of service tax under ‘negative list’ regime.

(Service Tax Order No. 2/2012 dated 29 June, 2012)

• The CBEC has issued a draft circular to clarify a number of issues raised post implementation of the negative list in relation to manpower supply or services provided by directors of a company or by the employer to the employees. The draft circular seeks comments and suggestions from all stakeholders.

(Draft Circular dated 27 July, 2012 issued by Tax Research Unit, CBEC)

• In Sinhal Engineering Enterprises vs CCE (2012-TIOL-918-CESTAT-KOL), the Tribunal has held that where the demand of service tax has been set aside by the order of Commissioner (Appeals), penalty cannot be imposed even under the revisionary proceedings initiated by Commissioner.

Case Law:

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Case Law:

• The high court, in CCE (Appeals) vs KVR Construction ([2012] 36 STT 33/22 taxmann.com 408) has held that where the service tax was not payable and was paid by mistake, the department has no authority to retain it and it would be outside the purview of the limitation period prescribed in law for filing refund claim.

SALES TAX:

Case Laws

• The Madras High Court, in the State of Tamilnadu vs. TVL Steel Authority of India Ltd [(2012) VIL 46 Mad], has disallowed the benefit of sale in the course of import under section 5(2) of the CST Act in the absence of an inextricable link between actual sale and import of goods into India. The court observed that an inextricable link was missing in the present case as there was no condition in the sale agreement which prohibited the diversion of goods to any third party after import.

• The Karnataka High Court, in State of Karnataka vs. Khoday India Limited [(2012) 52 VST 204], has held that a sale and lease back transaction executed to raise requisite funds for carrying on the business is in substance a loan transaction not liable to VAT. The court has the power to go behind the documents and determine the nature of the transaction, whatever may be the form of the documents.

• The Madras High Court, in Emerald Stone Export vs Assistant Commissioner [(2012) 52 VST 286 (Mad)], has held that the last sale preceding the export of goods outside India will be a sale in the course of export and therefore eligible for VAT benefits in the nature of input credits and refunds as available to zero-rated sales.

•

Indirect Taxes• The Andhra Pradesh High Court, in Bharat Heavy Electricals Limited vs the Commercial Tax Officer

[(2012) VIL 53-AP], has held that the contractor is eligible to claim refund of WCT-TDS, wrongly deducted and deposited by the contractee, on pure labour and service contracts not involving any transfer of property in goods.

• The Haryana Tax Tribunal, in Maruti Udyog Ltd vs State of Haryana (2012-43-PHT-48 (HTT-FB)), held that input tax credit is not allowable on the petrol or diesel filled in new vehicles at the time of assembling, testing, transportation and ultimate sale of vehicles to dealers. The diesel or petrol filled in new vehicles is neither used in the process of manufacture of vehicles nor is it resold. The value of the petrol or diesel is not included in the tax invoices for the sale of vehicles. Accordingly, no ITC is eligible on purchase of such petrol or diesel.

VAT:

Notifications/Circulars

Delhi

Filing of online declaration of tax rate wise details of closing stock as on 31 March has been made mandatory for all dealers. The due date for filing the declaration is 30 June of the relevant year. However, information pertaining to stock as on 31 March 2012 has to be furnished online by 31 October 2012.

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October 2012.

Notification No. F.7/433/Policy-II/ VAT/2012/472-483 dated 16 August, 2012)

Karnataka

The VAT rate slabs of 5 and 14% have been increased to 5.5 and 14.5% respectively effective from 1 August 2012.

(Karnataka Value Added Tax (Second Amendment) Act, 2012)

Tamil Nadu

A facility for online generation of Form C & Form F from the Commercial Tax Department website has been introduced in Tamil Nadu.

(Notification No. SRO A-20(a-1)/2012 dated 10 August, 2012)

Uttar Pradesh

VAT rate in UP has been increased from 13.50% to 14% w.e.f September 08, 2012 .

[Notification No.- KA.NI.-2-898/XI-9(1)/08-U.P.Act-5-2008-Order-(82)-2012 dated September 07, 2012]

Punjab

The VAT rate slabs have been increased from 5 and 12.5% to 5.5 and 13% on scheduled and residuary goods respectively. The rate of tax on declared goods has also been increased from 4 to 4.5% with effect from September 3 2012. The increased rates are also subject to additional tax at the rate of 10% as was

Indirect Taxesapplicable to the earlier rates.

[Public Notice dated September 03, 2012]

Entry Tax

Punjab

The entry Tax rate on specified goods has been increased by 0.50% effective from 18 September, 2012

(Public Notice dated 18 September, 2012)

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Indraneel Roy Choudhary

The report has been prepared by us solely for purpose of Toyota Motor

Asia Pacific Pte. Ltd., Singapore and parties listed under Schedule I of

the Engagement Letter and should not be shared with any third party.

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

Further, the information based on our interaction with the Government

officials is subject to change upon further deliberations and

discussions. It is recommended that cognizance of this information be

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

issue of official notification by the Government.

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