FOUNDER EDITOR U.K. Bhargava EDITOR Rakesh Bhargava COORDINATING EDITOR Hariom Jindal (CA) EDITORIAL BOARD AL Meghji OSLER, Canada Diane Hay Advisor PwC UK Jeffrey Owens Head TPA, OECD Mukesh Butani BMR Advisor India Rahul Garg PwC India Rashmin Sanghvi (CA) India Roger D. Wheeler Consultant KPMG, USA Roy Rohtagi (Prof.) FORTHCOMING ISSUE FIT India Shanto Ghosh (Dr.) Deloitte, India n Opportunities Abound in Canadian Capital Markets - A Case for Indian entrepreneurs Uday Ved Krstina Skocic, Manoj Pundit and Elinore Richardson, Borden Ladner KPMG India Gervais LLP, Canada EDITORIAL Taxmann Allied Services (P.) Ltd., AND SUBSCRIPTION 59/32, New Rohtak Road, n Comparability Adjustments – Some Issues New Delhi-110 005 (India) Manoj Pardasani and Bhavesh Dedhia , BSR & Co., India Phones : +91-11-45562222 Fax : +91-11-45562223 n Taxation of Designs & Drawings [email protected] Amit Aggarwal, Chartered Accountant http//www.taxmann.com n Delhi Tribunal reiterates that arm’s length remuneration to Material published in this part is the exclusive copyrighted property of Indian agent extinguishes liability of foreign principal Taxmann Allied Services (P.) Ltd. and cannot be reproduced or copied in Anshu Khanna, Director, Deloitte India any form or by any means without written permission of the Publisher. Editors do not necessarily agree with the views expressed by authors of n An overview of Expatriate Tax and Compliance Require- articles/features. Views so expressed are the personal views of author(s). ments in India This publication is sold with the understanding that authors/editors and Parizad Sirwalla and Nishit Kapadia, BSR & Co., India publishers are not responsible for the result of any action taken on the basis of this work nor for any error or omission to any person, whether a FEATURES purchaser of this publication or not. All disputes are subject to jurisdiction of the Delhi High Court. PRINTED AND PUBLISHED BY Amit Bhargava on behalf of Taxmann o U.S. Update by Charles W. Cope, Principal, KPMG LLP Allied Services (P.) Ltd. and Printed at Tan Prints (India) Pvt. Ltd., 44 Km. Mile Stone, National Highway, Rohtak Road, Village Rohad, Distt. Jhajjar, Haryana (India) and Published at 59/32, New Rohtak Road, New Delhi- o U.K. Update by PwC London 110 005 (India). EDITOR : Rakesh Bhargava International Taxation comes in three Volumes, Annual subscription from o Transfer Pricing : Query Point by Manoj Pardasani January - December 2010 is Rs. 6500 (US $ 325). Single copy Rs. 700 only. International Taxation is published on every 15th of the month. Non- o EU update by Maarten F. Koper receipt of part must be notified within 60 days of the due date.

MODE OF CITATION [2010] 2 ILT. . . PLUS TOTAL PAGES INCLUDING COVER 136 o Landmark Rulings

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 1 i Hariom Jindal

Simplicity is one of the basic principles of taxation, but it is becoming a part of history. Collection of taxes is the duty of the Government which is, nowadays, a thankless job for citizen. Withholding tax on payments to non-residents is becoming burdensome affair for the Indian corporates and other assessees. Even a bona fide mistake can be dangerous. One of the consequences of default results in disallowance of payment even though the foreign payee pays the Indian taxes directly. In the previous issue, we have discussed the different options before the payers on withholding tax front. In this issue also, we have covered this subject in more detail. Recently, the Chennai Special Bench of Tribunal in the case of Prasad Productions Ltd., held that when the person liable for payment to a non-resident has a bona fide belief that the payment is not chargeable to tax in India, the procedures prescribed under section 195 dealing with withholding tax or mitigation thereof are not necessary to be followed. Before this decision, in the case of Van Oord ACZ India (P) Ltd., the Delhi High Court had also held that the obligation to deduct tax at source is attracted only when the payment is chargeable to tax in India, however, if the payee considers that whole of the said sum would not be income chargeable in the case of the recipient, he may move an application to the Assessing Officer to determine this aspect. After the controversial decision of the Karnataka High Court in the case of Samsung Electronics, these decisions have provided some relief to the Indian corporates and

ii INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 2 FROM THE EDITOR’S DESK other assessees making foreign payments. As the issue is very important, we have invited three articles on the subject from three eminent tax experts. Mr. S. P. Singh, with Sharad Goyal from Deloitte India and Mr. Freddy R. Daruwala from Juris Corp, Mumbai have analysed all these decisions in a very lucid manner. Mr. D. P. Mittal, a renowned author on international taxation and transfer pricing, has also given his valuable thoughts on the concept of withholding tax and tax deduction at source. In one article, Mr. Rashmin Sanghvi has discussed about the Hon’ble Supreme Court’s decision in Chettiar’s case [267 ITR 654] in the context of taxability of foreign income in India. According to the learned author, with respect this decision is not correct. In a very important paper on treaty-shopping, Professor Reuven Avi-Yonah and Dr. Christiana HJI Panayi, have reassessed the traditional quasi-definitions of treaty- shopping in an attempt to delineate the contours of such practices. The learned authors have examined the various theoretical arguments advanced to justify the campaign against treaty-shopping and assess the extent to which these concerns are addressed by the OECD and the US Model. They have also considered the current trends in treaty-shopping and the anti-treaty-shopping policies under the OECD Model and the US Model. Finally, they have examined the possible implications of European Union law on the treaty-shopping debate. Marc M. Levey and Monique van Herksen have written an article on Marketing Intangibles. According to the learned authors, the concept of ‘marketing intangibles’ has developed itself as the new frontier for transfer pricing. Marketing intangibles find themselves near or beyond the boundary established by the definition of ‘services’ and that traditionally reserved for intangibles. Accounting for marketing intangibles is complex and becomes more so when the taxpayer fails to properly document as much as possible the nature of these intangibles, their ownership costs and other factors contributing to the value of these intangibles. Thus, we have covered three very important issues of international taxation, i.e., treaty-shopping, transfer pricing and withholding tax. We think that no other topic can be more important in the international taxation except these topics. I hope you will find these articles useful and interesting. We have also covered our regular updates on Indian and international taxation. We are planning special issues on transfer pricing, GAAR and withholding taxes provisions in different countries. I am expecting some very good articles for these issues. Feel free to mail your suggestions and feedback to [email protected]

(HARIOM JINDAL)

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 3 iii C O N T E N T S

MAY 2010

TAX TREATIES 40 UK Tax Update – DIANE HAY 1 Rethinking Treaty-Shopping: Lessons for the European Union 43 EU Tax Update – PROFESSOR REUVEN AVI-YONAH – MAARTEN F. KOPER – DR. CHRISTIANA HJI PANAYI BASIC CONCEPTS TRANSFER PRICING 51 Foreign Income – Taxability in India 21 The New Frontier: Marketing Intangibles – RASHMIN SANGHVI – MARC M. LEVEY – MONIQUE VAN HERKSEN TAX DEDUCTED AT SOURCE 75 Your Queries 54 Withholding Tax on Payments made to Non- – MANOJ PARDASANI residents – FREDDY R DARUWALA INTERNATIONAL SCENARIO 62 Withholding Tax and Tax deduction at source 31 World Tax Review - Two different concepts and obligations – ROGER D. WHEELER – D. P. MITTAL

35 Review of Significant U.S. Tax Developments 65 TDS on payments to non-residents: – CHARLES W. COPE “Playground of Controversies” – S. P. SINGH – SHARAD GOYAL

iv INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 4 CONTENTS

LANDMARK RULINGS 95 Section 44BB v. Section 44DA - Wavefield Inseis ASA, In re (AAR No. 884 of 2009, dated March 5, 77 MULTIPLE CONTRACTS v. MULTIPLE PEs - [Asstt. 2010)/[2010] 3 taxmann.com 21 (AAR - New Delhi) DIT (International Taxation) v. Valentine Maritime (Mauritius) Ltd. (ITA No.1532 of 2005, dated April 98 BENEFICIAL OWNERSHIP CONCEPT IN TREATY 5, 2010)]/[2010] 3 taxmann.com 92 (Mum. - Trib.) INTERPRETATION - KSPG Netherlands Holding B.V., In re [2010] 189 Taxman 357 (AAR - New Delhi) 83 AGENCY PE UNDER INDO-GERMANY DTA - Dy. DIT (Int’l Taxation) v. Daimler Chrysler A. G. [ITA No. 101 TRANSFER PRICING – COMPARABLES - Intervet 9211 of 2004, dated March 31, 2010]/[2010] 3 India Pvt. Ltd. v. Asstt. CIT (ITA No. 2845 of 2006, taxmann.com 102 (Mum. - ITAT) dated March 31, 2010)/[2010] 3 taxmann.com 101 (Mum. - ITAT) 87 ‘MAKE AVAILABLE’ CONCEPT UNDER INDO – UK TREATY - Real Resourcing Ltd., In re [A.A.R. No. 105 TRANSFER PRICING – COMPARABLES - Global 828 of 2009, dated March 5, 2010]/[2010] 3 Vantedge P. Ltd. v. Dy. CIT [2010] 37 SOT 1 (Delhi taxmann.com 19 (AAR - New Delhi) - Trib.)

91 ‘MAKE AVAILABLE’ CONCEPT UNDER INDO – USA 108 CHENNAI SPECIAL BENCH PROVIDED FURTHER TREATY - Federation of Indian Chambers of RELIEF ON WITHHOLDING TAX FRONT - ITO v. Commerce and Industry (FICCI), In re [2010] 189 Prasad Productions Ltd. [ITA No. 663 of 2003]/ Taxman 270 (AAR - New Delhi) [2010] 3 taxmann.com 70 (Chennai - ITAT)

113 JUDICIAL SNIPPETS

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 5 v NEWS In Brief

FINANCE BILL PASSED WITH SOME TAX is converted into a limited liability partnership, RELIEF the amended Bill proposed tax exemption for the transfer of shares during the conversion. www.livemint.com, dated 1-5-2010 - The Union Housing projects, which come up as a part of Budget for 2010-11 was cleared on 29th April, Central and State Governments’ slum-development with the Parliament passing the Finance Bill scheme, would qualify for investment-linked after amendments to provide marginal direct deduction, Mukherjee said. Other tax proposals and indirect tax concessions to sectors such as from the Budget, which saw the construction healthcare and construction. Finance Minister and aviation industries lobby for a revision, Pranab Mukherjee, replying to the debate on were retained or partially rolled back. Mukherjee the Bill, turned down demands from the Opposition marginally lowered the effective rate of tax relating to roll back indirect tax hikes for crude oil and to service tax provisions that were extended to related products—announced when he presented the construction sector in the Budget. Service the Budget on 26 February—saying they were tax on air travel was retained, but the tax levied crucial to keep fiscal deficit under check. “As will not be on a percentage basis. The maximum was expected, there are minimal changes to the tax on domestic air tickets would be limited to Finance Bill in the course of its passage into the Rs. 100 and, in case of international air travel, Finance Act,” said Dinesh Kanabar, Deputy Chief the tax would be capped at Rs. 500. Paper, Executive and Chairman, tax, KPMG. The amended tobacco and drugs were some sectors that got Bill extended direct tax benefits for building marginal concessions in indirect taxes. In the hospitals with at least 100 beds to the whole case of export of iron ore lumps, export duty country due to “the pressing need for more was enhanced by five percentage points to 15 hospitals”. Earlier, the benefits were not available percent. The increase in export duty will not to hospitals built in metros such as New Delhi have a significant impact on the industry as 90 and Mumbai. “This is a welcome move and a percent of iron ore exports consist of iron ore very positive development for the healthcare fines, said a steel analyst, who did not want to industry. It will contribute to the creation of be named. The increase may be more of a revenue much-needed infrastructure in the country,” said enhancement measure than a serious attempt to Shivinder Mohan Singh, Managing Director, Fortis restrict iron ore exports, the analyst said. Mukherjee Healthcare Ltd. Mukherjee announced a debt did not disclose the revenue implications of the relief package of Rs. 241.33 crore for coffee amendments. growers. To retain tax neutrality when a company

vi INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 6 NEWS In Brief

TAX BILL IN MONSOON SESSION inflows. However, at the moment, the country is not contemplating any such move, according www.thehindubusinessline.com, dated 29-4-2010 to the RBI Governor, Dr. D. Subbarao. “We - The Government is likely to place in the public have not so far imposed a Tobin-type tax nor domain by next month a revised discussion paper are we contemplating one. However, it needs on the proposed Direct Taxes Code (DTC). After reiterating that no policy instrument is clearly a quick round of consultations with some of the off the table and our choice of instruments will major stakeholders, the draft legislation (Bill) be determined by the context,” said Dr. Subbarao. on DTC will be introduced in the Parliament His comments come amid concerns that large in the Monsoon Session, the Finance Minister, capital inflows into the country are fuelling Mr. Pranab Mukherjee, told the Lok Sabha here. asset prices and are leading to appreciation of He also reiterated the Government’s commitment the rupee. The equity market also has been to usher in comprehensive tax reform through witnessing sharp upswing in prices. the introduction of DTC as well as the Goods and Services Tax (GST). The Centre has already indicated its intent to introduce GST from April 1, 2011. NEW ‘TOOL BOX’ TO COUNTER OPAQUE TAX HAVENS

TRIP TO TAX HAVENS IN GOVT. www.financialexpress.com, dated 27-4-2010 - In a significant move that will eventually help CROSSHAIRS the Government seek information from tax havens, www.economictimes.indiatimes.com, dated the revenue department in the Finance Ministry 28-4-2010 - As a rule, the Swiss Alps and sunsoaked has started the process of defining non-cooperative beaches of Cayman Islands make it to a tourist’s jurisdictions — countries that do not share any bucket list. Now, they also happened to have information about companies evading tax in made it to another list — the taxman’s — by India. Government sources told The Indian Express virtue of being tax havens. The income-tax that the Finance Ministry has formed a five- department is keeping a tight vigil on Indians, member committee for defining the characteristics notably the ones suspected of owning bank of such a jurisdiction and then prepare a list accounts, visiting tax paradises such as Switzerland, of countries that would qualify as a non-cooperative Cayman Islands, Mauritius and the Bahamas, as jurisdiction. The committee would have to do it amplifies efforts to trace tax evasion and slush a delicate balancing act as the issue is not only funds tucked away abroad. The tax department’s financial but also political, the sources said. investigation directorates have been asked to collect information on Indians visiting tax havens, junior Finance Minister SS Palanimanickam replied SARAL-II MAKES DEBUT; FILING IT RE- to a query in the Rajya Sabha on Tuesday. TURNS TO GET EASIER Besides peering into the itineraries of passengers from airlines, the Government is also stationing www.pti.com, dated 27-4-2010 - The Finance tax officials in these destinations to keep a watch Ministry has come out with ‘Saral-II’, the new on Indians. Taxpayers will have to also declare income-tax returns form, that seeks to make tax details of their foreign travels while filing returns. filing easy for the assessee and to gather information on TDS paid on salary and interest. The Saral-II, a two-page form, was mentioned INDIA OPEN TO USING TOBIN-TYPE TAX TO by the Finance Minister Pranab Mukherjee in CURB CAPITAL INFLOWS his Budget speech for 2010-11. “This form will enable individuals to enter relevant details in www.thehindubusinessline.com, dated 28-4-2010 a simple format in only two pages,” he had - India will not be averse to using an instrument said. Besides the usual columns to elicit details such as Tobin Tax to curb excessive capital of income chargeable under the head salaries

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 7 vii NEWS In Brief

and pension, house property and other sources in India, as depending on the character of income for calculating gross income, the form also includes (royalty, fee from technical services and the like columns to furnish details of Advance Tax and in addition to normal business income), tax could Self-Assessment Tax Payments and transactions now be levied at comparatively low rates of 10- reported through Annual Information Return. 20%. In contrast, the effective tax liability of an The form can be downloaded from income-tax ‘association of persons’ could be as high as 42% department’s website incometaxindia.gov.in. on the whole income, if the lead partner is a foreign firm. The ruling came in the case of a consortium bidding for a Delhi Metro Rail CAs, CSs TOLD TO REPORT ALL SUSPI- Corporation (DMRC) project. The AAR said that the firms in the consortium would be taxed as CIOUS FUND TRANSFERS separate taxable entities. The tax rate could vary www.economictimes.indiatimes.com, dated for each partner, depending on the character of 24-4-2010 - The Government has asked chartered its incomes. Certain kinds of income could even accountants, cost accountants and company be exempt. So, effectively, getting taxed as an secretaries to directly report to the Home Ministry, independent taxable entity would mean a lower cases of suspicious fund movements in and out tax liability in many cases, besides clarity on of companies, as it looks forward to crack down taxation for firms coming together to take up on money laundering and terror funding. The a project in India. Home Ministry, through the Ministry of Corporate Affairs, has asked the Institute of Chartered Accountants of India (ICAI), Institute of Company TAX: REVISED OECD-COUNCIL OF EUROPE Secretaries of India (ICSI) and the Institute of TREATY WILL BOOST MULTILATERAL Cost and Works Accountants of India (ICWAI) to ensure that their members report any instance COOPERATION of diversion of funds directly without any www.oecd.org, dated 6-4-2010 - The OECD and procedural formalities. “If any suspicious fund the Council of Europe have agreed on an update movement comes to the notice of the professionals, to an international treaty that aims to help details of it along with full particulars of its Governments enforce their tax laws, as part of clients should be reported within 24 hours,” the worldwide drive to combat cross-border tax said a senior Government official. evasion.The update takes the form of a protocol amending the Convention on Mutual Administrative Assistance in Tax Matters for which TAX OUTGO DOWN FOR FOREIGN COs the two multilateral organisations are the custodians. [Its effect is to align the convention www.financialexpress.com, dated 6-4-2010 - The to the international standard on information tax liability of foreign investors who bid for exchange for tax purposes by allowing for the infrastructure projects as consortium partners exchange of bank information.] The Protocol will could come down substantially, with a tax be opened for signature on the occasion of the authority’s ruling that these firms would be OECD’s annual Ministerial Meeting in Paris on taxed individually, not at the consortium level. 27-28 May. This initiative responds to a call by The Authority for Advance Ruling’s (AAR) order, G20 leaders at their April 2009 summit for which many tax experts termed as landmark, proposals as to ways to help developing countries would effectively mean that in most cases, foreign secure the benefits of the new cooperative tax entities in such partnerships would pay much environment. U.K. Prime Minister Gordon Brown, less tax than what they would have paid as as chair of the G20, indicated that “it would be ‘association of persons’, which is how a consortium helpful, in this regard, if an effective multilateral is defined in the tax law. Experts feel that the mechanism could be developed”. order is positive for the firms bidding for contracts

viii INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 8 NEWS In Brief

Tax Indirect tax collection in FY10 at Rs 2.44 trillion – www.livemint.com, Education loan tax sops extended to all streams – www.economictimes.indiatimes.com New tax norm may spook PE Party – www.livemint.com SEBI tightens norms for FIIS – www.business-standard.com ‘Don’t apply new tax code on SEZs’ – www.economictimes.indiatimes.com IPL probe confined to taxation aspects of transactions: CBDT – www.thehindubusinessline.com ECO-Tax should not spoil simplicity of GST – www.business-standard.com CAG pulls up I-T Deptt. for decreasing tax base – www.economictimes.indiatimes.com I-T Department surveys IPL sponsors, owners – www.thehindubusinessline.com ICAI recommends action against erring audit firms: Govt. www.economictimes.indiatimes.com Holding COS will now come under new RBI regulations – www.economictimes.indiatimes.com Tax authorities launch three-pronged probe – www.business-standard.com Economy: innovation and pro-green policies offer new sources of growth – www.oecd.org Finland : Fiscal consolidation key to restoring growth – www.oecd.org Poland : Ensuring balanced growth and preparing for euro adoption key challenges ahead – www.oecd.org Aid : Development aid rose in 2009 and most donors will meet 2010 aid targets – www.oecd.org Growth seen easing back slightly in US, Europe and Japan in first half of 2010 – www.oecd.org China still No. 1 foreign holder of Treasury debt – www.economictimes.indiatimes.com FBI probing Goldman for criminal case – www.economictimes.indiatimes.com US calls level of China copyright theft ‘unacceptable’ – www.economictimes.indiatimes.com Greece’s survival at stake: PM George Papandreou – www.economictimes.indiatimes.com China says banks face property, Government risks – www.economictimes.indiatimes.com US starts criminal probe into Goldman: – Source www.economictimes.indiatimes.com Industry hails tax concession on construction – www.business-standard.com Input tax credit ruling baffles BPOs – www.economictimes.indiatimes.com CBDT panel mulls retaining gross-assets based MAT – www.business-standard.com UK’s Brown vows anti-India M&A laws – www.financialexpress.com I-T Deptt. to issue letter rogatory to Swiss Govt. – www.economictimes.indiatimes.com Tax benefits for Indian seafarers in for review – www.thehindubusinessline.com CBDT moves to hasten resolution of tax cases – www.thehindubusinessline.com CBDT wants jail term for tax evaders – www.economictimes.indiatimes.com Foreign COs to seek tax clarity on investments via mauritius – www.economictimes.indiatimes.com Tax implications of IFRS convergence being studied – www.thehindubusinessline.com Survey of trends and developments in the use of electronic services for taxpayer service delivery OECD releases discussion draft on the application of Article 17 (Artistes and Sportsmen) of the OECD Model Tax Convention - www.oecd.org, dated 23-4-2010 Corruption: OECD’s Gurría welcomes passage into law of UK Bribery Bill - www.oecd.org, dated 8-4-2010

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 9 ix NEWS In Brief

INDIA - US: A COMPARATIVE STUDY OF INCOME-TAX RETURNS FILED

INDIA

e-FILING OF RETURNS

From Returns Recd. Returns Recd. % Change From Type From 1-4-2009 To 31-3-2010 From 1-4-2009 To L.y 31-3-2010 Total A.y. 08-09 (Incl. of A.y.07-08) A.y. 09-10 A.y. 08-09 A.y. 07-08

ITR-1 6,79,365 34,370 7,13,735 5,80,034 23.05%

ITR-2 9,12,940 76,544 9,89,484 8,73,483 13.28%

ITR-3 1,98,395 17,137 215,532 2,07,709 3.77%

ITR-4 20,50,879 2,51,327 23,02,206 21,92,419 5.01%

ITR-5 4,98,460 24,556 5,23,016 5,07,626 3.03%

ITR-6 4,72,409 35,439 5,07,848 4,68,851 8.32%

ITR-8 804 146 950 1,179 -19.42%

TOTAL 48,13,252 4,39,519 52,52,771 48,31,301 8.72%

ITR 7 (for not for profit Trusts) has not been Notified for e-Filing

TOTAL RETURNS RECEIVED ON LAST 3 DAYS

DATE RETURNS RECEIVED

29/03/2010 91,850

30/03/2010 1,51,666

31/03/2010 2,69,547

HIGHEST RETURNS RECD. PER HOUR 23,787 HIGHEST RETURNS RECD. PER MINUTE 445 RETURN RECD. FROM VOLUNTARY CATEGORY 79.81%

x INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 10 NEWS In Brief

US

2010 FILING SEASON STATISTICS CUMULATIVE THROUGH THE WEEKS ENDING 04/10/09 AND 04/09/10 Individual Income 2009 2010 % Change Tax Returns

Total Receipts 101,892,000 98,802,000 -3.0% Total Processed 97,425,000 93,193,000 -4.3%

E-filing Receipts: TOTAL77,003,000 77,395,000 0.5% Tax Professionals 51,169,000 50,070,000 -2.1% Self-prepared 25,834,000 27,325,000 5.8%

Web Usage: Visits to IRS.gov 167,850,189 163,678,440 -2.5

Total Refunds: Number 83,642,000 79,705,000 -4.7% Amount $225.351 Billion $234.306Billion 4.0% Average refund $2,694 $2,940 9.1%

Direct Deposit Refunds: Number 61,622,000 61,428,000 -0.3% Amount $182.766Billion $194.813Billion 6.6% Average refund $2,966 $3,171 6.9%

CUMULATIVE THROUGH THE WEEKS ENDING 04/03/09 AND 04/02/10

Individual Income 2009 2010 % Change Tax Returns

Total Receipts 92,292,000 89,970,000 -2.5% Total Processed 89,215,000 85,210,000 -4.5%

E-filing Receipts: TOTAL70,907,000 71,628,000 1.0% Tax Professionals 46,861,000 45,981,000 -1.9% Self-prepared 24,046,000 25,647,000 6.7%

Web Usage: Visits to IRS.gov 156,825,000 152,055,000 -3.0

Total Refunds: Number 77,720,000 74,115,000 -4.6% Amount $210.243Billion $219.368Billion 4.3% Average refund $2,705 $2,960 9.4%

Direct Deposit Refunds: Number 58,294,000 58,137,000 -0.8% Amount $173.408Billion $185.239Billion 6.8% Average refund $2,975 $3,186 7.1%

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 11 xi NEWS In Brief

CUMULATIVE THROUGH THE WEEKS ENDING 03/27/09 AND 03/26/10

Individual Income 2009 2010 % Change Tax Returns

Total Receipts 84,586,000 82,533,000 -2.4% Total Processed 81,970,000 77,800,000 -5.1%

E-filing Receipts: TOTAL 65,932,000 66,542,000 0.9% Tax Professionals 44,667,000 43,790,000 -2.0% Self-prepared 22,603,000 24,188,000 7.0%

Web Usage: Visits to IRS.gov 146,427,000 142,109,000 -3.0

Total Refunds: Number 72,290,000 68,587,000 -5.1% Amount $196.563Billion $204.260Billion 3.9% Average refund $2,719 $2,978 9.5%

Direct Deposit Refunds: Number 55,203,000 54,738,000 -0.8% Amount $164.658Billion $175.038Billion 6.3% Average refund $2,983 $3,198 7.2%

xii INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 12 TAX TREATIES

Rethinking Treaty-Shopping: Lessons for the European Union

Professor Reuven Avi-Yonah* and Dr. Christiana HJI Panayi**

n this paper, we reassess the traditional quasi-definitions of treaty- I shopping in an attempt to delineate the contours of such practices. We examine the various theoretical arguments advanced to justify the campaign against treaty-shopping and we assess the extent to which these concerns are addressed by the OECD and the US Model. We also consider the current trends in treaty-shopping and the anti-treaty- shopping policies under the OECD Model and the US Model. We focus on recent cases on beneficial ownership. Finally, we examine the possible implications of European Union law on the treaty-shopping debate. Professor Reuven Avi-Yonah I. INTRODUCTION Whilst treaty-shopping is not a new phenomenon, it remains as controversial as ever. It would seem that the more jurisdictions try to deal with it, the wider the disagreements as to what is improper treaty-shopping and what is legitimate tax planning. In this paper, we reassess the traditional quasi-definitions of treaty-shopping in an attempt to delineate the contours of such practices. We examine the various theoretical arguments advanced to justify the campaign against treaty-shopping. Dr. Christiana HJI Panayi

* Reuven S. Avi-Yonah, the Irwin I. Cohn Professor of Law and director of the International Tax LL.M. Program, specializes in corporate and international taxation, and is widely published in these subject areas. He also served as consultant to the U.S. Treasury and to the OECD on tax competition, and has testified numerous times before Congressional committees on corporate and international tax issues. ** Christiana is a lecturer in Tax Law at Queen Mary, University of London and a researcher at the Institute for Fiscal Studies. She is also a solicitor of England & Wales and an advocate of the Cyprus Supreme Court.

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We also consider the current trends in treaty- from accessing the benefits of a Convention shopping and the anti-treaty-shopping policies through the use of an entity that would otherwise under the OECD Model and the US Model. We qualify as a resident of one of these States”.6 focus on recent cases on beneficial ownership. Treaty-shopping features in a similarly elusive Finally, we examine the possible implications of way in the new Technical Explanation to the European Union law on the treaty-shopping debate. 2006 US Model.7 The term ‘treaty-shopping’ is II. TREATY-SHOPPING AND IMPROPER USE OF used in the Technical Explanation when describing TAX TREATIES the function of anti-treaty-shopping provisions.8 The new Technical Explanation to the Limitation II.1. Finding the contours of treaty-shopping on Benefits clause found in Article 22 states that The term ‘treaty-shopping’ is thought to have this Article “contains anti-treaty-shopping originated in the US. The analogy was drawn provisions that are intended to prevent residents with the term ‘forum shopping’, which described of third countries from benefiting from what is the situation in US civil procedure whereby a intended to be a reciprocal agreement between litigant tried to ‘shop’ between jurisdictions in two countries”. which he expected a more favourable decision If one looks at the quasi-definitions of treaty- to be rendered.1 David Rosenbloom, who served shopping, what one notes is that the term treaty- as International Tax Counsel in the US Treasury shopping, as used, may encompass a broad Department during 1977-1981, described the spectrum of structures, ranging from the purely phenomenon as “the practice of some investors abusive and artificial ones to others with more of ‘borrowing’ a tax treaty by forming an entity substance. However, are all these instances of (usually a corporation) in a country having a improper use of tax treaties? The OECD favourable tax treaty with the country of source Commentary seems to perpetuate this confusion. – that is, the country where the investment is The descriptions given in paragraphs 9 and 20 to be made and the income in question is to be of the OECD Commentary to Article 1 would earned”.2 In other words, a person ‘shops’ into seem to catch general forms of treaty-shopping; an otherwise unavailable treaty through complicated i.e. treaty-shopping without tax haven or conduit structures; hence the term treaty-shopping.3 connotations. However, the examples given in The term ‘treaty-shopping’ has never featured paragraph 11 of the Commentary would seem in any versions of the OECD Model. Nor has to catch treaty-shopping of a more specific and it been properly defined or explained in the abusive nature; i.e. treaty-shopping through OECD Commentary. Rather, the emphasis is conduits and/or base companies. always on eliminating treaty-shopping and the Therefore, there are the two obvious ends of the measures that can be taken against it. Most of spectrum: treaty-shopping through conduits and the references to treaty-shopping are references bona fide commercial structures. The typical scenario by default; i.e. when discussing anti-treaty- of treaty-shopping through conduits, as also shopping provisions. For example, references to described in the OECD Conduit Companies Report, the “problem commonly referred to as ‘treaty- is the following: shopping’”4 are made for the first time in the OECD Commentary on Article 1, when discussing A holding Company R would be organised in Limitation of Benefits (LOB) provisions and how a State R that has beneficial tax provisions both these provisions are meant “to address the issue with a State S where a subsidiary Company S [of treaty-shopping] in a comprehensive way”.5 is located and with a State P where its parent A description of treaty-shopping is given indirectly Company P is located. Company R would typically and in very general terms. It is stated that be controlled by Company P and Company S Limitation of Benefits provisions are there to would itself be controlled by Company R. address treaty-shopping. Then it is stated that If the income from Company S is paid directly LOB provisions are “aimed at preventing persons to Company P, it is subject to State S withholding who are not residents of either Contracting States tax with very little (if any) treaty benefits. The

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State S

Company S No P-S benefits, restricted benefits under tax treaty S/P Treaty reduces or eliminates State S withholding taxes

No domestic State P tax in State R State R on Company R due to special Company P tax regime Treaty reduces or eliminates State R Company R withholding taxes

income to Company P is, however, tax-exempt could be imbued by different degrees of artificiality. (or receives beneficial tax treatment) if channelled The intermediary company could be a complete through Company R. This may be, if the income sham or could have some de minimis economic is in the form of dividends, by virtue of a substance or the arrangement could be a bona parent-subsidiary regime under the domestic fide commercial nature.10 Surely, not all instances law of State R or a participation exemption or of third country residents benefiting from tax due to a convention between States S and R. treaties to which their own countries are not This is the obvious case where there is minimal privy are examples of improper use. or zero other activity. Whilst one may more readily distinguish a complete Therefore, treaty-shopping of a clearly improper sham from a bona fide commercial arrangement nature would entail the following: - not always easy, as it depends on the jurisdictional perspectives on tax planning - the disputes (and (1) the beneficial owner (Company P) of the litigation) usually relate to the borderline cases. treaty-shopping entity (Company S) does Successive Models and Commentaries have done not reside in the country where the entity little to clarify the confusion. In fact, they seem is created; to perpetuate it. This may be deliberate. It is (2) the interposed company (Company R) has certainly to the advantage of the tax authorities minimal economic activity in the jurisdic- to have discretion to determine on an ad hoc tion in which it is located; and basis what is improper treaty-shopping and what is legitimate tax planning. (3) the income is subject to minimal (if any) tax in the country of residence of the in- It also seems that the traditional theoretical terposed company. objections to treaty-shopping do not make a more convincing case. Nor are they targeted There could be many variations of this structure. against wholly artificial arrangements. This has For example, it may be possible to use more important implications on how treaty-shopping than one tax treaty and move the funds through is tackled in various jurisdictions. several countries, in the process of which, the funds may change their character (e.g. dividends II.2. Theoretical objections to treaty-shopping transformed to interest).9 Treaty-shopping is, arguably, an instrument of However, as already mentioned, this is only one international tax planning. What is it about this end of the spectrum. A treaty-shopping structure kind of tax planning that makes it objectionable?

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A number of arguments have been advanced in benefits of the given treaty are abused, the level the international tax community.11 and balance of these flows are distorted, with a resulting distortion in the share of the relevant Firstly, it has been argued that treaty-shopping chargeable income channelled to each State. Treaty- is an instance of tax avoidance and as such shopping expands the normal bilateral relationship improper and contrary to the purposes of tax of the treaty. A generous treaty with one trading treaties. partner becomes a treaty with the world.18 This It has also been argued that treaty-shopping de facto multilateralisation of the tax treaty is breaches the reciprocity of a treaty and alters thought to entail a large and indeterminate cost the balance of concessions attained therein between to the source country.19 the two contracting States.12 When a third country As for the first argument, it is never an easy resident ‘shops’ into a treaty, then the treaty task to distinguish between (international) tax concessions are extended to a resident, whose avoidance and legitimate tax planning. What is State has not participated in this arrangement it about treaty-shopping that makes it an instance and may not reciprocate with corresponding of the former rather than the latter? Why is it benefits (e.g. exchange of information). The usual assumed that all forms of treaty-shopping, quid pro quo of the treaty is therefore compromised irrespective of their degree of artificiality, constitute and the process subverted. tax avoidance? Another argument is based on the principle of As already mentioned, not all treaty-shopping economic allegiance. Pursuant to economic structures can be characterised as artificial and allegiance, a taxable base is attributable to the devoid of economic substance. The term ‘treaty- jurisdiction in which it is thought to owe its shopping’, applied generically, may encompass economic existence. Tax treaties are premised a variety of structures. It could encompass on the allocation of taxing rights according to structures in which the intermediary company this principle. Treaty concessions are of a personal imposed is a pure conduit with no economic nature and are not to be extended to third substance whatsoever, completely owned and country residents. As a result of treaty-shopping, controlled by the parent company and based the third country gains revenue power, absent in a notorious conduit location or tax haven. of any (substantial) claim to economic allegiance.13 However, this is only one end of the spectrum. Furthermore, it is often claimed that treaty- There is also the other end, where the intermediary shopping creates a disincentive for countries to company is a company with some substance, negotiate tax treaties. If third countries can get conducting its own trading activities, not the benefits of reduced taxation for their residents controlled by the parent company and liable without conferring reciprocal benefits to non- to some tax in the country of residence. It resident investors, then there is no need to enter should always be remembered that an into a tax treaty, especially if there are concerns arrangement may be imbued with some economic that the treaty might be imbalanced.14 This may substance that is not immediately apparent to put countries which comply with their duties the fiscal authorities. of fiscal co-operation arising through tax treaties As for the reciprocity argument, although (e.g. exchange of information), at a competitive persuasive, it is premised on the assumption disadvantage internationally. Furthermore, lack that there is always reciprocity and/or for every of fiscal co-operation enhances opportunities for treaty benefit. This may not always be the case. international tax evasion.15 Some treaty concessions may be unilateral if the Finally, it is argued that treaty-shopping is often other contracting State already provides for them linked with (undesired) revenue loss.16 Tax treaties in its domestic legislation. Also, whilst there are based on a perceived level of balance of might be reciprocity in the tax treaty, it is not actual and potential income and capital flows guaranteed that the underlying balance of the between one country and the other.17 When the treaty is a fair one. A tax treaty may be biased

4 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 16 TAX TREATIES in favour of the economically more powerful students, artists, dispute resolution). Tax treaty country. Therefore, breaching reciprocity may networks ensure that fiscal collaboration between not necessarily mean that a ‘fair’ balance has the contracting States is strengthened and adapted become ‘unfair’. It is the negotiated balance that to new forms of tax evasion and avoidance. is being subverted; whatever the fairness credentials Therefore, the concern that treaty-shopping creates of this balance. a disincentive to negotiate tax treaties is a valid As for the economic allegiance argument, this one, if treaties are entered into for the right seems to be tautological. Opinions diverge as reasons – that is to keep the momentum for to the defining characteristics of economic international fiscal convergence and co-operation allegiance; in other words, what kind of nexus rather than enable one country to bully another is required for the duty of economic allegiance into tax concessions. to be generated in favour of a jurisdiction. Even As for the revenue loss argument, again, there if the principle of economic allegiance was agreed is no concrete evidence that treaty-shopping upon, none guarantees that countries negotiating actually cause revenue loss and economic tax treaties would follow it. In any case, it distortions. Firstly, it is not easy to calculate the should not be readily assumed that all instances benefits and costs of a tax treaty to a State. A of treaty-shopping fall foul of the principle of contracting State might be both a country of economic allegiance. Some treaty-shopping might residence and a country of source and enjoy be more abusive than other, for example, where benefits or bear costs under both capacities.20 the conduit country is a tax haven or where the Therefore, finding the costs and benefits that a conduit company has no other activity other contracting State derives from a tax treaty entails than channelling payments to parent companies. quite complex calculations for which there might In such instances, the principle is flagrantly not be concurrence.21 Some of the benefits, for breached as there is no economic activity example mutual assistance, cannot even be whatsoever taking place in the conduit country translated in monetary terms. that could justify the latter’s claim of economic allegiance. Secondly, why is there a presumption of a loss? It could be argued that when treaty-shopping As for the disincentive to negotiate argument, increases economic activity, the overall economic in assessing the potency of this argument, the gain might exceed source country losses.22 This self-correcting forces of competition and the begs the question. When does treaty-shopping international economic pressure for fiscal increase economic activity and when does it convergence should not be ignored. Also, it not? Does it depend if the source country is a should be pointed out that the competitiveness developing country? For example, in Union of of foreign investors can still be preserved by India v. Azadi Bachao Andolan,23 the Indian Supreme their country of residence if double taxation is Court refused to imply an anti-treaty-shopping relieved through unilateral means. What is more, clause in the India-Mauritius tax treaty. In the it is all too often assumed that treaty-shopping judgment, the Supreme Court emphasised that disincentivises the third country from entering in developing countries, treaty - shopping was into tax treaties and that the source country often regarded as a tax incentive to attract scarce wants tax treaties. In some cases the source foreign capital or technology. “Developing country might not want a tax treaty with the countries need foreign investments, and the treaty third country, for example, if the third country - shopping opportunities can be an additional is a tax haven or a notorious conduit location. factor to attract them”.24 Countries had to take This is, however, a valid argument. Even if a holistic view. “The developing countries allow double taxation can be alleviated by unilateral treaty shopping to encourage capital and means, there are some reciprocal advantages technology inflows, which developed countries which can only or more easily be achieved through are keen to provide to them. The loss of tax tax treaties (e.g. provisions dealing with pensions, revenues could be insignificant compared to the

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 17 5 TAX TREATIES other non­tax benefits to their economy. Many a general concern that improper use of treaties of them do not appear to be too concerned should be avoided”.29 Other more specific measures unless the revenue losses are significant compared were suggested.30-31 The underlying theme of to the other tax and non-tax benefits from the these measures was that treaty benefits should treaty, or the treaty-shopping leads to other tax be available only to entities having a sufficient abuses.”25 Treaty-shopping may be a necessary nexus with the country of residence, either because evil, tolerated in a developing economy, in the of direct or indirect ownership of the entity or interest of long-term development.26 because of the economic ties between the entity and the treaty country. Therefore, it ought not to be assumed that treaty- shopping always leads to losses- in the medium These suggestions were subsequently incorporated or long term. The loss of tax revenues, as a in the 1992 Commentary to Article 1 and updated result of treaty-shopping, could be insignificant in the 2003 Commentary following the 2002 compared to the other non-tax benefits generated OECD Report on Restricting the Entitlement to in the economy as a result of the influx of Treaty Benefits. There have been no further capital and technology. An argument based on amendments in the 2008 update to the OECD revenue loss and economic distortions should Commentary. The current OECD Commentary factor this in. still does not offer a uniform solution for tackling improper use. However, it sets out the solutions, Thirdly, absent a truly neutral tax system, it is as suggested benchmarks that treaty negotiators difficult to assess any distortions caused by treaty- might consider when searching for a solution shopping. In fact, it could be argued that the to specific cases. These are the beneficial ownership inherent non-neutralities of tax systems create approach,32 the look-through approach,33 the an incentive to treaty shop. In other words, channel approach,34 the limitation on residence treaties generate treaty-shopping.27 Treaty-shopping approach,35 the exclusion approach36 and the is perhaps a self-help way of lessening or removing subject-to-tax approach37. fiscal impediments to international business imposed by the inadequate relief of international The first three methods focus on the ownership double taxation and the incomplete nature of of the intermediary entity and its relationship the treaty network. with the actual recipient of the payment. Their aim is to ensure that tax treaty benefits are Hence, so far, we see (deliberately) inadequate forfeited when the formal recipient of the income definitions and theoretical objections somewhat is not actually entitled to the income or the detached from reality. This would go some way income will most certainly be passed on to a in explaining the responses to treaty-shopping. third country resident. The last three methods III. RESPONSES TO TREATY-SHOPPING: THE focus on taxation in the country of residence. OECD AND THE USA Their aim is to ensure that tax treaty benefits on source-country income are forfeited when In this section, we examine how the OECD and the income is not taxed in the country of residence the US have dealt with treaty-shopping. of the recipient entity but passes on to a third III. 1. The OECD approach to treaty-shopping country resident.38 Some basic methods of curbing treaty-shopping It is recommended in the OECD Commentary practices existed ever since the 1977 OECD Model: that all of the above approaches be accompanied the beneficial ownership and the limitation on by “specific provisions to ensure that treaty residence provisions. In the OECD Conduit benefits will be granted in bona fide cases”.39 Companies Report, the Fiscal Affairs Committee Various bona fide provisions were suggested in recognised the deficiencies of these basic methods28 the OECD Conduit Companies Report40 and and conceded that the 1977 Model dealt with subsequently added in the OECD Commentary conduits in a rudimentary way, “expressing only to Article 1 in July 1992.41

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The 2003 OECD Commentary went further than but not legally obliged to pay to its ultimate its predecessors in suggesting a comprehensive owner any sums received, is in fact the beneficial clause to deal with treaty-shopping: the Limitation owner of such sums.48 of Benefits (LOB) clause.42 The Commentary The difficulty of explaining the concept of replicates the standard LOB clause found in the ‘beneficial ownership’ was illustrated in the Indofood US Model. case.49 In Indofood, an Indonesian trading group With the exception of the LOB, most of the (Indofood) wanted to raise finance by issuing OECD anti-treaty-shopping provisions tend to internationally marketed interest-bearing notes be broad and vague, likely to generate to the public. This was done through a Mauritian interpretational difficulties when applied in special purpose vehicle, in order to benefit from practice. This is hardly surprising, given the the reduced withholding tax rate of the Indonesia- definitional inadequacies and the lack of solid Mauritius tax treaty.50 theoretical underpinnings identified above. Two years after the issue of the notes, the Some recent cases on beneficial ownership illustrate Indonesian Government decided to terminate these difficulties.43 Beneficial ownership is perhaps the Indonesia-Mauritius tax treaty. This meant the most widely used anti-treaty-shopping that the Indonesian withholding tax of 20% would mechanism. However, the term is not defined have applied rather than the one under the in the OECD Model and most tax treaties do above tax treaty. Following this, Indofood tried not contain a definition of beneficial ownership.44 to initiate the get-out clause of the notes and Moreover, the term may not even have a domestic gave notice to the trustee of the bondholders tax meaning. This creates uncertainty when trying (JP Morgan) of its intention to redeem early.51 to delineate who is the true beneficial owner of The trustee refused to accept early redemption income when treaty-shopping concerns are raised. on the basis that Indofood had not taken reasonable measures to prevent this. According to the trustee, Under the OECD Commentary, the term “is not one such measure would have been the setting used in a narrow technical sense, rather, it should up of a Dutch special purpose vehicle to perform be understood in its context and in light of the the same function as the Mauritian one, but object and purposes of the Convention, including using the Indonesia-Netherlands tax treaty.52 avoiding double taxation and the prevention of fiscal evasion and avoidance”.45 In his authoritative The trustee initially succeeded at the High Court.53 treatise on tax treaties, Professor Philip Baker Indofood appealed. One of the issues considered QC claims that “the ‘beneficial ownership’ by the Court of Appeal was whether a newly limitation is intended to exclude: (a) mere nominees interposed Dutch company would have been or agents, who are not treated as owners of the the beneficial owner of the interest payable by income in their country of residence; (b) any Indofood for the purposes of the Indonesia- other conduit who though the formal owner of Netherlands tax treaty. The Court of Appeal the income, has very narrow powers over the decided the question of beneficial ownership in income which render the conduit a mere fiduciary favour of Indofood; i.e. the Dutch company could or administrator of the income on behalf of the not be a beneficial owner of the interest paid beneficial owner. [T]he mere fact that the recipient by Indofood.54 may be viewed as a conduit does not mean that After examining the OECD Commentary, the it is not the beneficial owner”.46 Court of Appeal confirmed that the term beneficial Professor Baker argues that “the term [beneficial ownership should be understood in its context ownership] should be accorded an ‘international and in light of the object and purposes of the fiscal meaning’ not derived from the domestic OECD Model; namely, the avoidance of double laws of Contracting States”.47 The salience of the taxation and the prevention of fiscal evasion matter lies in determining whether a company and avoidance. The Court of Appeal cited Professor controlled by another one, and therefore likely Baker’s commentary approvingly. The term

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‘beneficial ownership’ was to be given an withholding tax. Under Article 9 of the applicable international fiscal meaning not derived from France–UK tax treaty, the maximum withholding the domestic laws of contracting States.55 tax was 15%. The tax treaty also provided for a transfer of the avoir fiscal tax credit. The UK The Court of Appeal concluded that the concept bank requested a refund of the French withholding of beneficial ownership was incompatible with tax levied in excess of the maximum rate of 15% that of a formal owner who does not have “the and the avoir fiscal tax credit as provided by the full privilege to directly benefit from the income”.56 tax treaty. On the facts of the case, looking at the legal, commercial and practical structure, neither the The French Tax Administration rejected the claim Mauritian nor the suggested Dutch company on the basis that the beneficial owner of the could be perceived as beneficial owners.57 Rather, dividend distribution was not the UK bank but they were mere administrators of the income.58 the US parent. The case ended up in the Supreme Administrative Court, which agreed with the Following this decision, in a guidance note issued tax administration, in that the transaction on 9 October, 2006,59 Her Majesty’s Revenue & implemented by the contracting parties in reality Customs (HMRC) confirmed that the Court of concealed a loan agreement between the UK Appeal’s decision was consistent with existing bank and the US parent which was remunerated HMRC policy. HMRC found that the decision by the payment of the avoir fiscal tax credit to was binding insofar as it related to construing the UK bank. The Supreme Administrative Court beneficial ownership in the context of the UK’s concentrated on the fact that the price paid by tax treaties. Therefore, the international fiscal the UK bank to the US parent to acquire the meaning of beneficial ownership and the test of dividend coupons corresponded to the amount full privilege to directly benefit from the income of the dividends, before the levying of withholding are considered to be applicable in the UK context. tax. The beneficial owner of the dividends was, This test has been criticised in the UK as being in fact, the US parent. The US parent merely too limited.60 delegated to its French subsidiary the repayment Reading this case, it appears that the Court of of the loan contracted with the UK bank. Appeal focused more on what the intermediate Again, although the Supreme Administrative entity does or can do with the income, i.e. its Court looked at the overall scheme, in its analysis, narrow powers, rather than anything. The Court it focused on specific elements, such as the payment seems to have applied a technical test. Rather arrangement and the question of risk. What was than look at the overall substance of the scheme crucial to the French Tax Administration and and effectively the end-result, the Court the Supreme Administrative Court was the fact emphasized the specific payment and cashflow that the return to the UK bank was pre-determined arrangements61 and how those affected the and guaranteed. A possible default of the French economic credibility of the intermediate entity. subsidiary would not have affected the UK bank. In the Bank of Scotland62 case, the French Supreme All these factors pointed to a loan rather than Administrative Court followed a similar approach. the usufruct agreement described by the parties. Here, a US parent concluded a usufruct agreement63 A similarly factual approach was followed in with a UK bank. Under this usufruct agreement, the Prévost case.65 Here, a Netherlands company the UK bank acquired for a three-year period (Prévost Holding) was owned 49% by a UK fixed dividend coupons attached to the (non- company (Henlys) and 51% by a Swedish company voting preferred) shares of the French subsidiary (Volvo). Volvo had acquired all the shares of of the US parent company. The usufruct contract a Canadian company (Prévost) in 1995 and was structured in such a way that the UK bank, immediately thereafter transferred them to Prévost in fact, undertook very little risk of default.64 Holding. Volvo then sold 49% of its shares in The French company later on distributed dividends Prévost Holding to Henlys. Prévost paid around to the bank which were subject to a 25% CAD 80 million of dividends to Prévost Holding

8 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 20 TAX TREATIES in the 1996 to 1999 and 2001 tax years. The one does not pierce the corporate veil unless the Canadian tax authorities withheld tax at 5%. corporation is a conduit for another person and Prévost Holding was not subject to Netherlands has absolutely no discretion as to the use or tax on dividends from Prévost because of the application of funds put through it as conduit, Netherlands participation exemption. or has agreed to act on someone else’s behalf pursuant to that person’s instructions without Under the Canada - Netherlands tax treaty, the any right to do other than what that person 5% rate applied if the dividend recipient was instructs it, for example, a stockbroker who is a company that owned at least 25% of the capital the registered owner of the shares it holds for or at least 10% of the voting power in the clients.”71 company paying the dividends.66 The Canadian tax authorities refused to allow the application The relationship between Prévost Holding and of the Canada-Netherlands tax treaty by its shareholders was not one of agency, or mandate. maintaining that Prévost Holding was not the Prévost Holding was not a conduit for Volvo beneficial owner of the dividends received from and Henlys and could not be said to have Prévost. This was because Prévost Holding did absolutely no discretion as to the use or application not have any office, assets, activities or employees of funds put through it as a conduit. The Courts in the Netherlands, its only asset consisted of reasoned as follows. the shares in Prévost and all its expenses were There was no predetermined or automatic flow paid by its shareholders. The dividends paid by of funds to Volvo and Henlys. Prévost Holding’s Prévost were treated as if they had been paid Deed of Incorporation did not obligate it to pay to Henlys and Volvo directly. As a result, 49% any dividend to its shareholders. In fact, Henlys of the dividends were subject to tax at the 10% and Volvo could not take action against Prévost rate of the Canada - UK tax treaty and 51% of Holding for failure to pay dividends. Prévost the dividends were subject to tax at the 15% Holding was the registered owner of Prévost rate of the Canada - Sweden tax treaty.67 shares, paid for the shares and owned the shares The taxpayer objected to this treatment, arguing for itself. When dividends were received by that Prévost Holding was entitled to the benefits Prévost Holding in respect of shares it owned, of the Canada - Netherlands tax treaty. The the dividends were the property of Prévost Holding taxpayer also argued that this company structure and were available to its creditors, if any, until was a common form of business structure where such time as the management board declared two or more companies pooled their resources a dividend and the dividend was approved by to carry on a joint business and that the structure the shareholders.72-73 did not have any unusual or tax-driven aspects. Therefore, Prévost Holding, being the beneficial The Tax Court of Canada68 and later on the owner of the dividends, was entitled to the Federal Court of Appeal69 agreed with the taxpayer benefit of the reduced rate of tax on dividends in that Prévost Holding was the beneficial owner under the Canada-Netherlands treaty. of the dividends. The Federal Court of Appeal Broadly, in this case, the real powers of the concurred with the judgment of Chief Justice intermediary company and its relationship with Rip of the Tax Court in that the beneficial owner the parent company were crucial. The courts of dividends is the person who receives the focused on the governance model of the dividends for his or her own use and enjoyment intermediary company, its actual management and assumes the risk and control of the dividend and the composition of its parent company’s he or she received.70 board. The ownership of the income received, “Where an agency or mandate exists or the the discretion to use, enjoy and dispose of it, property is in the name of a nominee, one looks as well as issues of risk and control were addressed. to find on whose behalf the agent or mandatory As in Indofood, the arrangement was not to be is acting or for whom the nominee has lent his dismantled. Of course, the difference between or her name. When corporate entities are concerned,

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 21 9 TAX TREATIES the two cases is that in Indofood, a finding of provisions that specifically prevent misuse of no beneficial ownership of an intermediary (that treaties by residents of third countries”.75 ought to have been inserted, according to the Historically, however, the US attitude to treaty- trustee of the bondholder) protected the existing shopping had not always been so hostile. In arrangement and enabled Indofood to redeem fact, initially, the US fisc showed no particular the notes early. By contrast, in Prévost, a finding concern over treaty-shopping. After World War of beneficial ownership of the intermediary II, the US international tax policy focused on protected the arrangement and the reduced outbound rather than inbound investment. Its withholding taxes of the underlying tax treaties fiscal interests, mainly the minimization of foreign applied. (source country) taxes imposed on US legal entities, However, in all of the above cases, the courts were clearly influenced by its concerns as a seem to have proceeded on an ad hoc and factual country of residence. Therefore, treaty-shopping basis. The existence (or lack of) beneficial ownership was not a controversial issue in treaty negotiations was to be considered on the facts of each case, as it worked to the advantage of the US fisc. taking into account some of the factors mentioned If less tax was paid abroad by US persons, then above (ownership, risk, discretion etc.) in a non- less foreign tax credit depleting the US coffers exhaustive manner. Whilst clear cases of abuse/ was paid to such persons. sham may have been easily detected, there was In the 1980s, the transition from a major country no bright-line test for the less abusive but still of residence to country of source had begun. to an extent contrived situations. Much depended The US administration concentrated its initiatives on how national courts perceived and interpreted on attracting foreign capital, in order to help beneficial ownership in their own jurisdictions, finance domestic investment. Inter alia, it exempted independently of judicial precedents in other portfolio gains from taxation to encourage jurisdictions. foreigners to invest in the US markets,76 rendering As a result of the lack of bright-line tests and the US “a sort of tax haven for foreign portfolio the ad hoc application of beneficial ownership, investment”.77 At the same time, it tried to taxpayers are faced with uncertainty when discourage outbound investment.78 Gradually, structuring arrangements that are akin to treaty- the country became the world’s largest debtor shopping arrangements. Furthermore, the threshold with a huge trade deficit. Therefore, the US fisc test of business legitimacy with which the became increasingly concerned with reduction of intermediary is to be imbued so as not to be source taxes via treaty-shopping. Treaty-shopping part of a treaty-shopping arrangement may differ was not only disliked because it caused an from jurisdiction to jurisdiction. In other words, untoward erosion of source-based taxation. It the benchmark of impropriety may shift with was also objectionable as it often involved tax time and with location. This is hardly surprising, havens. given the theoretical limitations of the treaty- The US had no limitation on treaty shopping shopping polemic. until 1984, although certain cases limited the Neither does the US seem to display a more use of treaties in abusive situations. In Aiken uniform and coherent approach to treaty-shopping. Industries, the Tax Court held that the reduction This is examined next. of withholding tax under the US-Honduras treaty did not apply to back-to-back loans with identical III.2. The US approach to treaty-shopping interest payments between a US payor, a related The US was the first country to advance objections Honduras corporation, and the Bahamas parent to treaty-shopping.74 The country remains the corporation. The court held that the treaty required most vocal opponent to such practices. The that the recipient of the payment have “dominion Technical Explanation of the US Model, which and control” over the funds and that this describes treaty-shopping, contains an unequivocal requirement was not met when the Honduran statement in that “tax treaties should include corporation was a mere conduit.79

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In 1984, the US terminated the extension of its IRS even in situations which clearly involved treaty with the Netherlands to the Netherlands treaty-shopping. Antilles, which was used by many US corporations For example, in Northern Indiana Public Utilities as the location of finance subsidiaries that borrowed the Court of Appeals rejected the IRS’ attempt on the Eurobond market and onlent the funds to apply substance over form or economic substance to the US parent. At the same time, the IRS analysis to a Netherlands Antilles finance issued two Revenue Rulings applying the precedent subsidiary.84 In SDI Industries the Tax Court of Aiken Industries even to situations where there rejected the IRS attempt to argue that when a is a “spread” between the two loans or when Netherlands corporation licensed software from one payment is interest and the other a dividend.80 its Netherlands Antilles subsidiary and sub-licensed Subsequently, the US began to incorporate LOB it to a US affiliate, neither the royalty payments provisions first into the Internal Revenue Code from the US to the Netherlands nor from the and then into treaties. In 1986, the branch profit Netherlands to the Antilles were subject to US tax provision was adopted with a “qualified withholding tax.85 resident” definition that overrode treaties.81 The Recent US treaties (e.g. with the Netherlands US-Germany treaty from 1989 was the first to and Switzerland) include elaborate LOB provisions include an LOB provision, and all subsequent that are much more complex than the provision US treaties include LOB provisions, so that now in the 2006 US Model. These provisions were there are almost no US treaties without such generally negotiated by the other side to the provisions. treaty and indicate that despite the professed In addition, in 1993 Congress authorized the US hostility to all forms of treaty-shopping and IRS to adopt regulation involving “conduit its insistence on including LOB provisions in all arrangements” in multiple-party financing new US treaties, in practice these provisions can transactions.82 The regulations adopted by the be negotiated to address the concerns of the IRS follow the 1984 rulings and apply to a wide treaty partner and create opportunities for tax range of financing transactions, and they also planning. constitute a treaty override.83 Therefore, the US approach to treaty-shopping It is not clear to what extent these provisions is, to an extent, also beleaguered by lack of are effective to prevent treaty shopping. For uniformity. Even the LOBs in its tax treaty network example, in the period between 1997 and show variable degrees of severity which may 2001 many public US corporations engaged in exonerate a range of arrangements. This approach “inversion” transactions in which they became seems to be perpetuated in recent US tax treaties. subsidiaries of new public corporations in Bermuda. Overall, as far as treaty-shopping is concerned, Bermuda does not have a treaty with the US we identify variable standards and shifting so for treaty purposes the new parent corporations benchmarks of impropriety. What are the qualified as residents of Barbados. Subsequently, implications of this conclusion in the EU context? the new parent would lend funds to the US This is examined in the final part of this paper. subsidiary which would deduct the interest and pay no withholding tax under the Barbados IV. TREATY-SHOPPING AND EU LAW treaty. The LOB provision in the treaty proved In this section, we consider the effect of EU law ineffective because it does not apply to public on treaty-shopping and anti-treaty-shopping corporations (even though the corporation was provisions. In the past few years, the compatibility traded in New York, not in Barbados). of anti-treaty-shopping provisions with EU law The ambiguity as to what is treaty-shopping has been a topic of intense debate. It has been and as such improper use of tax treaties and argued that anti-treaty-shopping and especially what is mere tax planning and as such legitimate the LOB are in breach of freedom of establishment is reflected in the case law. US case law since and/or free movement of capital.86 Can Member Aiken Industries has tended not to side with the States include anti-treaty-shopping provisions

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 23 11 TAX TREATIES in tax treaties between themselves or with non- protection under freedom of establishment was EU Member States? withdrawn. Can this strand of reasoning also apply with treaty-shopping? Does the fact that For this argument to succeed, it has to be shown treaty-shopping entails tax location shopping that treaty-shopping, i.e. the activity that these rather than corporate forum shopping change anti-abuse provisions seek to curb, is an activity matters? protected under EU law. Of course, there has to be genuine (cross-border) activity; the more There is no reason why it should, at least prima abusive the structure, the less likely that the facie. It could be argued that treaty-shopping is fundamental freedoms will be triggered at all. an exercise of establishment, regardless of the For, if the intermediary entity is a complete motives behind it. What anti-treaty-shopping sham, then, arguably, there is no genuine exercise provisions tend to do, is to disregard the of establishment in that jurisdiction nor is there intermediary entity and treat another company any movement of capital. Therefore, the more as the ultimate recipient of the income. Therefore, economic substance there is in the intermediary it could be argued that anti-treaty-shopping company itself, the more likely that the setting provisions restrict freedom of establishment. Of up of the establishment itself will be recognised course this restriction could be justified, as as an activity that could be prima facie covered explained below, but this is nonetheless a by freedom of establishment. Similarly, the more restriction. economic substance there is in the intermediary, From a free movement of capital perspective, the more likely that investment through it could it could be argued that a treaty-shopper exercises be prima facie covered by the free movement of its free movement of capital by investing in a capital. company indirectly (i.e. through another Member Assuming this first threshold issue is satisfied State entity) and as a result receiving its return and the aforementioned fundamental freedoms from such investment indirectly. The analysis are prima facie engaged, is there a restriction to here focuses on the existence (or lack of) indirect them? investment rather than the use of an intermediary entity. The issue is not so much the fact of From a freedom of establishment perspective, establishing a related entity through which it could be argued that treaty-shopping, i.e. the investment is made. What is important is the use of the intermediary entity located in a fact that the treaty-shopper (whether EU national favourable tax jurisdiction to effect the investment, or not) takes advantage of the tax treaty network is an exercise of freedom of establishment. The of another Member State in order to invest in possibility that the intermediary entity has limited a third Member State, by channelling income economic substance (but is short of a complete through an intermediary entity which it does sham for threshold purposes) ought not prevent not control. this from being characterised as an exercise of establishment. An analogy may be drawn with In other words, this is an instance of indirect a line of non-tax related cases (Centros87/ rather than direct investment (investment through Überseering88). These cases dealt with corporate a related entity) and as such, prima facie protected forum shopping. Here, the ECJ approved the under free movement of capital. Anti-treaty- formation of primary and secondary shopping provisions tend to disregard the establishments, even if they lacked economic intermediary entity and/or re­characterise the substance in one Member State and were thought payment as being directly made to another to have been set up in order to circumvent the company. As a result, they may ultimately make company law formation requirements applicable the investment of capital through an intermediary in another Member State.89 Just because the in another Member State more expensive. undertaking was corporate forum shopping within Therefore, it could be argued that anti-treaty- the EU with little economic substance in the shopping provisions restrict the free movement establishment, did not necessarily mean that the of capital.

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Of course, as under freedom of establishment, allocation of tax jurisdiction is less threatened this restriction could be justified by imperative by intermediary entities imbued with economic requirements in the general interest. It also has substance. The more substance there is in the to be suitable and proportional.90 Not every treaty-shopping arrangement, the less likely that kind of structure will ultimately be protected the allocation scheme under the underlying tax under EU law. treaty would be frustrated. Anti-treaty-shopping provisions have to factor that in. For example, the restriction could be justified on the basis of preventing tax avoidance/evasion.91 Also, the applicability of this ground as an In order for this ground to succeed, the anti- imperative requirement could depend on the treaty-shopping provisions must have the specific actual effect of the anti-treaty-shopping provisions purpose of preventing wholly artificial on the structure. Do they restore the original arrangements.92 Broad anti-abuse clauses which withholding tax rate that would have applied do not distinguish between bona fide activities absent the treaty-shopping arrangement or do and abusive situations have been struck down.93 they impose a (penal) statutory withholding tax Prevention of tax avoidance/evasion could, rate? If the former, then it could be argued that therefore, exonerate a restrictive treaty provision what the anti-treaty-shopping provision actually if this is sufficiently targeted to that end. The does is to restore the treaty balance. However, provision must also be suitable and must not if the statutory withholding tax rate applies, go beyond what is necessary to attain the objective then it is more difficult to see how the anti- pursued, whether this is prevention of tax evasion treaty-shopping provision restores the treaty or tax avoidance. balance, since that balance is itself overridden. Therefore, if less than wholly artificial arrangements A point to note is that under free movement are caught by an anti-treaty-shopping provision, of capital, it does not matter if the capital movement then the restriction is unlikely to be justified. is to or from a non-Member State, so long as As a corollary, the more artificial the treaty- there is some capital movement to or from a shopping arrangement, the more likely to have Member State. However, this could be relevant tax avoidance connotations - against which an at the justification stage.99 A restriction may be anti-treaty-shopping provision can more readily more readily justified if it affects third country be justified. It should be noted that obtaining nationals, than if it affects EU nationals. a mere tax saving is not tax avoidance/evasion Nevertheless, this has to be proven. Another in the eyes of the ECJ.94 Loss of revenue and point to note is that freedom of establishment erosion of tax base has not been accepted as a is only available to EU nationals. Therefore, if justification by the ECJ.95 In any case, as explained the intermediary entity is in a non-EU Member above,96 treaty-shopping has not unequivocally State, then an anti-treaty-shopping provision proved to be fiscally harmful. frustrating the arrangement may not be incompatible with EU law. The restriction could also be justified on the basis of safeguarding the allocation of tax In conclusion, it is possible that anti-treaty- jurisdiction.97 It could be argued that what anti- shopping provisions restrict freedom of treaty-shopping provisions seek to do is restore establishment and/or the free movement of capital. the allocation choices of the tax treaty shopped. However, they could be justified, depending on If State S wanted to grant the same tax concessions how these provisions are phrased – whether to State P and State R, it would have done so. they are sufficiently targeted against wholly As the original allocative choices of the relevant artificial arrangements and proportional. It also tax treaties are respected by Community law depends on whether these provisions try to curb after the D case,98 so should measures to protect treaty-shopping through a non-EU Member State. and restore those allocative choices. The recent trend, however, at ECJ level appears Certainly, the application of this justification to be respect for the allocation of taxing rights has to be finely tuned and proportional. The under a tax treaty and, generally, respect for tax treaties.

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V. CONCLUSION cases anti-treaty shopping provisions are either absent or applied only to pure conduit situations. The first author has repeatedly stated his belief This may reflect the unclear theoretical basis to that an underlying principle of the international the attack on treaty-shopping in general, or (as tax regime is the single tax principle, i.e., that in the India/Mauritius case) practical constraints cross-border flows of income should be subject stemming from tax competition. In any case, to some tax and that double non-taxation should this debate is likely to continue. be addressed as much as double taxation.100 The rationale is that double non-taxation weakens As far as treaty-shopping within the EU is countries’ ability to tax income by encouraging concerned special considerations would seem to shifting income from domestic to cross-border apply. If anti-treaty-shopping provisions are activities. This view implies that reduction of targeted against wholly artificial arrangements, tax by the source country should be premised then it is more likely that they will be compatible on actual taxation by the residence country. with EU law. However, as was shown in part III, anti-treaty-shopping provisions may not be There is no question that this view was not targeted against such arrangements only. In fact, always taken by any country; the first US tax provisions such as beneficial ownership can be treaty (1937) was with France at a time when so vague that they can be subject to different it was purely territorial so that reduction of interpretations, catching a wider or narrower source taxation was not accompanied by residence array of arrangements in each jurisdiction. Whilst taxation. However, the introduction of LOB a wholly artificial arrangement may be more provisions into US tax treaties and into the easily found when double non-taxation is in OECD Commentary indicate that this view is place, anti-treaty-shopping provisions are not gaining ground and it may apply even in situations always applied to that effect. Therefore, EU that are not purely abusive. Member States should re-examine their tax treaty Nevertheless, this paper has shown that actual policies, to ensure that EU law safeguards are treaty practice and case law fall far short of reflected in the application and interpretation implementing the single tax principle. In most of their anti-treaty-shopping provisions.

1 Becker, Helmut & Würm, Felix J., Treaty Shopping: An Emerging Tax Issue and its Present Status in Various Countries (Kluwer, Deventer, 1988) 2 2Rosenbloom, David (1994)Derivative Benefits: Emerging US Treaty Policy [1994] 22 Intertax 83 3 The concept was traced back to the early 1970s at the US Congressional Hearings on Offshore Tax Havens. See US Congress, Offshore Tax Havens, Hearings before the Sub-committee on Oversight of the House Comm. On Ways and Means, 96th Congr. 1st Session (1977) and Rosenbloom, David (1983) Tax Treaty Abuse: Policies and Issues (1983) 15 Law & Pol’y Int’l Bus. 763. 4 (2008) OECD Commentary to Article 1, paragraph 20. 5 Ibid.

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6 Ibid. 7 The phrase “improper use of tax treaties” is not used anywhere in the Technical Explanation to the 2006 US Model. Neither was it used in the Technical Explanation to the 1996 US Model. 8 2006 Technical Explanation, p.63. Contrast with the Technical Explanation to the 1996 US Model where it is stated that “[a] treaty that provides treaty benefits to any resident of a Contracting State permits ‘treaty- shopping’: the use, by residents of third states, of legal entities established in a Contracting State with a principal purpose to obtain the benefits of a tax treaty between the United States and the other Contracting State”. The 1996 Technical Explanation emphasised that this definition “does not encompass every case in which a third state resident establishes an entity in a US treaty partner, and that entity enjoys treaty benefits to which the third state resident would not itself be entitled. If the third country resident had substantial reasons for establishing the structure that were unrelated to obtaining treaty benefits, the structure would not fall within the definition of treaty-shopping.” 9 For a description of various treaty-shopping arrangements see OECD Conduit Companies Report in OECD, Committee on Fiscal Affairs of the OECD, International Tax Avoidance and Evasion, Four Related Studies, Double Taxation Conventions and the Use of Conduit Companies, Issues in International Taxation Series, No. 1 (OECD, Paris, 1987). 10 For further analysis, see Christiana HJI Panayi, Double Taxation, Tax Treaties, Treaty Shopping and the European Community, Kluwer Law International, EUCOTAX Series 2007, Chapters 2 and 5. 11 See, inter alios, Rosenbloom, David & Langbein, Stanley, United States Tax Treaty Policy: An Overview (1981) 19 Colum. J. Transnational Law 359; Rosenbloom, David (1983) Tax Treaty Abuse: Policies and Issues (1983) 15 Law & Pol’y Int’l Bus. 763; Becker, Helmut & Würm, Felix J., Treaty Shopping: An Emerging Tax Issue and its Present Status in Various Countries (Kluwer, Deventer, 1988); Weeghel, Stef van, The Improper Use of Tax Treaties (Kluwer Law International, 1998); Reinhold, Richard L., What is Tax Treaty Abuse? (Is Treaty Shopping an Outdated Concept?), (2000) 54 Tax Lawyer 663; Grady, Kenneth A., Income Tax Treaty Shopping: An Overview of Prevention Techniques (1983-4) 5 Nw. J. Int’l L. & Bus. 626; Roin, Julie A., Rethinking Tax Treaties in a Strategic World with Disparate Tax Systems, (1995) 81 Va. L. Rev. 1753 ; Terr, Leonard O. (1988) Foreign Investors and Nimble Capital: Another Look at the US Policy Towards Treaty Shopping (1988) 439 Tax, Jan. 4, 25-26; Streng, William P., Treaty Shopping: Tax Treaty Limitation of Benefits Issues (1992) Houston Journal of International Law, 789; Terr, Leonard O. (1989) Treaty Routing v. Treaty Shopping: Planning for multi-country investment flows under modern limitation on benefits articles, [1989] 17 Intertax 521. 12This argument has been produced in both the OECD Report on Conduit Companiesa)) and (paragraph the 7( UN Report on the Prevention of Abuse of Tax Treaties. Conduit Companies Report, paragraph 7(a) in ‘Inter- national Tax Avoidance and Evasion, Four Related Studies, Double Taxation Conventions and the Use of Conduit Companies, Issues in International Taxation Series’, No. 1 (OECD, Paris, 1987). UN Department of International Economic and Social Affairs, Report of the Ad Hoc Group of Experts on International Co-operation in Tax Matters, Contributions to international co­operation in tax matters: treaty shopping, thin capitalization, co-operation between tax authorities, resolving international tax disputes (United Nations 1988) UN Doc. ST/EA/203, UN Sales No. E.88.XVI, p. 6. 13 Rosenbloom, David & Langbein, Stanley, United States Tax Treaty Policy: An Overview (1981) 19 Colum. J. Transnational Law 359, 397-8. 14 Conduit Companies Report, paragraph 7(c); Becker & Würm (1988) 6; Rosenbloom & Langbein (1981) 676. 15 Rosenbloom & Langbein (1981) 396-7. 16 Also see Rosenbloom & Langbein (1981) 84. 17 UN Report (1988) 6. 18 See US Treasury Department’s June 27, 1979 New Release B-1694 relating to the US treaty with the Netherlands Antilles. 19 Rosenbloom (1994) 84. 20 Weeghel, Stef van, The Improper Use of Tax Treaties (Kluwer Law International, 1998) p. 122. 21 Even the same authors may reach inconsistent conclusions in subsequent reports. See for example, Blonigen, Bruce A. & Davies, Ronald B. (2000) The Effects of Bilateral Tax Treaties on US FDI Activity, NBER Working Paper No. 7929, 2000; Blonigen, Bruce A. & Davies, Ronald B. (2002) Do Bilateral Treaties Promote Foreign Direct Investment, NBER Working Paper No. 8834, 2002.

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22 Bracewell-Milnes, Barry, Economics of International Tax Avoidance (Deventer, Kluwer, 1980) p.23. 23 Union of India v. Azadi Bachao Andolan [2003] 6 ITLR 233; (2003) SOL 619. For some commentary, see Eduardo Baistrocchi, “The Use and Interpretation of Tax Treaties in the Emerging World: Theory and Implications”, [2008] 4 British Tax Review 352. 24 Ibid., p.280. 25 Ibid., p.281. 26 Ibid. 27 Avery Jones, John, The David R. Tillinghast Lecture: “Are tax treaties necessary?” (1999) 53 Tax Law Review 1, 3-8; Spence, Ian, Globalisation of Transnational Business: The Challenge for International Tax Policy [1997] 25 Intertax 143, 143-144. 28 Conduit Companies Report, paragraph 13-15. 29 Ibid., paragraph 15. 30-31 Ibid., paragraph 10. 32The beneficial ownership provision which is found in Articles 10 to 12 of the OECD Model, precludes the extension of specific treaty benefits to entities which are not beneficial owners of the particular income, even if they are formal recipients of it. Neither the OECD Model nor its Commentary give a definition of the term ‘beneficial owner’. However, a substance over form approach is preferred. 33 Look-through clauses focus on direct and indirect ownership of the entity. The typical wording of the clause reads as follows: “A company that is a resident of a Contracting State shall not be entitled to relief from taxation under this Convention with respect to any item of income, gains or profits if it is owned or controlled directly or through one or more companies, wherever resident, by persons who are not residents of a Contracting State.” OECD Commentary, paragraph 14. It is up to the Contracting States to agree on the criteria according to which a company would be considered to be owned or controlled by non­residents. 34 The channel approach, also called base erosion, seeks to catch intermediary entities whose tax base is eroded in favour of third country residents (usually controlling shareholders or associated persons) through the payment of interest or royalties or by the discharge of obligations. The typical wording of a channel clause reads as follows: “Where income arising in a Contracting State is received by a company resident of the other Contracting State and one or more persons not resident in that other Contracting State: (1) have directly or indirectly or through one or more companies, wherever resident, a substantial interest in such company, in the form of a participation or otherwise, and (2) exercise directly or indirectly, alone or together, the management or control of such company, any provision of this Convention conferring an exemption from, or a reduction of, tax shall not apply if more than 50 per cent of such income is used to satisfy claims by such persons (including interest, royalties, development, advertising, initial and travel expenses, depreciation of any kind of business assets including those on immaterial goods, processes etc.).” 35 The limitation on residence features in Article 4 of the OECD Model. The Article reads as follows: “[ ] the term ‘resident of a Contracting State’ means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature, and also includes that State and any political sub-division or local authority thereof. This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein.” [Emphasis added] 36 The exclusion approach denies treaty benefits to companies that are tax-exempt or nearly tax-exempt. A typical clause would read as follows: “No provision of the Convention conferring an exemption from, or reduction of, tax shall apply to income received or paid by a company as defined under section [ ] of [ ] the Act, or under any similar provision enacted by [ ] after signature of the Convention”. 37 General subject-to-tax provisions provide that source country treaty benefits are granted only if the respective income is subject to tax in the country of residence. The subject-to-tax approach, although similar to the exclusion

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approach, is not confined to tax-exemptions or reductions in the country of residence. The OECD Model suggests a more restrictive clause incorporating a safeguarding provision such as the following: “Where income arising in a Contracting State is received by a company resident of the other Contracting State and one or more persons not resident in that other Contracting State: (a) have directly or indirectly or through one or more companies, wherever resident, a substantial interest in such company, in the form of participation or otherwise, or (b) exercise directly or indirectly, alone or together, the management or control of such company, any provision of this Convention conferring an exemption from, or a reduction of, tax shall apply only to income which is subject to tax in the last-mentioned State under the ordinary rules of its tax law”. OECD Commentary, paragraph 15. 38 Christiana HJI Panayi, Double Taxation, Tax Treaties, Treaty Shopping and the European Community, Kluwer Law International, EUCOTAX Series 2007, Chapter 2. 39 OECD Commentary to Article 1, paragraph 19. 40 Conduit Companies Report, paragraph 42. 41 See Weeghel, Stef van, The Improper Use of Tax Treaties (Kluwer Law International, 1998), 216. 42 OECD Commentary, 2003, paragraph 20. 43 See, Lee Sheppard, “Beneficial ownership too onerous?”, Tax Analysts, 10th September, 2008, 2008 WTD 176-4. 44 For exceptions, see Jack Bernstein, “Beneficial Ownership: An international perspective”, 45 Tax Notes Int’l 1211 (Mar. 26, 2007), at 1212. 45 OECD Commentary to Article 10, paragraph 12. In other words, the limitation of source country taxes by virtue of a tax treaty would not be available “when, economically, it would benefit a person not entitled to it who interposed the conduit company as an intermediary between himself and the payer of the income”. See Conduit Companies Report, paragraph 14(b). 46 Philip Baker, “Double Taxation Conventions”, (Sweet & Maxwell 2001) paragraphs 10B-10.4. 47 Ibid., paragraph 10B-14. 48 “As a practical approach, one can ask whose income the dividends (interest/royalties) are in reality. One way to test this is to ask: what would happen if the recipient went bankrupt before paying over the income to the intended, ultimate recipient? If the ultimate recipient could claim the funds as its own, then the funds are properly regarded as already belonging to the ultimate recipient. If, however, the ultimate recipient would simply be one of the creditors of the actual recipient (if even that), then the funds properly belong to the actual recipient.” Ibid, paragraph 10B-15. 49 Indofood International Finance Ltd. v. J P Morgan Chase Bank NA (2006) EWCA Civ 158 50 Had the notes been issued from Indonesia, a 20% withholding tax would have been levied on interest. By raising the finance through the Mauritian subsidiary, the withholding tax rate was reduced to 10%. There was no further withholding tax in Mauritius. 51 Under the terms and conditions of the notes, Indofood was entitled to redeem early on an adverse change of Indonesian law, if the effect of such adverse change could not have been avoided by Indofood taking reasonable measures. 52According to this scenario, on payment of interest by Indofood, the funds would have moved from Indofood, to the Dutch company, to the Mauritian company, to the noteholders. The debt owed by Indofood to the Mauritian company would have been novated to the Dutch company. In other words, when the Dutch company paid the interest to the Mauritian company, the Dutch company would be discharging a liability (the novated debt) to that company. 53 The reason why the case was litigated in English courts was because there was a ‘governing law’ clause providing to that effect. 54 As a corollary, the setting up of a Dutch company was not a reasonable measure that Indofood could have undertaken to avoid the adverse consequences from the change of law. 55 Indofood v. JP Morgan (2006) paragraph 42 (Lord Justice Chadwick). 56 Ibid., paragraph 42.

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57 In paragraph 42, Lord Justice Chadwick pointed out that the fact that neither the Mauritian nor the suggested Dutch company were or could be a trustee, agent or nominee for the noteholders or anyone else in relation to the interest received from Indofood was “by no means conclusive”. Nor was the absence of any entitlement of a noteholder to security over the interest received from Indofood. However, in his subsequent analysis, beneficial ownership was dismissed. 58 Ibid., paragraph 44. 59 Available at http://www.hmrc.gov.uk/manuals/intmanual/updates/intmupdate101007.htm. 60 See, for example, Fraser, Ross & Oliver, J.D.B., Treaty Shopping and Beneficial Ownership: Indofood International Finance Ltd v. JP Morgan Chase Bank NA London Branch [2006] 4 BTR 422-426; Nikhil V. Mehta and Kate Habershon, “U.K. Tax Authorities Issue Draft Guidance in Wake of Indofood Decision”, Tax Notes International, 8th November, Doc 2006-22678 or 2006 WTD 216-2; M. Kandev, “Beneficial Ownership: Indofood Run Wild,” CCH Tax Topics No. 1812 (Nov. 30, 2006) 1; Philip Baker, ‘‘Beneficial Owner: After Indofood,’’ Grays Inn Tax Chamber Review, Vol. VI, No. 1, Feb. 2007, p. 15; Metha and Habershon, ‘‘U.K. Issues Guidance in Response to Indofood Decision,’’ Tax Notes Int’l, Nov. 13, 2006, p. 490, Doc 2006-22678, or 2006 WTD 216-2; Jakob Bundgaard and Niels Winther-Sørensen, “Beneficial Ownership in International Financing Structures”, 50 Tax Notes Int’l 587 (May 19, 2008) 61 Two business days before the due date for the payment of interest to the noteholders, Indofood was to pay the Mauritian subsidiary. One business day before the due date, the Mauritian subsidiary was to pay the paying agent. On the due date, the paying agent was to pay the noteholders. 62 Conseil d’Etat, 29 December, 2006, Ministre de l’Economie, des Finances et de l’Industrie c/Societe Bank of Scotland, No. 283314; Revue de Droit Fiscal No. 4/2007, p. 34, section 87. See Lee Sheppard, “Indofood and Bank of Scotland: Who Is the Beneficial Owner?”, 45 Tax Notes Int’l 406 (Feb. 5, 2007); Christiana HJI Panayi, “Recent Developments to the OECD Model Tax Treaty and EC Law”, 47 [2007] European Taxation 452. 63 A usufruct is a civil law concept. It is the legal right to use and derive profit or benefit from property that belongs to another person, as long as the property is not damaged. 64 The US parent had guaranteed the return and agreed to indemnify the UK bank against Government failure to refund the avoir fiscal. The amount of the dividends was also predetermined. In addition, the usufruct contract contained an acceleration clause entitling the UK bank to sell the shares back to the US parent on a change in the applicable tax law. 65 Michael Kandev, “Prévost Car: Canada’s First Word on Beneficial Ownership”, 50 Tax Notes Int’l 526 (May 19, 2008); Louise Summerhill, Jack Bernstein, and Barb Worndl, “Taxpayer Prevails in Canadian Beneficial Ownership Case”, 50 Tax Notes Int’l 363 (May 5, 2008); Michael N. Kandev and Brandon Wiener, “Some thoughts on the Use of Later OECD Commentaries After Prévost Car”, 54 Tax Notes Int’l 667 (May 25, 2009); Christiana HJI Panayi, “Recent Developments to the OECD Model Tax Treaty and EC Law”, 47 [2007] European Taxation 452; Sander Bolderman, “Tour d’Horizon of the Term ’Beneficial Owner’”, 54 Tax Notes Int’l 881 (June 8, 2009); Vern Krishna, “Using Beneficial Ownership to Prevent Treaty Shopping”, 56 Tax Notes Int’l 537 (Nov. 16, 2009); Jack Bernstein and Louise Summerhill, “Canadian Court Respects Dutch Holding Company”, Doc 2009-4953 or 2009 WTD 43-2 (March 9, 2009). 66 Art. 10(2) Netherlands–Canada tax treaty. 67 The Canadian tax authorities initially applied the 5% rate under Art. 10(2)(a) of the Canada–Sweden tax treaty for certain years, but then revised the rate to 15% in a subsequent reassessment. Art. 10(2)(a) of the Canada– Sweden tax treaty provides for a 5% rate if the beneficial owner of the dividend is a company that directly controls at least 10% of the voting power of the dividend payer or directly holds at least 25% of its capital. 68 Prévost Car Inc. v. The Queen, 2008 TCC 231 (Apr. 22, 2008). Judgment by the Associate Chief Justice Rip. 69 Prévost Car Inc. v. The Queen, 2009 FCA 57 (Feb. 26, 2009). 70 Ibid., paragraph 13, citing paragraph 100 in 2008 TCC 231. 71 Ibid. 72-73 Paragraph 16, citing paragraphs 100-105 in 2008 TCC 231. 74 In fact, most of the literature mentioned in part II.2 above originates in the USA. See, for example, Rosenbloom & Langbein (1981) 396-7; Reinhold, Richard L., What is Tax Treaty Abuse? (Is Treaty Shopping an Outdated Concept?), (2000) 54 Tax Lawyer 663; Oliva, Robert, The Treasury’s Twenty Year Battle with Treaty Shopping: Article 16 of the 1977 United States Model Treaty (1984) 14 Ga. J. Int’l & Comp. L. 293

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75 See Technical Explanation on Article 22 of US Model. 76 See Foreign Investors Tax Act (1966). 77 Haug, Simone M., The United States Policy of Stringent Anti-Treaty Shopping Provisions: A Comparative Analysis (1996) 29 Vanderbilt Journal of Transnational Law 191, 239. 78 See Interest Equalisation Tax Act (1964) which restricted portfolio investment by US persons in long-term debt obligations of foreign issuers. 79 Aiken Industries Inc. v. Commissioner, 56 TC 925 (1971). 80 Rev. Rul. 84-153, 1984-2 CB 383; Rev. Rul. 84-152, 1984-2 CB 381; see also Rev. Rul. 85-163, 1985-2 CB 349 and Rev Rul 89-110, 1989-2 CB 275. 81 IRC 884(e), 884(f)(3). 82IRC 7701(l). 83 Treas. Reg. 1.881-3. 84 Northern Indiana Public Service Co. v. Commissioner, 115 F.3d 506 (7th Cir. 1997). 85 SDI Netherlands v. Comm’r, 107 TC 161 (1996). The case was decided for a tax year before there was an LOB provision in the Netherlands treaty. 86 See, for example, Christiana HJI Panayi, Open Skies for EC Tax? [2003] 3 BTR 189; Georg W. Kofler, European Taxation Under an ‘Open Sky’: LoB Clauses in Tax Treaties Between the U.S. and the EU Member States (2004) Tax Notes International 45; Luca Hinnekens, “Compatibility of Bilateral Tax Treaties with European Community Law - The Rules,” [1994] EC Tax Review 146; Luca Hinnekens, “Compatibility of Bilateral Tax Treaties with European Community Law - Application of the Rules”, [1995] EC Tax Review 202; Doyle, H., “Is Article 26 of the Netherlands-United States Tax Treaty Compatible With EC Law?” [1995] European Taxation 14; Martín- Jiménez, A.J., “EC Law and Clauses on ‘Limitation of Benefits’ in Treaties with the U.S. after Maastricht and the U.S.-Netherlands Tax Treaty,” [1995] EC Tax Review 78; Anders, D., “The Limitation on Benefits Clause of the U.S.­German Tax Treaty and Its Compatibility With European Union Law,” [1997] 18 Nw. J. Int’l L. & Bus. 165; P. Essers, G. de Bont, and E. Kemmeren, E. (Eds.), The Compatibility of Anti-Abuse Provisions in Tax Treaties With EC Law (1998). 87 Case C-212/97 Centros [1999] ECR I-1459. 88 Case C-208/00 Überseering [2002] ECR I-9919. 89 For recent analysis, see Christiana HJI Panayi, “Corporate Mobility under Private International Law and European Community Law: Debunking Some Myths”, [2009] Yearbook of European Law 124. 90 Case C-55/94 Gebhard, [1995] ECR I-4165 paragraph 37. 91 See, for example, Case C-264/96 ICI [1998] ECR I-4695; Case C-9/02 Hughes de Lasteyrie du Saillant v. Ministère de L’Economie des Finances et de l’Industrie [2004] ECR I-02409. The ECJ tends to use the terms avoidance and evasion without distinction. In some cases, it refers to the justification as being based on tax avoidance (e.g. Case C-264/96 ICI, paragraph 26) whereas in others (usually more recent ones), it referred to tax evasion (e.g. Case C-324/00 Lankhorst-Hohorst, paragraph 37). 92Case C-264/96 ICI, paragraph 26; Case C-324/00 Lankhorst-Hohorst, paragraph 37. 93 See Case C-324/00 Lankhorst-Hohorst, paragraphs 34-38; Case C-9/02 Lasteyrie du Saillant, paragraph 50. 94 See, for example, Case C-294/97 Eurowings [1999] ECR I-7447, paragraph 44 and other cases cited therein. 95 See, for example, Case C-264/96 ICI, paragraph 28; Case C-307/97 Saint-Gobain [1999] ECR I-6161, paragraph 50; Case C-385/00 De Groot, [2002] ECR I-11819 paragraph 103. 96 See II.2. and the analysis on Union of India v Azadi Bachao Andolan [2003] 6 ITLR 233; (2003) SOL 619. 97 See Case C-376/03 D case [2005] ECR I-5821; Case C-446/03 Marks & Spencer [2005] ECR I- 10837; Case C-231/ 05 OyAA [2007] ECR I-6373; Case C-470/04 N [2006] ECR I-7409l; Case C- 414/06 Lidl Belgium GmbH & Co. KG/Finanzamt Heilbronn [2008] ECR I-3601, paragraph 51; Case C- 182/08 Glaxo Wellcome GmbH & Co. KG v. Finanzamt München II, paragraph 88. 98 In the D case, the ECJ accepted the allocation attained in the relevant tax treaties, even if this meant that some non-residents were treated more harshly than other non-residents. The ECJ found that the Netherlands was not obliged to extend to a German resident the treaty benefits given to Belgian residents. The Germany– Netherlands tax treaty did not provide for the same allowances as the Belgium–Netherlands tax treaty. This

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was a question of pre-agreed allocation of tax powers between these States. The relevant treaties were not to be interfered with by extending benefits given to Belgian residents also to German residents. The current tendency of the ECJ seems to be respect for the allocative choices enshrined in tax treaties. See, for example, Case C-414/06 Lidl Belgium [2008] ECR I-3601, paragraph 51; Case C-182/08 Glaxo Wellcome GmbH & Co. KG v. Finanzamt München II, paragraph 88. The only case which explicitly dealt with anti-treaty-shopping provisions is the ACT Group Litigation case. Here, both the Advocate General and the ECJ refrained from using tax treaty allocation as a justification to a restriction. Instead, reliance was placed on non-comparability. However, the overtone of both the opinion and the judgment is respect for tax treaties. The tax treaty package represented an equilibrium, into which no enquiries could have been sustained. Case C-374/04 ACT Group Litigation, paragraphs 88-91 (ECJ). For further analysis, see chapter 5 in Christiana HJI Panayi, Double Taxation, Tax Treaties, Treaty Shopping and the European Community, Kluwer Law International, EUCOTAX Series 2007. 99 See, for example, Case C-446/04 FII Group Litigation case [2006] ECR I-11753, paragraphs, 169–172; Case C-524/04 Thin Cap Group Litigation [2007] ECR I-2107; Case C-101/05 Case A [2007] ECR I-11531; Case C-201/ 05 The Test Claimants in the CFC and Dividend Group Litigation v. HMRC [2008] STC 1513; Case C-540/07 Commission v. Italy [2009] ECR I-0000. 100 Reuven S. Avi-Yonah, International Tax as International Law (2007), ch, 10.

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The New Frontier: Marketing Intangibles

Marc M. Levey and Monique van Herksen*

Background The concept of “marketing intangibles” has developed itself as the new frontier for transfer pricing: Marketing intangibles find themselves near or beyond the boundary established by the definition of services and that traditionally reserved for intangibles. Initially, the concept appeared in the United States in the Internal Revenue Services (“IRS”) transfer pricing regulations and administration announcements, some Tax Court cases, Advance Pricing Agreement proceedings, yet by now is prevalent in most, if not virtually all, transfer pricing audits. Tax authorities in non-US countries regularly raise the issue as well. Many of these countries have by now also issued announcements in various forms on the subject. Marc M. Levey While the precise meaning of a “marketing intangible” still remains unclear from a tax and legal perspective and may vary in application by company, industry and country, the breadth of its grasp continues to grow as the concept has been variously applied and practitioners consider its legal and tax implications. Generally, the term ‘marketing intangibles’ can be meant to include tradenames, trademarks and trade dress, logos, the local market position of a company and/or its products, know-how that surrounds a trademark such as the knowledge of distribution channels and customer relationship, and trade secrets. The IRS believes the investment in these intangibles is derived from, among other things, the company’s levels of advertising, marketing and promotion (“AMP”) expenditures, particularly Monique van Herksen those that transcend pure routine costs.

* Marc M. Levey is an International Partner at Baker & McKenzie LLP in New York. Monique van Herksen is a partner and the EMEIA Transfer Pricing and Controversy leader for Ernst & Young/Holland Van Gijzen, based in Amsterdam. This article is a follow up to “The Quest for Marketing Intangibles, 33 Intertax3 (2005) as prepared by the authors together with Alexander Odle, a private lawyer in Amsterdam; Pam Church and Phil Carmichael of Baker & McKenzie New York and Stephan Schnorberger and Kazuo Taguchi of Baker & McKenzie’s Düsseldorf and Tokyo offices, respectively. ® All Rights Reserved. Photo Credit - Bret Littlehales

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The concept initially gained prominence in the the DHL trade name by DHL’s foreign affiliates. late 1980’s in a docketed Tax Court case involving At issue was the taxpayer’s assertion that a the sale of vacation destinations by a U.S. royalty should not be imputed from these foreign distributor on behalf of a related foreign travel affiliates because they bore the economic and vacation entity. The transfer price for the investment for the development of the DHL destination package was not directly at issue, trademark. but the level of AMP incurred by the U.S. While marketing intangibles surrounding the distribution entity for these sales was scrutinized. DHL trade name were not directly discussed, The IRS sought either to (1) disallow a portion the DHL case stood for the proposition that for of the AMP under the notion that it was incurred items of intangible property, the party who bore on behalf of the foreign trademark owner, or the economic burden of the investment should (2) deem a service fee for the marketing efforts reap the economic rewards. The aggregate levels performed by the U.S. distributor on behalf of of AMP, as well as certain other expenses that the foreign trademark owner. While the case were incurred by the DHL foreign affiliates, was settled by the parties prior to litigation, this were considered for purposes of this economic case foreshadowed issues related to marketing investment, although there was neither a real intangibles that we see today. analysis of the expenditures that made up the Subsequently in 1994, the IRS issued final transfer AMP nor what component of the underlying pricing regulations under IRC Section 482 wherein costs were directed to trademark development it addressed the juxtaposition between the foreign or surrounding intangibles in this case. While owner of a trademark and the economic costs the Tax Court found in favoury of the IRS and incurred by its U.S. affiliate to promote and assessed penalties against the taxpayer, in 2002 exploit that item of intangible property in its the Appellate Court reversed the Decision, holding territory.1 In examples then referred to as the that under then applicable section 482 regulations, “Cheese Examples,” a number of scenarios between the DHL foreign affiliates made the economic a foreign parent trademark owner, Fromages investment for the development of the DHL Frères, and its affiliated U.S. distributor were trademark and were considered the owners of cited: (1) the U.S. distributor was simply given those intangibles for tax purposes. Thus, the a set transfer price and the development of the foreign affiliates were entitled to the economic U.S. market was at the risk and economic cost return associated with the marketing intangibles. of the U.S. distributor; (2) the foreign parent In effect, the Tax Court followed the money in indirectly subsidized the development of the order to match income with expense. U.S. market through a reduced transfer price; It was the dictum in the underlying Tax Court and (3) the foreign parent provided the distributor case, however, that bore real importance for with a rebate of a portion of the distributor’s purposes of the marketing intangible concept. AMP based on sales volumes. Following the IRS Here, the Trial Judge espoused his “bright-line” position in the above Tax Court case, the Cheese test which notes that, while every licensee or Examples could require a return for the distributor’s distributor is expected to incur a certain amount investment in the marketing intangibles either of cost to exploit the items of intangible property in the form of a service fee arrangement with to which it is provided, it is when the investment an appropriate profit markup or more robust crosses the “bright line” of routine expenditures operating margins to reflect the return for the into the realm of non-routine that, economic developed marketing intangible.2 ownership, likely in the form of a marketing The DHL Incorporated and Subsidiaries v. intangible, is created. Unfortunately, the Trial Commissioner of Internal Revenue Tax Court case3 Judge did not expand on this test to provide decided in 2002 became the next significant step practical guidelines to this theory because he in the evolution of the marketing intangible essentially held that the taxpayer failed to meet concept. This case addressed the IRS’ attempt its burden of proof. Stated otherwise, he was to impute a trademark royalty for the use of concerned that DHL did not expressly identify

22 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 34 TRANSFER PRICING those costs that were actually incurred in the ways to raise revenue, a potentially attractive development of the DHL trade name and whether vehicle to raise revenue.7 those costs were truly earmarked for such The theories described above continue to be development. raised in most global tax audits and Advance The marketing intangible issue was most publicly Pricing Agreement proceedings, and are presently considered in the GlaxoSmithKline Holdings v. under consideration by the U.S. Tax Court in Commissioner of Internal Revenue case in the U.S. current pending cases. The underlying thread Tax Court4 where the IRS asserted a tax deficiency seems to be that AMP, if substantive enough, in amounts approximating almost $20 billion creates an intangible. Numerous unanswered for all open tax years that were impacted by questions remain, however, such as how to define the Court. The underpinning to the IRS claim a company’s marketing intangibles from a tax was that Glaxo’s U.S. affiliate was the economic and legal perspective, what expenses truly owner of the U.S. marketing intangible through contribute to the building of this intangible, its investment in a marketing strategy conceived how to determine in tax parlance where the and directed by Glaxo U.S. executives. This level of AMP transcends from routine to non- investment arguably resulted in a fully integrated routine expenditures, what expenses qualify for business and led to the success of its products these considerations, (e.g. registration costs, legal in the U.S. market. It appeared that the IRS costs for routine expenses and real broad brand simply reviewed expenditures that were referenced building expenses as such non-routine expenses), on Glaxo U.S.’s profit and loss statement, namely whether an analysis of each underlying accounting its detailing and marketing expense, which the code requires the segregation of routine from IRS believed created the market for the Glaxo non-routine expenditures, what allocation keys product. Critical facts, however, that must have may be employed and what is the “shelf life” been considered in the parties’ resolution of the of the created marketing intangible, as well as case included that all items of intellectual property any pre existing marketing intangibles that are were owned by Glaxo UK and that the marketing included within the considered intangible. One platform and strategy were developed by Glaxo further practical problem, and a significant one, UK. As a distributor, Glaxo U.S. earned an is that not every taxpayer accounts for its AMP approximate 16 percent operating profit margin. within the same accounting classifications. The IRS was apparently not satisfied with this While there may be merit in the DHL “bright profit return, however, especially when compared line” test from a practical point of view, the to the robust return earned by Glaxo UK. definition of non-routine expenditures is so industry Accordingly, the IRS asserted that the U.S. affiliate and company specific, that it may be impossible was entitled to operating income commensurate to apply in most cases. Similar companies within with its expenditures. the same industry may have vastly different While the Glaxo case was settled for approximately approaches to their marketing philosophies, $3.4 Billion (although a significant amount, this product launches, and/or product dependence constituted only a mere 7 per cent at the initial or interdependence. This could create very different adjustment), it serves as a precursor for the IRS levels of AMP and different “bright lines.” This to continue challenging this issue on audit, arguably may even occur within the same companies and seeking a better set of facts that would give the for similar product categories. These expenditures potential for meaningful jurisprudence on the can also be influenced by, among other things, issue.5 There are currently other cases in the the product’s position in other countries, the U.S. Tax Court6 and IRS audit pipeline that may timing of product launches, and the competitors produce jurisprudence on this issue as well. and their products, each of which impacts the However, the Cheese Examples in the early “bright line” benchmarking and comparability regulations and the global attention given the standards. Also, the legal status of the intangibles Glaxo case has alerted many other tax authorities concerned may impact the expenditures differently. to this evolving issue and as they look for additional Even more complexity arises where the company

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 35 23 TRANSFER PRICING has many product lines and the AMP expenditures Avenue in Chicago, Rodeo Drive in Los Angeles. are not segregated by those lines. The taxing authorities have often characterized the “excess rental costs” associated with flagship In the Mary Kay Holdings case,8 that was docketed properties as brand builders to be borne by the in the Tax Court and later on settled the Petitioner brand owner. begged the question of whether AMP are deductible under I.R.C. Section 162 when they are incurred The likelihood of attaining a consensus view on for the development of a brand outside the these items of brand building is nil. But what United States. In the facts contained in the Petition, is clear is that the brand building/development the U.S. parent company seemingly used the costs will be company specific and will require AMP spend as a vehicle to make a transfer a detailed analysis to meet the ever increasing pricing adjustment to its “limited risk” distribution challenges of global tax authorities in this area. under the guise that the adjustments (i.e. AMP International Developments charge backs) were made by the parent to support the development of the “Mary Kay” brand. The The marketing intangibles discussion, which is amounts of these expenses were approximately challenging at best, lately appears to stretch $16.1 million in 1997, $20.6 million in 1998 and itself beyond the AMP discussion, however. Where $14.2 million in 1999. While the case was settled, in the early days sometimes reference was made and some underlying papers indicate the to “Super Distributors”, such being distributors Government was challenging the documentation, that took on additional functions as compared it is not clear therefore how the Tax Court to regular distributors and which usually also would have held on this issue. However, what were very successful distributors, tax authorities is clear is that there should be a distinct delineation outside of the United States have lately become between how transfer pricing adjustments are eager to raise marketing intangibles in their made and how AMP support payments and/or respective jurisdictions. This even occurs when charge-backs are addressed so that there is a distributors perform services that would appear clean line of demarcation between the two and to fall within their ordinary role of distributor, the AMP payments can truly be tracked to brand and serves to justify the allocation of additional development and enhancement expense codes. income to that distributor. Less and less, an analysis seems to be made of AMP or an effort Notwithstanding the above, the analysis that is made to determine when and if the “bright has evolved from the prior jurisprudence begs line” was passed, so as to conclude that the the question of what expenses are truly brand investments made cross routine expenditures building. For example, some marketing consultants into the realm of non-routine expenditures that would argue that pure advertising is not a brand ostensibly creates these marketing intangibles. building cost. Instead, placements for specific This coupled with the burden of proof, is becoming events (e.g., the Super Bowl, the U.S. Open, etc.) a lethal concoction for taxpayers may be considered to produce lasting brand equity. The same can be said that celebrity The OECD added another twist to the international endorsements create more brand building and view of marketing intangibles when it referenced brand association than pure advertising. Similarly, their impact on the allocation of profits to either market campaigns and strategic focus groups headquarter or permanent establishment in their geared to market knowledge, spending habits, “Attribution of Profits to a Permanent and market placement can be of equal value. Establishment” Report and the previous Discussion In tax audits, the IRS and other taxing authorities Drafts leading up to this Report.9 The re-drafted have focused on flagship stores as brand builders, Part I of the OECD Report on the Attribution or another form of AMP. The premise is that of Profits to Permanent Establishment did not these flagships are strategically positioned in help to clarify the concept of marketing intangibles locations where their presence is of greater value when it established that they include, inter alia, than the revenue, if any, generated from the the name and logo of a company and a brand.10 store (e.g. 5th Avenue in New York City) Michigan Intentionally or unintentionally, the draft lends

24 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 36 TRANSFER PRICING a hand to the inventive fiscal quest for marketing restructurings involve cross-border redeployment intangibles and the assumed related increase in by Multinational Corporations (MNCs) of functions, income, by sympathizing with the decentralized assets, and risks. Typically, the OECD provides allocation of “global” marketing intangibles as that MNCs have restructured their global business “significant people functions”. In particular, day- models from vertically integrated business models to-day risk management efforts are hypothesized with full-fledged manufacturing and distribution to be “dispersed within the enterprise”. It must activities and associated services through locally be remembered that the OECD Report is designed incorporated enterprises to a centrally controlled to be an analogous application of the OECD supply chain model. The focus of tax Transfer Pricing Guidelines to permanent administrations thus far is on these transactions establishment/headquarters cases. By reverse but, as noted in passing, the Restructuring Draft analogy, therefore, similar principles may be defines “business restructuring” far more broadly applied to company-to-company transactions. This in an introductory statement that suggests that is explicitly provided in the Final Report on the a business restructuring may include any cross- Attribution of Profits to Permanent Establishments border transfer of functions, assets and/or risks. as follows: “This analytical difficulty is not limited The OECD has been requested to clarify that to Permanent Establishments, but similarly applies this broader interpretation is not intended. These to the analysis of marketing intangibles between centrally controlled models are often located in associated enterprises under Article 9 (of the a tax-benefited jurisdiction, structured with OECD Model Convention)”11 If there can be a appropriate economic substance, and act as the definition of marketing intangibles, we believe risk-taking entrepreneur who oversees limited- that it should arguably not include tradenames, risk distributors or commissionaires and contract logos, and brands once they obtain protection manufacturers typically located in high-tax under intellectual property laws. The legal owner environments with reduced profitability will generally want to control and preserve the commensurate with their limited-risk profit. validity of the intellectual property and its The Restructuring Draft is composed of four enforcement capabilities. The expenditures involved Issue Notes that consider various issues related in these efforts are not the same as AMP to restructurings and, among other things, Expenditure. Also, the legal owner may want challenge the “pragmatism and appropriateness” to determine that all goodwill associated with commercial rationale for the transactions and the use of its intellectual property is to inure appear to revise the tenets of the established to its own benefit, so to avoid future claims on arm’s length standard: (part of) the goodwill by its licensees and be able to claim full compensation of lost value in u Issue Note No. 1 (Special Considerations case of infringement, even if the significant people for Risk). function lies in the distribution country. u Issue Note No. 2 (Arm’s Length Compen- European tax authorities have generally observed sation for the Restructuring). the marketing intangibles debate in the United u Issue Note No. 3 (Transfer Pricing Aspects States, and as it was blatantly used to re-allocate of Post-Business Restructurings). income from the UK to the US in Glaxo, not surprisingly, they are using the same arguments u Issue Note No. 4 (Recognition of the Actual now to their advantage. Particularly in the field Transaction Undertaken). of business restructuring AMP investments or Generally, the Issue Notes address (1) general any effort to develop business, for that matter, guidance in the allocation of risks by and among are considered as creating marketing intangibles the related parties to the restructuring; that merit profit allocation. (2) application of the OECD Transfer Pricing The OECD released a 56-page discussion draft Guidelines for Multinational Enterprises and Tax on business restructurings (“Restructuring Draft”) Administrations (“OECD Transfer Pricing on September 19, 2008. Generally, business

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Guidelines”) to the restructuring with intercompany profit allocations where marketing compensation or indemnifications for any intangibles are present. Most common in the terminations or “buy-ins”; (3) application of the United States is that we will see an information arm’s length principle to “post-restructurings”; document request that requests a set of comparable and (4) exceptional circumstances where a companies that establish similar AMP expenditures restructuring may be disregarded by a tax under similar circumstances. Most similar authority. circumstances generally involve periods of new product launches, market penetration or loss Focusing largely on risk transfer and the periods largely due to expansion and/or centralizing of functions, the OECD raises the restructuring costs. These document requests issue of intangibles, by providing that in some are issued largely for burden of proof purposes cases, the local operation will have developed where the IRS believes that the taxpayer cannot valuable intangibles which are in effect transferred provide such data. Of course, the IRS is correct in the restructuring to other members of the since this data rarely exists. Most taxpayers group. The example is provided of “the switch market and exploit their brands differently, launch from a full-fledged distributor to a commissionaire, products differently, do not have the same where marketing intangibles, goodwill, clientele, expansion plans and do not always account for and the like are involved”. This allows for the their AMP in the same way. Indeed, either the introduction of presumptions that adopt the IRS believes it will find magic in the public data skepticism and adverse attitudes of many tax or they simply do not believe the taxpayer and authorities and challenge the business judgment are pressing them to meet a burden of proof. of MNCs through a “commercial rationale” Logically, of course, the answers are company standard. specific and lie in the actual facts of the matter. While the OECD Discussion Draft generally Below we discuss some of the problems associated annunciates the well known transfer pricing with determining the appropriate allocation of concepts to be applied to a business restructuring, profits to a distributor that engages in AMP it is apparent that the critical issues involve activities. restructurings where items of intangible property, In the context of the “bright line” test cited in including marketing intangibles, are transferred the DHL a key component of identifying as a result of the restructuring. This would be appropriate economic benchmarks (i.e., most prominent when a buy-sell or full-fledged “comparables”) is to first review the expense distributor is converted to a limited risk distributor, categories and sub-categories that comprise the but arguably also upon (full) termination of company’s AMP expenditures. While this exercise activities. The notion here is that the buy-sell may provide a strong basis for establishing routine distributor must receive arm’s-length consideration versus non-routine expenditures, the approach for the marketing intangibles that it presumably can be difficult to implement. The timing of developed. While the Discussion Draft does not expenditures, such as for product launches, may do anything new to the transfer pricing knowledge distort the relative importance of particular base, it again highlights the possibility to tax categories of AMP expense compared to others, authorities of this significant issue. and underscores the difficulties in assessing Economic Benchmarking Challenges investment value and payback periods. Another challenge may be the need to separate routine The disparity in approaches to marketing and non-routine expenditures within a particular intangibles, as well as the amorphous nature of expense category, which presents the question the issue itself, make the identification and selection of whether particular expenditure thresholds of comparable, independent economic benchmarks constitute a reliable separation of routine extraordinarily difficult. Without reliable, expenditures from non-routine. These factors independent economic benchmarks (i.e., obviously are fact-specific and must always be “comparables”), it is more difficult to establish evaluated in the context of the company’s and defend the arm’s length nature of circumstances, its products and its industry.

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Nonetheless, even if this important initial step lists and knowledge of distribution channels.12 is reliably addressed, the identification of Although customers are not considered to be appropriate comparables remains a challenge. “intangible” property per se, customers (and more broadly, customer relationships) are a key The most significant difficulty in identifying value driver and one of the main indicators of comparables for marketing intangibles is that growth potential. Similarly, transfer pricing there are very few (if any) data sources that practitioners often engage in discussions with provide sufficiently detailed information regarding the tax authorities over the value to be attributed the allocation of profits (i.e., value) of the to the “customer list” in the context of business intangibles. For example, one can consider various reorganizations and supply chain restructuring rates of return on the cost of the investment, processes. It is not precisely clear where in the (such as a corporate hurdle rate of return) but financial statements expenditures related to the that is not entirely reflective of a market value development of these items may be reflected. for intangible property. One can also extrapolate certain information by reviewing the relationship The lack of transparency and consistency in of gross receipts to operating expenses to establish reporting practices for AMP expenditures across ratios to be applied to the taxpayer, but that firms and across jurisdictions makes it difficult analysis may be imprecise because operating to reliably identify comparable levels of routine expenses represent an aggregation of several AMP expenses. There are a number of databases expenditure classes. Public companies are not that are commonly used to conduct comparables required to disclose their AMP expenditures, analysis and benchmarking of financial data within and even for those that do, there is no way to industries, including Compustat, Disclosure, determine the percentage of these expenses devoted Moody’s, Worldscope, Global Vantage, and to intangible property enhancement. Other financial Amadeus, among others. Although the database statements, such as the balance sheet, do little providers may attempt to standardize data across to address this classification problem. When companies, they ultimately rely on public filings intangible assets appear on the balance sheet, that present the same challenges regarding the they generally are the result of an asset allocation transparency and consistency of financial data. exercise that may assign accounting values across In addition, the database providers may also various asset classes (e.g., patents, trademarks make certain decisions regarding classification and goodwill) that are not necessarily consistent and organization that may not easily align with with the required economic valuation (i.e., the needs of the practitioner analyzing AMP “marketing intangibles”). expenditures. For example, the Compustat database defines Advertising Expense as follows: “This The idea that there are clear industry standards item represents the cost of advertising media that establish or provide guidelines for what a (radio, television, newspapers, periodicals) and distributor should spend on AMP can be promotional expenses. This item excludes selling problematic. The financial statements of companies and marketing expenses.” It seems clear that within an industry may classify and define AMP there could be expenditures that relate to the expenditures entirely differently. One company creation of marketing intangibles that are not may define spending as advertising while another being captured by this line item. However, the company defines similar spending as media or category of Selling, General, and Administrative distribution. Other items, such as market studies, Expense is defined, as one would expect, far promotional brochures, and media may be more broadly and includes 27 separate items, classified under completely different accounting such as salaries and related costs, R&D, codes. engineering, legal expenses, marketing, and others Contributing to the difficulty is the uncertain in addition to advertising. Using this item as definition of what exactly constitutes marketing a proxy would surely overstate the investments intangibles. In addition to trademarks and trade in marketing intangibles. names, marketing intangibles can be company Further, most contemporary databases that address or product specific, but may also include customer trademark royalties (e.g. LiveEdgar, RoyaltySource

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 39 27 TRANSFER PRICING and RoyaltyStat) contain information on license Factors to Consider agreements between unrelated parties, but may In analyzing marketing intangibles for transfer not provide sufficient elements to segregate the pricing purposes one should consider, among remuneration paid for the intangible property others, the following questions: (e.g. trademark) from the one paid, for instance, for ancillary services. Again, this is generally a u Have the marketing intangibles obtained factor of the amount of specificity contained in protection under intellectual property laws the underlying license agreement. Additional and if so, which entity is the legal owner? benchmarking and/or economic/financial u Will certain costs and expenditures result modelling may provide alternative ways to produce in an economically valuable asset? meaningful results. Nonetheless, close comparability in terms of property, market, and u How should one distinguish developmen- profit potential is rare so that the result of the tal (i.e. non-routine) from non-developmental analysis may be a range of values for broadly (i.e. routine) expenses? similar property. u Can expenditure on intangibles be com- The level and nature of AMP expenditures also pensated by simply reimbursing all expenses can be also impacted by a variety of business above a prescribed amount or identifying factors, including management policies, market specific expense codes with allocation keys share, characteristics of the market, and the where appropriate? timing of product launches. As indicated above, u How are allocation keys established for the Annual Reports and SEC documents of public applicable expense codes? companies, as well as the information organized and distributed by database providers, generally u What is the “base date” for marketing do not provide the necessary level of detail that intangible valuation? would be required to reconcile these management u What is the expected use of the intangible considerations and classification differences. asset by the parties? An additional challenge to an analysis of marketing u What is the expected useful life of the intangibles is that AMP spending generally has marketing intangible and how is this eco- spillover effects to or from other products or nomically determined? product lines. Also, the effects of AMP spending are distributed over time and so the accounting u Are there any legal or regulatory restric- practice of expensing these AMP “investments” tions related to use of the intangible? in the current period can create distortions in u What are the effects of obsolescence or other determining economic profits. This dynamic is external economic factors? most evident when dealing with issues such as a product launch, where there may be a sharp u What level of expenditures is necessary to increase in spending prior to the launch of a maintain the intangible? product or product line, followed by subsequent u What are the customs and indirect tax decreases to more stable spending levels. It might ramifications of marketing intangibles ex- be appropriate to segregate out the spending penses and/or royalties? related to the product launch, or at least ensure that the data being considered covers a sufficient It also is important to consider the nature of time period so that the lifecycle dynamics can the relationship between the related parties (e.g., be properly addressed. This requires estimations manufacturer, licensor/license, etc.). Even assuming of the useful life of AMP spending. Economic that it is possible to estimate a normal level of modelling of investment cycles and profitability AMP spending for a particular industry, and curves may address these types of issues, although that the distributor/license in question spends the data required for such analyses may be at a greater rate than this routine level, a critical significant and, in many cases, unavailable. factor is whether the intercompany arrangements

28 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 40 TRANSFER PRICING are such that the distributor/license is assuming result. Most important is that the relationship risks consist with an entrepreneurial role. If the between the parties regarding the expenditures intercompany arrangements are such that the for the development of the marketing intangible distributor/license is effectively guaranteed a must be documented within the parties’ distribution routine profit level regardless of the level of its and/or license agreement. Failure to do so leaves marketing expenditure, then the question of the parties vulnerable to adjustment by any tax whether these expenditures are above a normal authority, and goodwill can easily be swept up level is not relevant because any resulting profits into the calculation at that point. would be attributable to the manufacturer that If an entity is intended to make investments in is assuming the entrepreneurial risk. developing marketing intangibles, the nature Reading the Tea leaves and degree of expected spending should be clearly delineated, documented and benchmarked. An So where does this leave us? If one follows the attempt should also be made to demonstrate normal trend that has been experienced in transfer that these activities differ from those undertaken pricing over the past years, this concept will by the distribution comparables, keeping in mind continue to be seriously debated among taxing the data and information challenges previously authorities as they each grapple for a share of discussed. Not only should the intercompany a multinational company’s global profit such pricing policies reflect that the entity is making that economic modelling will become in vogue. additional investments and assuming additional It can be assumed that for taxpayers who employ risks and therefore should reasonably expect to an operating income method as their best or have the potential for non-routine benefits should most appropriate method for transfer pricing the intangible-developing activities prove purposes (i.e., the Comparable Profits Method successful, but intercompany contracts must clearly or Transactional Net Margin Method), all items reflect the same. Today, the starting point for of cost and expense included in the calculation this analysis often begins with the contracts and of operating profit will be subject to detailed their obligatory provision. Transfer pricing issues reviews. If the item of intangible property (e.g., are decided and settled largely based on the the trademark) is owned within the same legal burden of proof, and timely prepared and signed entity, the AMP expenses can be perceived as intercompany contracts are an important strategic enhancing the item of intangible property’s value tool in this respect. On the other hand, if an and that value should be reflected within its entity is not expected to be permitted to realize operating profit margin positively or negatively the potential benefits from local activities designed as the case may be. If the intangible is owned to develop, maintain, or expand marketing by another affiliate, the taxpayer will be perceived intangibles, the intercompany pricing policies as the owner of the local marketing intangible, should be structured such that the entity is not in whole or in part, based on the contributions assuming the risk and expense of developing of the other affiliate and the taxpayer. Here, the those marketing intangibles. taxpayer’s contributions will be considered to the extent its AMP expenditures exceed the “bright Conclusion line” test, constituting non-routine intangibles. Accounting for marketing intangibles is complex These facts will signal a real need to engage in and becomes more so when the taxpayer fails planning to assure that any perceived marketing to properly document as much as possible the intangible is consistent with the taxpayers’ business nature of these intangibles, their ownership costs realities and not inadvertently ignored. This is and other factors contributing to the value of particularly true where the marketing intangibles these intangibles. In the face of inadequate are part of a migration exercise. It is here that documentation, tax authorities are not only able a more refined and documented definition of to project their own views of the taxpayer’s the company’s marketing intangible is needed markets, investments, and ultimately marketing for a more reliable economic analysis and financial intangibles, but will most certainly do so, which

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 41 29 TRANSFER PRICING at times can be totally at odds with the taxpayer’s transfer policy and planning for future years. facts and commercial realities. And, if the matter Taxpayers therefore are obligated to stay on top is resolved adversely to the taxpayer, the company of the ongoing regulatory and enforcement will have to live with those results for subsequent developments associated with marketing tax years. Accordingly, it is prudent for taxpayers intangibles. Failure to do so could expose to first take control of this issue by defining for companies to significant unnecessary tax risk. themselves their marketing intangibles in the It is highly recommended that while looking at context of their business, marketplace and and trying to manage marketing intangibles, investments, and by documenting them in legal the tax directors liaise with intellectual property agreements between the related parties. These lawyers, because a combination of transfer pricing issues can involve substantial tax dollars and knowledge and intellectual property law goes create significant tax and financial statement a long way in protecting taxpayers against exposure, as evidenced by Glaxo. Equally unexpected and undesirable tax costs related to important, these issues can disrupt a taxpayer’s marketing intangibles.

1 Reg. 1.482-4 (f) (3) (iv), Exs. 2, 3, 4. (1994). 2 We observe that the present proposed regulations which update the “Change Examples” maintain the viability of the issue yet arguably bring the issue closer to the OECD Guidelines standard. 3 DHL Corporation, TCM 1998-461, aff’d in part, rev’d in part 285 F.3d 1285, 89 AFTR2d 2002-1978 (CA-9, 2002). 4 GlaxoSmithKline Holdings (Americas) Inc., v. Commissioner, T.C. No. 5750-04. GlaxoSmithKline Holdings (Americas) Inc., v. Comm’r., T.C. No. 6959-05. Note: The Glaxo Docket No. 5750-04 covers years 1989-1996 while the Glaxo Docket No. 6959-05 covers years 1997-2000. 5 Because this case settled for all years at less than 20 per cent of the amounts due for all years, one can speculate that the IRS factual position was well compromised. Generally, the Government, as a practice, concedes cases where the litigating hazards are 20 per cent or less. Notwithstanding, $3.4 billion is a significant amount of money and has drawn much attention. 6 See Mary Kay Holding Corporation and Subsidiaries v. Commissioner, Docket Nos 14352-03 and 18150-02 (March 24, 2006 Stipulation of Settlement) where the IRS questioned market support payments to Petitioner’s CFCs that were incurred to build the “Mary Kay” Brand. The case was eventually settled. 7 See e.g., “IRS Answer Charges U.S. Glaxo Subsidiary Developed Marketing Intangibles Under § 482” 13, No. 2 BNA Transfer Pricing Report, p 97, June 9, 2004, “IRS Argues Activities of Glaxo Subsidiary Imported Drugs Sold in U.S.” 14 No. 4 BNA Transfer Pricing Report, p 157, June 22, 2005. 8 See Footnote 6. 9 OECD, Final Report on the Attribution of Profits to Permanent Establishments (finalized and approved by the committee on Fiscal Affairs on June 24, 2008) and Discussion Draft on the Attribution of Profits to Permanent Establishment – Part I (General Considerations), 2nd August 2004, s. 221, 239 et seq. 10 OECD Final Report, s. 27 11 OECD Final Report, s.128 12 See Levey, Shapiro, Cunningham, Lemein and Garofolo, “DHL: Ninth Circuit Sheds Very Little Light on Bright Line Test,” 13 J. of International Taxation 10 (Oct. 2002).

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World Tax Review

Roger D. Wheeler*

n August of last year, India’s Finance Minister announced a new I proposed direct tax code which, among many other things, includes a general anti-avoidance rule (GAAR). This month, in my “Commentary” section, I’ll discuss India’s GAAR in the context of other global anti-avoidance measures. In particular, I’ll look at Canada’s now mature anti-avoidance regime, as well as approaches being taken in the United States. India’s new direct tax code also provides for using “advance pricing agreements” (APAs), as a means of resolving or avoiding prolonged transfer pricing disputes. I’ll take a look at recent U.S. experience with APAs in the “Overheard” section. And, as usual, I’ll have a few comments of my own in the “If You Ask Me” section. Roger D. Wheeler

COMMENTARY

Simply stated, a general anti-avoidance rule allows the Revenue Authority to disallow tax benefits to a taxpayer even though, under the tax code as otherwise written, the benefit would have been totally permissible. The principal difference among the various GAAR regimes is largely based on the circumstances triggering GAAR’s applicability. Under India’s proposed GAAR, for example, a transaction will be “impermissible” if the tax benefit itself is one of the purposes of any step of an arrangement. This broadly defined triggering mechanism may distinguish India’s GAAR proposal from global norms. Tax avoidance is a matter of growing interest around the world, and many countries have adopted general anti-avoidance measures, among them: Canada, South Africa, Australia, Germany and China. The United Kingdom

* The author is a Tax Consultant with KPMG LLPs Washington National Tax Office, based in DC, USA. Wheeler retired from General Motors Corporation in 2006 after a 34-year career there, the last 15 as Chief Tax Officer. This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG LLP.

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 43 31 INTERNATIONAL SCENARIO flirted with a GAAR in the late 1990’s but decided commercial purpose, or GAAR would seem to against it, and the United States historically has be triggered. opted for a plethora of specific tax code anti- Aspects of Canadian GAAR avoidance measures, supplemented by a number of judicial doctrines such as economic substance, The Canadian Parliament enacted its current GAAR business purpose, substance over form, step provisions into law in 1988, with the express transaction, and sham transaction. Just recently, intent of capturing abusive tax avoidance the U.S. Congress enacted into its tax code a transactions or arrangements, without interfering form of the “economic substance” doctrine, with legitimate commercial ones. The parameters discussed later. of this statutory anti-avoidance measure have been interpreted over the years, ultimately by Anti-avoidance is so important on the world the Supreme Court of Canada. scene that the International Fiscal Association (IFA) has designated it as one of the two plenary Although the Canadian GAAR, on its surface, may session topics for its upcoming 2010 Annual be viewed by some as similar to India’s provision, Congress in Rome. Reporters have been selected there are some significant differences, both under from over 40 IFA national branches to prepare the statute itself and in the interpretation. For a report describing the anti-avoidance doctrines example, the Canadian statute is one of those and provisions in their countries. This that would look at the totality of a transaction, compendium of anti-avoidance mechanisms should and its place in the context of a commercial be useful to the tax practitioner community. endeavour, rather than just “any step” in a transaction. One would expect the Canadian Proposed Indian GAAR GAAR to be triggered in far fewer situations Under India’s proposed direct tax code, if one than in India, under the proposed wording of of the purposes of any step in an arrangement India’s provision. is to obtain tax benefits, or if the There is another fundamental difference. By its arrangement departs from the arms’ length wording, the proposed new Indian GAAR would principle, and if it lacks commercial substance, apply if an arrangement lacks commercial it would be an “impermissible avoidance substance, whereas the Canadian statute does arrangement.” Once an arrangement is determined not specifically mention economic or commercial to constitute “impermissible avoidance,” the substance. Further, the Supreme Court of Canada Revenue Authority may disregard, amend or has concluded that a transaction does not recharacterize the arrangement in whole or in constitute abusive tax avoidance simply because part, in order to undo the sought after tax benefits. there is no economic or commercial substance. In certain cases, for example, business restructuring, See, Canadian Trustco Mortgage Company, thin capitalization or round trip financing may Appellant, vs. Her Majesty the Queen, Respondent, be impermissible under GAAR. 2003 TCC 215, 2005 SSC 54. It should be noted that, under the extant proposed Smell Test wording, India’s GAAR provision — requiring tax avoidance to be one of the objectives — There is a natural tendency to simplify general seems far more expansive than most other GAAR anti-avoidance rules into a “smell test,” which statutes. GAAR statutes usually require tax may have some appeal. I remember sitting with avoidance to be the “sole” or a “prominent” my friend Ned Shelton at last December’s Mumbai objective for the transaction to be considered to International Tax Conference. Ned is with Shelton’s be abusive. Moreover, most GAAR statutes are International Tax Training Institute, a world- more likely to look at the totality of a situation, renowned tax authority. He laughed as he whereas India’s GAAR would look only to any reviewed charts for his upcoming presentation, step. To say it another way: each and every and pointed to one where the “smell test” was step of a transaction would have to have a mentioned three times in one chart. A bit of

32 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 44 INTERNATIONAL SCENARIO an overstatement, he suggested. And correctly landmark Duke of Westminster case, wherein so, I believe, because if you ask me, the smell the Canadian House of Lords held that taxpayers test is really only applicable in absence of statutory are entitled to arrange their affairs to minimize GAAR provisions. When GAAR is statutory, as their tax liabilities. IRC v. Duke of Westminster in Canada, the wording of the provision itself (1936) AC 1 (H.L.), 19 TC 490. One might expect must control. that India, as a member of the Commonwealth adopting the Westminster principle, to embrace Let’s take a lake a look at the above-mentioned the Canadian interpretation with respect to GAAR. Canadian Trustco case, which considered whether On the other hand, the United States generally the taxpayer’s lease-back transaction constituted favours a substance over form approach, as most abusive tax avoidance, disentitling it to the capital famously expressed by the United States Supreme cost allowance deductions it claimed on assets Court in Gregory v. Helvering, 293 U.S. 465 it purchased and leased back to vendor. The (1935), aff’g 69 F.2d 809 (2d Cir. 1934). India court, in its conclusion said: would be in good company following this “The Appellant derived a tax benefit in the approach. form of a deferral in a transaction under- Economic Substance in the United States taken primarily to obtain that benefit - an avoidance transaction. As much as the As part of recent health care legislation, the Respondent may not like the end economic U.S. Congress enacted a statutory codification result, the Appellant’s capturing of the tax of the economic substance doctrine, a move benefit in this instance does not run afoul under consideration since 1999. Simply stated, of a Government policy to allow CCA on when the economic substance provision applies, exempt property acquired by the purchaser, a transaction will only be considered to have where the purchaser/lessor has provided economic substance if two tests are satisfied: (1) financing to the vendor/lessee. This is the transaction must change the taxpayer’s one of those paradoxes where the sheer economic position in a “meaningful way” (apart complexity of the series of transactions from the federal income tax effects), and (2) the involving many players tweaks the nose taxpayer must have a “substantial purpose” for upward on that least scientific of analysis entering into the transaction (also, apart from known, in tax vernacular, as the smell test, the federal income tax effects). yet legislation and case precedent guide In rather awkward triggering-event language, the analysis down a more structured and new statutory definition of “economic substance” deliberate path past the olfactory sense and must be applied to a transaction if “relevant” into the more certain realm of reason, though to it. Relevance is to be determined in the same less precise purview of policy, where the manner, as under the current common law, as GAAR debate, in this case, rages. In fol- if the doctrine had not been codified. Don’t be lowing that approach, I have concluded embarrassed if this sounds a bit circular to you. this avoidance transaction is not subject to GAAR, and on that basis I refer the matter Although codification of the economic substance back to the Minister for reconsideration doctrine was intended to bring greater uniformity and reassessment. (Paragraph 94).” to the sometimes inconsistent body of precedent under the U.S. judicial common law, the statutory So, in Canada at least, all that smells is not provisions actually enacted by Congress are necessarily abusive. themselves uncertain enough to cause many to Matters of Form and Substance suspect even more litigation, rather than less, will be necessary. While many applaud the recent The Canadian interpretation of GAAR, as U.S. legislation, one formerly high-placed enunciated above in Canadian Trustco, is perhaps government official called codification of the not surprising given that country’s preference economic substance doctrine a “solution in search for “form over substance,” consistent with the of a problem.” He wondered whether aggressive

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 45 33 INTERNATIONAL SCENARIO taxpayers might structure transactions right up pending, 23 unilateral and 108 bi/multilateral. to the edge of the economic substance definition, During the year, there were no APAs cancelled eventually resulting in a new niche for tax shelters, or revoked, and only 14 were withdrawn. and another round of litigation. I suppose only The average length of time to complete an APA time will tell. request, new or renewal, was about 38 months, OVERHEARD with bi/multilateral ones taking nearly twice as long as unilateral ones. The average time to In this part of my column I report on things complete unilateral APAs was 23 months, while other tax practitioners have said or written, the average time for bi/multilateral was just stubbornly protecting the confidentiality of my over 45 months. In terms of time-span parameters, sources. This month, however, I am reporting two APAs took only nine months to complete on information contained in an official Internal while the longest one took 122 months. Revenue Service (IRS) document, so confidentiality is not necessary. Of those APAs executed in 2009, 45 involved a foreign parent with U.S. Subsidiaries, of which 2009 APA Statistics 18 were unilateral and 27 bi/multilateral; 16 On March 21, 2010, the U.S. IRS released its involved US parents with foreign subsidiaries, annual ”Advanced Pricing Agreement (APA) 3 unilateral and 18 bi/multilateral; 3 were Statutory Report” describing experiences, structure partnerships. and activities of the APA program during the IF YOU ASK ME year 2009. Let’s take a look at some of the interesting and important statistics from the Call me sentimental, call me old fashioned; but report. I kind of like judicial doctrine. If you ask me, I’d much rather read about Mrs. Gregory and During 2009 a total of 63 APAs were executed, the Duke of Westminster than I would section 21 unilateral and 42 bi/multilateral; this compares 7770 (o) of the Internal Revenue Code. The with 68 total APAs for 2008. The cumulative Code is for “instruction readers”, while judicial total of APAs executed since the program’s decisions are action-packed and interesting. So inception now exceeds 900. In addition, there I mourn the enactment of a statutory “economic were 28 APA renewals executed during 2009, substance” provision, and shudder at expected 8 unilateral and 20 bi/multilateral; 8 APAs were attempts to draft the presumably necessary amended. interpretive regulations to implement it. If you As of year-end 2009, there were 352 APA requests ask me, the good old case law was just fine. pending, 70 unilateral (of which 47 were new So that’s what I say, let me know what you requests) and 282 bi/multilateral (of which 174 think. Write me at [email protected]. were new). There were also 131 renewal requests

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG LLP. ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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Review of Significant U.S. Tax Developments

Charles W. Cope*

his monthly column provides an overview of recent significant T developments in U.S. income tax law that may be of interest to tax advisors in India that have clients with U.S. interests, or tax directors of companies in India with U.S. interests.1 Many aspects of U.S. tax law are covered, including proposed legislation, Treasury regulations, IRS rulings, judicial decisions and income tax treaties. In this column, we review some recent legislative developments and a new IRS reporting requirement.

Charles W. Cope Legislative Developments On March 3 Congressman Charles Rangel stepped down as chairman of the House Ways and Means Committee because of an ongoing ethics investigation by the House. Congressman Sander Levin became the acting chairman of the Ways and Means Committee. During a speaking engagement on April 19, Congressman Levin stated his plan to push for enactment of the American Workers, State and Business Relief Act of 2010 (Jobs II) and the Small Business and Infrastructure Jobs Tax Act of 2010 (Jobs III) before the U.S. Congress recesses for the Memorial Day holiday (May 31). Congressman Levin also stated lawmakers are giving serious consideration to the revenue raiser in Jobs III that would limit treaty benefits for certain deductible payments to third-country subsidiaries of foreign countries.

* Charles W. Cope is a member of the International Corporate Services Group in KPMG LLP’s Washington National Tax practice (“WNT”). The author thanks Jennifer Blasdel and Steve Massed of WNT for their assistance in the preparation of this column. 1 The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG LLP. ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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Also noteworthy, he stated that lawmakers are deductions of interest expense related to income considering certain other “unspecified” revenue earned offshore that has not been repatriated, offsets. (ii) prevent splitting of foreign income and foreign taxes, (iii) reform certain other foreign tax credits The Jobs II Revenue Offset Dilemma: On December rules, and (iv) subject excess returns associated 9, 2009, the House of Representatives (the “House”) with transfers of intangibles offshore to current passed Jobs II. On March 3, 2010, the U.S. Senate basis taxation. passed an amended version of Jobs II. Jobs II generally extends for one year (through 2010) Codification of Economic Substance Doctrine certain expiring tax incentives (the “Extenders”). On March 30, 2010, President Obama signed In their respective version of Jobs II, the House into law the Health Care and Education and Senate propose different revenue offsets to Affordability Reconciliation Act of 2010 (the pay for the expiring tax incentives. As both “Reconciliation Act”). The Reconciliation Act versions of Jobs II contain revenue offsets that adds a new paragraph (o) to section 7701 of the were included as revenue offsets in other legislative Internal Revenue Code (the “Code”) which clarifies packages, it is unclear at this time which revenue how the economic substance doctrine will be offsets will ultimately be included in the final applied. This provision is effective for transactions Jobs II bill. According to Senator Charles E. entered into after March 30, 2010. The Schumer, the Senate and House are expected to Reconciliation Act also adds new penalties for hold a formal conference committee in the next transactions that are found to lack the required couple of weeks. economic substance. Up until recently, the Senate has shown strong Section 7701(o) provides that, if the economic opposition to the House-passed revenue offset substance doctrine is relevant to a transaction, that requires investment fund managers to treat the transaction will be treated as having economic a “carried interest” (i.e., a partnership interest substance only if: (i) the transaction changes in received in exchange for services provided to a meaningful way (apart from U.S. federal income the partnership) as ordinary income received in tax effects) the taxpayer’s economic position (the exchange for the performance of services to the “Economic Substance Requirement”); and (ii) the extent it does not reflect a reasonable return on taxpayer has a substantial purpose (apart from invested capital (the “carried interest proposal”). U.S. federal income tax effects) for entering into Recent statements by certain members of the the transaction (the “Business Purpose U.S. Senate, however, seem to suggest that the Requirement”). This conjunctive test settles a Senate may now be more open to the possibility split among the various U.S. Court of Appeals, of including this revenue offset in the final Jobs some of which apply a disjunctive test. II bill. Even if the Senate goes along with the carried interest proposal, the House and Senate Section 7701(o) defines the term “economic must agree on additional revenue offsets because substance doctrine” as the common law doctrine the carried interest proposal alone cannot fully under which tax benefits under subtitle A finance the Extenders. (concerning income taxes) with respect to a transaction are not allowable if the transaction Obama’s 2011 Budget Proposal: President Obama’s does not have economic substance or lacks a 2011 Budget Proposal contains a number of business purpose. Section 7701(o) is not intended international provisions that could be used as to change the scope of transactions to which the revenue offsets to pay for the Extenders. At this economic substance doctrine is relevant. The courts time it is not clear whether Congressman Levin’s generally have applied the doctrine to transactions reference to “unspecified” revenue offsets was in which the tax benefits significantly outweigh intended as a reference to any of these provisions. the potential economic impact of the transactions Revenue raising international tax provisions on the taxpayer. Although the determination of included in Obama’s 2011 Budget Proposal include, whether the economic substance doctrine is relevant for example, provisions that would: (i) defer is based on all the facts and circumstance, the

36 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 48 INTERNATIONAL SCENARIO courts typically have considered the application refund or credit attributable to a transaction of the doctrine where one or more of the following lacking economic substance is treated as not factors were present: having a reasonable basis. Thus, taxpayers may not rely on the opinion of a tax advisor to avoid u The taxpayer achieved large tax benefits the penalty. with a relatively small amount at risk eco- nomically. Developments Concerning Cross-Border Equity Swaps u The transaction contained more steps than necessary to achieve the intended business Dividend payments from U.S. domestic purpose or economic consequences and the corporations made to foreign shareholders are superfluous steps gave rise to significant generally subject to a 30-percent withholding tax benefits. tax, unless reduced by an applicable income tax treaty. The U.S. Treasury regulations provide u The transaction enabled the taxpayer to that a substitute dividend payment made in a utilize a tax attribute that was about to securities lending transaction or a sale-repurchase expire or to shelter an extraordinary item transaction is sourced in the same manner as of income or gain. actual dividends on the transferred stock of a u The transaction included one or more tax U.S. domestic corporation. By contrast, the indifferent parties, who may have recog- regulations provide that a foreign person’s income nized a tax item that would have been related to a notional principal contract (“NPC”) detrimental to a party subject to U.S. tax. that references stock of a U.S. domestic corporation (e.g., a total return swap) generally is sourced u The transaction included hedges, swaps, guarantees, or other arrangements designed to the residence of the recipient and not subject to limit the taxpayer’s actual economic risk to U.S. withholding tax. Over the years financial from the transaction that gave rise to the institutions and foreign investors have relied on tax benefit. the sourcing rule in the total return swap regulation when asserting dividend-equivalent payments u The transaction was unwound within a rela- made pursuant to total return swaps and other tively short period after the tax benefits NPCs are not subject to U.S. withholding tax were achieved. and Form 1042-S reporting.

u The transaction was brought to the tax- New Legislation Changes Sourcing Rule for Income payer by an outside promoter or by a tax Related to NPCs: On March 18, 2010, President advisor, rather than arising from an opera- Obama signed into law the Hiring Incentives to tional need or business objective. Restore Employment Act (the “HIRE Act”). The The Reconciliation Act adds a 40-percent penalty HIRE Act adds to the Code section 871(l) which under section 6662 for tax underpayments provides that a “dividend equivalent” will be attributable to non-disclosed transactions lacking treated as a dividend from U.S. sources. The economic substance or transactions that fail to effect is to subject the dividend equivalent to meet the requirements of any similar law or a U.S. withholding tax of 30 percent, unless the rule. Taxpayers may not avoid the penalty by dividend article of a U.S. income tax treaty showing that they had “reasonable cause” for reduces or eliminates the tax. failure to disclose, e.g., because they relied on The provision defines a dividend equivalent to the opinion of a tax advisor. When the taxpayer include, inter alia, “any payment made pursuant does adequately disclose the transaction, the to a specified notional principal contract that penalty is reduced to 20 percent. What constitutes (directly or indirectly) is contingent upon, or it “adequate disclosure” is unclear at this time. is determined by reference to, the payment of The Reconciliation Act also toughens the erroneous a dividend from sources within the United States.” refund penalty under section 6676(c) in the case The statute describes five situations in which a of transactions lacking economic substance. Any NPC is considered a “specified notional principal

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 49 37 INTERNATIONAL SCENARIO contract.” In one case, in connection with entering IRS Releases Draft Schedule Requiring Certain into the NPC, any long party to the contract Taxpayers Disclosure Uncertain Tax Positions transfers the underlying security to a short party As noted in an earlier column, in January the to the contract. In another case, in connection IRS announced it was developing a new schedule with the termination of a NPC, any short party to require the annual disclosure of “uncertain to the contract transfers the underlying security tax positions.” Under FASB Interpretation No. to any long party to the contract. 48, Accounting for Uncertainty in Income Taxes, The new provision also defines a “payment” to an Interpretation of FASB Statement No. 109 include “any gross amount which is used in (FIN 48), many U.S. taxpayers identify and quantify computing the net amount which is transferred uncertain tax positions for financial accounting to or from the taxpayer.” Thus, in the case of purposes. a payment made to a foreign party under a On April 19, 2010, the IRS released, in draft NPC, U.S. tax will be imposed on the gross form, the schedule requiring disclosure of uncertain amount due the foreign party under the NPC tax positions by certain taxpayers: Schedule UTP. (i.e., before reduction by any amount due the The draft schedule was accompanied by draft U.S. party from the foreign party). instructions and an announcement, Announcement Industry Directive on NPCs: On January 14, 2010-30, providing background on the new form. 2010 the International Revenue Service (IRS) The announcement and the instructions make issued an industry directive on Total Return clear that, for 2010, Schedule UTP will be required Swaps Used to Avoid Withholding Tax, LMSB- only for taxpayers that file Form 1120, U.S. 4-1209-044 (the “Directive”). The Directive, which Corporation Income Tax Return; Form 1120-L, US is issued under prior law, provides insight into Life Insurance Company Income Tax Return, Form the specific types of total return swaps that the 1120-PC, U.S. Property and Casualty Insurance government deems abusive and whose dividend- Company Income Tax Return and Form 1120-F, equivalent payments the IRS believes should be U.S. Income Tax Return of a Foreign Corporation. treated as U.S.-source income for withholding The instructions also provide three other conditions tax purposes. that must be satisfied in order for the Schedule UTP to be required. The corporation must: The Directive provides guidance to field agents as to the specific types of total return swaps u have assets of at least $10 million that should be characterized as another type of have issued (or a related party must have arrangement that would subject the dividend- u issued) an audited financial statement (pre- equivalent payments to withholding tax. The pared according to GAAP, IFRS or other Directive focuses principally on transactions in country specific accounting standards) that which a foreign investor terminates its investment covers all or a portion of the corporation’s in a U.S. dividend-paying stock while retaining operations for all or a portion of the identical economic exposure to the stock through corporation’s tax year, and a total return swap. Subsequently, the swap is terminated, and the foreign investor reacquires u have one or more tax positions that must the position in the same stock. In the interim, be reported on Schedule UTP a dividend is paid on the stock, and the foreign A taxpayer has an uncertain tax position if it investor receives a dividend-equivalent payment (or a related party) either (i) has recorded a under the swap that is not subject to withholding reserve in an audited financial statement with tax, assuming the form of the transaction is respect to a tax position taken on an income tax respected. The Directive also addresses situations return or (ii) has not recorded a reserve because in which the foreign investor never makes a the taxpayer expects to litigate the position taken direct investment in the equity or equities on the return or because of IRS administrative underlying the total return swap. practice with respect to this position.

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The instructions provide that the reporting Schedule UTP generally requires disclosure of requirements apply to foreign corporations that the “maximum tax adjustment” with respect to file “protective returns” showing no tax due. each uncertain tax position. Some taxpayers are For example, a foreign corporation that files a concerned that the maximum adjustment shown Form 1120-F because it believes that is engaged on Schedule UTP will be the basis on which IRS in a U.S. trade or business, but reports no taxable field agents will propose adjustments i.e., income on the return because it believes it has adjustments will be made more or less no effectively connected income, would have to automatically using the maximum amount. In file Schedule UTP if there was uncertainty addressing various tax groups, officials of the concerning whether the foreign corporation had IRS have denied that would be the case. effectively connected income and the company had recorded a reserve with respect to that position (and it satisfied the other filing requirements enumerated above).

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UK Tax Update

Diane Hay*

n this issue, members of PricewaterhouseCoopers LLP comment I on the Finance Act 2010 including, in particular, the bank payroll tax applicable to certain remuneration payable between 9 December 2009 and 5 April 2010. Recent cases also shed light on US-related issues involving the availability of double tax relief for disregarded entities and the fiscal transparency of an LLC. The UK’s Tax Authority, HMRC, has provided additional guidance on thin capitalisation and made new proposals for a smoother process for obtaining clearance for applying treaty-reduced withholding tax rates to certain interest payments. Finally, there is a reminder about the deadline for reporting details of non-tax favoured share plans. Diane Hay

Finance Act, 2010 Finance Bill 2010 received Royal Assent as Finance Act, 2010 on 8 April 2010. It has 161 pages, 70 sections and 20 Schedules. It is worth noting that there were a similar number of provisions announced in the March 2010 Budget which were not included in the Act. They may only appear, if the new government sees fit, in a subsequent Finance Bill after the general election which is due to take place on 6 May 2010. “Treaty passport” proposed As an improvement to the existing process under which non-residents receive ‘treaty clearance’ from the UK tax authority (HMRC) to receive interest payments from a UK resident at a reduced or nil rate under the terms of a double taxation agreement, HMRC is intending to introduce a ‘treaty passport’ scheme for both connected and unconnected lenders. The scheme would apply to lenders who are corporates or otherwise are regarded by HMRC as opaque entities for tax treaty purposes, where they are lending to UK borrowers.

* The author is a Special Advisor to PwC in the U.K.

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Under the proposed scheme, which would run However, for those relying on a particular LLC from 1 September 2010, a non-resident lender being treated as opaque, the case highlights the would file a short application with HMRC which need to consider the particular terms of the has been stamped by its domestic tax authorities. entity before coming to a conclusion. HMRC would then allocate a treaty passport Updated guidance on thin capitalisation number which can be passed to UK resident borrowers. Once the treaty passport is issued HMRC’s International Manual now features by HMRC, no separate application for clearance significantly updated guidance in respect of thin need be made by the lender to HMRC for any capitalisation. other loans made to the same or another UK A large amount of the guidance has been re- borrower. written and several new chapters have been Passports would be renewed every five years, added. Many of the changes reflect PwC’s own and non-UK residents are likely to be able to discussions with HMRC in the past two or three pre-register from 1 June 2010. years. Double tax relief for UK disregarded entity In recent years the practice of reaching agreement on thin capitalisation issues with HMRC has The case of Bayfine UK v. HMRC concerned two moved on considerably - particularly following UK subsidiaries of a US bank which were treated the introduction of the Advance Thin Capitalisation as disregarded entities for US tax purposes. Agreement (ATCA) procedure in March 2007. These UK subsidiaries entered into equal and opposite interest rate contracts with subsidiaries Some of the key updates include those set out of another US bank. The intention was that one below: of the UK subsidiaries would make a loss and u Practical advice in respect of the ATCA this would be surrendered to other UK group process, such as what types of transactions companies, while the other would make an equal are within the ATCA regime, periods cov- and opposite profit, but that the UK tax liability ered, expected content, penalties and with- on that profit would be eliminated by credit drawal from the process. relief for US tax paid on the same profit paid by its immediate US parent company (due to u Specific commentary on typical private equity the UK subsidiary’s disregarded status in the structures and the implications for negoti- US). ating ATCAs.

The UK tax authorities challenged the UK tax u Accountancy issues, in particular the im- treatment, arguing that relief for the loss should pact of pension costs arising from FRS 17. not be allowed and that double taxation relief u The use of third party loan agreements (DTR) should not be available to offset UK tax containing financial covenants as poten- payable on the profit. tially comparable evidence of an arms’ length The High Court has now held for the taxpayers. borrowing.

Delaware LLC held to be fiscally transparent u Discussions around the process of obtain- ing an independent credit rating and the In the recent personal tax case of Mr Swift v. use of company-produced credit ratings in HMRC, the First-tier Tribunal (Tax) found that pricing debt. a Delaware Limited Liability Company (LLC) was fiscally transparent for UK tax purposes u The process of applying for treaty clear- and not - as has been the established practice ance, which in the majority of cases is now - opaque. dealt with separately from any thin capitalisation negotiations. The decision is based on the specific facts of the specific LLC concerned and, since there is wide As is always the case with HMRC’s manuals, freedom to contract the terms of a Delaware the updates should be viewed as guidance and LLC, the case may not be of general application.

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 53 41 INTERNATIONAL SCENARIO an indication of HMRC’s view rather than binding companies completing Form 42 - the annual interpretation. The updates are far from prescriptive share plan reporting form for non-tax favoured and emphasise the practical nature of thin share plans. In particular, this might apply to capitalisation enquiries and the need for companies that made changes to their reward commercial awareness on the part of HMRC. structures in advance of the introduction of the new 50% income tax rate for higher earners Bank payroll tax finalised from 6 April 2010. The tax levy of 50% payable on certain “banking” Companies often find completing Form 42 a remuneration payable between 9 December 2009 complex process anyway and, as HMRC continues and 5 April 2010 was finally introduced by to conduct focused tax audits, examining, amongst Finance Act, 2010 on 8 April. Self-assessment of other things, any share plans operated by a bank payroll tax (BPT) and payment must be company or group, it is essential that returns made by 31 August 2010. Record keeping will are completed correctly and on time. be necessary even where a company subject to BPT has no liability. The form is due by 6 July 2010 in respect of the 2009/10 tax year and companies often factor While the name may suggest that BPT only in insufficient time for what turns out to be a affects banks, the reality is that a broad range lengthy process, particularly in relation to of companies may be affected. However, the internationally mobile employees. final provisions exclude various independent “insurance companies, asset managers, The form cannot be filed electronically this year. stockbrokers etc” from scope. HMRC frequently reviews these forms in detail and if any non compliance is found, the results Form 42 reporting of share plans could be expensive for employers. Complexities may have increased this year for

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EU Tax Update

Maarten F. Koper*

LATEST EU DEVELOPMENT Mr. Algirdas Semeta appointed as the new European Commissioner for Taxation and Customs Union, Audit and Anti-Fraud Mr. Algirdas Semeta had been the Commissioner in Lithuania responsible for Financial Programming and Budget and has been appointed as the new European Commissioner for Taxation and Customs Union, Audit and Anti- Fraud. At the European Parliament in early January 2010, Mr. Semeta was questioned by members of the European Parliament Committees for Budgetary Control, Maarten F. Koper Economic and Monetary Affairs and for Internal Market and Consumer Protection about the future status of the EU Anti-Fraud Office, the control of EU spending in Member States, combating VAT fraud and dealing with tax havens among other matters. Questions raised by the MEPs included, for instance, tax havens and banking secrecy. Mr. Semeta promised to focus on the creation of a CCCTB for all Member States. He also expressed his commitment to the fight against tax evasion and fraud both outside and within the EU. His plans include the development of agreements with countries such as Lichtenstein, Andorra and Switzerland to prevent the loss of tax revenue. Customs and Excise Duties were also mentioned during the debate in the Parliament. The Commissioner elect said he would encourage the development of e-customs and further introduction of new technologies, so as to improve the cooperative working of the different customs administrations. The main priority selected by Mr. Semeta for his mandate as Commissioner for Taxation is the revision of the Energy Taxation Directive. The process of revising the Directive 2002/96/EC started in 2009 and should provide

* Maarten F. Koper has a Masters Degree in Tax Economics from the University of Amsterdam, the Netherlands and a Bachelors Degree in Tax Economics from the Amsterdam Business School and he is an International Tax Services partner of Ernst & Young located in Cyprus with over 15 years of experience in advising on international tax matters. The author can be approached at [email protected]

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 55 43 INTERNATIONAL SCENARIO the EU with stronger means to tackle CO emissions Under the new system, portfolio dividends from 2 while enforcing better energy efficiency and an EU or Norwegian as a European Economic environmental protection. The final Directive should Area (EEA) country with information exchange be adopted during the first half of 2010 and and enforcement assistance, are treated as tax come into force in 2013. The revised text should exempt if certain conditions are met for which take into account the EU climate and energy the burden of proof is with the taxpayer. The package meeting, inter alia, the 2020 climate and taxpayer has to prove that there is comparable energy efficiency targets. The new Directive will taxation in the country paying the dividends, introduce CO as a fiscal element in the areas that the tax rate is at least 15% and that the 2 not yet covered by the EU’s emissions trading foreign company is not subject to any personal scheme. or factual exemption under the foreign tax legislation. As a consequence, the exemption – Other topics mentioned both during the debate factually – may not be granted in the majority and in subsequent press conferences included of cases in which the taxpayer cannot provide the fight against the fraudulent use of European the proof that the conditions for exemption are Commission(EC) funding, the establishment of met. The new system is applicable to all open the Eurofisc operational network for information assessments. Third-country portfolio dividends exchange on VAT and the elimination of double may still not be exempt in any case. Therefore, taxation. the different treatment of portfolio dividends The College of Commissioners was approved by from domestic and third-country sources on the the European Parliament on 9 February 2010. one hand, and domestic and EU and Norwegian The new team in charge of Taxation and Customs dividends on the other, may still constitute a Union, Audit and Anti-Fraud can now start breach of the fundamental freedoms. directing their energies towards fulfilling all that As this system is also applicable retroactively, is expected of them for the years ahead. in October 2009, the ECJ sent a formal request COUNTRY UPDATES (DIRECT TAX) to the Austrian court referring to the Haribo and Salinen cases to clarify whether the amended AUSTRIA legislation in Austria has an influence on the Rephrased preliminary questions in Haribo and preliminary questions. As a consequence, the Salinen cases regarding the taxation of portfolio Austrian court restated some of the preliminary dividends and third country issues questions in order to cover the new system as well. The main questions regarding the equality There are two cases pending before the ECJ in of the exemption method and the credit method which the Court will have to decide whether the and the different tax treatment of domestic and parallel application of the exemption method for certain EU and EEA-dividends on the one hand, domestic dividends and the application of the and third- country dividends on the other, as credit method for foreign portfolio dividends is well as the question as to whether the burden in line with EC Law [(Haribo case (C-436/08) of proof is in line with the fundamental freedom. and Salinen AG case (C-437/08)]. This treatment These questions still have to be answered by the was held to be in line with the fundamental ECJ also in the light of the new legislation. freedoms by the Austrian Supreme Administrative Court in a case handed down in 2008. In the light of the uncertain outcome of the ECJ cases, in the Haribo and Salinen cases it might After that judgment of the Supreme Administrative be worthwhile to keep procedures open (e.g., by Court, and after the preliminary questions regarding appealing against tax assessments in which foreign the same issues had been sent to the ECJ by portfolio dividend income in included in the another Austrian tribunal, the Austrian legislator taxable base). changed the tax regime for portfolio dividends before receiving the answers of the ECJ on this As the Haribo and Salinen cases concern third- matter. country dividends, and even the revised legislation

44 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 56 INTERNATIONAL SCENARIO does not exempt third- country portfolio dividends, Since it had less than 20% participation, withholding this is certainly true for this type of dividend. tax was applied to dividend distribution. The fund claimed that this constituted violation of Also, for participations in EU and EEA countries, Articles 56 and 58 of the EC Treaty since there the same procedure should be applied as the was no tax withheld from dividends paid to a new requirements for exemption may only be domestic UCITS. demonstrated by the taxpayer in exceptional cases and therefore, exemption – factually – may not In Estonia, UCITS can only be established as a be granted in the majority of cases. This is not contractual fund. The Court of First Instance had only true for investment funds and pension funds therefore stated that the situations were not but also for “ordinary” shares in companies in comparable. The District Court (Court of Appeal) which the participation does not lead to the came to a different conclusion that not only the right to claim the documents needed to fulfil the legal status but also the economic functions the criteria of the Austrian dividend taxation legislation. funds are performing should be taken as the basis to determine whether the free movement There may also be a second implication for the of capital is violated or not. Furthermore, if non- taxpayer. In case the ECJ decides in favour of residents make investments in an Estonian company the taxpayer in the Haribo and Salinen cases and through an Estonian UCITS, such income should the exemption method has to be applied also for not be taxed at the level of the Estonian fund foreign portfolio investments, a refund of foreign or at the level of the non-resident unit holder. withholding taxes in the state of the company The Court therefore concluded that it is not paying the dividends may be claimed based on merely a difference in the timing of taxation. the Amurta (C-379/05) and Denkavit Internationaal (C-170/05) cases of the ECJ. The ECJ decided The case was appealed by the tax authorities at that, in case the withholding tax cannot be credited the Supreme Court, but it is not yet clear whether in the country of residence, the country paying the case will be accepted for proceedings. Therefore out the dividends may be prevented from levying the District Court decision has not entered into withholding taxes. force and is not publicly available yet, including the argumentation advanced by the parties. The As the exemption – after the judgment of the decision is expected to become an important ECJ – may only be granted to “open cases” the landmark in Estonian tax case law on the refund procedure for foreign withholding taxes compatibility of Estonian direct tax rules with is only available to these cases too (depending the EC Treaty. on the domestic law of the relevant states). FRANCE ESTONIA French tax authorities provide guidelines for District Court says Estonian withholding tax EU/EEA non-profit entities, including pension on dividends is incompatible with the EC Treaty funds, in order to benefit from the same tax Until 1 January 2009, Estonia applied withholding treatment as French non-profit entities tax on dividends paid to non-resident legal entities The French Administrative Supreme Court decided if a certain participation threshold was not met on 13 February 2009 that the French withholding (20% in 2004 and 2005). Dividends paid to resident tax levied on dividends distributed to Dutch legal entities were not subject to withholding pension funds is contrary to the free movement tax; however, the dividend income was subject of capital (Article 56 EC Treaty). This is because to taxation by resident legal entities at the moment French pension funds, known as “caisses de retraite of profit distribution. et de prévoyance,” which are regarded as non- The case at hand involved a Luxembourg profit organizations and whose activities are Undertaking for Collective Investment in comparable to those of Dutch pension funds, Transferable Securities (UCITS) receiving dividends would benefit from a tax exemption on such from an Estonian legal entity in 2004 and 2005. dividends.

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Reacting to this decision, and completing the starting from 1 January of the year in which the new provisions set out in the Amended Finance certificate is delivered. For example, a certificate Bill for 2009 which aim to abolish the discrimination issued in 2010 should be valid from 1 January between French non-profit entities and foreign 2010 to 31 December 2012. ones as regards French source dividends, the Such a certificate may be provided to the French French tax authorities issued new administrative paying agent of the French source income received guidelines on 15 January 2010. by the EU/EEA entity in order to directly benefit After stating that non-profit entities located in from the tax treatment applicable to French non- a EU Member State, or in an EEA State with profit entities. For instance, where an EU/EEA which France has entered into an administrative entity provides the French paying agent with a assistance agreement that aims at preventing certificate before the payment of the French source fraud or tax evasion, are subject to the same tax dividends, the French paying agent should levy treatment. In respect of their French source income withholding tax at the rate applicable to French as French non-profit entities, the new guidelines non-profit entities (i.e., 15% instead of 25% for define the conditions to be fulfilled and their dividends distributed in 2010). practical implications. Where the EU/EEA entity does not provide the According to the guidelines, in order to enable French paying agent with a certificate before the the French tax authorities to ascertain that the dividend payment, the certificate may be used EU/EEA entity fulfils the requirements set out retrospectively to request the French tax authorities in French tax law in order to be regarded as a to refund the excess withholding tax levied. Such non-profit entity, the entity must provide the request should be filed by 31 December of the French “Direction of the Non-Residents” with: second year following the one during which the withholding tax was levied (e.g., 31 December 1. Its constitution 2012 for dividends paid in 2010). 2. Copies of the minutes of the entity’s gen- For previous years, and under the same eral meetings for the last three years documentation requirements, the French tax 3. Copies of the general accounts for the last authorities acknowledge that EU/EEA non-profit three years entities may benefit from the extended deadline provided by Article L190 of the French Tax 4. Copies of the payslips of the entity’s man- Procedure Code. Hence, administrative claims agement for the last three years for the refund of excess withholding tax levied, 5. A questionnaire, as the one annexed to the for instance, on dividends received from 1 January guidelines, duly completed 2006 may be filed up to 31 December 2011. 6. Upon request, a document certifying the Finally, for pending claims, it should be noted location of the entity that the French tax authorities require the provision of similar information and documentation before The questionnaire, which is written in French deciding whether to accept or reject these claims. and should be completed in French, contains questions ranging from general information about GERMANY the entity (identification of the entity, organization, The Columbus Container case (C-298/05): German membership, means and resources) to more specific Federal Tax Court (BFH) statement ones about its management (salaries and wages, etc.) and its activities. Columbus was a Belgian limited partnership that was treated as a “coordination center” by the Once provided with all this information and Belgian tax authorities. Its interests were held documentation, the French tax authorities will by German resident partners, its economic activities assess whether or not the entity may be regarded were mainly intra-group financial services. For as a non-profit one under French tax law and, German tax purposes, Columbus was treated as if so, deliver a certificate valid for three years a foreign permanent establishment of the partners.

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The income was, therefore, directly allocated to For the time being, the German legislator has the partners. introduced the possibility of counter-evidence with section 8 Para 2 FTA. However, such proof According to the double tax treaty between is neither possible for the switch-over rule nor Germany and Belgium, profits from a Belgian for situations where the application of the free permanent establishment are exempt in Germany. movement of capital principle applies. It therefore Under the German Controlled Foreign Corporation remains doubtful whether the new legislation (CFC) Rules, Columbus, as a transparent entity, and German CFC rules are in line with the was not in itself regarded as a CFC. CFC rules, sound principles developed by ECJ in the Cadbury as laid down in section 7 to 14 Foreign Tax Act Schweppes case (C-196/04). (FTA), only apply to foreign subsidiaries. However, to prevent circumvention, section 20 paras 2 and Taxpayers adversely affected by the German CFC 3 FTA provides for a switch-over clause in respect rules, or by similar rules of other Member States, of certain passive income from non-German should consider whether it is appropriate to make permanent establishments based on the fictional claims for refunds of CFC charges paid in respect taxability of income and assets under the CFC of subsidiaries or investments that are not “wholly rules. In the case at hand, the exemption method artificial arrangements” established to avoid the was disregarded and such income was taxed, national law of that Member State. with double taxation on income derived from European Commission likely to start infringement the foreign permanent establishment being procedure against German Anti-Treaty/Anti- mitigated by a tax credit. Directive Shopping Rules On 6 December 2007, the ECJ issued a ruling The European Commission examined the German that the switch-over rule is not an infringement anti-abuse rules and it is expected that the of freedom of establishment and the free movement Commission will reach the conclusion within the of capital. However, in its judgment, the ECJ did next few months that these rules do not comply not consider the application of the underlying with Community law. CFC rules per se, ruling instead narrowly on the switch-over rule. Background The German Federal Tax Court has now stated The German domestic withholding tax of 26.37% that the underlying CFC rules, the provisions of on dividends and certain other payments is section 7 to 14 FTA, and subsequently the switch- generally reduced to a 0%—15% rate under the over clause, do not comply with EC law, as they EU Directive and tax treaties. aim to avoid tax abuse/circumvention without However, under the German anti-abuse rule (Sec. providing for proof of counter-evidence. Application 50d para. 3 German Income Tax Act) on withholding of the CFC rules is a prerequisite of the switch- tax exemptions under a tax treaty or EU Directive, over rule and, therefore, even the switch-over any foreign company which receives a payment rule may require proof of counter-evidence in subject to German withholding tax and is owned order to be in line with EC law. If the taxpayer by shareholders that would not be entitled to can successfully prove that the arrangement is a corresponding benefit under a treaty, or the not wholly artificial, the switch-over rule is not EU Directive. If they had received the payment applicable. The consequence of this is not the directly, they will be entitled to a reduced or non-application of the CFC rules, but rather an 0% withholding tax rate but only if three tests EC law supplementing the CFC rules. In the case are all satisfied in order to obtain treaty or EU at hand, Columbus was not considered to be Directive benefits: wholly artificial due to necessary substance and business reasons. A re-examination of this result 1. Business Purpose Test by the ECJ was not considered necessary by the 2. 10% Gross Receipt Test German Federal Tax Court. 3. Substance Test

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Potential breach of EC Treaty Freedoms The second infringement proceeding relates to the tax deductibility of certain types of consumer The German anti-abuse rules go far beyond the expenditure which, according to the Greek criteria for the restriction of EC Treaty Freedoms legislation, is allowable only if it is incurred in than the generally accepted reason to reduce the Greece by Greek tax residents. The Commission risk of tax avoidance. In the Cadbury Schweppes considers this dual restriction on the tax case, the ECJ stated that “the specific objective deductibility of expenditure income, i.e., of such a restriction must be to prevent conduct involving the creation of wholly artificial (a) it has to be incurred in Greece and arrangements which do not reflect economic reality, (b) by Greek tax residents to be contrary to the with a view to escaping the tax normally due freedom to provide services and the free on the profits generated by activities carried out movement of persons. on national territory.” The Court further pointed out that the taxpayer must be given an opportunity The non-deductibility of consumer expenditure to provide evidence that the structure is not a incurred abroad discourages Greek residents from wholly artificial arrangement (counter-evidence). receiving services from abroad and also impedes foreign service providers from offering their services Expected further proceedings to Greek tax residents. If the Commission considers that the German Apart from the above, non-resident taxpayers anti-abuse rules violate Community law, it will who derive their income exclusively, or almost deliver a detailed opinion on the matter and set exclusively, within Greece is in a comparable Germany a deadline for compliance. If Germany situation to a Greek resident, according to the does not comply with the opinion by this deadline Schumacker doctrine, and thus he should enjoy the Commission may bring the matter before the the same benefits afforded to Greek residents. ECJ. Despite this doctrine, non-resident taxpayers earning It remains to be seen how Germany would deal the majority of the worldwide taxable income with the opening of an infringement procedure. are not afforded this benefit. In this context, it will be particularly interesting As the reasoned opinion sent to Greece states, to see whether Germany will seek to avert the if Greece does not amend the said tax rules lawsuit before the ECJ by introducing a counter- within a two-month period, the Commission may evidence option into its Anti-Treaty/Anti-Directive refer the case to the ECJ. Shopping Rules. SPAIN GREECE Commission sends reasoned opinion to Spain Commission commences two new infringement on Capital Duty proceedings against Greece The European Commission has sent a reasoned The EC has commenced two new infringement opinion to Spain for not complying with the proceedings against Greece in the field of direct Capital Duty Directive (2008/7/EC) by imposing taxation. The first case relating to the change of transfer tax on certain contributions of capital the Greek legislation on the taxation of income in addition to the Capital Duty. from inbound dividends should soon close; this is because Greece has already amended its Reasoned opinions are the second step of the legislation in this respect with L. 3697/2008 but infringement procedure as stated in Article 258 has not advised the Commission. It is to be of the EC Treaty. This means that after two noted that, as of 1 January 2009, both domestic months, if no change as required by the reasoned and inbound dividends received by individuals opinion is verified by Spain, the EC may decide tax resident in Greece are subject to 10% exhaustive to refer the matter to the ECJ. income taxation.

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The Capital Duty Directive authorizes Member provision of services. Spain has two months to States to levy Capital Duty on contributions of provide a satisfactory response to the Commission. capital, as long as the tax rate does not exceed If it fails to do so, the Commission may refer 1% of the capital increase and, according to the matter to the ECJ. Article 5 of the Directive, Member States may not levy any other tax on such an increase. The COUNTRY UPDATES (INDIRECT TAX) Commission considers that the current Spanish UNITED KINGDOM legislation, i.e., Article 108 of Law 24/1988 on the securities market, is not in agreement with Limited application of the Lennartz principle Article 5 of this Directive as it allows another in the UK tax to be levied in addition to capital duty on Following the ECJ’s decision in February 2009 certain contributions of capital. in the case of Vereniging Noordelijke Land-en Tuinbouw This Spanish law on the securities market provides Organisatie v Staatssecretaris van Financien (C- for, in cases where a contribution of capital to 515/07) hereinafter “the VNLTO case,” HM Revenue a company whose real estate assets located in and Customs (HMRC) has limited the application Spain constitutes more than 50% of its total of the Lennartz principle from 22 January 2010 assets, or whose assets include securities in another onwards. entity whose assets consist for at least 50% of The Lennartz principle real estate located in Spain, any contributor who, as a result of this contribution, gains a position The Lennartz principle came into force on 1 allowing the control over this entity or, once this November 2007 and provides that a taxable person, control has been obtained, increases his who incurs tax on goods that are intended for shareholding in the entity to be required to pay both business and private purposes, may treat a transfer tax (at a tax rate ranging from 6% to the goods entirely as a business asset, in which 7%) supplementary to the Capital Duty (1%) case the VAT thereon is treated as input tax and paid by the company increasing its capital. is fully reclaimable. VAT must be accounted for only when the goods are used for private purposes. EC sends formal request to Spain to end If the taxable person can prove there is a genuine discriminatory treatment of non-resident natural business use intended at the time of purchase, and legal persons it gives him the right to input tax deduction. The EC has sent Spain a reasoned opinion regarding Hence, a person will be considered acting as a its law relating to the appointment of fiscal private person and not as a taxable person, when representatives. That law requires certain non- there is no business use of the goods at all, or resident natural and legal persons to appoint a no intention to use the goods for business purposes. fiscal representative in Spain. Among those obliged Background to appoint a resident representative are foreign pension funds located in Member States other In the VNLTO case, the ECJ questioned whether than Spain providing for occupational pension the Lennartz accounting could be used by a schemes in Spain, EU insurance companies taxpayer while engaging in activities that are operating in Spain under the freedom to provide not within the scope of VAT. The decision of the services principle, non-resident companies operating ECJ finally clarified the application of the Lennartz in Spain through a permanent establishment and principle in those cases where a good is solely non-resident natural persons subject to Inheritance intended for business purposes, and ruled the and Gift Tax in Spain. Lennartz accounting principle is not available in cases where goods (including services used to The Commission holds the opinion that this create goods) are used wholly for business purposes. requirement is not proportionate as it results in Until this case, it was assumed that “purposes discriminatory treatment and restricts the free other than business” included what are known

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in the UK as “non-business activities” by charities u When the goods are used in part for making and other bodies. supplies in the course of an economic activity that gives a right to input tax deduction, The VNLTO case concerned a Dutch association and promoting the interests of the agricultural sector in four provinces, in exchange for a membership u When they are also used in part for the fee. VNLTO applied for full deduction of the private purposes of the trader or his staff, amounts of input VAT paid in respect of its or exceptionally, for other uses wholly out- provided services, including those relating to its side the taxpayers business. activities of promoting the general interests of From 22 January 2010 onwards, Lennartz accounting its members. This was denied by the Dutch tax is thus only available where there is a mix of authorities. The fact that the activities carried business and private use (or for purposes wholly out to promote the members’ interests are not outside the purposes of the taxpayer’s activities). subject to VAT, does not mean that they are not Where goods are used for business and non- business activities. The ECJ considered this activity business purposes, the VAT incurred must be to be “business” in as far as it includes any apportioned between business and non-business activity that forms parts of the wider purpose use and only the proportion relating to business of the taxable person’s undertaking or enterprise. use can be recovered. VNLTO was therefore not allowed to apply the Lennartz accounting principle as its activities This decision of HMRC is expected to have major are wholly for business purposes. implications for undertakings in the UK whose former “non business” activities may now be Limitation of the application of the Lennartz principle regarded as business and thereby fall outside Lennartz will now only be available in the following the scope of Lennartz accounting. specific limited circumstances:

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Foreign Income – Taxability in India

Rashmin Sanghvi*

ITAT had arranged a conference at Vigyan Bhavan, Delhi on 19th & 20th February, 2010. Several dignitaries spoke at the conference. Parts of two speeches relevant to this article are covered here. 1. Honourable Supreme Court held in Chettiar’s case (267 ITR 654) that once an Indian resident’s income is taxed abroad by a treaty country, it cannot be taxed again in India. Detailed analysis of the decision by the author was published in CA Practice Journal, issue dated March, 2009. It is also available on ITAT website at: http://www.itatonline.org/articles_new/index.php/principles-of- jurisprudence-in-international-taxation Rashmin Sanghvi 2. The case may be summarised briefly as: An Indian resident Chettiar – partnership firm had immovable property income in Malaysia. The income was taxed in Malaysia. Indian Income-tax department sought to tax the same income and give credit for the taxes paid in Malaysia. The assessee contested. Finally, the Honourable SC held that the income cannot be taxed in India. 3. Several issues have been decided in the case. Some issues decided by Honourable SC are as under: 3.1 Assessee firm – Chettiar had income from immovable property in Malaysia. Hence, it was a foreign income – Malaysian income. It was taxed in Malaysia. 3.2 Assessee had no PE in India. It had a PE in Malaysia. Hence, it must be treated as being fiscal resident of Malaysia. 3.3 Any analysis of the phrase ‘may be’ is semantic.

* The author is a partner in Rashmin Sanghvi & Associates, Mumbai, India

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3.4 Honourable SC has not specifically said income of its resident. When a resident has that this income cannot be taxed in India. a foreign income, that income may be taxed However, Honourable Court has held that in the Country of Source (COS). However, the assessee is a non-resident of India and the use of the phrase “May be Taxed in the income is sourced in Malaysia. Inevi- COS” does not affect the taxing jurisdiction table conclusion is that this income cannot of COR. The foreign income will be taxable be taxed in India. in COR. The tax paid in COS will be available as credit against the tax payable in COR. 4. With respect, this decision is incorrect because briefly: If Prof. Shelton’s clarification is right, the Honourable Supreme Court’s decision in 4.1 Concept of PE is irrelevant for Article 6 – the case of Chettiar is, with respect, incor- income from immovable property. rect. 4.2 For determination of residential status, one 5.2. Honourable Shri Justice Kapadia, (Judge of has to first determine the status as per the the Supreme Court of India) addressed the domestic law. In case of dual residential conference. He quoted Justice P. D. Desai. status, tie breaking rules have to be con- “When giving a judgment the Judge must sidered under article 4. Since the assessee look at the consequences of the judgment.” a partnership firm, provisions of article 4(3) will apply. “Place of Effective Management” While generally one may look at the clear determines the status for the purposes of interpretation of the law, if the interpreta- the treaty. PE and “personal & economic tion is likely to cause unexpected conse- relations” both are irrelevant. quences, the interpreter may give second thoughts to the interpretation. Let us con- 4.3 Honourable SC has reproduced Article 22 sider the consequences of the decision in in the decision. This provides for elimina- Chettiar’s case. tion of double tax in India by Credit Method. The “Exemption Method” of elimination of The consequences of this judgment are that double taxation is not applicable for the wherever India has signed a Double Tax treaty between India & Malaysia. Correct Avoidance Treaty, when Indian resident position in law is that the assessee’s earns incomes from those countries, there Malaysian income is taxable in India and will be no tax in India. And in the Coun- credit is to be given for the taxes paid in try of Source, the income will be taxed at Malaysia. a lower rate. For example, in the case of dividend and interest, normally the income 5. In this background, let us see the discussions is taxed at the rate of 10% or 15%. The at the ITAT conference. assessee has tremendous advantage which 5.1 Prof. Ned Shelton from Denmark had made is not at all intended by the Parliament. a presentation at the conference. After the This opens up floodgates for manipula- presentation a querist asked: Double Tax tions and tax evasion. Some possibilities Avoidance Treaties use the terms: “May be have been discussed in the earlier article Taxed” and “May Also be Taxed” in the by author (available on ITAT website). Country of Source. What are the implica- 6. It seems that judiciary has drawn a conclusion tions of these phrases! In other words, once that in all cases of foreign income which have the income is taxed in the Country of Source, been taxed by a treaty country, the Government can it be taxed again in the Country of of India loses the jurisdiction to tax. (Though Residence? such a statement is not evident in the judgment.) Prof. Shelton explained in detail. The Country In Turquoise case (300 ITR 001), the assessee of Residence (COR) has always got a had dividend income from Malaysia. This income fundamental jurisdiction to tax the global

52 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 64 BASIC CONCEPTS was taxed in Malaysia. Honourable Supreme in a series of decisions, something is serious. Court decided that the foreign dividend income This situation may call for a review. is not taxable in India. 8. Government has issued Notification Nos. 90 The incorrect decision in the case of Chettiar has & 91 dated 28th August, 2008. These notifications led to several incorrect decisions. The latest provide that even if an Indian resident’s income decision by the Honourable Supreme Court is is taxed abroad, it shall still be taxable in India. in the case of: CIT, Madurai v. A. C. Narayanan Double Tax will be eliminated as provided in –decided in February, 2010. In this case also, the Double Tax Avoidance Agreement. These Honourable Supreme Court has decided that notifications cannot override the law of the land foreign income once taxed abroad cannot be laid down by Supreme Court. Hence, there is taxed in India. High Courts and Income-tax little practical impact of these notifications. They Appellate Tribunal Benches have to follow suit. do indicate the Government’s interpretation of the law and the treaty. 7. When a decision is incorrect, there is a victim. He suffers. Even if the victim is Government of 9. Direct Taxes Code Bill, 2009, section 3 – India, there is certainly some injustice. Government Scope of Total Income, sub-section 3 takes care suffers loss of revenue. When that loss continues of this injustice by providing that such incomes will be taxable in India.

Statutory Happenings CIRCULAR/PRESS NOTE CLARIFICATIONS ON ROADMAPS FOR APPLICATION OF CONVERGED INDIAN ACCOUNTING STANDARDS WITH INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRSs) PRESS RELEASE No. 4/2010 [No. 1/1/2009-IFRS], DATED 4-5-2010, ISSUED BY MINISTRY OF CORPORATE AFFAIRS

A meeting of the Core Group constituted by the Further, on the basis of the deliberations taken Ministry of Corporate Affairs for convergence place in the meeting on 29th March, 2010, a of Indian Accounting Standards with the Press Release (No. 3/2010) related to the roadmap International financial Reporting Standards (IFRSs) for the application of the converged Indian from the year 2011 was held on 11th January, Accounting Standards by the Banking companies, 2010 and on 29th March, 2010 under the Insurance companies and Non-Banking finance chairmanship of Shri R. Bandyopadhyay, Secretary, companies was issued on 31st March, 2010. Ministry of Corporate Affairs. These meetings Both the Press Releases are available on the were attended by the officials from Ministry of Ministry’s website at www.mca.gov.in. Finance, SEBI, RBI, IRDA C&AG, PFRDA, ICAI, 3. In response to the requests seeking clarifications Industry Representatives and other experts. on the roadmaps issued, a consolidated statement 2. On the basis of the deliberations taken place on clarifications is being annexed with this Press in the meeting on 11th January, 2010, a Press Release. Release (No. 2/2010) related to the roadmap ANNEX for application of the converged Indian Accounting Standards by companies (other than Banking [NOT REPRODUCED. Full text shall be sent to companies, Insurance companies and Non-Banking subscribers on request by e-mail] finance companies) was issued on 22nd January, 2010.

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Withholding Tax on Payments made to Non-residents

Freddy R Daruwala*

“It (the law) ought to be defined by the fixed rule of law, what Lord Coke calls the golden metwand of the law, and not by the crooked cord of discretion” 1. Introduction The above axiom in respect of the law would totally fail if applied to the obfuscatory and often bewildering progress of law in respect of Withholding Taxes (WHT) law whose development in India is more reminiscent of a corkscrew rather than a golden metwand. The mnemonic equivalent of the abbreviation TDS, (tedious) would best describe the onerous section of the Income-tax Act, 1961 relating to tax Freddy R Daruwala deduction at source on payments to non residents. In this write-up, the terms are used interchangeably though a significant difference is that WHT is a machinery provision for recovery of tax while TDS collection may also amount to an assessment in special cases relating to NRIs. As with all sections relating to WHT, the Government expects the payers of the specified sums to do its work (i.e. revenue collection) gratis, and if they delay or default in any way, impose onerous liabilities, including but not limited to disallowance of the deduction of the amount paid. Section 195 of the Act is now ever increasing in importance since it impacts nearly every commercial venture dealing in any cross border transactions, however miniscule, dealing with payments to non residents. The objective of section 195 is justifiable as it seeks to avoid a revenue loss as a result of tax liability in the hands of a foreign resident, by

* Mr. Freddy R. Daruwala is a Partner in Juris Corp, a leading full service law firm practicing mainly in the areas of Direct Taxation, Private Equity, Derivatives, Securitization & Structured Finance, Banking and Alternate Dispute Resolution.

54 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 66 TAX DEDUCTED AT SOURCE deducting the same from payments made to an authorized dealer prior to making a them at source. This will obviate the difficulty remittance to a non resident (as is the case in chasing such foreign nationals for recovery on a practical front). of their tax dues subsequently, due to jurisdictional u The imminent Direct Taxes Code, which in and other operational difficulties. Further, most its present form is expected to override of such foreign nationals are likely to have nil existing treaties and also has the draconian or at best very meager assets in India, which General Anti Avoidance Rule (“GAAR”) may be totally inadequate to recover the tax which collectively may have the effect of dues. making WHT applicable on every single Section 195 of the Income-tax Act, 1961 is an payment to non residents under the ex answer to the above difficulty as it not only abundanti cautela ( extreme caution) doctrine provides the mechanism for deduction of tax at by payers who would not like to risk the source, but also contains, in a large measure, draconian consequences of non deduction. the procedures to be followed in the mitigation The law on WHT as it stands is in a constant of the same in genuine cases. state of flux and is likely to be specially affected 2. Recent Developments affecting the law on WHT by the above factors. on payments to Non Residents 3. Scope of Section 195(1) This section’s applicability has been further It is very pertinent to note that this section is confused and the waters muddied by some recent much wider in scope than all the other TDS developments in this branch of law which virtually sections insofar as all payers are covered and offer no alternative to a payer rather than to there is also no threshold exemption. deduct tax or approach the Assessing Officer for a certificate under section 195(2). Section 195, as regards the payer of any sum chargeable to tax, applies to any person unlike These are: certain other sections relating to TDS and covers: u The CIT v. Samsung Electronics Co. Ltd. [2009] u Individuals 185 Taxman 313 (Kar.) case decision by the Karnataka High Court prima facie making u Hindu Undivided Families it incumbent on every importer to with- u Firms and AOPs hold tax on import payments. u Non Residents u The decisions post Samsung Electronics Co. Ltd. case (supra) in the case of ACZ. BV, u Foreign Companies In re [2001] 115 Taxman 317 (AAR - New u Persons having exempt income in India e.g. Delhi) and Prasad Productions (Mum.- ITAT) trusts and non profit organisations claim- (SB) whose rulings are diametrically op- ing exemption under sections 10 and 11 of posed to Samsung. the Income-tax Act u The withdrawal of Circular No. 23 of 1969 u Any other juristic person irrespective of which unsettles established legal precedents whether such person has an income charge- and muddies the waters further. able to tax in India or not. u Amendment of the scope of business con- As regards the recipient of amounts, the section nection in section 9 of the Act with retro- covers all non residents in its ambit. Residents spective effect from 1-4-1972 by the Fi- and resident but not ordinarily resident tax status nance Act, 2010. persons are not covered by the section. u Introduction of section 195(6) and rules there The general rules to be followed in this area may under, whereby Form 15CA and CA Cer- be outlined as follows: tificate in Form 15CB has to be filed with

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u All sums bearing the character of income 86 ITD 791 (Mum ITAT) or even on adjust- chargeable to tax under the provisions of ment of dues [J B Boda & Co. (P.) Ltd. v. the Income-tax Act, 1961 are covered CBDT [1997] 223 ITR 271/[1996] 89 Taxman 311 (SC)]. u All sums in which income can reasonably be expected to be embedded are covered. u There is no liability to deduct TDS on a This rule follows the judgment in Transmis- payment made under a void agreement sions Corpn. of A.P. Ltd. v. CIT [1999] 239 (absence of a contract) as held in Ericsson ITR 587/105 Taxman 472 (SC) where the Communications Ltd. v. Dy. CIT [2002] 81 Apex Court has categorically ruled that a ITD 77 (Delhi ITAT). payer cannot sit in judgment as to what 4. Application of Section 195 proportion of the amount paid to the payee constitutes the income of the payee. Some common instances of applications of this section may be outlined as follows:- u A corollary to the above rule is that if it cannot be determined with any certainty as u Payment by an Indian Branch of a For- to what part of the payment constitutes the eign Company to its overseas Head Office income of the payee, then the payer is In this context, CBDT Circulars 649/ obliged to deduct tax on such gross amount. 31.3.1993 and 740 /17.4.1996 give some There are mitigation provisions by appli- clarification. Further, the landmark cation to the respective Assessing Officer Kolkata Tribunal judgment of ABN by both the payer as well as the payee in Amro Bank NV [2005] 97 ITD 89 (SB) certain circumstances within the section itself. also lays down the law that if a u Even payments made in kind are subject deduction for interest payment by a to TDS under section 195 as ruled in branch to overseas head office is sought, Kanchanganga Sea Foods Ltd. v. CIT [2004] then it is obligatory to deduct tax, 265 ITR 644/136 Taxman 8 (AP). since it presupposes a distinct payer and payee with separate identities and u There is no obligation to deduct TDS on makes section 195 applicable. a payment made under the decree of a court by a judgment debtor to a decree u Payment by a Resident to an Indian Branch holder as decided in Lalta Prosad Goenka v. of a Foreign bank Biratnagar Jute Mills Ltd. [1963] 48 ITR 653 This payment is squarely covered by (Col.). the CBDT Circular 20/3.8.1961 and u There is no clear ruling on TDS in respect there is no doubt that TDS has to be of capital gains and one must take it up effected. The payee may however ap- on a case to case basis.If no mitigation is ply to the Assessing Officer for nil/ available even after application by either lower deduction under section 195(3). the payer or the payee, after disclosing the A precaution which would be advised quantum of capital gains likely to be here is that the payers of such sums embedded in the payment, then TDS on like interest, bank charges, etc.; (which the gross amount is advisable on the prin- are more often than not recovered by ciple of ex abundant cautela i.e. by way of direct debits to their bank accounts) abundant caution to mitigate the conse- insist on a copy of the exemption quences of non-deduction to the payer. certificate under section 195(3) from the Indian branch of the foreign bank u TDS has to be effected even on net pay- since there are a few foreign banks ments (TDS applicable on the gross amount) which do not have a valid certificate as decided in Raymond Ltd v. Dy. CIT [2003] at the time of effecting such debits.

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u Payment by a resident to an agent of a u Payment of interest on listed Indian non-resident Corporate Bonds held by a Foreign Insti- tutional Investor in dematerialized mode This settled branch of law appears to have been overruled by the withdrawal This is another area where one may of the CBDT Circular No. 23 of 1959. fall prey to the misconception that However one may take the help of securities held in demat mode do not the decisions in the DIT (International suffer WHT on their interest payments. Taxation) Morgan Stanley & Co. [2007] This is a fallacy since the exemption 162 Taxman 165/292 ITR 416 (SC) as on WHT on such interest is covered well as the Ishikawajma Harima Heavy under section 193, which is applicable Industries Ltd. v. DIT [2007] 158 Taxman only to Indian residents. Thus, the FII 259 (SC) and come to a conclusion will have to suffer WHT since the that the settled law in this regard interest paid on demat corporate listed remains the same. However, the with- securitiers will be out of the purview drawal of the above Circular No. 23 of section 193 and will be covered by of 1969 (which was binding on the section 195. department) will certainly foment This section will have an increased disputes due to the I T Department applicability after the Finance Act, 2007 taking a stand that all the payments due to the proposed modification of would be subject to withholding, unless the definition of India to cover the an application under section 195(2) is airspace above it with retrospective made. effect from 1976 as well as the non- The recent decision of the Mumbai ITAT in the requirement of territorial nexus to case of Prasad Productions (Supra) further stresses constitute a business connection in India that a mere parent subsidiary relationship or for any enterprise being proposed. The even the existence of an agency agreement will two developments listed above will not by itself constitute an agency PE, which also further enhance its applicability. must be substantiated by the facts and conduct u Non-resident in India paying interest to of the parties. the Indian branch of a foreign bank Payment by the branch of an Indian u This payment will be squarely hit by company located offshore to the offshore the provisions of section 195 and WHT branch of an Indian bank will need to be affected (despite the In this situation, even if the amounts procedural requirements of PAN,TDS are not covered by the exception to returns, etc.) unless the foreign bank section 9(1) when interest is paid on branch in India has obtained an exemp- funds for use outside India, the trans- tion certificate under section 195(3) action is strictly between two resi- u Payment to a resident agent of a non resident dents (Indian company and Indian bank) shipping company and merely because it is being carried out on foreign soil will not change its It should be noted here that in case character. Therefore, section 195 will of a payment to agents of a non-resi- have no application and section 194A dent shipowner, it is section 172 that which specifically exempts such pay- will apply and not section 195 as a ments from the purview of WHT to special provision will always over- Indian banks will apply. ride a general one. (Generalia specialibus non derogant)

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5. Rate of Tax and point of affecting WHT by section 195(6) which calls for uploading Form No. 15CA electronically and then submitting The wording of section 195 specifies the “rates the electronic uploading acknowledgement along in force”. This term has been interpreted judicially with Form No. 15CB duly certified by a chartered to mean the lower of the rate between the Finance accountant for all offshore remittances. In case Act and the relevant DTAA. Further, if the DTAA the CA certifying Form No. 15CB feels that no rate is applied and the term ‘income tax’ is WHT is to be affected on the payment, provision employed in the DTAA, it does not need to be for the same is also inbuilt (notwithstanding the augmented with any surcharge or Education Samsung ruling).The CBDT has further clarified cess as held in CIT v. K Srinivasan [1972] in 83 that Form No. 15CB need not be certified by ITR 346 (SC). a CA in case of diplomatic/consular channel In the case of a conflict in the intervening period payments. between an old Finance Act and a new Finance 7. Consequences for Default Bill, the rate more beneficial to the payee must be applied. As with other TDS defaults, the consequences for non deduction may be broadly classified as The next question which arises is the point at follows: which the TDS has to be effected. The law states that TDS has to be effected at the earlier of (a) Disallowances of the amounts paid under actual payment or credit. This would be tempered section 40(a)(i). It should be noted that the by the decision in the IDBI’s case which makes scope of the section dealing with payments the ascertainment of a definite payee a precondition to non-residents is wider than that of sec- for effecting TDS. Thus, mere credit to a general tion 40(a)(ia) which deals with residents. suspense account would not attract TDS. Certain However, there is no disallowance of any decisions have held that TDS needs to be deducted salary due to non-deduction if the employee only in the year of RBI approval Pfizer Corpn. concerned pays the tax, but interest on the v. CIT [2003] 259 ITR 391/129 Taxman 459 (Mum.). delayed period may be chargeable 6. Procedure for Exemption/ Mitigation of WHT (b) Simple interest at 12% p.a. u/s 201A (which is on a month to month basis after the Section 195 is a self-contained section and there Finance Act, 2007) are two different provisions for mitigation viz by the payer u/s 195(2) and the payee u/s 195 (c) Penalties for non-deduction (u/s 271C) and (3)/section 197. failure to pay the deducted tax to the Government (u/s 221) The payer can make an application to his respective Assessing Officer seeking permission to effect (d) Prosecution u/s 276B nil or lower deduction on a certain payment Section 195A provides for the grossing up of with cogent reasoning for the same in the payments in case of Net Of Tax Payments. This application. is not applicable in case of non monetary perquisites, Under section 195(3), there is also a provision which are subject to TDS under section 192(1A). for the payee making an application to its Assessing Further, there is no gross up on presumptive tax Officer for lesser rate of TDS or nil TDS. However, as held in CIT v. ONGC [2003] 264 ITR 340/ this is limited by the conditions set out in rule [2004] 134 Taxman 156 (Uttaranchal). 29B. 8. Royalty and Fees for Technical Services (“FTS”)- TDS wrongly deducted may be refunded in certain a vexing issue limited cases and after certain set-offs and the At the outset, it should be noted that TDS on CBDT Circular No. 769/16.8.1998 deals with the royalty and FTS will not only be dependent on conditions and procedure. the particular payment, but will also be affected An alternative mechanism has been provided by the provisions of the relevant Double Tax by the CBDT in exercise of its powers conferred Avoidance Agreement (“DTAA”) which India

58 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 70 TAX DEDUCTED AT SOURCE has with the country to which the payment is TDS especially if the services payment is non- being made and the judicial decisions and the severable and forms part of the main contract advance rulings on the subject must be interpreted for the supply of Capital Goods [Hindalco Industries after considering this factor also. Ltd. v. Asstt. CIT [2005] 2 SOT 528 (Mum.)]. No discussion on this issue will be complete without Further, the Apex Court in the case of Tata some discussion on the Samsung case as decided Consultancy Services v. State of Andhra Pradesh by the Karnataka High Court and the subsequent [2004] 141 Taxman 132 (SC) has also distinguished decisions in Van Oord case (supra) and Prasad between the assignment of copyright and the Productions case (supra) discussed later. sale of a copyrighted article (i.e. a book or a CD containing software licenced to the purchaser). 9.Reimbursement of expenses While in the former case, the payment will be This is a question on which no clear direction in the nature of royalty and attract TDS, in the is available and keeping in line with the general latter case it will not being in the nature of the trend of tax judgments there are conflicting views sale of goods. In the following decisions, it was held by the various courts and Tribunals in the held that the transaction in question amounted country. to a mere sale of a copyrighted article and, hence, not liable to TDS In the case of mere reimbursement of expenses, TDS need not be effected as ruled in the case u Lucent Technologies Hindustan Ltd. v. ITO of reimbursement of out of pocket expenses to [2005] 92 ITD 366 (Bangalore ITAT) a noted law firm. Clifford Chance United Kingdom u Motorola Inc. v. Dy. CIT [2005] 95 ITD 269 v. Dy. CIT [2002] 82 ITD 106 (Mum). The most (Delhi ITAT) (SB). important recent Judgment in Mahindra & Mahindra Ltd. v. Dy. CIT [2005]/SOT 896 Mumbai ITAT Further, it was also held that the mere payment has also held that reimbursement of expenses of connectivity charges was not royalty or FTS not having the character of income chargeable and, hence, not liable to TDS as held in Skycell to tax under the provisions of the IT Act cannot Communications Ltd. v. Dy. CIT [2001] 251 ITR be subject to WHT. 53/119 Taxman 496 (Mad.). However, where the cost of services is charged Even payment made for an access to a database and recovered by way of reimbursement, even on an overseas server will not attract TDS as without any profit element TDS will be applicable held in Dun & Bradstreet Espana, S.A., In re as ruled in the case of Asstt. CIT v. Arthur [2005] 272 ITR 99/142 Taxman 284 (AAR-New Anderson & Co. [2006] 5 SOT 393 (Mum.). Delhi). There are also judgments which reflect that TDS FTS which covers only Fees for Included Services under section 195 will be applicable even on (“FIS”) in the relevant DTAA (e.g. USA) will mere reimbursement of expenses. This view finds attract TDS if the fees paid only falls under the support in the decisions given by Cochin Refineries definition of ‘included services’, and not otherwise Ltd. v. CIT [2002] 222 ITR 354 (Ker.) and HNS as held in the case of C.E.S.C. Ltd. v. Dy. CIT India VSAT Inc. v. Dy. DIT [2005] 95 ITD 157 [2003] 87 ITD 653 (Kol.) (TM.). Such treaties (Delhi ITAT) and also in Hindalco Industries Ltd. usually have a ‘make available’ clause in the v. Asstt. CIT [2005] 94 ITD 242 (Mum.). definition of ‘FTS’ and the relevant treaty will have to be scrutinized in detail along with the 10. Latest Judicial Developments nature of payment to determine whether TDS The Karnataka High Court has ruled that TDS is applicable or not. The old adage that one u/s 195 is applicable on all payments of ‘shrink man’s food is another mans poison may well wrapped software’ and further gone on to state apply here so that one man’s FTS is not taxable that all payments to non residents would need while the other ones may well be. to suffer WHT and the only measure available Payment for any subsidiary/ ancilliary services to the payer of such sums to get out of this for sale of capital equipment will also not attract obligation would be to apply to the Assessing

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Officer for a certificate of lower WHT under u The Karnataka High Court in the earlier section 195(2). The position seems to have been case of Jindal Power dealing with EPC contracts further exacerbated with the withdrawal of the has categorically ruled that amounts not Circular No. 23 of 1969 which had fettered the having the character of income are not subject IT department from agitating on the issue of to WHT u/s 195. This case was not cited WHT on the payments which were covered within during the hearing of the Samsung Electron- it. Transmissions Corpn. of AP Ltd. case (supra) ics Co. Ltd. case (Supra) and, therefore, the also seems to have been misconstrued by the latter may be easily to have been decided Hon’ble High Court. This case also overturns per incuriam. Further, there is a well-settled the principle of the TCS case (supra) that sale principle of tax law that in a case where of a shrink wrapped software amounts to the there are two interpretations, the one sale of a copyrighted product and not to license favourable to the taxpayer will prevail. of the copyright. u The decisions in Van Oord case (supra) by Nevertheless, the Delhi High Court in the case the Delhi High Court and Prasad Produc- of Van Oord case (supra) has made a significant tions case (supra) and Mahindra & Mahindra departure from the Samsung ruling and clearly Ltd. case (supra) by the SB of the Mumbai held that no WHT will be applicable if prima ITAT may be referred to in all jurisdictions facie there is no chargeability to tax in India of except, Karnataka for persuasive effect. the amounts paid to the non-resident. u Last but not least section 195(6) gives the The Special Bench of the Mumbai Tribunal, in power to the CBDT to ask for information the case of Prasad Productions (supra), has gone from persons effecting remittances offshore a step further and even made a ruling on the and in exercise of this power has prescribed procedural issue of applications under section Form Nos. 15CA and 15CB (a CA’s certifi- 195(2) for exemption/mitigation of WHT. The cate) as an alternative to section 195(2). Honourable SB has ruled that in case there is This fact is not considered in the Samsung a bona fide belief that the amount payable is case. not chargeable to tax in the hands of the non Though the above arguments will be far harder resident recipient, the payer has no liability to to sustain in areas subject to the jurisdiction of deduct tax and further has no obligation to the Karnataka High Court, yet they do have approach the Assessing Officer under section some substance in cases where the I T department 195(2) for mitigation /exemption thereof. It has adopts a procrustean approach (literally) to WHT correctly interpreted the decision in Transmission post Samsung, which they are very likely to do. Corporation of A.P. Ltd. case (supra) that an application under section 195(2) is only necessary The CBDT sadly has not come out with any if the quantum of embedded income in the directions or clarifications and one looks to the payment made to the non resident is to be Apex Court for a ruling in the Samsung Electronics determined and not otherwise. Co. Ltd. case (supra) which will hopefully set the law on an even keel. Therefore, the following lines of arguments are likely to assist a payer of sums to a non-resident 11.Section 195, DTAA and Business Connection in defence to an overzealous TDS officer who One of the most complex situations may arise sends notices and adverse orders in relation to if one considers the warp and weft of the interplay section 195: of section 195 along with the provisions of a u Section 195(1) covers WHT on interest and Double Tax Avoidance Agreement with the other sums chargeable to tax under the embroidery of section 9, dealing with business provisions of this (the IT Act).With due connection thrown in for good measure. respect to the Bench, this fact emphasized Initially, one must consider the distinction between above seems to have been totally ignored a legal liability to tax as opposed to a fiscal

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liability. Even in this sphere, there is no clarity. u In case of doubt, an application for miti- In Abdul Razak A. Menan, In re [2005] 146 Taxman, gation of TDS under section 195(2) to the 115 (AAR - New Delhi), it was held that a payers Assessing Officer must be made. person was not entitled to claim the benefits of The alternative route of the CA Certificate the earlier Indo UAE Tax treaty since there was in Form No. 15CB must be used in the no liability to tax in the UAE, and, hence, the same way as one gets into bed with a 900 income would be subject to tax in India. However pound gorilla i.e. with great care and caution. in another case of Green Emirates Shipping, the Only where there is strong justification and exact opposite was decided. Currently, there is judicial support in the respective jurisdic- a new India UAE DTAA in place which addresses tion should this alternative be used. In this anomaly. Karnataka even if the payer is certain that no income element is embedded in the Another issue to be considered in this context proposed payment it is advisable to use the is that taxability in the case of an airline and section 195(2) route until the Apex Court shipping company is based on the theory of takes a view on the Samsung Electronics Co. effective control also known as the ‘Head & Ltd. case (Supra). Brain’ theory. The question of residence versus control and management is to be considered. u The exact rate as determined by the appli- Again a distinction needs to be made for effective cation of a DTAA or the Act needs to be management against mere operational management carefully determined. to determine the question of the situs of taxation. A point to be noted in this very important Further, the question of a Permanent Establishment branch of law is that articles on the subject are (“PE”) as per the relevant DTAA and the attribution ever increasing and interpretations multiplying of income to it (different under various treaties) with each passing decision. also needs to be considered. The impending Direct Taxes Code will redraw Taxability, if no DTAA is subsisting, will depend the landscape in this important branch of law on whether there is a business connection under and in its present form is expected to foment section 9 of the Act, as a business connection litigation even more. is wider in scope than a PE (Western Union’s The Bard of Avon, William Shakespeare might case). Further, the Apex court has held that well have rephrased his famous lines in Hamlet there needs to be a territorial nexus in order as above had he been subject to the complexities to constitute a PE as held in Ishikawajma Harima of Withholding Tax (“WHT”) or Tax Deducted Heavy Industries Ltd. case (Supra). The territorial at Source (“TDS”), especially in relation to cross nexus clause as a necessity for a business connection border payments. If this situation were prevalent has been removed from Finance Act, 2007 and in Victorian England, the bard of Avon, William the definition of ‘India’ is also sought to be Shakespeare may well have rephrased his famous widened with the inclusion of the airspace. soliloquy in Hamlet as follows:- 11. Conclusion “To Cut or Not to Cut, that is the question? Thus, it is imperative for a payer to ensure that And suffer the slings and arrows of the provisions of section 195 are strictly followed outrageous disallowances, in all payments to non residents and the following Or Take Arms against a sea of penalties and rules would be helpful: prosecutions. And by litigating for long years, stay them If the amount of income embedded in a u Only until the law gets amended with payment cannot be ascertained, it is better retrospective effect” to deduct the amount based on the gross amount.

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Withholding Tax and Tax deduction at source - Two different concepts and obligations

D. P. Mittal*

Introduction 1. Section 195 of the Income-tax Act, 1961, casts an obligation on the person responsible for paying to a non-resident or to a foreign company any interest or any other sum chargeable under the provisions of the Act, at the time of credit of such income to the account of the payee or at the time of payment thereof deduct income-tax thereon at the rates in force. If, however, he considers that the whole of such sum would not be income chargeable, he may deduct tax on the amount so chargeable as determined by the Assessing Officer on an application having been made to him. The expression ‘rates in force’ for that purpose has been defined in section 2(37A)(iii) as the rates specified in the relevant Finance Act or as specified in the DTA. D. P. Mittal There has been much debate about the applicability of section 195 as also about the rates, resulting in many rulings of the Authority for Advance Rulings. But so far no question has been raised about the non-applicability at all of the provision to the payments made as dividend, interest and royalty in terms of the provisions of the DTA. There could be a view about such non-applicability. Its applicability could be sustained only in a case where there is difficulty in ascertaining the nature of income whether royalty, fees for technical services or income from business. No DTA refers to the expression ‘tax deduction at source’. The expression in usage is withholding tax. The Indian Income-tax Act, 1961, nowhere refers to the expression ‘withholding tax’. The two expressions are not synonymous, though there is a tendency to use them interchangeably. The question is whether the amount of tax withheld from the payment of dividend, interest and royalties in terms of provisions of paragraph 2 of articles 10, 11 or 12 of a tax treaty, could be said to have been deducted at source. The view is that it cannot be said.

* The author is an Advocate

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Source State does not exercise jurisdiction to tax The obligation to withhold is entirely different dividend interest royalty; but right to withhold tax from the obligation to deduct tax. The income on which tax is withheld in terms of the treaty 2. The concept of ‘withholding tax’ is peculiar to is of nature of interest, dividend or royalty. the international taxation. The law in the Such income is not subject to deduction of tax implementation of every treaty is that the provisions under section 195 or any other sections of the of the treaty apply only insofar as they restrict Act dealing with deduction of tax at source. tax liability under the domestic law. Therefore, Income earned by way of dividend, interest, etc., a treaty provision that extends the taxing powers if not effectively connected with the PE, cannot of the domestic jurisdiction, cannot be exercised be said to be arising to the foreign taxpayer under the domestic law. This relationship between from doing business in India. The obligation to the domestic and treaty law would mean that deduct tax is on the payer. The charge is on him a provision in a treaty allowing source State to and not on the payee. The tax is deducted on tax certain income for example dividend, interest, behalf of the payee and not withheld to discharge or royalties, and withhold tax at specified rates, the charge imposed on the payer. cannot be exercised by that State unless the activities are effectively connected with the PE in that TDS is in respect of income which is assessable and State. For example, article 12 of the Indo-US computed in accordance with the provisions of the treaty gives the principle right to the resident Act State to tax royalties and fees for technical services. 4. The TDS provisions would only require deduction The source State is also authorised to tax, but of tax from payments that are assessable to income- at the rates specified therein. Thus, only the tax in the hands of the non-resident as per the residence State is to exercise jurisdiction to tax charging provisions. Those provisions may be such income. The source State may withhold tax rendered inapplicable or modified by a tax treaty; at the specified rates, having no power to exercise if modified, deductions as per provisions of the jurisdiction in respect of such income. Exercising tax treaty, if inapplicable no deductions, are to taxing jurisdiction under the Indian Income-tax be made. Section 195(1) of the Act imposes duty Act, 1961, means charging total income at any to deduct tax at source at the rates in force upon rates in accordance with and subject to the provisions all persons responsible for paying to a non-resident of the Act and total income for that purpose any sum chargeable under the provisions of the means total amount of income computed in Act. Whether tax deducted in terms of that section accordance with the provisions of the Act, [see could be termed as tax withheld, is not clear, section 4]. Such income as referred to in respect especially in view of sections 190 and 199. Section of which India is only authorised to withhold 190 provides as follows: tax, is not to be computed in accordance with the provisions of the Act nor taxed at the rates prescribed “190(1). Notwithstanding that the regular in the Act or the Finance Act of the relevant year. assessment in respect of any income is to The Assessing Officer does not exercise taxing be made in the latter assessment year ; the jurisdiction in the manner as mentioned above tax on such income shall be payable by in respect of such income. Section 4 of the Act deduction at source in accordance with the is modified to this extent. Income under articles provisions of this chapter.” 10, 11 or 12 of a tax treaty is taxed by withholding Deduction of tax at source is to be made in as dividend, interest or royalties. Further, the respect of income which is subject to regular provisions relating to deduction of tax at source assessment. If no regular assessment is to be made, under the Income-tax Act [Chapter XVII] are there is no requirement of deduction of tax at machinery provisions for the collection of tax as source. As aforesaid, income in respect of which opposed to provision that imposes a tax charge tax is to be withheld in terms of the treaty ( section 4 read with sections 5 and 9). provisions is not subject to regular assessment Obligation to withhold is different from obligation and, therefore, tax withheld cannot be said to to deduct tax at source be tax deducted at source. Tax is withheld in terms of the treaty provisions and not in accordance 3. The tax deducted under section 195 is often with the provisions of the Act. Further, section referred to tax withheld. But it is a misnomer.

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199 provides that the tax deducted at source for foreign taxpayers, depending upon the nature shall be treated as a payment of tax on behalf and source of income. Income connected with of the person from whose income-tax is deducted conduct of business or investment is taxed at which is to be given credit. It is provisional and the rates prescribed in the Finance Act, every not final. The amount deducted on behalf of an year, or at the rate provided, in a tax treaty if assessee from his income is an advance payment it happens to be lower. The amount of income on account of tax he is liable to pay calculated paid by way of dividend interest or royalty in : on the rates of income-tax applicable to him in respect of which tax has to be withheld is not the year of assessment in respect not only of subject to computation in accordance with the that income but also in respect of all his income. provisions of the Act. It does not require any The credit is given on final assessment on the assessment, when income is known. No income-tax return to be filed by that person. In computation is required both in regard to income a case where tax has been withheld in terms or tax. Both have been fixed by treaty and are of tax treaty, the person from whose income- final. The foreign taxpayer is not required to file tax is withheld is not required to file an income- a return of income. Section 115A(5) also provides tax return. That tax is final (article 23A of the that an assessee is not required to file a return OECD Model convention). of income if his total income in respect of which he is assessable consisted only of dividend or No return to be filed and no assessment to be made interest as referred to in section 115A(a) and tax in respect of income withheld deductible at source has been deducted at source. 5. Indian tax laws provide for various tax regimes Statutory Happenings

RBI/FEMA- CIRCULAR/PRESS NOTE EXTERNAL COMMERCIAL BORROWINGS (ECB) POLICY A.P. (DIR SERIES) CIRCULAR NO. 51, DATED 11-5-2010, ISSUED BY FOREIGN EXCHANGE DEPARTMENT, RBI

Attention of Authorized Dealer Category - I (AD funds would require the approval of the Reserve Category - I) banks is invited to the A.P. (DIR Bank and will, therefore, be considered under the Series) Circular No. 5 dated August 1, 2005 and approval route. Designated Authorized Dealer banks A.P. (DIR Series) Circular No.39, dated March 2, should ensure compliance with the extant norms 2010 relating to External Commercial Borrowings while certifying the ECB application both under (ECB). the automatic and approval routes. 2. On a review of the policy, it has been decided 3. All the other aspects of ECB policy such as USD to modify the extant ECB policy in respect of the 500 million limit per company per financial year Infrastructure Finance Companies (IFCs) i.e. Non- under the automatic route, eligible borrower, Banking Financial Companies (NBFCs) categorised recognised lender, end-use, average maturity period, as IFCs by the Reserve Bank. As per the extant pre-payment, refinancing of existing ECB and norms, IFCs have been permitted to avail of ECBs reporting arrangements remain unchanged. for on-lending to the infrastructure sector, as defined 4. AD Category-I banks may bring the contents in the extant ECB policy, under the approval of this circular to the notice of their constituents route. As a measure of liberalisation of the existing and customers concerned. procedures, it has been decided to permit the 5. The directions contained in this circular have IFCs to avail of ECBs, including the outstanding been issued under sections 10(4) and 11(1) of the ECBs, up to 50 per cent of their owned funds Foreign Exchange Management Act, 1999 (42 of under the automatic route, subject to their compliance 1999) and is without prejudice to permissions/ with the prudential guidelines already in place. approvals, if any, required under any other law. ECBs by IFCs above 50 per cent of their owned

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TDS on payments to non- residents: “Playground of Controversies”

S. P. Singh & Sharad Goyal*

Tax administrators all over the world seek to reduce cost of collecting tax, as well as making tax collection more effective and efficient by sharing this responsibility with persons making payments to taxpayers and taxpayers as well. Withholding of tax or tax deduction at source (TDS) and advance tax collection are two such methods. These methods not only pre-pone payment of tax but, also, free valuable manpower with tax administrations to undertake complex tax audit. In India, the dependence on these methods can be appreciated from the fact that during the financial year 2008-09 out of the total net collection under direct taxes of INR 323,512 crore, INR 130,172 crore was from TDS while 145,128 crore was from advance S. P. Singh tax. In order to ensure compliance with the provisions on TDS, heavy burden in the form of interest, penalty and disallowance of expenses in the hands of payers is cast by the tax law. However, payer is given option to approach tax authorities for a certificate of Nil/lower tax deduction. There are several important issues on the application of the provisions of TDS on payments to non-residents. Should a payer deduct taxes in all circumstances? If, prima facie, there is no income, should taxes be still deducted? Who should decide whether TDS be made – can a payer decide? If yes, when? In this article, answers to the above questions are searched in light of some of the recent important cases. It is observed that there is no denying Sharad Goyal of the fact that there is a legal obligation on payers to deduct tax in specified situations. However, if there is no element of taxable income involved on prima facie basis itself then the provisions should not apply. For this, a taxpayer need not approach tax authorities for lower or Nil withholding tax certificate.

* S. P. Singh, an ex-IRS officer, is Senior Director, International Taxation and Sharad Goyal is Manager with Deloitte Haskins & Sells, New Delhi, India. Views expressed in this article are the personal views of the authors.

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TDS provisions applicable to non-residents The controversy Chapter XVII of the Income-tax Act, 1961 (the The issues which have generated maximum Act) deals with “collection and recovery of tax”. controversy are the following: Sections 190 to 206AA provide scope and u Whether TDS provisions of section 195 apply mechanism of TDS. While there are separate where the payer considers that payment to provisions dealing with specified items of income non-resident is not chargeable to tax under in respect of residents, the provision on non- the Act? residents is quite wide and seeks to cover all types of payments. The relevant concept of it u Is it always obligatory on the payer to is laid down in section 195(1)1 of the Act. The follow the procedures laid down in section salient features of this provision include the 195(2), viz., to approach the tax authorities, following: even if the payer considers that the pay- ment is not subject to tax and, therefore, It requires that every person, whether he u there should not be any TDS thereon? is an individual, a HUF, a company or any other person, should deduct tax while making The Supreme Court of India dealt with the above payment to a non-resident or to a foreign issues in the case of Transmission Corporation company. of Andhra Pradesh4. The same have again been analysed in the four recent decisions, namely, u There is no minimum threshold limit for Samsung Electronics5, Van Oord6, Prasad TDS. Production7 and Maharishi Housing Development u It applies to all types of payments except Finance Corporation Ltd.8 In the case of “salaries” for which the general provision Transmission Corporation, the Andhra Pradesh applies. State Electricity Board made certain payments to non-residents against the purchase of machinery u Unlike other provisions on TDS, no single and equipment and also against the work executed rate is prescribed; it has to be made at by the non-residents in India entailing erecting “rates in force”2. The payer has to deter- and commissioning of the machinery and mine the applicable rate depending upon equipment. In this case, the Supreme Court the nature of the payment. observed that if a payment is not chargeable to u Section 195 applies even on capital pay- tax under the Act, the payer would not be liable ments like payment for imports if the same to deduct tax at source. is chargeable to tax in India in the hands It may be argued that, in the light of the fact of the non-resident. that it is section 4, read with section 5, that In situations where payer considers that the defines chargeability, if an income is not chargeable whole payment would not be income chargeable under these provisions, then the provisions of in the hands of the non-resident, the payer may TDS would not apply. In fact, similar views approach tax authorities for order3 to determine have been expressed by the Supreme Court of the appropriate proportion of such sum so India in the case of Eli Lilly & Co9. chargeable. The payer thereafter would deduct Samsung Electronics Co. Ltd.10 tax accordingly. In this case, the assessee, which is a branch of The Income Tax Department and Reserve Bank Samsung Electronics Co. Limited, Korea, was of India have issued circulars putting a system engaged in the business of development, in place whereby a remittance can be made on manufacture and export of software for use by the basis of a certificate issued by a Chartered its parent company. The assessee purchased certain Accountant. This is to ensure that such remittances “shrink wrapped ready to use, off the shelf” do not get delayed on account of pendency of software from non-resident parties for use in its certificates from the tax department. This has business. The assessee did not deduct tax on the been referred to by the council of taxpayers in amounts payable for the purchases of software, the case of Prasad Production.

66 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 78 TAX DEDUCTED AT SOURCE since the payments did not fall under the purview accelerated method of collecting tax, where of “royalty” under the Act and under the relevant under, some part of the tax liability is DTAAs. It was, further, argued that as the non- recovered in advance at source and remitted resident parties did not have permanent to the Income Tax Department which can establishment in India, their business income ensure avoidance of the later lamentation was not liable to taxation in India. As the non- by the revenue due to the non-availability residents had no income assessable in India, it of the assets of the assessee against which was, therefore, argued that there was no obligation the revenue could have proceeded for on the part of the resident payer to deduct tax. recovery of the amount.”11 The assessee was fully and bona fide satisfied This appears to be the backdrop in which the that the amount was not at all taxable in the court decided the issue. It appears that the court hands of the non-residents in India and, therefore, is of the view that section 195 has to be seen had not chosen to apply for any relief or concession different from assessment wherein actual issue in terms of the provisions of section 195(2) or of taxability of a receipt is to be decided. Further, 195(3) of the Act. TDS needs to be seen only as a security for On the other hand, the Assessing Officer (AO) likely tax demand in future. This inference flows contended that software is a ‘scientific work’ from the observation that and payments for import of software would be “although the respondents in all these appeals ‘royalty’ under section 9(1)(vi) of the Act and are quite aware that it is not actually an that the importer cannot contend that the payment exercise for determination of the tax liability made by it would not constitute income in the of the non-residents but is only in the hands of the non-resident recipient and that, the context of the obligation of a resident assessee importer is duty bound to deduct tax at source making payments to the non-resident as under section 195. The first appellate authority contemplated under section 195 of the Act.”12 upheld the view of the AO. The Tribunal upheld the assessee’s contention that the import of software The High court unambiguously held that in would be in the nature of a transaction involving view of the decision of the Supreme Court in import of goods, in the light of the precedents the case of Transmission Corporation there lies set by the various Courts including the Hon’ble obligation on payer to deduct tax while making Supreme Court in the Tata Consultancy Services payment to a non-resident. In fact, the High case. The Revenue appealed to the High Court court went a couple of steps forward. It observed against the Ruling of the Tribunal. that under section 195(2) examination of the issue of taxability cannot be on the same level The Karnataka High Court underlined the concept as assessment of non-resident. Their following behind enacting provisions on TDS. It observed observation is very important: that “ we should bear in mind that the exercise “it was the experience of the revenue that under section 195(2) of the Act is only for realization of tax becomes much more difficult extending a limited concession in favour when once the income earned has been of the resident payer when things are very spent by the assessee, even before the clear or does not involve any doubt or finalization of the tax liability for the ambiguity such as in a situation where the assessment year and by the time a demand non-resident recipient of the amount, filed notice is served following the assessment a return of this income as one arising from order, the assessee either may not be left such a transaction with the resident payer with much fund or may not even be available and the Assessing Officer has actually (in India) for enforcing the tax liability examined the nature of payment and has and to get over such situations framers of indicated in an assessment order passed the Act have envisaged the scheme of advance on the return of income filed by the non- payment of tax as indicated in Chapters resident that no part of the receipt is taxable XV and XVI of the Act providing for an under the provisions of the Act [for whatever

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reason] and if so based on this settled/ received by VOAMC from the non-resident service undisputed factual/legal position, the providers. resident payer by quoting the assessment Assessee’s application to the revenue authorities order passed by the Assessing Officer on for Nil withholding tax certificate for reimbursement the return of income filed by the non- of abovementioned expenses to VOAMC was resident for any earlier year seek for granting rejected. The AO in the assessment order passed the commensurate relief from the obligation under section 143(3) disallowed the said expenses, of deduction of the percentage of payment invoking provisions of section 40(a)(i) of the Act to the non-resident.” on the ground that the appellant had defaulted A combined reading of the various observations in deducting tax at source under section 195, leads to conclusion that while making a payment while making payment to VOAMC. The first to a non-resident tax must be deducted on that appellate authority upheld the disallowance made payment and any concessional treatment would by the AO. be available under section 195(2) of the Act The Tribunal also upheld the disallowance of depending on the findings in assessment of income expenses to VOAMC. According to the Tribunal, of the non-resident. since payment was made to a non-resident, the This decision caused a lot of worries among the appellant was mandatorily liable to deduct tax business community. Questions were being asked at source under section 195 of the Act. The whether payment for purchase would also be Tribunal further held that it was not necessary liable to TDS, and if there was no deduction, to determine whether such payment was chargeable would the expense be disallowed? to tax in India in the hands of the non-resident. Van Oord case Though the decision of the Delhi Tribunal in this case came much earlier to the Samsung When this case was taken up by the Delhi High ruling, the views of the Delhi Tribunal were in Court everyone was waiting to see whether this line with the Karnataka High Court. The Tribunal Court would agree with the Karnataka High held that it is not for the assessee to decide the Court on all the points. Before going into the taxability of payments made by it in the hands analysis of the observations, it may be useful of the non-resident recipient and that is a separate to look at the facts. issue and in the absence of any certificate obtained The appellant/assessee in this case is a company from the concerned authorities under section incorporated in India, which is a wholly owned 195(2), it is obligatory on the part of the assessee subsidiary of Van Oord ACZ Marine Contractors to deduct tax at source from the payments made BV, the Netherlands (“VOAMC”), engaged in to the non-resident. The authorities would not the business of dredging, contracting, reclamation even be required to look into whether such and marine activities. During the year under payments are income or part of income in the consideration, the appellant executed inter alia hands of the recipient non-resident taxable in dredging contract at Port Mundra. For this contract, India. it incurred certain costs towards transportation The assessee went into appeal before the Delhi of dredger, survey equipment and other plant High Court against the order of the Tribunal. and machinery from countries outside India to Since, both the parties before the High Court the site in India and re-transportation of the relied heavily on the Hon’ble Supreme Court same on completion of the contract, including ruling in the case of Transmission Corporation13, fuel cost incurred on transportation. The aforesaid the Court first looked into the ratio arising from services were contracted by VOAMC and were the Transmission Corporation case. The Court provided by various non-resident parties. The observed that in Transmission Corporation case, appellant reimbursed the cost relating to the contention of the assessee was that “any mobilization and demobilization of dredger other sum chargeable under the provisions of incurred by VOAMC on the basis of invoices

68 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 80 TAX DEDUCTED AT SOURCE this Act” would mean “sum” on which income or no deduction is required to be made, tax is leviable and, therefore, only on that they are required to file an application before component which was “pure income profits”, the Assessing Officer for obtaining such tax was to be deducted and not which were certificate. If no such application is filed or trade receipts and, therefore, outside the ambit the application is rejected, then the payer of income. In other words, the question before is duty-bound to deduct tax as per the the Supreme Court was whether tax is to be prescribed rates in force at the relevant deducted from the gross amount of the trade time. In case of failure to do so, conse- receipts or on the income component thereof. quences under section 40(a)(i) would fol- low. In the instant case, the High Court interpreted that in the case of Transmission Corporation, 5. The order of the Assessing Officer under the Supreme Court was not concerned with the section 195 of the Act is tentative in nature. situation where no tax at the hands of recipient 6. In case in the assessment proceedings re- is payable at all. However, certain observations lating to the recipient, it is ultimately held in that judgment clearly depict the mind of the that the sum received by the recipient was Supreme Court that liability to deduct at source not chargeable to tax, the effect of that arises only when the sum paid to the non- would be that there was no obligation on recipient is chargeable to tax. Once that is the assessee to deduct tax at source on the chargeable to tax, it is not for the assessee to sum paid to the said non-resident and in find out how much amount of the receipts is that eventuality, the assessee will not be chargeable to tax, but it is the obligation of the treated as in default and would be ab- assessee to deduct the tax at source on the solved of any consequences for non-deduc- entire sum paid by the assessee to the recipient tion of the tax at source. non-resident. It is important to observe that the Delhi High It may be observed that the Delhi High Court Court gives freedom to the AO while dealing differed from the conclusion drawn by the with application under section 195(2). Further, Karnataka High Court. While drawing conclusion, this Court provides for relief when assessment Delhi High Court observed that the judgment order is passed in the case of the non-resident of the Supreme Court is not to be read as a holding the income in question as not chargeable. statute, rather one has to cull out the ratio of the judgment viz. what it decides and not logically Recently, Income Tax Appellate Tribunal, Chennai what follows from it. had occasion to deal with similar issue. They had all the above mentioned cases before them. The Court summarized the legal position as The Tribunal decided to follow the Delhi High follows14: Court. This case is discussed hereunder. 1. Section 195 deals with the deduction of tax Prasad Production case at source by the payer, i.e., assessee if the payments are to be made to non-resident, The assessee-company was awarded a contract by the Tourism Department of the Government 2. The payer/assessee is required to deduct of Andhra Pradesh to establish IMAX Theatre Income-tax on such payments made to non- at Hyderabad. The assessee entered into an resident at the specified rates in force. agreement on with IMAX Ltd., Canada (“IMAX”) 3. The obligation to deduct the tax at source for purchase of equipment, maintenance and arises only when the payment is charge- installation. As per the agreement, the total able under the provisions of the Income- consideration was for purchase of the system tax Act. and technology transfer fee. During the year under consideration, the assessee remitted money 4. If the parties feel that either the deduction to IMAX on account of technology transfer fee of tax at source by the payer is required without deducting tax at source. The assessee to be at a lower than the prescribed rate

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 81 69 TAX DEDUCTED AT SOURCE was required by the AO to show cause as to Besides the issue of fees for technical services, why demand should not be raised under section the moot question in this departmental appeal 201 of the Act for non-deduction of tax on was whether the assessee has discretion under payment to IMAX. section 195(2) to decide whether it should or not deduct tax. In response to this, a number of The AO found that the payment made by the parties appeared as intervener in this case. Main assessee was for provision of a variety of services submission of the assessee and interveners was to be provided by the personnel of IMAX in that when income of the recipient is not chargeable India like installation charges, testing and training to tax as per section 4 of the Act, then section for projectionists. The training was to be provided 195 would not apply. Referring to section 4(2) with regular service visits. It was also stated in it is pointed out that tax is to be deducted at the agreement that IMAX personnel would be source or paid in advance only if the income present for supervision in India. Therefore, the is chargeable to tax under any provision of the AO was of the view that the amount remitted Act. It was submitted that the obligation of TDS by the assessee was fees for technical services is a vicarious liability and the basic assessability under section 9(1)(vii) of the Act. Relying on the of the deductee only. Therefore, it is necessary, Transmission Corporation case, the AO concluded always, to determine the correct tax liability of that since the assessee had not obtained any the recipient of the income. order under section 195(2), the gross sum remitted by the assessee was liable to withholding tax Regarding the claim of the department that the under section 195. assessee has no option but to approach the revenue authorities for lower or Nil TDS certificate, reliance On the facts of the case and department’s allegation was placed on CBDT circular15 which gives an that the amount remitted was fees for technical option to the deductor to furnish an undertaking services, the Special Bench (“SB”) of Chennai to the Reserve Bank of India (“RBI”) to make Tribunal observed that the agreement entered remittance without obtaining a No-Objection into by the assessee with IMAX was very clear Certificate from the AO. In the light of this to point that IMAX was to install the equipment, circular, it was contended that the whole question test it and also provide training for up to four referred to the SB becomes irrelevant when the projectionists. The AO had mistakenly treated department itself has dispensed with the these services as payment of technology transfer requirement of section 195(2) by way of the whereas they were auxiliary to the sale of the abovementioned undertaking. The choice is with equipment. The department had not been able the deductor whether to follow the procedure to show that these services were independent under section 195(2) or to approach a Chartered of the equipment. The maintenance agreement Accountant as prescribed in the CBDT’s circular. which provided for provision of variety of services Further, it was contended that section 195(2) and for which separate consideration was payable uses the expression “may make an application” in the course of time was different from the to contend that it is not obligatory on the part main purchase agreement. The payment under of the deductor to undergo the procedure under consideration was part of the equipment price section 195(2). which included the services of installation and training. Analysing the Supreme Court’s decision in Transmission Corporation case, the SB construed By the time this ruling was pronounced, the SB that the person making payment to the non- had the fortune to go through the Delhi High resident would be liable to deduct tax if the Court’s ruling of Van Oord and the Karnataka payment so made is chargeable to tax under the High Court’s ruling of Samsung. Though the Act. Impliedly, if the payment is not chargeable Samsung ruling was relied on by the department to tax under the Act, the payer would not be in their support, SB by a detailed order refused liable to deduct tax at source. Connection between to follow the Karnataka High Court’s ruling of TDS and chargeability of the payment was again Samsung.

70 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 82 TAX DEDUCTED AT SOURCE clarified by the Supreme Court in the case of that when the payer has a bona fide belief that Eli Lilly case16. Though the Eli Lilly case relates no part of the payment bears income character, to TDS under section 192 (salary payments), but section 195(1) itself would be inapplicable and the rationale laid down by the Apex Court is hence, no question of going into the procedure equally applicable to the TDS provisions under prescribed in section 195(2) of the Act, arises. section 195. In this case, it was argued by the Sub-section (3) is enacted to deal with a situation department that TDS provisions are independent where the payer wants to deduct tax from the of the charging provisions which are applicable payment but the payee believes that he is not to the recipient of income whereas the TDS chargeable to tax in respect of that payment provisions are applicable to the payer of income. and, hence, sub-section (3) provides an opportunity However, the Supreme Court observed that section to the payee to seek certificate to receive the 4(2), inter alia, provides that in respect of income payment without deduction of tax. chargeable under section 4(1), income-tax shall The department raised a pertinent issue as to be deducted at source whether it is so deductible who would decide whether the payment bears under any provision of the Act which, inter alia, any income character or not. In its view, it brings in the TDS provisions contained in Chapter could be either the AO or a Chartered Accountant XVII-B of the Act. In fact, if a particular income as prescribed by the CBDT, but certainly not the falls outside section 4(1), then the TDS provisions assessee (the payer). The SB patently rejected cannot come into play. this claim of the department. In this regard, the Reverting on the Transmission Corporation case, SB observed that if a taxpayer is expected to the SB observed that the reply of the Supreme determine his taxable income and pay taxes in Court that the scheme of TDS applies not only advance, why can’t he decide in respect of the to the amount paid which wholly bears “income” payment he is making to a non-resident. It is character, but also to gross sums, should be to be appreciated that the payer is not to determine considered in the light of the assessee’s contention the tax liability of the total income of the payee. that section 195 is applicable only when whole He has to consider the chargeability only in of the payment is income chargeable to tax. respect of the payment he is making to the Accordingly, the principle emerging from this payee. For this proposition, the SB relied on the ruling of the Supreme Court is that if the payer language of sub-section (2) of section 195. Sub- has a bona fide belief that no part of the payment section (2) states that, “Where the person has income character, then section 195 will not responsible for paying any such sum chargeable apply because section 195 applies only if the under this Act to a non-resident considers that payment is chargeable to income-tax, either wholly the whole of such sum would not be income or partly. chargeable in the case of the recipient.....”. Section 195(2) clearly indicates that it is the payer who To give strength to its abovementioned point, will first consider whether the payment or any the SB made an observation which might sow part of it bears income character. seeds of new controversy. The SB pointed towards the distinction between sub-sections (2) and (3) Regarding the alternative procedure of Chartered of section 195. Firstly, under sub-section 2, it Accountant certificate, the SB referred to the is the payer who applies to the tax authorities CBDT circular No. 759 of 1997. The SB observed for deduction of tax at lower rates, while under that as per this circular the payer has to deduct sub-section (3), it is the payee. The second and tax at source only when he is paying any sum the more important difference is that under sub- chargeable under the Act. To mitigate the hardship section (2), the payer can make application only caused by RBI instruction which compelled the for deduction of tax at a lower rate, whereas payer to obtain a No Objection Certificate from under sub-section 3, the payee can make application the Revenue, the CBDT evolved the procedure for Nil rate. For this conclusion, the SB reasoned of filing an undertaking by the remitter along

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 83 71 TAX DEDUCTED AT SOURCE with a certificate from a Chartered Accountant. obligatory on the part of the assessee to deduct Considering the circumstances in the background tax at source from payments made to non-residents of which the procedure was evolved, the SB or to obtain certificate under section 195(2) of observed that it is a clear indication that as per the Act even though the payment to the recipient CBDT’s interpretation also, the payer need not was not liable to tax in India. The court referred enter into the procedure of section 195 if no part to the decision in the case of Van Oord and of the payment was chargeable to tax17. observed that the question of deducting tax at source in the case of non-resident would only Based on the above discussions, the SB visualized arise if the said payment was chargeable to tax the following situations that can arise for the in the hands of the recipient under the provisions applicability of section 195:

S. No. Factual Situation Action

1 Payer has bona fide belief that no part of Section 195 is totally inapplicable the payment has any portion chargeable to tax

2 Payer believes that whole of the payment Deduct tax under section 195(1) of the Act is income chargeable to tax

3 Payer believes that only a part of the payment He can apply under section 195(2) for is chargeable to tax deduction at appropriate rates

4 Payer believes that a part of the payment is He will have to deduct tax from the entire income chargeable to tax, but does not make payment an application under section 195(2)

5 Payer believes that the entire payment or a He will face the consequences under the Act part of it is income chargeable to tax and fails to deduct tax at source

6 Payer believes that he has to deduct tax and It is for the payee to apply under expresses this duty to the payee section 195(3) to receive the payment without any deduction at source

7 If the payee fails to obtain certificate Payer, based on his belief, will certainly under section 195(3) withhold the tax

It may be mentioned that SB’s conclusion was of the Act. The issue of chargeability was referred based on the Mumbai SB ruling in the case of back to the Delhi Tribunal for their consideration. Mahindra & Mahindra Ltd. v. DCIT18 Further, the Conclusion SB relied on the Van Oord case of the Delhi High Court to hold that this entire exercise is The entire discussion above is to find answer tentative and the ultimate liability of the payer to the question whether a taxpayer can suo motu will depend on as to what happens in the decide the issue of TDS on payments to non- assessment of the payee. The SB also analyzed residents or not. The Chennai Tribunal has rightly various situations before coming to the conclusion observed that the issue is both easy and difficult that provisions like regular assessment, section to deal with. The issue is easy because number 201 and 40(a)(i) take care of the interest of of judicial precedences are available on the subject revenue even where taxpayer has not deducted from different forums including the Supreme tax under bona fide belief. Court. Still it is difficult because despite so many authorities available on the subject, Maharishi Housing Development Finance controversies of section 195 are still alive. Corporation Ltd. It is the decision of the Supreme Court in the In a very recent ruling19 of the Delhi High Court, case of Transmission Corporation which has been the question before the court was whether it is

72 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 84 TAX DEDUCTED AT SOURCE discussed in all the decisions mentioned above High Court is pending before the Supreme Court and relied upon by both the parties to their and the final word on the issue is awaited. likings. There is no denial in any of these decisions One thing which is of concern is the remarks of that tax can be recovered only when chargeability the Chennai SB at Para 25 of the order. While is established under section 4 of the Act. It is comparing the provisions of sub-sections (2) and also not denied that section 195 is tentative. The (3) of section 195, the SB remarked that under differences are on the implementation of this sub-section (2), the payer can make application section. Karnataka High Court appears to give only for deduction of tax at a lower rate. Does a lot of importance to the fact that TDS is to it mean that if the payer has a bona fide belief ensure that revenue is not only collected in that payment is not chargeable to tax in the advance but to protect the interest of revenue hands of the non-resident and, hence, is not in case the payer/receiver vanishes later on. subject to TDS under section 195, but only for The court does not give any freedom to taxpayer the sake of certainty or to avoid future litigation in taking suo motu decision. The court goes step and he wants to obtain a No-Objection Certificate further and wants AOs to be conservative in from the AO, he has no recourse. Practically, tax dealing with applications under section 195(2) authorities have been issuing Nil TDS certificate of the Act. Contrary to this, other decisions vary under section 195(2). Karnataka High Court in over a wide spectrum. Delhi High Court seeks Samsung has also observed that the payer can to look for an answer which satisfies the legal make an application to the AO under section requirement as well as is practical in application. 195(2) for a lower or a Nil withholding tax certificate. It encourages taxpayer to approach tax authorities under section 195(2); at the same time does not The casualty of all the litigation is ‘certainty’, limit tax authorities. It absolves taxpayer of which taxpayer and advisors look for. Neither divergence in approach and links the consequences any decision nor any circular can deal with all to the assessment of non-resident. Chennai Tribunal possible situations. A lot would depend upon has structured the position in such a manner how the present regulations are applied by the that interest of taxpayer as well as of revenue tax authorities. If they are quick in dealing with is protected in all situations – whether payer the application and free and judicious in taking makes TDS or not. decisions, it will go a long way in reducing the administration cost as well as compliance cost. For a taxpayer the approach of Chennai SB is At the same time, Chartered Accountants have the best approach. However, it is not known to be equally diligent in issuing certificates under whether tax administration has accepted this section 195. decision or not. The decision of the Karnataka

1 Section 195(1): “Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest or any other sum chargeable under the provisions of this Act (not being income chargeable under the head “Salaries” shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force...” 2 The term “rates in force” is defined as the rate prescribed in the relevant Finance Act or the relevant Double Taxation Avoidance Agreement (“DTAA” or “tax treaty”). 3 Section 195(2): “Where the person responsible for paying any such sum chargeable under this Act (other than salary) to a non-resident considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make an application to the Assessing Officer to determine, by general or special order], the appropriate proportion of such sum so chargeable .” 4 Transmission Corpn. of A.P. Ltd. v. CIT [1999] 239 ITR 587/105 Taxman 742 (SC) 5 CIT v. Samsung Electronics Co. Ltd. [2009] 185 Taxman 313 (Kar.) 6 Van Oord ACZ India (P) Ltd. v. CIT [2010] 189 Taxman 232 (Delhi) 7 ITO v. Prasad Production Ltd. [IT Appeal No. 663/Mds./203, dated 9-4-2010]

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8 ITA 222/2009 (Delhi) 9 CIT v. Eli Lilly & Co. (India) (P.) Ltd. [2009] 178 Taxman 505 (SC) 10 CIT v. Samsung Electronics Co. Ltd. [2010] 320 ITR 209/[2009] 185 Taxman 313 (Kar.) 11 Para 38 of ibid. 12 Para 45 of ibid. 13 ibid. 14 Para 22 ibid. 15 CBDT Circular No. 759 dated 18 November, 1997 16 Eli Lilly & Co. Ltd. (supra) 17 It is pertinent to mention here that deduction on the basis of Chartered Accountant certificate was also upheld by the Delhi Tribunal in the case of Millennium Infocom Technologies Ltd. v. ACIT (117 ITD 114). 18 313 ITR (AT) 263 19 Pronounced in April 2010

Statutory Happenings RBI/FEMA - CIRCULAR/PRESS NOTE RELEASE OF FOREIGN EXCHANGE FOR VISITS ABROAD – CURRENCY COMPONENT A.P. (DIR SERIES) CIRCULAR NO. 50/A.P. (FL SERIES) CIRCULAR NO. 7, DATED 4-5-2010, ISSUED BY FOREIGN EXCHANGE DEPARTMENT, RBI

Attention of Authorised Persons in foreign 2. Authorised Dealers and Full Fledged Money exchange is invited to A.P. (DIR Series) Circular Changers may, as hitherto, continue to sell No. 19, dated October 30, 2000 and A.P. (DIR foreign exchange in the form of foreign currency Series) Circular No. 11 [A.P. (F.L. Series) Circular notes and coins up to USD 5,000 or its equivalent No. 1] dated November 13, 2001, in terms of to the travellers proceeding to Iraq or Libya, which Authorised Dealers and Full Fledged out of the overall foreign exchange released Money Changers are permitted to sell foreign and full foreign exchange may be released in exchange in the form of foreign currency notes the form of foreign currency notes and coins and coins, up to USD 2,000 or its equivalent, to the travellers proceeding to the Islamic Republic to the travellers proceeding to countries other of Iran, Russian Federation and other Republics than Iraq, Libya, Islamic Republic of Iran, Russian of Commonwealth of Independent States. Federation and other Republics of Commonwealth 3. Authorised Persons may bring the contents of Independent States. The existing limits have of this circular to the notice of their constituents been reviewed and it has been decided to increase and customers concerned. this ceiling, with immediate effect, to USD 3,000 (US Dollar Three thousand only) to the travellers 4. The directions contained in this circular have proceeding to these countries, without the prior been issued under sections 10(4) and 11(1) of permission from the Reserve Bank. Authorised the Foreign Exchange Management Act, 1999 Dealers and Full Fledged Money Changers may (42 of 1999) and are without prejudice to accordingly sell foreign exchange in the form permissions/approvals, if any, required under of foreign currency notes and coins, up to USD any other law. 3,000 or its equivalent, out of the overall foreign exchange released.

74 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 86 TRANSFER PRICING

Your Queries

Manoj Pardasani*

How can Mutual Agreement Procedure (MAP) help resolve transfer pricing disputes? MAP provisions in most tax treaties seek to alleviate the impact of any potential double taxation. Double taxation can be either ‘juridical’ double taxation or ‘economic’ double taxation. Juridical double taxation represents instances where same entity’s income is being taxed twice by different countries. Economic double taxation, on the other hand, represents cases where the same income is being taxed twice albeit in the hands of different taxpayers. Every transfer pricing adjustment proposed by revenue authorities entail economic double taxation. Thus, for transfer pricing adjustments Manoj Pardasani proposed by the revenue authorities, it should ordinarily be possible to invoke the MAP provisions of the relevant tax treaty. MAP typically requires the taxpayer to approach the Competent Authority (CA) in the country of its tax residency. Since transfer pricing disputes are economic double taxation which have two associated enterprises in two different countries being taxed on the same income, the process of initiating MAP process needs to be practically coordinated amongst them. Under MAP, the CAs of the two countries discuss and negotiate with each other and strive to resolve the dispute. Owing to the bilateral approach adopted in MAP, it serves as an effective tax dispute resolution mechanism as the resolutions arrived at under MAP are binding on the tax authorities and, thus, this mechanism takes precedence over the domestic tax dispute resolution mechanism. Where MAP proceedings are ongoing, the normal tax appellate procedure under the domestic tax laws can also continue in parallel. Further, MAP process also enables (in some cases, depending on certain criteria) suspension of collection of disputed taxes by the

* Manoj Pardasani is Partner - Transfer Pricing, BSR & Co. Views expressed are personal. Comments above are generic in nature, and readers may seek specific professional advice based on their respective facts. Please send your Transfer Pricing queries to [email protected]

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 87 75 TRANSFER PRICING revenue authorities. However, MAP is typically provisions shall become applicable on the said a long drawn and time-consuming process, and transaction. The said circumstances are – where it may not always result in an agreement as the there is a prior agreement for the said transaction CAs of the two countries may not agree on the between the other party and an associated matter in dispute. Overall, MAP is an effective enterprise of the taxpayer; and where terms of tool of dispute resolution, particularly where the transaction are determined in substance the amounts involved are large and/or where between the other party and an associated the subject-matter is likely to have an impact enterprise of the taxpayer. across multiple years. Whether an uncontrolled quotation can be used as Are there any circumstances wherein transactions an uncontrolled comparable for applying CUP between two unrelated entities can be subjected to Method? transfer pricing provisions? The CUP method requires that an international Yes, there are certain deeming provisions under transaction needs to be benchmarked using a the Indian tax legislation wherein transactions comparable uncontrolled transaction. Although amongst unrelated entities are also subjected to a quotation from unrelated entity can act as a transfer pricing provisions. significant indicator to reflect prevailing market price, it is strictly not an actual transaction. Firstly, on satisfaction of certain criteria, two However, depending upon market and business entities would be deemed to be associated circumstances, obtaining an uncontrolled quotation enterprises, and hence the transfer pricing may be the only or best possible manner for provisions shall be applicable on all transactions obtaining a reliable comparable. Further, obtaining amongst them. The said criteria – shareholding, quotations from non-associated enterprises even voting power, loans, guarantees, appointment while awarding a contract to an associated of board members, dependence on intellectual enterprise, is in itself a significant evidence of property, purchase of raw material, sale of goods, the objectivity and arm’s length character with mutual interest relationships, etc. which price determination may be undertaken Secondly, a transaction amongst two entities amongst associated enterprises. Thus, in the which are not associated enterprises, would be absence of uncontrolled transactions, uncontrolled deemed to be an international transaction in quotations can be considered as a significant certain circumstances and transfer pricing indicator to demonstrate the arm’s length character and intent.

Statutory Happenings

NOTIFICATION - INCOME-TAX ACT SECTION 90 OF THE INCOME-TAX ACT, 1961 – DOUBLE TAXATION AGREEMENT – AGREEMENT FOR AVOIDANCE OF DOUBLE TAXATION AND PREVENTION OF FISCAL EVASION WITH FOREIGN COUNTRIES OR SPECIFIED TERRITORIES – NOTIFIED ‘SPECIFIED TERRITORY’ NOTIFICATION NO. 25/2010 [F.NO. 500/124/97-FTD-II]/S.O. 909(E) DATED 20-4-2010, ISSUED BY MINISTRY OF FINANCE, DEPARTMENT OF REVENUE (CBDT)

In exercise of the powers conferred by Explanation “Hong Kong Special Administrative Region of 2 to section 90 of the Income-tax Act, 1961 (43 the People’s Republic of China” as ‘specified of 1961), the Central Government hereby notifies territory’ for the purposes of the said section.

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Landmark Rulings*

Multiple Contracts v. Multiple PEs Recent Mumbai Tribunal’s decision in the case of Valentine Mauritius [Asstt. DIT (International Taxation) v. Valentine Maritime (Mauritius) Ltd. (ITA No.1532 of 2005 Assessment Year : 2001-02 dated April 5, 2010)/[2010] 3 taxmann.com 92 (Mum. - ITAT)] affirms the tax position (given in OECD and UN Model Commentaries) against aggregation of time spent in India for commercially or geographically unconnected or independent construction / installation / assembly / supervisory projects, for determining permanent establishment (PE) threshold under tax treaties. Further, the Tribunal has held that Protocols to tax treaties are often clarificatory provisions and should be interpreted accordingly. On another issue, the Tribunal held that consideration for barge hire is ‘royalty’ under the domestic tax law being for ‘use of equipment’.

FACTS OF THE CASE Assessee is a tax resident of Mauritius (having Mauritian tax residency certificate) and engaged in the business of marine and general engineering and construction. During the relevant previous year, the assessee executes three contracts in India, summarized below:

* Landmark Rulings are compiled by the following authors: • Mr Freddy R. Daruwala, Partner in Juris Corp, a leading full service law firm practicing mainly in the areas of Direct Taxation, Private Equity, Derivatives, Securitization & Structured Finance, Banking and Alternate Dispute Resolution • Mr. Amit Aggarwal, (FCA), Senior Manager, B.S.R. & Co. • Ms. Rachna Jindal, Delhi based Advocate. Section and Rule referred to in this article are Section of Indian Income-tax Act, 1961 and Rule of Indian Income Tax Rules, 1962 respectively, if not otherwise mentioned.

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Contracting Party Contract Number Nature of activities Duration of work in India Arcadia Shipping Ltd. C 99/07 Replacement of B121 main 99 days Deck with temporary deck Arcadia Shipping Ltd. C 99/05 Charter of hook up/ 137 days accommodation Barge for BHN revamp project Kier International C 99/06 Charter of barge JU 253 Seven and a for PPN power project half months alongwith technical personnel

ASSESSEE’S SUBMISSIONS Act on the payments received during the relevant financial year in tax return filed, based on certificate The assessee submitted before the Assessing Officer obtained under section 197 of the Act. During (AO) that under Article 5(2)(i) of the India-Mauritius assessment proceedings, assessee revised his claim tax treaty, a permanent establishment (PE) will and argued nil India taxation since time threshold include ‘a building site or construction or assembly under this contract was not exceeded. It was project or supervisory activities in connection therewith, contended that if a claim has not been made in where such site, project or supervisory activity continues the income tax return, or if an income is offered for a period of more than nine months’ but for the under the wrong basis, the same can be corrected purpose of applying this threshold limit of PE at assessment and even appellate stage. duration, each of the contracts is to be examined separately. It is pointed out that the word ‘contract’ The assessee further contended that ‘a barge, is used in singular and not plural and the reference along with technical personnel was provided by is clearly for individual contract. the assessee’, that ‘this contract was for rendering technical services as such, and hire of barge was Assessee argued that since the total duration of only incidental thereto’ and, therefore, ‘the work in India under contract # C 99/07 was consideration was in the nature of fees for technical only ninety nine days which was less than threshold services arising in the course of normal business limit of nine months, a PE did not exist. activities’. Since the assessee did not have any For # C 99/05 contract, assessee accepted taxability PE in India, the income earned under this contract @ 7.5% on gross basis, under section 44B of the [C 99/06] was not taxable in India.

Mumbai Tribunal’s decision in Valentine Maritime (Mauritius) case provides welcome clarification of law with respect to calculating time duration for construction PEs. The principle that period of stay in respect of different project sites (in pursuance of different contracts / different contracting parties) should not be taken together has earlier been affirmed in Jt. DIT v. Krupp Uhde GmbH [2009] 28 SOT 254 (Mum. - Trib.) . However, this case was not cited in the subject decision in Valentine Mauritius. At the same time, even if contracts are different but they constituted a coherent whole commercially and geographically, then they should be aggregated relying on OECD and UN Model Commentaries. In Caribjet Inc. v. Dy. CIT [2005] 4 SOT 18 (Mum. - Trib.), Tribunal has held that wet leasing (leasing with operation / maintenance crew) of aircraft was not ‘royalty’. Further, the decision in Poompuhar Shipping Corp. Ltd v. ITO [2007] 109 ITD 226 (Chennai - Trib.) relied upon by the Tribunal is not in conformity with OECD Commentary. The taxation of leasing or hire of equipment (or ship) is still an open question. Further, article 8 dealing with taxation of shipping profits, in most tax treaties, would need to be looked into for companies engaged in business of transportation in international traffic.

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OLD DECISIONS ON CONSTRUCTION PE While determining existence of a PE in India of a company incorporated in Germany, minimum period of six months, as prescribed in article 5(2)(i) of DTAA between India and Germany, cannot be considered together in respect of various sites under different contracts entered into by said company, particularly when different contracts have no effective inter-connection with each other. 1. Jt. DIT v. Krupp Uhde GmbH [2009] 28 SOT 254 (Mum. - Trib.) The scope of a PE has to be examined under clause (i) of article 5(2). There is nothing in the language provided in the above clause to indicate that different sites on which work was carried on by the assessee could be considered together in determining the scope of a PE. In computing the minimum period of six months, various sites could not be considered together, particularly when different contracts had no effective inter-connection with each other. As regards the question as to whether the minimum period of six months would commence from the date when the project or building site commenced, the contention that it was the responsibility of the assessee that the entire project was commissioned successfully and, therefore, the date of commencement of the project could be considered as the date of commencement of the PE was too extreme to be accepted. The date of commencement of threshold limit of six months would depend on the facts of each case considering the terms of contract. The period can be counted from the date of commencement of the project only where there is one single indivisible contract for various activities undertaken by the non-resident. Whether the contract is one single indivisible or not would depend on the facts of each case. Where different contracts are awarded which are not inter-dependent on each other, the period of six months would be counted separately in respect of each activity, since there is no effective connection between the various contracts. Therefore, when the supervisory activity is carried out under a separate and independent contract, then the minimum period of six months would commence only when such activity itself has commenced and not from the date of the project. Further, the intervening period caused on account of various factors could not be excluded while computing the minimum period of six months. As regards the question as to whether the period under article 5 should be calculated with reference to each year, considering the rule that period commences when the activity commences and ends on the completion of the contract, it would have to be held that the minimum period of six months has to be counted irrespective of the year involved. An activity may start in January and may end in July. In such a case the total period is more than six months but falls under two financial years. If the period of each year is to be counted, then in each year, period would be of less than six months. Such construction would defeat the object behind such provisions. Therefore, the minimum period of six months is to be counted from the date when activity starts till the date when the contract is completed, irrespective of the year/years to which such period relates. The assessee, a company incorporated under the laws of Federal Republic of Germany, was engaged in the business of providing - (i) technical know-how/license; (ii) basic engineering services, and (iii) supervisory activities in connection with construction or installation of the specified machineries/ assembly provisions. During the relevant assessment years, the assessee-company received income from certain Indian parties in respect of aforesaid service contract which was offered to tax at the rate of 10 per cent as per article 12 of the DTAA. In the course of assessment proceedings, it was noticed by the Assessing Officer that liability to pay tax at the rate of 10 per cent under article 12(2) of the DTAA would arise only if the assessee had no PE in India. On the other hand, if the assessee had a PE in India, then the rate of tax would be 30 per cent as per the provisions of section 115A. The Assessing Officer further noted that ‘a building site or construction, installation

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or assembly project or supervisory activities in connection therewith, where such site, project or activities continue for a period exceeding six months’ would be treated as a PE in terms of article 5(2)(i) of the DTAA. The Assessing Officer was of the view that the assessee had been actively engaged in assisting the installation of various projects and also continued its supervisory activities. The projects on which the assessee had assisted continued for many years. Accordingly, the Assessing Officer held that the assessee had a PE in India, therefore, the fees for technical services received by it were taxable at the rate of 30 per cent. Held that only three contracts entered into by the assessee with the Indian companies were placed on record, even though the assessee had entered into contracts with many other Indian companies. However, in view of the above discussion, the matter was to be restored to the file of the Assessing Officer for fresh adjudication in accordance with findings given above, as well as on the basis of material which might be placed before him by the assessee. 2. Van Oord Atalanta B.V. v. Asstt. DIT [2008] 23 SOT 29 (Kol. - Trib.) (URO) Maintenance of books of account or bank account cannot be a factor for determining a fixed place of business as PE; where assessee’s project office in India was in operation for only 153 days, it could not be treated as PE, as period of 153 days was much less than period prescribed under DTAA with Netherlands for establishment to be treated as PE. 3. Dy. CIT v. Hyundai Heavy Industries Co. Ltd. [2009] 31 SOT 482 (Delhi - Trib.) Provisions of article 5(3) of DTAA with South Korea are more specific as compared to those of article 5(1) and 5(2) and so provisions of article 5(3) take precedence over those of article 5(1) and 5(2); according to article 5(3), a permanent establishment encompasses a building site, a construction assembly or an installation project or supervisory activity in connection therewith but only where such site, project or activity continues for a period of more than 9 months.

DECISION OF THE ASSESSING OFFICER (AO) accordingly its income from all the con- tracts would be taxable in India. u The AO took the view that there is no good reason to assume that each of the contracts u The AO further observed that ‘a barge with is to be considered individually as this crew provided by the assessee may itself approach is ‘not based on sound logic’. also constitutes a fixed place of business through which business of the assessee is carried It was pointed out that in India UK Double out’. Taxation Avoidance Convention [1994] 206 ITR (St.) 235, it is specified in the protocol The income from the contract was, there- that for the purposes of applying the duration fore, held to be taxable in India under threshold test, each of the project is to be section 44BB on gross basis @ 10%, which considered separately. In the absence of thus works out to an effective tax @ 4.8% any such provision or protocol clause in on gross receipts. the India Mauritius tax treaty, all the contracts The AO alternatively held that even if it are to be considered together for the pur- was to be held that the assessee did not poses of applying duration threshold test. have any PE in India, since barge hire is Having noted that ‘it is a fact that if all admittedly covered by consideration for the projects are taken together, it exceeds ‘use of industrial, commercial or scientific more than nine months’, the AO concluded equipment’, the assessee will be liable to that the assessee had a PE in India and be taxed @ 15% on gross basis.

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CIT (A) HELD IN FAVOUR OF ASSESSEE weld shop’, yet the Delhi Tribunal came to the conclusion that ‘it cannot be said that The CIT(A) held that, for the purpose of u all contracts put together formed a coher- determining the existence of PE, all the ent whole-commercially or geographically’. contracts were to be considered indepen- dently as these are not inter-connected. The Tribunal relied on OECD Model Con- vention Commentary adopted by the UN Model It is also held that these amounts cannot u Convention Commentary as well. Further support be treated as royalty under section 9(1)(vi), from this view was placed on US Model clause (iva) of Explanation 2 thereof, of the Convention’s Technical Explanation to US Act, as the amounts were paid for time Model Income Tax Convention -1996. charter of the barges. It was observed that while bare boat charter (agreement to hire u It can be noted that in certain treaties entered ship/ boat without crew) is covered by the into by India, there is a specific departure definition of ‘royalty’ under the domestic from this rule, law, time/voyage charter (charter with crew) – for example, article 5(2)(k) of India is not covered by the said definition. Australia Tax Treaty [1992] 194 ITR Thus, the CIT(A) concluded that income (St.) 241, states that ‘the term ‘perma- earned under various contracts was neither nent establishment’ shall exclude es- taxable as business profits under article 7 pecially .... a building site or con- of the India-Mauritius tax treaty [in ab- struction, installation or assembly sence of PE], nor can it be taxed as ‘roy- project, or supervisory activities in alties’ under the Act. connection with such a site or project, where that site or project exists or those TRIBUNAL ALSO HELD IN FAVOUR OF activities are carried on (whether sepa- ASSESSEE rately or together with other sites, projects u ITAT held that treating a project site as PE or activities) for more than six months.’ under the main rule, i.e. article 5(1), cannot – In the case of India Thailand Tax Treaty be without taking into account the provi- [1986] 161 ITR (St.) 82, Article 5(2)(h) sions of article 5(2)(i) because in the case is worded as ‘a building site or con- of an construction, installation or project struction or assembly project, or super- site, what is given in article 5(2)(i) is a test visory activities in connection there- of permanence, howsoever arbitrary as it with, where such site, project or ac- may be, for the purpose of article 5(1). tivity continues for the same or a con- Construction ‘fictional’ PE clause provides nected project for a period of periods a deeming fiction for ‘permanence’ thresh- aggregating to more than 183 days.‘ old and this deeming fiction, like all deem- – Similar are the provisions in India’s ing fictions, is to be applied strictly. tax treaties with Austria 251 ITR (St.) u Aggregation of time spent on various ac- 97, Belgium 247 ITR (St.) 39, Bulgaria tivities is to be done when the activities 220 ITR (St.) 30, Canada 229 ITR (St.) are so inextricably interconnected or inter- 44, China 214 ITR Stat 160, Denmark dependent that these are essentially re- 180 ITR (St.) 1, Italy 220 ITR (St.) 3, quired to be viewed as a coherent whole New Zealand 166 ITR (St.) 90, Norway [geographically and commercially]. 169 ITR (St.) 15, Spain 214 ITR (St.) 197, Turkey 224 ITR (St.) 145 and USA The Tribunal relied on the case of Sumitomo 187 ITR (St.) 102. Corpn. v. Dy. CIT [2008] 114 ITD 61 (Delhi - Trib.) where even though the situs of u The provisions set out in protocol to the activities were at different parts of the same tax treaties need not necessarily be sub- factory ‘viz. assembly floor, paint shop and stantive provisions, and these can also be,

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EXCERPTS FROM THE OECD MODEL TAX CONVENTION ON INCOME AND ON CAPITAL, CONDENSED VERSION 17 JULY 2008 5.1 Where the nature of the business activities carried on by an enterprise is such that these activities are often moved between neighbouring locations, there may be difficulties in determining whether there is a single ‘place of business’ (if two places of business are occupied and the other requirements of Article 5 are met, the enterprise will, of course, have two permanent establishments). As recognised in paragraphs 18 and 20 below a single place of business will generally be considered to exist where, in light of the nature of the business, a particular location within which the activities are moved may be identified as constituting a coherent whole commercially and geographically with respect to that business. 5.2 This principle may be illustrated by examples. A mine clearly constitutes a single place of business even though business activities may move from one location to another in what may be a very large mine as it constitutes a single geographical and commercial unit as concerns the mining business. Similarly, an ‘office hotel’ in which a consulting firm regularly rents different offices may be considered to be a single place of business of that firm since, in that case, the building constitutes a whole geographically and the hotel is a single place of business for the consulting firm. For the same reason, a pedestrian street, outdoor market or fair in different parts of which a trader regularly sets up his stand represents a single place of business for that trader. 5.3 By contrast, where there is no commercial coherence, the fact that activities may be carried on within a limited geographic area should not result in that area being considered as a single place of business. For example, where a painter works successively under a series of unrelated contracts for a number of unrelated clients in a large office building so that it cannot be said that there is one single project for repainting the building, the building should not be regarded as a single place of business for the purpose of that work. However, in the different example of a painter who, under a single contract, undertakes work throughout a building for a single client, this constitutes a single project for that painter and the building as a whole can then be regarded as a single place of business for the purpose of that work as it would then constitute a coherent whole commercially and geographically. 5.4 Conversely, an area where activities are carried on as part of a single project which constitutes a coherent commercial whole may lack the necessary geographic coherence to be considered as a single place of business. For example, where a consultant works at different branches in separate locations pursuant to a single project for training the employees of a bank, each branch should be considered separately. However if the consultant moves from one office to another within the same branch location, he should be considered to remain in the same place of business. The single branch location possesses geographical coherence which is absent where the consultant moves between branches in different locations. 18. The twelve months test applies to each individual site or project. In determining how long the site or project has existed, no account should be taken of the time previously spent by the contractor concerned on other sites or projects which are totally unconnected with it. A building site should be regarded as a single unit, even if it is based on several contracts, provided that it forms a coherent whole commercially and geographically. Subject to this proviso, a building site forms a single unit even if the orders have been placed by several persons (e.g. for a row of houses). The twelve months threshold has given rise to abuses; it has sometimes been found that enterprises (mainly contractors or sub-contractors working on the continental shelf or engaged in activities connected with the exploration and exploitation of the continental shelf) divided their contracts up into several parts, each covering a period less than twelve months and attributed to a different company which was, however, owned by the same group. Apart from the fact that such abuses may, depending on the circumstances, fall under the application of legislative or judicial anti-avoidance rules, countries concerned with this issue can adopt solutions in the framework of bilateral negotiations.

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and often are, merely clarificatory provi- u So far as the question of the consideration sions ‘ex abundanti cautela’. What is stated for barge hire being treated as ‘royalty’ is in the said protocol to India-UK tax treaty concerned, the same is covered against the is nothing other than what is anyway within assessee in view of Poompuhar Shipping the scope of the construction PE clause Corpn. Ltd v. ITO [2007] 109 ITD 226 (Chennai - Trib.). u An assessee cannot be expected to demon- strate that contracts are not artificially split, u As regards levy of interest under section that the affairs are not so contrived so as 234B and section 234C, issue is now covered to circumvent the duration test. It is for the in favour of the assessee by a large number revenue authorities to establish, beyond a of decisions of the Tribunal, including Special reasonable degree of doubt, that there is Bench decision in the case of Motorola Inc an abuse of treaty provisions by so artifi- v. Dy. CIT [2005] 95 ITD 269 (Delhi - Trib.) cially contriving the affairs as to wrong- which has since been approved by the Mumbai fully entitle the assessee to treaty benefits. High Court in the case of DIT (Interna- tional Taxation) v. NGC Network Asia LLC u Even such an aggregation, when applicable, [IT Appeal No. 1037 of 2008, dated 14-1- would require exclusion of double count- 2009]. Hence, assessee is not liable to inter- ing of days when more than one site or est for delay/default in payment of advance project exists on a day, or when work is tax, since advance tax was not payable at carried out at two or more different places all considering that tax was ‘deductible’ at on a day, as multiple counting of common source on such income. days would lead to an absurdity.

Agency PE Under Indo-Germany DTA Tribunal in the case of Dy. DIT (Int’l Taxation) v. Daimler Chrysler A. G. [ITA No. 9211 of 2004, dated March 31, 2010]/[2010] 3 taxmann.com 102 (Mum. - ITAT), held that merely being termed an ‘agent’ in name for a non-resident principal does not trigger the existence of an Agency Permanent Establishment (‘PE’) for the purpose of attribution of profit under the India-Germany Double Tax Avoidance Agreement (‘DTAA’)

FACTS OF THE CASE claimed that there was no office or fixed place of business in India and, hence, in the absence Daimler Chrysler AG (‘DC’) is a premier of a PE in India, it did not offer to tax in India manufacturer of premium passenger cars and the income from sale of CKDs and spares to heavy vehicles and is duly incorporated under DCIL as well as the income from sales of completely the laws of Germany. DG entered into a joint built cars directly to Indian customers. DC’s AO venture with the erstwhile Tata Engineering and sought to tax the income from sale of CKDs and Locomotive Company Ltd., now Tata Motors spares as well as income from sale of cars in Ltd., (‘TM’) to form a joint venture, namely, India to tax under the grounds that DC had an Daimler Chrysler India Ltd. (‘DCIL’) with 51% agency PE in India under article 5 of the DTAA stake held by DC and 49% by TM. DC, and, hence, was liable to suffer tax in India subsequently, increased its stake to 86%in DCIL. under article 7 of the DTAA. An order under DC sold CKDs, kits and other auto spares to section 143(3) of the Income-tax Act, 1961 was, DCIL and also made direct sales to Indian customers accordingly, made and served on DC with a of completely built passenger cars, for which notice of demand and applicable interest. DC DCIL rendered certain assistance services. DC preferred an appeal to the CIT (Appeals) who

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set aside the AO’s order and ruled that DC had u DC which was the respondent in the above no Agency PE in India and, hence, was not liable appeal raised the following contentions in to tax on its business income in India under its memo of cross objections as well as in articles 5 and 7 of the DTAA. The IT Department its arguments before the ITAT preferred an appeal against the order of the CIT u No manufacture or sale of CKDs or auto (Appeals) in the Mumbai Income Tax Appellate spare parts which were sold in India by DC Tribunal (‘ITAT’) to DCIL was done in India, nor are any REVENUE’s SUBMISSIONS other operations carried out by DC in India in relation to these u DC and DCIL had entered into an agree- ment for distribution of cars in India and u DC did not have a right to use DCIL’s Bhutan premises in India and, hence, did not satisfy the ‘disposal’ test necessary to constitute a The sale of CKD’s and auto spares and u PE in India parts by DC to DCIL constituted a PE under article 5(2) of the DTAA and, hence, the u No significant decision in regard to man- income from the same was chargeable to agement of DC was taken in India since tax in India it was managed entirely by its Board situ- ated in Germany u Further the sale of CKD’s and auto spares and parts by DC to DCIL also constituted u The MD and ED of DCIL had separate a ‘business connection’ under section 9(1) agreements in place with DCIL rendering of the Act and hence the income therefrom them subject to the supervision and control was chargeable to tax in India of DCIL Board. Support of Carborandum Co. v. CIT [1977] 108 ITR 335 (SC) and Tekniskil DCIL derived its entire business from DC u (Sendirian) Berhad v. CIT [1996] 222 ITR and received commission from DC on sales 551/88 Taxman 439 (AAR - New Delhi) made by it on behalf of DC was cited to prove that mere deputation of u The engine, and related technology which the MD and ED by itself did not constitute is the sine qua non of the automobile, were a PE in India supplied by DC and in its absence DCIL u Sales outlets and warehouses where DCIL would lose the substratum of its business stored the goods of DC were wholly be- in India longing to DCIL u The MD and ED of DCIL were employees u In respect of cars directly imported and deputed by DC and, hence, it may be taken sold to Indian Customers by DC it was that DC effectively controled the employ- contended that DC and DCIL were in a ees of DCIL principal to principal relationship and no u DCIL executes the day-to-day business of ‘agency PE’ for the purpose of article 5 of DC in India the DTAA was satisfied. Even the dispatch of cars by DC to the Indian customers was u Interest under section 234B of the Act was made ex works also chargeable on the amount of tax demand raised by the AO u The conditions prescribed in article 5 of the DTAA which had to be satisfied to consti- ASSESSEE’s SUBMISSIONS tute a PE in India were not fulfilled by DC u The mere existence of a general agency and hence there was no PE constituted in agreement between DC and DCIL did not India. For support DC relied on the OECD satisfy an ‘agency PE ‘ under article 5 of Model Commentary to article 5 which clearly the DTAA when the facts did not support lays down that a mere parent subsidiary the conditions necessary for the same relationship ( since DC had 86% stake in DCIL) is not sufficient to constitute a PE

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TRIBUNAL HELD IN FAVOUR OF ASSESSEE (g) a warehouse or sales outlet ; In order to obtain an insight into the Tribunal’s ** ** ** line of thinking, it is necessary to refer to the 4. Notwithstanding the preceding provisions of relevant excerpts of the DTAA which are this Article, the term ‘permanent establish- reproduced below for ease of reference: ment’ shall be deemed not to include,— ‘ARTICLE 5 : Permanent establishment - (a) the use of facilities solely for the purpose 1. For the purposes of this Agreement, the term of storage, display or delivery of goods ‘permanent establishment’ means a fixed place or merchandise belonging to the enter- of business through which the business of an prise ; enterprise is wholly or partly carried on. (b) the maintenance of a stock of goods or 2. The term ‘permanent establishment’ includes merchandise belonging to the enterprise especially,— solely for the purpose of storage, display or delivery ; (a) a place of management ; (c) the maintenance of a stock of goods or (b) a branch ; merchandise belonging to the enterprise (c) an office ; solely for the purpose of processing by another enterprise ; ** ** **

Key Takeaways & Conclusions

u This case reaffirms the principle that if there is no PE constituted in India on facts, no part of the income is attributable to India and hence no tax liability in India

u Another key takeaway is that a mere subsidiary in India will not constitute a PE in India

u This decision also stresses the doctrine of ‘substance‘ over ‘form’ in the assessee’s favour. The mere existence of an agency agreement was not considered a factor to constitute an agency PE in India when the facts and the actual conduct of the parties showed otherwise. Having said this one must also read the decision keeping in mind the following facts:

u The decision is rendered solely based on an India–German DTAA framework. At most it may be held applicable to India France DTAA cases where the wordings are very much similar

u Circular 23 of 1969 was in force at the time of the transactions. This circular had since been withdrawn and as a result, though the final legal position will not change, the IT department may refuse to give ground at the AO and CIT (Appeals) stages necessitating further litigation

u Section 8 dealing with rendering of services for constituting a ‘business connection ‘has been amended with retrospective effect from 1-4-1972 by the Finance Act, 2010.Under the new section the IT department may well go in appeal to the Bombay HC against the ITAT’s decision

u Finally, last but not the least, section 90 which clearly states that in case of a conflict between the Act and DTAA, the DTAA will prevail which is presently on the statute book. If the Direct Taxes Code in its present form which removes this provision comes into force, the legal position may well suffer a volte face and future decisions on similar facts may well favour the IT department Therefore this decision while being regarded as a positive step in Income tax jurisprudence, is by no means final or conclusive given the fluid and ethereal nature of income tax law in India at present.

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(d) the maintenance of a fixed place of business State that enterprise shall be deemed to have solely for the purpose of purchasing goods a permanent establishment in the first-men- or merchandise or of collecting informa- tioned State, if this person,— tion, for the enterprise ; (a) has and habitually exercises in that State (e) the maintenance of a fixed place of business an authority to conclude contracts on solely for the purpose of carrying on, for behalf of the enterprise, unless his activi- the enterprise, any other activity of a ties are limited to the purchase of goods preparatory or auxiliary character ; or merchandise for the enterprise ; (f) the maintenance of a fixed place of business (b) has no such authority, but habitually solely for any combination of activities maintains in the first-mentioned State a mentioned in sub-paragraphs (a) to (e), stock of goods or merchandise from which provided that the overall activity of the he regularly delivers goods or merchan- fixed place of business resulting from dise on behalf of the enterprise ; or this combination is of a preparatory or (c) habitually secures orders in the first- auxiliary character. mentioned State, wholly or almost wholly 5. Notwithstanding the provisions of paragraphs for the enterprise itself or for the enter- 1 and 2, where a person - other than an agent prise and other enterprises controlling, of an independent status to whom paragraph controlled by, or subject to the same common 6 applies - is acting in a Contracting State on control, as that enterprise. behalf of an enterprise of the other Contracting

SOME CASES WHERE AGENCY PE CONCEPT WAS DISCUSSED 1. Western Union Financial Services Inc. v. Addl. DIT [2007] 104 ITD 34 (Delhi - Trib.) Assessee, a non-resident company, registered in USA and engaged in money transfer services through agents in India, though can be said to have a business connection so as to be taxable under section 9(1), but since it could not be said to have PE in India within meaning of article 5 of DTAA between India and USA, no profits could be attributed to its operations through PE in India and taxed 2. Set Satellite (Singapore) Pte. Ltd. v. Dy. DIT (International Taxation) [2008] 173 Taxman 475 (Bom.) Where assessee-appellant was deriving advertisement revenue from its dependent agent PE in India and was paying fee to its agent on arm’s length price, it would not be liable to tax in India in respect of advertisement revenue received by it 3. Galileo International Inc. v. Dy. CIT [2008] 19 SOT 257 (Delhi - Trib.) Where assessee-non-resident company developed a global computerized airline reservation system, which was used by Indian subscriber travel agents as well, premises of Indian subscribers would amount to a fixed place of business for carrying on business of enterprise in India and assessee could be said to have established a PE within meaning of article 5(1), and exception provided in article 5(3) would not apply

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6. An enterprise shall not be deemed to have a The salient features of the Mumbai Tribunal’s permanent establishment in a Contracting State order have been set out below:– merely because it carries on business in that u No PE was said to have been constituted State through a broker, general commission since the conditions specified in article 5(2) agent or any other agent of an independent were not conclusively satisfied by DC. status, provided that such persons are acting in the ordinary course of their business and u Since DC’s business was carried out in India in their commercial and financial relations to by DCIL in the regular course of its (DCIL’s) the enterprise no conditions are agreed or imposed business as clearly specified by article 5(6), which differ from those usually agreed between no PE of DC was said to be constituted in independent persons. India

7. The fact that a company which is a resident u Further the argument that being a mere of a Contracting State controls or is controlled subsidiary did not automatically give rise by a company which is a resident of the other to a PE was clearly set out in article 5(7) Contracting State or which carries on business and since DC had satisfied the same, no in that other State (whether through a perma- PE was to be constituted in India nent establishment or otherwise), shall not of u Since mere purchase of goods from a non- itself constitute either company a permanent resident was one of the exclusions from establishment of the other.’ being a ‘business connection’ (and further The Mumbai Tribunal also cited the following bolstered by erstwhile CBDT Cir 23 of 1969 decisions in support of its conclusions: which has since been withdrawn) no part of DC’s income was liable to tax in India u DIT (International Taxation) v. Morgan Stanley & Co. [2007] 292 ITR 416/162 Taxman 165 u The relationship between DC and DCIL (SC) was taken as a principal to principal rela- tionship as borne out by the relevant facts, Motorola Inc. v. Dy. CIT [2005] 95 ITD 269 u the mere existence of the agency agree- (Delhi - Trib.) (SB) ment between DC and DCIL would not be u Kno Werx Education (India) (P.) Ltd., In re regarded as the existence of an agency PE [2008] 301 ITR 207/170 Taxman 98 (AAR in India - New Delhi) u Since there was no PE constituted in India u Western Union Financial Services Inc. v. Asstt. by DC, no part of any income was attrib- DIT [2007] 104 ITD 34 (Delhi - Trib.) utable in India and, consequently, not li- able to tax in India. Hence the order under u Speciality Magazines (P.) Ltd., In re [2005] 274 section 143(3) was set aside ITR 310/144 Taxman 153 (AAR - New Delhi) u The IT Department’s appeal was dismissed

‘Make Available’ Concept Under Indo – UK Treaty ‘Make available’ concept under some of the treaties entered by India have made the payment for ‘Fee for Technical (Included) Service’ (FITS/FTS) almost out of Indian tax net. Indo-US treaty, Indo-UK treaty, etc., are such treaties where the Indian tax department found itself helpless in taxing FITS/FTS. Recently, in the case of Real Resourcing Ltd., In re [A.A.R. No. 828 of 2009, dated March 5, 2010]/[2010] 3 taxmann.com 19 (AAR - New Delhi), the question before AAR was about taxability of receipts from referral services, where the applicant, a UK Company, would refer potential Indian clients to a third party based in India (likely

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to be another Indian-based recruitment agency) for which the payment will be received by applicant from the third party in India. It is the contention of the applicant that the payments received in respect of these services are not chargeable to tax in India as it has no permanent establishment in India and moreover, as per the India-UK Tax treaty, the provision relating to ‘fees for technical services’ is not attracted. The AAR held that taking steps to make available the experience and skill of candidates available for recruitment does not at all fall within the ambit of ‘making available the technical knowledge and experience of the service provider,’ and, hence, receipt in the nature of referral fee for rendering referral services by applicant-British Company from Indian based recruitment company cannot be subjected to tax as business profits in absence of PE in India.

FACTS OF THE CASE informations of suitable candidates for recruitment is a consultancy service and the applicant is The applicant-Real Resourcing Limited is a making available the experience and skill of the Company incorporated in United Kingdom and candidates who seek recruitment. Further as per is said to be a tax-resident of UK. It is a subsidiary the information downloaded from the internet, of S-Three Group Plc. In the application originally it appears that Real Resourcing Ltd. is having filed, the nature of services to be provided by an office at Nehru Place, New Delhi which is the applicant in India is stated to be two-fold; indicative of the presence of the permanent (i) recruitment services where the applicant would establishment of the applicant in India. But as place a candidate with an Indian company and per applicant, this office is basically a virtual receives payment for providing such service from office i.e., the applicant rent the use of the address the Indian company; (ii) referral services where and telephone numbers but it does not have the applicant would refer potential Indian clients actual office space. The applicant does not have to a third party based in India (likely to be any kind of physical presence in India and, another Indian-based recruitment agency) for which therefore, it confirms there is no PE in India. the payment will be received by applicant from the third party in India. Broadly, it is the contention THE AAR HELD IN FAVOUR OF APPLICANT of the applicant that the payments received in u Under Art.13.2 of the DTAA, royalties and respect of these services are not chargeable to fees for technical services may be taxed in tax in India as it has no permanent establishment the contracting State in which they arise in India and moreover, as per the India-UK Tax and according to the law of that State and treaty (DTAA), the provision relating to ‘fees for if the beneficial owner is a resident of the technical services’ is not attracted. Therefore, it other contracting state, the tax rate shall is submitted that while making payments to the not exceed the specified limits. applicant, the Indian clients are not obliged under law to withhold the tax at source. The applicant u Though the Commissioner, in his comments has relied on the ruling of the Authority in has attempted to bring the income in question Cushman & Wakefield(s) Pte. Ltd., In re [2008] 172 within the scope of clauses (a) & (c) of Art. Taxman 179 (AAR - New Delhi) 13.4, the Authority does not think that they have any application. The contention that On the other side, it is pointed out by the revenue the applicant will be rendering consultancy that the applicant has not furnished full facts to services which are ancillary and subsidiary establish that it has no permanent establishment to the application of a right or information in India while being engaged in recruitment of the nature described in Paragraph 3(a) related activities. Further, a stand has been taken of Art.13, is untenable. that sub-art.4(a) of Art.13 dealing with fees for technical services is attracted as the data-base u Collecting data and analyzing it and mak- maintained by the applicant for providing ing a data base for providing information

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on suitable candidates for recruitment, even carried on through a permanent establish- if they are in the nature of consultancy ment situated in India. The term ‘perma- services, cannot be considered to be ancil- nent establishment’ (PE) has been defined lary and subsidiary to the enjoyment/ap- in Art.5. On the facts stated by the appli- plication of the right or information re- cant, it cannot be said that the applicant ferred to in paragraph 3(a). Moreover, by operates through a permanent establish- giving access to the data base, it cannot be ment in India. Catering to the function of said that the information concerning in- referring the potential Indian candidates to dustrial, commercial or scientific experi- the Indian based recruitment company ence will be transmitted by the applicant without creating any commitment to re- to the recruiting agencies. If the contention cruit them does not, without anything more, of Revenue is accepted, it would amount give rise to an inference of PE. For render- to unwarranted expansion of the terms FTS ing such services, a fixed place of business and Royalties. Consideration for providing in India or dependent agent need not information concerning industrial, commercial necessarily be there. or scientific experience basically involves u The applicant has clarified that it has really the sharing of technical know-how and no office or business place in New Delhi experience which is not the case here. and that the address in New Delhi is basically u Secondly, it would be far-fetched to sug- a ‘virtual office’. Evidently, it means that gest that the ingredient of ‘making avail- the address and phone number is given so able’ technical knowledge, experience, skill, as to serve as a contact point and for some know-how or process is involved in this routine work of inconsequential nature. case. Taking steps to make available the However, as and when the applicant starts experience and skill of candidates avail- extending its referral services to India, the able for recruitment does not at all fall factual position will be notified to the Com- within the ambit of making available the missioner herein so that inquiries could be technical knowledge and experience of the made as to the role if any played by the service provider. The expression ‘make so-called office in India. At the same time, available’ has been interpreted in a num- the department is bound by the legal position ber of rulings of this Authority viz. Anapharm clarified herein and in Cushman and Inc. Intertek Testing etc. The Authority do Wakefield. not think that the criterion envisaged by u Subject to this observation, the authority is Art.13.4(a) of DTAA has been satisfied in of the view that the receipts in the nature the instant case. of referral fee from the Indian based re- u The exigibility of such referral fee in rela- cruitment company cannot be subjected to tion to the services rendered in real estate tax as business profits in view of the pro- sector was discussed by this Authority in visions of the Treaty. However, it is made the case of Cushman & Wakefield (supra), in clear that this ruling would only apply to which it was held that the ‘know how’ or referral services. As regards the proposed the technical knowledge or commercial recruitment services, no details have been experiences, etc., cannot be said to have furnished by the applicant as to the exact been ‘made available’ to the Indian com- modalities of operations. In the latest com- pany (CWI) merely by reason of customer munication of the applicant, reference has referral. been made only to referral services and not a word has been said about the recruitment u If the payments received by the applicant services, though the Department in its com- are not in the nature of royalty or FTS, then ments did point out that the details were they can be subjected to Indian income tax not forthcoming. The Authority, therefore, in terms of Art.7 of the Tax Treaty only if decline to give any ruling on this aspect. the income results from a business activity

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DTA HAVING ‘MAKE AVAILABLE CONCEPT’ UNDER FTS WITH DIFFERENT COUNTRIES Indo – USA Treaty - ARTICLE 12 - Royalties and Fees for Included Services 4. For purposes of this Article, ‘fees for included services’ means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services : (a) are ancillary and subsidiary to the application or enjoyment of the right, property or infor- mation for which a payment described in paragraph 3 is received ; or (b) make available technical knowledge, experience, skill, know-how, or processes, or consist of the de- velopment and transfer of a technical plan or technical design. Indo – Netherlands Treaty - Article 12 - Royalties and Fees for Technical Services 5. For purposes of this Article, ‘fees for technical services’ means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services : (a) are ancillary and subsidiary to the application or enjoyment of the right, property or infor- mation for which a payment described in paragraph 4 of this Article is received; or (b) make available technical knowledge, experience, skill, know-how or processes, or consist of the devel- opment and transfer of a technical plan or technical design. Indo – UK Treaty - Article 13 -Royalties and fees for technical services 4. For the purposes of paragraph 2 of this Article, and subject to paragraph 5, of this Article, the term ‘fees for technical services’ means payments of any kind of any person in consideration for the rendering of any technical or consultancy services (including the provision of services of a technical or other personnel) which : (a) are ancillary and subsidiary to the application or enjoyment of the right, property or infor- mation for which a payment described in paragraph 3(a) of this article is received ; or (b) are ancillary and subsidiary to the enjoyment of the property for which a payment described in paragraph 3(b) of this Article is received ; or (c) make available technical knowledge, experience, skill know-how or processes, or consist of the devel- opment and transfer of a technical plan or technical design. Indo – Singapore Treaty - Article 12 - Royalties and Fees for Technical Services 4. The term ‘fees for technical services’ as used in this Article means payments of any kind to any person in consideration for services of a managerial, technical or consultancy nature (including the provision of such services through technical or other personnel) if such services : (a) are ancillary and subsidiary to the application or enjoyment of the right, property or infor- mation for which a payment described in paragraph 3 is received ; or (b) make available technical knowledge, experience, skill, know-how or processes, which enables the person acquiring the services to apply the technology contained therein ; or (c) consist of the development and transfer of a technical plan or technical design, but excludes any service that does not enable the person acquiring the service to apply the technology contained therein.

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For the purposes of (b) and (c) above, the person acquiring the service shall be deemed to include an agent, nominee, or transferee of such person. Indo – Canada Treaty - Article 12 - Royalties and Fees for Included Services 4. For the purposes of this Article, ‘fees for included services’ means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services : (a) are ancillary and subsidiary to the application or enjoyment of the right, property or infor- mation for which a payment described in paragraph 3 is received; or (b) make available technical knowledge, experience, skill, know-how, or processes or consist of the development and transfer of a technical plan or technical design.

‘Make Available’ Concept Under Indo – US Treaty The ruling tendered by the Authority for Advance Rulings at the end of 2009 [Federation of Indian Chambers of Commerce and Industry (FICCI), In re [2010] 189 Taxman 270 (AAR - New Delhi)] deals with a lot of important issues in relation to taxability of Fees for Technical Services (‘FTS’) within the narrow confines of applicability under the India U S Double Tax Avoidance Agreement (‘DTAA’). Under the DTAA FTS is taxable only if it satisfies the ‘make available’ clause under Article 12 of the DTAA. The ruling also throws some light on certain other aspects as to what constitutes ‘teaching’ by an educational institution and consequently falls under the exclusionary clause of FTS under the DTAA and taxability of a Non profit Organization. Very similar issues were also decided before the AAR in an earlier advance ruling No. 811 of 2009 where the applicant was also FICCI and both these rulings,i.e. 811 and 812 of 2009 need to be examined together to analyze the course of law and the ratios of the AAR’s orders which is done in the paragraphs to follow.

FACTS OF THE CASE payments to UT on account of technology assessment services and travel of UT personnel FICCI, a section 25 ( not for profit)Indian company to India for a commercialization and entrepreneurial received contractual confirmation from Indo US workshop. Some payments would be made directly Science and Technology Forum (‘IUSSTF’)to assist to UT by Lockheed Martin in USA. The project it in administering the DST Lockheed Martin parameters are similar to those which were India Innovation Growth Programme 2009(‘IIGP’) performed by FICCI by UT earlier ( referred to jointly with IUSSTF and the University of in AAR 211 of 2009) and comprising of four Texas(‘UT’). IIGP would have two major components; i.e. programme components but the question before the AAR concerns only the India Innovation u Technology Assessment Growth Programme component as the other is u Training not relevant. FICCI would perform some part of the services and take the assistance of the University u Programme management of Texas (‘UT’) based in USA to perform certain u Business Development services for which FICCI would have to make

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DECIDED CASES ON ‘MAKE AVAILABLE CONCEPT’ UNDER FTS WITH DIFFERENT COUNTRIES 1. Invensys Systems Inc., In re [2009] 183 Taxman 81/317 ITR 438 (AAR - New Delhi) Where applicant-company, engaged in business of manufacture of process control instruments, engineering and research and technology-based services, had entered into an agreement with its Indian group company ‘I’ for providing certain centralised assistance to it services provided were managerial in nature and, even if they were treated as of technical nature, they did not make available technical knowledge, etc., within meaning of article 12.4(b) of DTAA with USA, payments made by recipient-company ‘I’ to applicant towards costs allocated by applicant were not liable to be taxed in India 2. McKinsey & Co., Inc. (Philippines) v. Asstt. DIT [2006] 6 SOT 186/99 ITD 549 (Mum. - Trib.) (SMC) In order to attract taxability of an income under article 12(4)(b) of DTAA with USA, not only payment should be in consideration for rendering of technical or consultancy services, but in addition to payment being consideration for rendering of technical services, services so rendered should also be such that ‘make available’ technical knowledge, experience, skill, know-how, or processes, or consist of development and transfer of a technical plan or technical design; generally speaking, technology would be considered ‘made available’ when person acquiring service is enabled to apply ‘technology’ 3. Dy. DIT (International Taxation) v. Scientific Atlanta Inc. [2009] 33 SOT 220 (Mum. - Trib.) Making available technical knowledge, experience or skill to recipient is of paramount importance for including consideration paid for it, as fees for included services (FIS) under article 12 of DTAA with USA 4. Anapharm Inc., In re [2008] 174 Taxman 124/305 ITR 394 (AAR - New Delhi) For considering a payment of consideration as ‘fees for technical/included services’ in terms of article 12(4)(b) of DTAA with Canada, mere provision of technical services is not enough; it additionally requires that service provider should also make its technical knowledge, experience, skill, know-how, etc., known to recipient of service so as to equip it to independently perform technical function itself in future without help of service provider 5. Mahindra & Mahindra Ltd. v. Dy. CIT [2009] 30 SOT 374 (Mum. - Trib.) (SB) Fees for technical services under section 9(1)(vii), read with Explanation 2, covers management commission and selling commission allowed to the non-resident in respect of the GDR issue. Underwriting commission does not fall within the definition of ‘fees for technical services’ under section 9(1)(vii). Reimbursement of expenses does not have the income element and, hence, cannot assume the character of income deemed to accrue or arise in India. Where the technical services were not made available to the Indian party though used by the non-resident for its benefit, the amount of management and selling commission could not be held to be taxable as per the DTAA with UK. 6. ITO v. De Beers India Minerals (P.) Ltd. [2008] 115 ITD 191 (Bang. - Trib.) Where assessee was a private company engaged in business of prospecting and mining for diamonds and other minerals and it engaged a party to conduct airborne survey for providing high quality, high resolution, geophysical data suitable for selecting probable kimberlite targets, payment made by it to such party was not ‘fees for technical services’ and did not fall within ken of article 12(5)(b) of DTAA between India and Netherlands, for the reason that such party had not made available technical knowledge, experience, skill, know-how or process to assessee while providing service.

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In addition to the above, screening and programme u Whether the provisions of section 195 en- conduct in India would also be done. Thus, the visaging Withholding Tax (‘WHT’) on set up in brief involves five entities Deptt. of payments made by FICCI to UT will be Science and Technology (‘DST’), Lockheed Martin triggered ? (‘LM’),IUSSTF, UT and FICCI ( the applicant for u If tax is payable by UT and as a conse- this ruling and the one preceding it; viz.; 811 of quence WHT provisions are triggered, what 2009). UT is a non-profit organization registered are the amounts which are taxable and also under the laws of USA (and applicable Texas liable to WHT ? state law) and is not subject to federal and state taxes in the USA. AAR held in the favour of Applicant

Under the Income-tax Act, 1961 (‘Act’), fees for u UT was held to be a resident of the USA managerial, technical or consultancy services are under Article 4 of the DTAA and clearly taxable as FTS, while under the DTAA taxability ‘liable to tax’ in USA, and was not eligible of FTS is restricted by the ‘make available’ clause for the exempt status granted under the and, therefore, only Fees for Included Services(‘FIS’) taxing statute. Further, UT was also liable falls within the ambit of chargeability to tax . to tax in respect of its unrelated ( to education) Article 12 of the DTAA also contains an exclusionary business income and had to undertake clause which exempts even FIS from tax if they statutory compliances like filing tax returns. are provided for teaching within or by an Therefore, it cannot be said that UT has a educational institution general immunity from taxation under the laws of USA . This conclusion was facili- REVENUE’s SUBMISSIONS tated in AAR 211 of 2009 by a filing of a The Income-tax department in its representations certificate of ‘Statement of Federal Status’ under AAR 811 of 2009 had contended that the of UT by FICCI before the AAR DTAA only covered persons resident in the USA u UT was, therefore, held as eligible to claim and also subject to tax in the USA. Since UT was DTAA benefits and, as a consequence, would not subject to tax in the USA, it was not entitled be governed by the definition of ‘FIS’ under to claim benefit under the DTAA. Similar article 12 rather than FTS under the Act in contentions were raised in this matter. (This is respect of sums received by it a very technical contention and may be regarded somewhat similar to the controversy between ‘liable u Since education was not the predominant to tax ‘ and ‘subject to tax’ under the old India UAE purpose of the services provided and only DTAA). an incidental and ancillary part thereof, as decided in AAR 211 of 2009 and also It further contended that the sums paid to UT applicable here,UT would not be eligible to by FICCI were clearly on account of FIS since avail of the exemption accorded to teach- they ‘made available’ services to FICCI through ing by an educational institution, under Quicklook Reports submitted, (both under the Article 12 of the DTAA exempting taxabil- resent ruling as well as under 811 of 2009) ity under the ambit of FIS (The AAR cited ISSUES FOR CONSIDERATION BEFORE THE example 10 of the protocol of the DTAA AAR as support for this conclusion)

The following Issues were deliberated upon and u The fees received by UT did not come under considered by the AAR the ambit of taxability under FIS since mere provision of services was not sufficient and UT being a tax exempt entity in the USA u some technical know-how, skill or exper- is eligible to claim benefits of the DTAA tise was needed to be made available to u Payments by FICCI to UT are taxable in the recipient of services. This was clearly India as FIS from the DTAA/Act perspec- not the case. tive

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This ruling along with its predecessor AAR 811 of 2009 reinforces the existing body of jurisprudence on the subject and sheds light on the following issues

u Further clarifying the concept of FIS and ‘make available’ under article 12 of the DTAA

u Eligibility for DTAA benefits and taxability of a non-profit organization in the USA under article 4 of the DTAA

u The parameters for qualifying (or disqualifying) an entity under the exemption available for teaching/training by or in an educational institution under the FIS requirement

u Viewing the services holistically (in this case the entrepreneurial development programme as a part of total services) where they are not severable and the payment made is consolidated and not apportionable to the individual services

u No liability to WHT where such payments are not taxable under the DTAA (This is another nail in the coffin of the Karnataka HC decision of CIT v. Samsung Electronics Co. Ltd. [2009] 185 Taxman 313 on section 195, though indirectly since taxability of royalty and FTS are generally handmaidens of each other in the question of taxability) Though this decision is an AAR and, hence, suffers from the usual infirmity of AARs (in respect of being binding only on the IT deptt. and the applicant for the transaction contemplated), it certainly has a great deal of persuasive value and is a beacon of constancy in the dark and obfuscatory maze of tax jurisprudence in relation to taxability of FTS, Royalty and attendant WHT compliances.

u The training provided by UT to FICCI was u The additional feature in the issues raised held as incidental to the provision of ser- before the AAR in the present case vis-a- vices and was not of a nature so as to vis AAR 811 of 2009 was the Entrepreneur- enable the recipient to render similar ser- ial Development Programme. The AAR did vices to others. Even if this were the case, not specifically rule on the taxability of the AAR further ruled that since there was payments in relation to this programme no consideration separately apportioned but concurred that since the programme towards training, a holistic view of the was of short duration and was an integral services in toto would prevail and these part of the compendium of services ren- were clearly not within the ambit of FIS. dered, it would also not be treated sepa- rately from the other services and held the u Technical assessment done by UTs not within payments for the services as an integral FIS and even the Quicklook report does whole was not taxable as FIS under the not enable FICCI to be capable of render- DTAA. ing similar technical assessment services to others and, hence, out of the ‘make avail- u Since all the payments made by FICCI to able ‘ requirement for taxing the sums received UT were not taxable either under the DTAA as FIS. or the Act, FICCI was not required to effect any Withholding Tax (‘WHT’) or related u Business Development and Programme man- compliances in respect of these payments agement were clearly out of the purview as prescribed under section 195. of FIS and, therefore, not taxable.

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Section 44BB v. Section 44DA Recently, in the case of Geofizyka Torun Sp.zo.o, In re [2010] 186 Taxman 213 (AAR - New Delhi), the AAR, after discussing exhaustively the scope of section 44BB vis-a-vis section 44DA, gave the ruling that the profits derived by a non- resident from business of providing services in connection with prospecting for or extraction or production of mineral oil are squarely and exclusively governed by section 44BB, irrespective of nature of services, provided services are intimately connected to prospecting and exploration of oil. This ruling was followed by AAR in its other rulings as well. In the case of Wavefield Inseis ASA, In re [2010] 187 Taxman 62 (AAR - New Delhi) also, AAR followed its ruling given in the case of Geofizyka Torun Sp.zo.o (supra). Again in the case of same assessee, Wavefield Inseis ASA, In re [A.A.R. No.844 of 2009, dated March 5, 2010]/[2010] 3 taxmann.com 21 (AAR - New Delhi) also, the AAR followed its earlier ruling and held in favour of applicant. But these rulings of AAR have not gone well with the revenue department. Perhaps the intention of the revenue was otherwise. Under the Finance Act, 2010, both the sections, i.e., section 44BB and section 44DA, have been amended so as to exclude the applicability of section 44BB to the income which is covered under section 44DA. Similarly, section 44DA is also amended to provide that provisions of section 44BB shall not apply to the income covered under section 44DA., w.e.f. assessment year 2011-12 and subsequent years.

Introduction the AAR, after discussing exhaustively the scope of section 44BB vis-a-vis section 44DA, gave the Where there is a special provision specifically ruling that the profits derived by a non-resident dealing with a subject, a general provision, from business of providing services in connection howsoever widely worded, must yield to the former. with prospecting for or extraction or production This principle is expressed in the maxim Generalia of mineral oil are squarely and exclusively governed specialibus non derogant. The aforesaid rule of by section 44BB, irrespective of nature of services, construction was applied in various decisions. provided services are intimately connected to But sometimes it is very difficult to judge which prospecting and exploration of oil. In this case provision is special and which provision is general. the applicant, a foreign company, is providing While section 44BB deals with special provision geophysical services to international oil and gas for computing profits and gains in connection industry. It conducts seismic surveys and provides with the business of exploration, etc., of mineral onshore seismic data and other associated services oils, section 44DA deals with special provision such as processing and interpretation of such for computing income by way of royalties, etc., data to global oil companies. Such services are in case of non-residents. Should one treat section aimed at ensuring success at exploration of its 44DA as special section for computing income customers and assisting them in maximizing relating to royalty from every source and treat production from their existing reservoirs. It has section 44BB, as general section for computing been providing aforesaid services to various oil income from business of exploration, etc.? Or and gas exploration and production companies should one treat section 44BB, as special section in India. So the question before AAR was whether for computing income from business of exploration, income derived by applicant in India has to be etc., including royalty income and 44DA as general computed under provisions of section 44BB? The section for computing income relating to royalty AAR held that there is no compelling reason to which is not covered by other provisions. assign a narrow and restricted meaning to the Recently, in the case of Geofizyka Torun Sp.zo.o, expression ‘services’ employed in section 44BB In re [2010] 186 Taxman 213 (AAR - New Delhi), as contended by the revenue and confine it to

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 107 95 LANDMARK RULINGS the services other than technical, consultancy or Under the existing provisions contained in managerial services. In the absence of any words section 44BB(1) of the Income-tax Act, income of limitation or exclusion, the word ‘services’ of a non-resident taxpayer who is engaged shall be understood in its plain and ordinary in the business of providing services or sense and the income derived by applicant in facilities in connection with, or supplying India has to be computed under provisions of plant and machinery on hire used, or to be section 44BB. As per AAR - section 44BB, inserted used, in the prospecting for, or extraction into the Act with effect from 1-4-2004, is a special, or production of, mineral oils is computed specific and exclusive provision dealing with the at ten per cent of the aggregate of the computation of profits of the non-resident assessees amounts paid. Section 44DA provides the engaged in the business of providing services in procedure for computing income of a non- connection with or supplying plant and machinery resident, including a foreign company, by on hire to be used ‘in the prospecting for, or way of royalty or fee for technical services, extraction or production of mineral oils’. It is in in case the right, property or contract giving the company of three other sections, viz., sections rise to such income are effectively con- 44B, 44BB, 44BA and 44BBA specially providing nected with the permanent establishment for computation of profits of the non-residents/ of the said non-resident. This income is foreign companies engaged in the specified types computed as per the books of account of business. As per AAR, there is nothing in maintained by the assessee. section 44DA which has the effect of superseding Section 115A provides the rate of taxation or overriding section 44BB. Both these provisions in respect of income of a non-resident, in- should be harmoniously read. If so read, the cluding a foreign company, in the nature profits derived from business of providing services of royalty or fee for technical services, other in connection with the prospecting for or extraction than the income referred to in section 44DA or production of mineral oils are squarely and i.e., income in the nature of royalty and fee exclusively governed by section 44BB, irrespective for technical services which is not connected of the nature of services, provided the services with the permanent establishment of the are intimately connected to prospecting and non-resident. exploration of oil. Combined effect of the provisions of sec- This ruling was followed by AAR in its other tions 44BB, 44DA and 115A is that if the rulings as well. In the case of Wavefield Inseis income of a non-resident is in the nature ASA, In re [2010] 187 Taxman 62 (AAR - New of fee for technical services, it shall be Delhi), also AAR followed its ruling given in the taxable under the provisions of either sec- case of Geofizyka Torun Sp.zo.o (supra). Again in tion 44DA or section 115A irrespective of the case of same assessee, Wavefield Inseis ASA, the business to which it relates. Section In re A.A.R. No. 844 of 2009 March 5, 2010 also, 44BB applies only in a case where consid- the AAR followed its earlier ruling and held in eration is for services and other facilities favour of applicant. relating to exploration activity which are But these rulings of AAR not gone well with the not in the nature of technical services. revenue department. Perhaps the intention of However, owing to judicial pronouncements, the revenue was otherwise. Under the Finance doubts have been raised regarding the scope Act, 2010, both the sections, i.e., section 44BB of section 44BB vis-à-vis section 44DA as to and 44DA have been amended. The clarification whether fee for technical services relating given for such amendments is given herein below: to the exploration sector would also be covered under the presumptive taxation ‘Income of a non-resident providing ser- provisions of section 44BB. vices or facilities in connection with pros- pecting for, or extraction or production of, In order to remove doubts and clarify the mineral oil distinct scheme of taxation of income by way of fee for technical services, it is proposed

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to amend the proviso to section 44BB so The applicant has stated that it filed an application as to exclude the applicability of section under section 195 requesting for a withholding 44BB to the income which is covered under tax order @ 4.223% on the basis that the services section 44DA. Similarly, section 44DA is rendered by PF Thor fall within the scope of also proposed to be amended to provide section 44BB and, accordingly, the income that provisions of section 44BB shall not chargeable to tax has to be computed as per that apply to the income covered under section section. The Assessing Officer, without setting 44DA. These amendments are proposed to out any reasons, passed a withholding tax order take effect from 1st April 2011 and will, according to which the applicant has to deduct accordingly, apply in relation to the assess- tax at source at the rate of 10.56% on gross basis. ment year 2011-12 and subsequent years. Hence, this application. FACTS OF THE CASE THE AUTHORITY HELD IN FAVOUR OF APPLICANT In this case the applicant is a marine geophysical company that conducts seismic survey and provides u The facts of the present case and the questions offshore seismic data acquisition and other raised are identical to those in an earlier associated services to global oil companies. The application filed by the same applicant in applicant has stated, it is beyond doubt, that for AAR/823/2009 [Wavefield Inseis ASA, In re any oil and gas activity, seismic survey is the [2010] 187 Taxman 62 (AAR - New Delhi)] first step and a very critical part of the activity. The only difference is that the vessel cov- Seismic data acquisition and processing activities u ered by the time charter was a chase vessel carried on by the applicant increases exploration whereas in the present case it is a seismic success and reduces the risk of exploration drilling. vessel. The discussion and reasoning in the Hence, it is the case of the applicant that seismic above ruling squarely governs the present survey and related services is an integral part case. The Authority is, therefore, relieved of the exploration/prospecting activities for mineral of the need to discuss the merits once again. oil (petroleum and natural gas) and, therefore, they fall under the ambit of section 44BB and u It was held in that case that the second the income has to be computed in accordance limb of section 44BB was clearly attracted with that provision. for the reason that the ‘plant and machin- ery’ which includes a ship or vessel has The applicant was awarded a three year contract been supplied on hire for being used in the by ONGC for 3D Seismic data acquisition and prospecting operation. Following the rul- onboard processing Offshore India during field ing in the above case, it is not in dispute season 2008-09, 2009-10 and 2010-11. For the that as per section 44BB read with Part II purpose of executing the contract with ONGC, of the First Schedule to the Income-tax Act, the applicant has entered into a global Time the effective rate at which the tax has to Charter Agreement with Geo Subsea Pte Ltd., be withheld from the payments made by a company incorporated in Singapore, for the the applicant to P.F. Thor would be 4.223%. provision of seismic vessel. It is stated that the No answer is called for as the contentions vessel was, subsequently, transferred to Master were confined to the provisions of the Income- & Commander AS, a company incorporated in tax Act, 1961 but not DTAA. Once section Norway, and as a result of this, an addendum 44BB is attracted, it is common ground that to the original agreement was entered into between the computation has to be made in accor- Wavefield and M&C. As per time charter dance with that provision and no other arrangement, the operation and navigation of special provision, viz., section 44DA or section the vessel is by the personnel of M&C. A copy 115A would come into play in view of the of the Time Charter Agreement has been filed. fact that the payment is being made by a non-resident to another non-resident.

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Beneficial Ownership Concept in Treaty Interpretation In a recent ruling in the case of KSPG Netherlands Holding B.V., In re [2010] 189 Taxman 357 (AAR - New Delhi), the AAR held that dividends received by applicant, a Netherland holding company, would not be taxable in its hands under the Act, as under section 115-O, an Indian subsidiary company would be liable to pay tax on the distribution of profits by way of dividends to the applicant @ 15 per cent. Applicant would also not be liable to pay tax in India on capital gains that may accrue to it from transfer of shares in Indian company to another non-resident as per provisions of article 13 of Indo-Netherland Treaty. The Authority rejected the revenue’s argument that the gains accruing to the applicant by the transfer of shares held in the Indian company will not enure to the benefit of the applicant or will not enter into the profit and loss account of the applicant but the gains will be just passed on to the ultimate holding company (i.e., German company), dictated by its mandate. In relation to question of liability to pay tax in India on the capital gains that may accrue to applicant-company from a buy-back of shares by its wholly owned Indian subsidiary, as per the provisions of the Act, the Authority declined to answer it as the transaction of buy-back of shares as and when it takes place, would be an altogether different transaction.

FACTS OF THE CASE pay tax in India on the capital gains that may accrue from a buy back of shares by its wholly The applicant is a company incorporated in the owned Indian subsidiary, PG India as per the Netherlands. In November, 2008, it purchased provisions of the Act. the entire shareholding in an Indian company, PG India from a German company for a valuable AAR HELD IN FAVOUR OF APPLICANT consideration of Rs. 10 crores and, consequently, u As regards dividend, as contended by the it became 100 per cent shareholder and the holding applicant, under section 115-O, PG India company of PG India. It made substantial would be liable to pay tax on the distri- investments in PG India. It expects to receive bution of profits by way of dividends to income in the form of dividends declared and the applicant @ 15 per cent. However, such distributed by PG India. It may also realize dividends received by the applicant (share- capital gains through a sale of a portion or all holder of PG India) would not be taxable of its shares in PG India to another non-resident in its hands under the IT Act. This legal company. PG India may also consider a buy- position admits of no doubt and, in fact, back of its shares by the applicant. Consequent it has not been disputed by the revenue in to the buy-back, PG India would continue to its comments. be the wholly owned subsidiary of the applicant. On these facts, the applicant has sought advance u As regards capital gains on transfer of shares ruling on the questions : (i) whether it would to other non-resident, the applicant seeks be liable to tax pay in India on the dividends to invoke para 5 of article 13 of the India- received by it from its wholly owned subsidiary; Netherlands Treaty in support of its con- (ii) whether it would be liable to pay tax in tention that capital gains tax cannot be India on the capital gains that may accrue to levied and collected by the Indian Tax it from the transfer of shares in PG India to authorities under the Act. It is beyond dispute another non-resident as per the provisions of that the applicant is a resident of the the DTAA between India and Netherlands; and Netherlands within the meaning of 4(i) of (iii) whether the transferor would be liable to the Treaty. The applicant is entitled to invoke

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E*Trade Mauritius Ltd., In re A.A.R. No. 826 of 2009, dated March 22, 2010 Question for consideration: Whether sale of shares of Indian Co. by Mauritius Subsidiary Co. of US company to other Mauritius Co. is taxable in India as per article 13(4) of the Indo–Mauritius Tax Treaty? Applicant’s Submissions: Under Article 13(4) of the India-Mauritius Tax Treaty, such gains were not chargeable to tax in India. Revenue’s Submissions: Though the legal ownership ostensibly resides with the applicant, yet the real and beneficial owner of the capital gains is the US company which controls the applicant and the applicant-company is merely a façade made use of by the US holding company to avoid capital gains tax in India. The DIT has taken a prima facie view that the capital gains are taxable in the hands of the US entity. AAR’s Ruling: The AAR held that there is no ‘legal taboo’ against ‘treaty shopping’ and beneficial ownership concept is not relevant for taxation of capital gain under Indo–Mauritian Tax Treaty (Heavily relied on Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706/132 Taxman 373 (SC) and two Circulars of CBDT [Circular No. 682, dated 30th March, 1994 and Circular No.789, dated 13th April, 2000]

the benefit of the provisions in the Treaty can be taxed in India. It is submitted on notwithstanding the provisions of the In- behalf of the revenue that Kolbenschundt come-tax Act, 1961 on the same subject. Pierburg AG is the ultimate holding com- Section 90(2) of the IT Act recognizes this pany of the Indian company and it is that principle. It lays down that in relation to company which has beneficial ownership the assessee to whom the Agreement (Treaty) in the shares of the Indian company sought applies, the provisions of the Act shall apply to be transferred. The revenue further avers to the extent they are more beneficial to that till November 2008, Pierburg GMBH the assessee. (German Company) was the immediate holding company, but, the applicant (Neth- u The opening sentence of para 5 of Art.13 erlands Company) incorporated on 6th mandates that the gains from the alien- November, 2008 became the immediate ation of any property (other than that referred holding company of the Indian company. to in the following paragraphs of the rel- In this background, it is alleged by the evant article) are liable to be taxed only in revenue that ‘the interpolation of the the State of which the alienator is a resi- Netherlands’ Company as recently as 6th dent. Property in the form of shares is not November, 2008 is a part of the scheme for excluded from the purview of the above the avoidance of liability to tax on capital opening provision in para 5. That being the gains’. position, the Govternment of India is pre- cluded from subjecting to tax the gains on u The Authority finds it difficult to accept account of transfer of shares of the Indian the contention of the revenue. Assuming company to a non-resident. This clear legal that the concept of beneficial ownership position is not in dispute. However, the which finds specific mention in Articles 10 revenue contends that ‘the beneficial owner to 12 of the Treaty (relating to dividends, of capital gains arising out of the transac- interest, royalty and FTS), can be trans- tions, if and when undertaken, would be posed into Art.13, the Authority finds no the German company’ and, accordingly, the factual or legal basis to hold that the German provisions of the India-Germany DTAA would company is the real beneficial owner of the be applicable in which case the capital gains shares and the capital gains that would

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accrue. The transferor, i.e., the Netherlands absence of details such as the number of company though a subsidiary of the afore- shares, the consideration and the name of mentioned Germany Company, yet is a the non-resident transferee, this Authority distinct legal entity having its own board shall desist from giving a ruling on the of directors and management systems. The legal issue. Not much turns out from these glaring fact which is to be taken note of details. However, the Authority would like in this context is that the applicant which to observe that at the time of transfer, the was incorporated towards the end of 2008 applicant shall furnish information to the made significant investments in the Indian Department. Of course, the revenue is bound company. It is stated that from September by this ruling and observations made herein 2009 onwards, it invested nearly 17 million in making any inquiry at that stage. Hence, Euros (110 crores) in Pierburg India. It is the applicant is not liable to pay the tax seen from the facts stated by the applicant on capital gains by virtue of the opening that the applicant had initially acquired sentence of Art.13.5 of the Treaty. the shares of the Indian company from u As regards capital gains on buy-back of Pierburg GMBH at a price determined as shares by Indian company, the applicant per the evaluation guidelines prescribed relies on section 47(iv)(b) of the IT Act and under the Foreign Exchange Management submits that the transfer of capital assets Act, 2000. The substantial investments it by a company to its subsidiary would not has made was with a view to broaden the be regarded as a transfer for the purposes capital base of the Indian company, as stated of section 45 if the transfer is made to a by the applicant. The implied suggestion wholly owned subsidiary and the subsid- of the revenue that the applicant is a sham iary is an Indian company. It is submitted entity or a conduit company deliberately that both these conditions are satisfied and, set up to avoid the tax liability relating to therefore, the buy-back of shares of Pierburg capital gains is wholly misconceived. India which continues to be the Indian u It would be presumptuous to predicate that subsidiary of the foreign company (appli- the gains accruing to the applicant by the cant-company) will not be chargeable to transfer of shares held in the Indian com- capital gains tax under the IT Act. pany would not enure to the benefit of the u The relevant part of the definition of ‘ad- applicant or will not enter into the profit vance ruling’ contained in section 245N and loss account of the applicant or that reads thus: ‘a determination in relation to the gains will be just passed on to the the tax liability of a non-resident arising ultimate holding company (i.e. German out of a transaction which has been under- company), dictated by its mandate. It is of taken or proposed to be undertaken by a course open to the tax authorities to look non-resident’. The transaction of buy-back to the facts at the time of transfer, but, on of shares as and when it takes place, would principle and in the light of the facts stated be an altogether different transaction from and substantiated in this application, the the transfer of shares embraced within Ques- Authority cannot reach the conclusion that tion No. 2. The transferee will be PG India, the beneficial ownership in the gains re- whereas in the transaction falling under sulting from the transfer of shares is vested Question No. 2, the transferee is a non- with the ultimate holding company, i.e., resident entity. The buy-back is within the the German company. volition and decision of PG India which is u In the comments furnished on behalf of the not the case in regard to Question No.2. revenue, it is pointed out that no details Moreover, the buy-back of shares is not are available now and, therefore, the ques- something which is integrally connected tion cannot be adjudicated at this stage. with the first transaction resulting from the The Authority does not think that in the investments it made in the Indian com-

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pany. The Authority is of the view that the made and to be made by the applicant and applicant has to make a separate applica- the question cannot be characterized a hy- tion at the appropriate time. It would not pothetical one. The Authority says so, es- be proper and appropriate to give an advance pecially for the reason that the expression ruling on this question in this application. ‘arising out of’ a transaction is wide in its scope and can reasonably encompass the u The revenue has raised the contention that disposal of shares as it cannot be isolated the contemplated transfer is neither a pro- and dissociated from the applicant’s stake posed transaction much less a transaction in India having regard to substantial in- already undertaken, the Authority finds no vestments it made. force in such argument. The Authority agrees with the applicant’s submission that it is closely linked to the investments already Transfer Pricing – Comparables When the same commodity in the same market is not sold by the seller at same price to two different customers, how the prices of product can be same in two different countries. In a recent case before the Mumbai Bench of Tribunal [Intervet India Pvt. Ltd. v. Asstt. CIT (ITA No. 2845 of 2006, dated March 31, 2010)/ [2010] 3 taxmann.com 101 (Mum. - ITAT)], the question was whether the sale price of USD 3.66 per unit charge to independent enterprise situated in Vietnam, can be used as CUP for the actual sale price USD 1.17 per unit, charged to associated enterprise situated in Thailand? The Tribunal held: How can the sale prices to wholesale agents in two different countries be comparable, when the sale price to the final user in the one country is less than the sale price to the whole-sale agent in another country, unless adjustment for the same has been considered. Thus, as per Tribunal, the adjustments merely for volume offtake, credit period and credit risk done by the TPO were though material, yet were not sufficient to make the sale price to AE in Thailand comparable with the sale to unrelated party in Vietnam and set aside the case to the file of the Ld. CIT(A) for deciding the matter afresh.

INTRODUCTION discussed the ‘Formulary Approach’ in transfer pricing. Is that the solution? It is established fact that from a financial perspective transfer pricing is probably the most important In a recent case before the Mumbai Bench of international tax issue in the World and it is also Tribunal, the question was whether the sale price the established fact that there is no easy solution of USD 3.66 per unit charge to independent of this problem because the issue is very fact enterprise situated in Vietnam, can be used as sensitive. When the same commodity in the same CUP for the actual sale price USD 1.17 per unit, market is not sold by the seller at same price charged to associated enterprise situated in Thailand to two different customers, how the prices of after minimal adjustment? The Tribunal held: product can be same in two different countries. how can the sale prices to wholesale agents in Price of many vegetables is twice to thrice in two different countries be comparable, when the retail market as compared to wholesale market sale price to the final user in the one country in Delhi. But what is the solution? In the previous is less than the sale price to the whole-sale agent issue of this magazine, Mr. T.P. Ostwal has in another country, unless adjustment for the

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 113 101 LANDMARK RULINGS same has been considered. Thus, as per the Tribunal, parties and took the per Ampoule Unit price the adjustments merely for volume offtake, credit charged to unrelated parties of USD 3.66, as the period and credit risk done by the TPO were Arm’s Length Rate, subject to adjustments, as though material, yet were not sufficient to make provided in Rule 10B(1)(a)(ii). Considering this, the sale price to AE in Thailand comparable the Arm’s Length Rate, for per unit of the medicine with the sale to unrelated party in Vietnam and was computed at USD 3.092 per Unit as per Rule set aside the case to the file of the Ld. CIT(A) 10B(1)(a) of the I. T. Rules, 1962. Due to this, for deciding the matter afresh. What will be an upward adjustment of Rs. 2,717,821 was required sufficient is again a question which may again to be made to the income of the assessee. On surface before the Tribunal? It is not the number the basis of the TPO’s report, the Assessing Officer of adjustments but the amount of adjustment had added a sum of Rs. 2,717,821 as adjustments which is relevant to fill such a wide gap between on account of transfer pricing between Associated the two prices? Enterprises. FACTS OF THE CASE ASSESSEE GOT PARTIAL RELIEF FROM CIT (A) M/s. Intervet India, the assessee, was the wholly After considering the various submissions, the owned subsidiary of Intervet Holdings B.V. Ld. CIT(A) held that the TNMM is the residual Netherlands. Company belongs to Intervet Group method and thus is to be adopted only if the Head quartered in Netherlands. The entities under other direct methods provided in section 92C(1) the Intervet Group were part of the Akzo Nobal of the Act are found not applicable. There existed Group a multinational group with headquarters an internal comparable inasmuch as the assessee in Netherlands. The group entities were located had sold the same product that it had sold to in Singapore, Germany, France, Bangkok, Turkey, an associate enterprise to the Vietnamese concern Austria, Indonesia and Netherlands. The raw in an uncontrolled transaction. On the other hand, material was mainly imported from Intervet the associate concern was located at Thailand. International B.V. Netherlands and Intervet Both these countries are located in Far East Asia Germany. It had exported the raw material/ and have similar demographical constitution. traded goods to group entities in France, Austria, Therefore, in the circumstances, where the product Germany and Bangkok. It imported traded/ finished in the transactions was similar and location of goods from group entities in Germany and the concerned parties was also somewhat similar, Netherlands. it would not be correct to hold that on account of differences in economic condition, volume of The company used Transactional Net Margin transaction, the material difference was such that Method by considering the operating profit margin it could not be overcome by way of adjustment as the profit level Indicator. The matter of transfer in the price charged in the uncontrolled transaction pricing in respect of transactions between associate and the ALP could not be determined in respect enterprises was referred to the Transfer pricing of the transaction with the associate enterprise. officer. The details filed indicated that, though Therefore, the claim of the assessee to change same manufactured products were exported to the appropriate method from CUP to TNMM associated enterprises and independent enterprise, was rejected. yet, these transactions were not separately analysed in the TP Report. The sale price to independent Coming to the adjustment per se made, after enterprise of USD 3.66 per unit, was 3.12 times considering the submissions of assessee, the of the sale price USD 1.17 per unit, charged to adjustment on account of volume difference in associated enterprise. Considering the various the market conditions and economic development submissions put forth by assessee, the TPO held level was held to be made at 20% as against 10% that the international transactions were comparable made by the Transfer Pricing Officer. Similarly, to the transactions entered into with unrelated the adjustment on account of credit period was held to be made at 0.6% as against 0.5% adopted

102 INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 114 LANDMARK RULINGS by the Transfer Pricing Officer. No other variation was situated) had totally different market in the adjustment made by the Transfer Pricing conditions. Thailand was dominated by Poultry, Officer was called for. Vietnam was dominated by Pigs and, hence, the needs were different. Market sizes of the two ASSESSEE’S SUBMISSIONS BEFORE THE countries were not comparable. Size of the Thailand TRIBUNAL market was large as compared to that of Vietnam. The assessee submitted that the AO and the Ld. It was also submitted that in view of some defects CIT(A) had not taken into account all the adjustment in the vaccine, it was difficult to sell it at higher factors while making adjustments in comparing price in a competitive and developed market the sale price to an AE and a third Party while like Thailand. The assessee had pointed out that adopting the CUP method. The assessee had the sale price of vaccine by the AE in Thailand submitted that Thailand (where the AE was to an unrelated customer was only USD 2.90 and situated) and Vietnam (where the unrelated party USD 3.14 which was less than the price charged

INTERVET INDIA’S CASE FACTS IN BRIEF Particulars Modern Veterinary, Intervet Thailand (AE) Vietnam (independent Party) Total Business during the period 9 million 37.7 million April 2001-March 2004-(In INR) Price charged for property transferred in a USD 3.66 per unit USD 1.17 per unit comparable Uncontrolled transaction Adjustment made by Relief given by Ld. TPO CIT(A) The adjustment on account of the difference (-) 0.3660 Adjustment increased to of Volume (10% of USD 3.66 per Unit) 20% (The assessee had asked for 50% adjustment) Adjustment on account of Credit Period (-) 0.0183 Adjustment increased to (The assessee had asked for adjustment for .6% instead of .5% given credit period at interest rate of 18%, by TPO but TPO accepted interest rate of 12%) Adjustment on account of Credit Risk (-) 0.1830 (On this account TPO considered a discount of .5% as appropriate) Total adjustment (-) 0.5673 The Adjusted Arm’s Length Rate USD 3.092 per Unit as per the Ld. CIT(A) order

Tribunal set aside the case to the file of the Ld. CIT(A) for deciding the matter afresh One of the main reasons: The sale price of vaccine by the AE in Thailand to an unrelated customer was only USD 2.90 and USD 3.14, which was less than the price charged by the assessee for its sale to the unrelated party in Vietnam

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TP - METHODS FOR DETERMINING ALP 1. Asstt. CIT v. MSS India (P.) Ltd. [2009] 32 SOT 132 (Pune) In a situation in which assessee has followed one of the standard methods of determining ALP, such a method cannot be discarded in preference over transactional profit methods, unless revenue authorities are able to demonstrate fallacies in application of standard methods; in any event, any preference of one method over other method must be justified by Transfer Pricing Officer on basis of cogent material and sound reasoning; as long as assessee has entered into raw material purchase transaction with AE at an arm’s length price, it is of no consequence whether or not assessee made sufficient profits on manufacturing products from such raw material; merely because a method of ALP determination presents complexity in approach, it cannot be discarded. 2. Aztec Software & Technology Services Ltd. v. Asstt. CIT [2007] 107 ITD 141/15 SOT 49 (URO)/ 162 Taxman 119 (Mag.)(Bang.)(SB) Transactional Net Margin Method (TNMM) [Rule 10B(1)(e)] : The TNMM requires establishing comparability at a broad functional level. It requires comparison between net margins derived from the operation of the uncontrolled parties and net margin derived by an associated enterprise on similar operation. Under this method, the net profit margin realized by an associated enterprise from an international transaction is computed in relation to a particular factor such as costs incurred, sales, assets utilized, etc. The net profit margin realized by an associated enterprise is compared with net profit margin of the uncontrolled transactions to arrive at the ALP. The TNMM is similar to RPM and CPM to the extent that it involves comparison of margin earned in a controlled situation with margins earned from comparable uncontrolled situation. The only difference is that in the RPM and CPM methods, comparison is of margins of gross profits whereas in TNMM the comparison is of margins of net profit. TNMM requires a comparison between net margins derived from the operations of the uncontrolled parties and net margins derived by an associated enterprise from similar operations. Net margin is indicated by the rate of return on sales or cost or operating assets, and this forms the basis for TNMM. A functional analysis of the tested party or the independent enterprise, as the case may be, is required to determine whether the transactions are comparable and the adjustments are required to be made to obtain reliable results. The tested party would have to consider other factors, like cost of assets of comparable companies, etc., while applying the return on assets measure. Ordinarily, the tested party has to be the party providing services because it is on the basis of rate of return on sales or cost or operating assets that transactional margin is computed. These parameters are generally available in the case of a party providing services. 3. Sony India (P.) Ltd. v. Dy. CIT [2008] 114 ITD 448 (Delhi - Trib.) While comparing controlled and uncontrolled transactions of enterprises, one has to look for differences and whether such differences are likely to affect price, cost charged or paid or profit arising from transaction in open market; it has further to be examined whether a reasonable accurate adjustment can be made to eliminate material effect of differences between transactions or entities; if a reasonable accurate adjustment for difference to eliminate material effect of differences cannot possibly be made, then such comparables (uncontrolled) are to be rejected. An entity can be taken as uncontrolled if its related party transaction does not exceed 10 to 15 per cent of total revenue. Within the above limit, transactions cannot be held to be significant to influence the profitability of comparable. For the purpose of comparison, what is to be judged is the impact of the related party transaction vis-a-vis sales and not profit since profit of an enterprise is influenced by large number of other factors. 4. UCB India (P.) Ltd. v. Asstt. CIT [2009] 30 SOT 95/121 ITD 131 (Mum. - Trib.) Where assessee, while adopting TNMM method, had compared its operating profits as a whole with overall operating profits of other comparable companies, without any adjustment, that would not satisfy requirements of evaluating an international transaction under TNMM, for purpose of arriving at arm’s length price.

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by the assessee for its sale to the unrelated party u Mere geographical contiguity of two coun- in Vietnam. These factors would show that the tries need not mean similarity in economic market condition in Thailand was totally different or market conditions. How can the sale from that prevailing in Vietnam. prices to wholesale agents in two different countries be comparable, when the sale price THE TRIBUNAL SET ASIDE THE CASE WITH to the final user in one country is less than DIRECTIONS the sale price to the whole sale agent in u It is true that when there is a sale of identical another country, unless adjustment for the product to an unrelated party, it will form same has been considered. the basis of determining the ALP in respect u Thus, the adjustments merely for volume of sales to an associated enterprise; but one offtake, credit period and credit risk, though of the essential prerequisites is that reason- material were not sufficient to make the ably accurate adjustments are to be made sale price to AE in Thailand comparable to eliminate material factors affecting price, with the sale to unrelated party in Viet- cost or the profit arising from such trans- nam. Scope of adjustments had to be widened action. But at least all material factors should and all the submissions of the assessee be considered in arriving at the adjust- regarding the disparity between the two ments. transactions should be considered and suitable u The TPO and the CIT(A) had assumed simi- adjustments made for the same. larity of markets and economic conditions u With the above directions, the issue was and had made adjustments only for the volume set aside to the file of the Ld. CIT(A) for discount, credit offered and a small adjust- deciding the matter afresh after giving a ment of credit risk. They had completely reasonable opportunity to the assessee to ignored the disparate economic and market present its case. conditions of Thailand and Vietnam and had made no adjustments for the same. Transfer Pricing – Comparables In a recent decision in the case of Global Vantedge (P.) Ltd. v. Dy. CIT [2010] 37 SOT 1 (Delhi - Trib.) CIT(A), the first appellate authority, held that where the difference between the ALP determined and value of transaction declared exceeds 5% of the ALP, no adjustment is allowable and international comparables cannot be accepted because it is difficult to compare entities in different jurisdictions. When TNMM is used as the Most Appropriate Method to determine the Arm’s Length Price, the TNMM, as the name itself suggests, evaluates profitability of transactions rather than profitability of an enterprise and transactions of different nature cannot be aggregated for the purpose of comparison under TNMM. Before the Tribunal, neither the assessee nor the revenue had been able to point out any basis or material or criteria to controvert or to rebut these findings and conclusion of first appellate authority. The Tribunal, therefore, upheld the first appellate authority’s order.

FACTS OF THE CASE Vantedge, Bermuda. The assessee was engaged in rendering IT enabled services in the field of The assessee, an Indian company, was subsidiary credit collection and telemarketing services and of Global Vantedge, Mauritius and which, in was eligible for deduction under section 10A of turn, was a wholly owned subsidiary of Global

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 117 105 LANDMARK RULINGS the Act. The RCS Centre Crop, a Delaware ASSESSEE GETS PARTIAL RELIEF FROM CIT(A) Corporation, was wholly owned subsidiary of After identifying four main issues, ld. CIT(A) Global Vantedge, Bermuda. As the assessee and held as under: RCS had the common shareholder of Global Vantedge, Bermuda, which held more than 26% u With regard to the assessee’s claim that shares (directly and indirectly), they were associated RCS was to be accepted as the tested party enterprise by virtue of provisions of section 92A(2)(b) as against the assessee, the ld. CIT(A) con- of the Act. sidered the assessee’s submission and held that international comparables cannot be RCS was engaged in the business of contracting accepted because it is difficult to compare with clients located in USA, to provide them entities in different jurisdictions since the debt collection and telemarketing services. RCS facts and circumstances are different in each did not own the requisite infrastructure or capacity geographical location. for execution of that work. The work was actually performed in India by the assessee under an u With regard to the assessee’s claim that the arrangement with RCS. The assessee and RCS ALP of the international transaction be- had entered into an agreement as per which the tween the assessee and its associated en- assessee performed the work for clients who terprise cannot exceed the total amount of entered into contract with RCS. Once a client revenue earned from clients by the asses- was identified by RCS and a contract finalizing see and RCS together, the ld. CIT(A), based the terms of services was entered into with it, on a report on the Indian BPO Industry a corresponding work order was executed by prepared by INGRES, a division of ICRA RCS with the assessee to perform that work. Ltd. in December, 2003, held that the ALP During the year 2002-03, the assessee received determined cannot exceed 98.60% of the Rs. 8,32,66,596 from RCS for clients services by revenue earned by the Global Vantedge the assessee (which was 90.6% of the revenue Group as a whole, i.e., the ALP 98.60% of earned by RCS from clients). In addition to the revenue earned by the Global Vantedge rendering services to clients of the RCS, the Group as a whole, i.e., the ALP has to be assessee was also engaged in rendering services restricted to Rs. 9,16,55,231 (Rs. 9,29,56,624 to other independent clients and during the financial X 98.6%). year 2002-03, approximately 18% of the total u With regard to the question that no tax revenue earned by the assessee was attributable benefit being obtained by the assessee through to such independent clients services by the assessee. shifting of profits, the ld. CIT(A) held that The A.O. made reference under section 92CA(1) it cannot be the only basis to accept assessee’s of the Act to the TPO for computation of Arm’s contentions in this regard. It was well un- Length Price in respect of the above transaction. derstood that one associated enterprise can The TPO after analyzing the international try to use its influence to determine the transaction, business model and the relationship transaction in a manner prejudicial to the between the assessee and associated enterprise interest of the other associated enterprise concluded that associated enterprise was not to because of several reasons. be treated a tested party. The TPO had chosen u As regards contention of the assessee that the assessee itself as the tested party and identified transaction of the assessee with indepen- 9 Indian comparables. The average operating dent clients, should not be benchmarked margin of the comparables was 11.88% as against under TNMM, the ld. CIT(A) held that the loss of 53.5% incurred by the assessee. Applying when TNMM is used as the Most Appro- the Arm’s Length Margin of 11.88% on the total priate Method to determine the Arm’s Length operating cost of Rs. 22,46,97,971, the TPO proposed Price, the TNMM, as the name itself sug- the adjustment to the extent of Rs. 14,70,10,071. gests, evaluates profitability of transactions On the basis of the TPO’s report, the A.O. made rather than profitability of an enterprise. an adjustment of Rs. 14,70,10,071 while making Transactions of different nature cannot be the assessment under section 143(3) of the Act.

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aggregated for the purpose of comparison ISSUE BEFORE TRIBUNAL under TNMM. In practice though the prof- Thus, the main grounds raised by the assessee itability of comparable entities is used to and revenue revolved around the issue regarding benchmark the international transactions the determination of the Arm’s Length Price in of taxpayers, yet, in such a scenario an respect of transactions entered into by the assessee underlying assumption overrides the analysis with the related parties. for the lack of data. Thus, while applying the TNMM to determine ALP, the revenue DELHI TRIBUNAL UPHELD CIT(A) ORDER earned by the assessee from servicing the Before the Tribunal, neither the assessee independent clients, without any involve- u nor the revenue had been able to point out ment of RCS, should not be benchmarked. any basis or material or criteria to contro- The proportionate costs (18.14%) attribut- vert or to rebut the findings and conclu- able to such revenue should be ignored sion arrived at by the ld. CIT(A), except while computing ALP of the international by relying upon their respective stand taken transactions. before the ld. CIT(A). Though the assessee u With regard to the assessee’s claim that made a specific submission about the ben- there should be an adjustment to the extent efit of adjustment of + 5% to be given of + 5% under the proviso to section 92C(2) while determining the Arm’s Length Price, of the Act, the ld. CIT(A) held that in the yet the assessee had not been able to point present case, since the difference (Rs. 83,88,635) out as to how and in what manner, the between the ALP determined (9,16,55,231) order of ld. CIT(A) in rejecting this claim and value of transaction declared of the assessee was improper and unjusti- (Rs. 83,266,596) exceeded 5% of the ALP fied. (9,16,55,231), no adjustment was allowable Since both the parties had not been able to the assessee. u to controvert the findings recorded by the

DECIDED CASES ON SCOPE OF TP PROVISIONS Coca Cola India Inc. v. Asstt. CIT [2009] 177 Taxman 103/309 ITR 194 (Punj. & Har.) There is no merit whatsoever in contention that provisions of Chapter X cannot be made applicable to parties which are subject to jurisdiction of taxing authorities in India, without there being any material to show transfer of profits outside India or evasion of tax between two parties. Aztec Software & Technology Services Ltd. v. Asstt. CIT [2007] 107 ITD 141/15 SOT 49 (URO)/ 162 Taxman 119 (Mag.) (Bang. - Trib.) (SB) Where the assessee submitted that income of the assessee being exempt under section 10A, the overpricing or under pricing of an international transaction would not affect the computation of income : Held that the assessee’s argument was without force in view of the specific provisions contained in the first proviso to section 92C(4), which clearly states that no deduction under section 10A/ 10AA or section 10B or under Chapter VI-A shall be allowed in respect of the amount of income by which the total income of the assessee is enhanced after computation of income under this section. It is abundantly clear that the Legislature, while introducing the enactment, did comprehend a situation requiring investigation and addition on account of computation of ALP in the cases where the assessee is entitled to benefit under section 10A/10AA or section 10B. In the light of specific provision, it is difficult to contend that ALP cannot be determined under section 92C or 92CA where the assessee is entitled to the benefit of sections 10A/10AA or 10B.

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ld. CIT(A) or point out any material to the point of determination of Arm’s Length enable the Tribunal to take a view other Price in respect of the transactions entered than view taken by the ld. CIT(A), the into by the assessee with its associate Tribunal upheld the order of ld. CIT(A) on enterprise, namely, RCS Centre Corp.

ADJUSTMENT OF + 5% Delhi Bench of Tribunal in the case of Sony India (P.) Ltd. v. Dy. CIT [2008] 114 ITD 448 held that the determination of arm’s length price on application of most appropriate method is only an approximation and is not a scientific evaluation; therefore, benefit of second limb of proviso to section 92C(2) [adjustment of + 5%] is available to all assessees irrespective of fact that price of international transaction disclosed by them exceeds margin provided in said provision. Similar decisions were also given by other Benches of the Tribunal. To override these decisions, the Act was amended by the Finance Act, 2009. The reason for amendment as explained in the official memorandum is given below: Determination of arm’s length price in cases of international transactions The proviso to sub-section (2) of section 92C provides that where more than one price is determined by the most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean. The above provision has been subject to conflicting interpretation by the assessee and the Income- tax Department. The assessee’s view is that the arithmetical mean should be adjusted by 5 per cent to arrive at the arm’s length price. However, the department’s contention is that if the variation between the transfer price and the arithmetical mean is more than 5 per cent of the arithmetical mean, no allowance in the arithmetical mean is required to be made. With a view to resolve this controversy, it is proposed to amend the proviso to section 92C to provide that where more than one price is determined by the most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such price. However, if the arithmetical mean, so determined, is within five per cent of the transfer price, then the transfer price shall be treated as the arm’s length price and no adjustment is required to be made. This amendment will take effect from 1st October, 2009 and shall, accordingly, apply in relation to all cases in which proceedings are pending before the Transfer Pricing Officer (TPO) on or after such date.

Chennai Special Bench Provided Further Relief on Withholding Tax Front When the person liable for payment to a non-resident has a bona fide belief that the payment is not chargeable to tax in India, the procedures prescribed under section 195 dealing with withholding tax or mitigation thereof are not necessary to be followed. The decision of Chennai Special Bench of Tribunal in the case of ITO v. Prasad Productions Ltd. [ITA. No. 663 of 2003/[2010] 3 taxmann.com 70 (Chennai - ITAT)] is a landmark decision in the often obfuscatory and confusing area of Withholding Tax (WHT) which involves the warp and weft of the strands

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of legislation under section 9 of the Act and the respective Double Tax Avoidance Agreement with India coupled with a plethora of often vacillating and conflicting decisions which often ‘turn on a dime’, so to speak. This decision and its predecessor by the Delhi High Court are like a breath of fresh air, an oasis in what was threatening to become a desert after the decision of CIT v. Samsung Electronics Co. Ltd. [2009] 185 Taxman 313 by the Karnataka High Court on the subject of WHT on payments to non-residents.

FACTS OF THE CASE in view of the importance of the matter and several conflicting decisions on the subject, chose Prasad Productions Ltd, entered into an agreement to constitute a Special Bench to hear and decide with a Canadian entity, IMAX Ltd. to purchase, the matter. install and maintain sophisticated projection equipment in its theatres. The total consideration The main question before the Special Bench of payable to IMAX Ltd. was split into two parts; the Chennai Tribunal was whether there was a one as purchase consideration for equipment mandatory obligation on the part of any payer and the second as technology transfer fees. A of sums to a non-resident to effect WHT or in notice was issued by the payer’s Assessing Officer the alternative follow the procedure for mitigation for application of WHT under section 195 of the prescribed under the provisions of section 195 Act as the payments were held to be on account of the Act, in light of the Transmission Corpn. of a variety of services mainly: of A.P. Ltd. case (supra).

u Installation charges REVENUE’S SUBMISSIONS

u Testing of equipment In its appeal and in the course of its arguments and submissions, the income-tax department raised u Training for projectionists the following contentions in support of its case: u Supervision by IMAX personnel in India u WHT was a tentative procedure and, hence, u Minor maintenance and operation of equip- the payer of any sum to a non-resident had ment in the initial stages an obligation to effect WHT (or apply under section 195 for mitigation thereof). There- The Assessing Officer, therefore, contended that fore, there was no discretion on such a WHT was liable on all the payments made and payer to decide whether WHT was appli- if WHT was sought to be mitigated in any cable or not. manner, the procedure prescribed under section 195 of the Act needed to be mandatorily followed. u The payer of any sum to a non-resident Reliance was placed by the Assessing Officer was not entitled to sit in judgment on what on the Supreme Court’s decision in Transmission amount constituted the income of the non- Corpn. of AP Ltd. v. CIT [1999] 239 ITR 587/ resident for the purposes of WHT. Such 105 Taxman 742 and an adverse order passed discretion was only vested in an Assessing under section 201 of the Act. Officer, who alone had the right to deter- mine the quantum of such income of the Prasad Productions preferred an appeal to the non-resident. [This was decided in the Trans- CIT (Appeals), who contended that the amount mission Corpn. of AP Ltd. case (supra)]. remitted was prima facie for the purchase consideration of the equipment and, hence, was u Various circulars issued by the CBDT in not liable to WHT. Hence, the order of the Assessing this regard, though beneficial to the asses- Officer under section 201 was set aside by the see and binding on the revenue could not CIT (Appeals). The Income-tax Department chose negate the provisions of section 195. In the to prefer an appeal to the Chennai Tribunal main, the circulars which were sought to against the order of the CIT (Appeals) which, be overridden were as follows:

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q Circular No. 759 of 1997, dated specify ‘income’ and as a natural conse- 18-11-1997 quence all sums payable to a non-resident had to suffer WHT or follow the prescribed q Circular No. 10 of 2002, dated procedure laid out in section 195 of the Act 9-10-2002 for mitigation. q Circular No. 4 of 2009, dated 29-6- The payer of sums to a non-resident cannot 2009 u decide about taxability of sums paid and q CBDT Instruction No. F. 5759, dated this taxability could only be decided by the 11-9-2007 payer’s Assessing Officer or a Chartered Accountant [under the alternative proce- q RBI Circular No. AP DIR03, dated dure prescribed under earlier CBDT Circu- 19-7-2007 lar No. 10/2002 and now a part of section u The wording of section 195 specifies ‘sum’ 195(6)] while section 190 and all other provisions

This special Bench decision certainly throws a lot of illumination on the Hamletian Dilemma which every payer of any sum to a non-resident faces; viz; ‘to cut . Or not to Cut, that is the question ’ It lays down certain precepts of law both on the substantative front as well as the procedural front and deftly interweaves the two into an integral fabric, which throws some guidance on WHT provisions in respect of non-resident payments. The most important ones may be summarized as follows:–

u When there is a bona fide belief in the mind of the payer that there is no element of income, embedded within the payment to a non-resident, section 195 has no applicability

u Payments whose predominant purpose is purchase consideration for equipment and also involve payments for incidental services, do not lose such character and are not liable to suffer WHT

u The procedure of the CA’s certificate [under Cir. No. 10/2002 and now section 195(6)] is a requirement under exchange control regulations and is not mandatory for the payer of a sum to non-resident to follow (However, in the practical real world scenario, no Authorized dealer will remit any sum to a non-resident, unless form 15CA is duly uploaded by the payer and a hard copy of the same accompanied by form 15CB certified by a CA is filed with the authorized dealer, prior to the remittance)

u A Special Bench of a Tribunal is not bound by the decision of a non-jurisdictional High Court (in this case the Karnataka High Court in the CIT v. Samsung Electronics Co. Ltd. [2009] 185 Taxman 313 and may consider each case on merits

u The procedure under section 195(2) of the Act or the alternative of a CA’s certificate is applicable only to determine the quantum of income (and the resultant WHT applicable). These procedures are not applicable in the event the sum itself has no chargeability to tax, i.e., there is a NIL income chargeable to tax embedded within the sum paid to the non-resident as per the bona fide belief of the payer (On a practical front, if the payer has such a bona fide belief, it must be substantiated by documentation and certain declarations and certifications by the receiver of the sum (like non-existence of a PE, sum payable on account of consideration of equipment, etc.) Nevertheless considering the ‘moving target’ character set by plethora of WHT decisions as well as the shifting quicksand of retrospective amendments and legislation, one needs to take precautions in following it and must use the same only for illumination, and not the way a drunk uses a lamppost, i.e., for total support.

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ASSESSEE AND INTERVENORS SUBMISSIONS other than that prescribed under section 195(2) u Since the wording of section 195(1) refers to “sums chargeable under the provisions u The Transmission Corpn. of AP Ltd. case of the Act” WHT would apply only if such (supra) was decided by the Apex Court sums were chargeable under the charging much prior to the date of the CBDT Cir- section 4(2) of the Act. In case such sums cular No. 10/2002 prescribing alternative were not chargeable, the provisions of section modes of mitigation of WHT 195, which were tentative and procedural, SPECIAL BENCH HELD IN FAVOUR OF would also fail to apply ASSESSEE u An Assessing Officer cannot proceed on a The salient features of the Special Bench’s ruling notional basis to recover tax under section on the issue may be laid out as follows:– 201 since the liability of a deductor and a deductee cannot differ (i.e., either the in- u On the facts of the case (since the ITAT is come is chargeable to tax and suffer WHT the final fact finding authority), the Special or not be chargeable to tax and exempt Bench ruled that the Assessing Officer failed from WHT under section 195) to demonstrate that the payments were not an integral part of the purchase consider- u Application to the Assessing Officer under ation (which was the dominant purpose). section 195(2) is not mandatory since the Therefore, mere incidental payments in CBDT has itself prescribed an alternative relation to services which formed an inte- procedure of a CA’s certificate in Circular gral part of purchase consideration, even No. 10/2002 [and now under section 195(6) though made separately would not alter of the Act] the overall character of such payments. As u If the payer has a bona fide belief that the a consequence, all the sums paid were not sum paid is not chargeable to tax in the liable to WHT under section 195 of the Act hands of the payee, section 195 has no The decision of the Supreme Court in Trans- application whatsoever u mission Corpn. of AP Ltd. case (supra) has u The Karnataka High Court in Samsung an application only where sum fraction of Electronics Co. Ltd. case (Supra) has misin- the sum paid to a non-resident has an element terpreted the Supreme Court ruling in Trans- of income embedded in it. In such a case, mission Corpn. of A.P. Ltd. case (supra) and section 195(1) in respect of WHT and the the Samsung decision conflicts with a plethora other section 195(2)/195(3) or CBDT Circu- of other High Court and ITAT Special Bench lar No. 10/2002 [now 195(6)] would apply decisions and AAR rulings. Further, the for mitigation thereof. Samsung decision, being through a non- When the payer has a bona fide belief that jurisdictional High Court, was not binding u the income is not chargeable to tax at all, on the payer. there is no application of the section 195 u When two interpretations of the law are at all and there is no liability on the payer possible ( i.e., to cut or not to cut), the one to follow its provisions when making pay- more beneficial to the assessee (i.e., not to ment to non-residents. As a consequence, cut) would be applicable all the proceedings as a result of non-com- pliance thereof would be otiose. u If section 195(2) is mandatory, does it imply that alternative routes prescribed by the u The Special Bench also observed that in a CBDT circulars (like CA’s certificate, Forms case where section 195 was not applicable, 15CA and 15CB) were nugatory at all, the contention that only the Assess- ing Officer of the payer or the CA ap- u Samsung’s case does not even consider the pointed to issue a certificate could sit in alternative modes of mitigation of WHT,

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judgment whether any income was embed- a payer need not undergo the procedure ded in the sum so paid. of section 195(2) if the payment made is not chargeable to tax in India u If the payer decides that no element of income is chargeable to tax having a bona u The payer and the Assessing Officer both fide belief for the same, it does not have have concurrent power to decide on the to follow the procedure laid out in section taxability of the amounts paid to a non- 195(2) [or even the CA certificate route resident. If the payer has a bona fide belief prescribed under Cir. No. 10/2002 or now that the amount is not taxable under sec- 195(6)] tion 4 of the Act, section 195 has no ap- plicability. u The Special Bench further contended that a perusal of the new format of the CA u The IT department’s appeal was dismissed certificate (Form 15CB) clearly lays out that as a result of these conclusions.

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Judicial Snippets

SECTION 37(1) OF THE ACT – BUSINESS EXPENDITURE ROYALTY WHERE AS PER AGREEMENT ASSESSEE COULD USE TECHNICAL INFORMATION EVEN AFTER TERMINATION OF AGREEMENT AND NOTHING HAD BEEN BROUGHT ON RECORD TO SHOW THAT ANY TECHNICAL SERVICE WAS TO BE PROVIDED ON REGULAR BASIS, MERELY BECAUSE THE CONSIDERATION HAD BEEN DIVIDED INTO TWO PARTS, I.E., ONE PART BEING US DOLLARS 1 MILLION PAY- ABLE IN THREE INSTALMENTS AND THE OTHER PART IN THE FORM OF ROYALTY AT A SPECIFIED PERCENTAGE OF SALES, IT COULD NOT BE SAID THAT THE SECOND PART OF THE PAYMENT WAS NOT CAPITAL IN NATURE.

Climate Systems India Ltd. v. CIT [2009] 185 Taxman 139 (Delhi) The assessee was engaged in business of radiator. It had entered into an agreement with certain company, whereby said company had to provide various technology and technical services in connection with the assessee’s business in lieu of payment of royalty of 3 per cent on domestic and 5 per cent on export sales by the assessee. According to the agreement, the assessee could use the technical information in production of the licensed product (radiator) even after the termination of agreement and the assessee would have the right to export such licensed products to all the countries of the world excluding countries specified in the agreement. The assessee- company debited royalty expenses in profit and loss account. The Assessing Officer disallowed the same holding that royalty expenses were not of the revenue nature. On appeal, the Commissioner (Appeals) confirmed the order of the Assessing Officer. HELD THAT :

u In the instant case, it was found that as per article 6 of the agreement even after termination of the agreement, the assessee could continue to use the technical information in production of the licensed products and shall have the right to export the licensed product to all the countries of the world excluding the countries enumerated in article 2 of that agreement. The countries excluded under article 2 of that agreement were those countries where licensor had agreements for local manufacture and, hence, it meant that as per that agreement, the assessee was getting an enduring benefit, which was available to the assessee even after termination of that agreement.

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u Nothing had been brought on record to a company of France, namely, ‘U’ were in the show that any technical service was to be nature of technical services as defined in section provided to the assessee on day to day 9(1)(vii) and, accordingly, directed the assessee basis or on regular basis at a specified to deduct tax at source at the rate of 10 per cent. interval to support the claim of the asses- The assessee made an application under section see that the impugned payment was of 195(2) before the Assessing Officer requesting revenue nature. him to permit it to remit the amount payable to ‘U’ without deducting tax at source. It stated u For that reason and in view of the com- in the application that there was no enrichment bined reading of clauses of that agreement, or gaining of technical knowledge or expertise it was opined that it was a case of outright by it; that ‘U’ had merely performed its business transfer of technical know-how and merely in France by conducting the impact tests on cars because the consideration had been divided sent by it; and that since ‘U’ was not transferring into two parts, i.e., one part being US Dollars any knowledge or method by which the required 1 million payable in three instalments and testing could be carried out and, further, since the other part in the form of royalty at a those tests were required for obtaining regulatory specified percentage of sales, it could not approval only, the payments would not be in be said that the second part of the payment the nature of technical services as defined under was not capital in nature and, hence, the section 9(1)(vii). The Assessing Officer held that impugned payment was capital in nature. ‘U’ had the expertise and the skill to perform In the result, the appeal of the assessee was the tests which were required to be made as per partly allowed. section 9(1)(vii). He further held that fees for technical services meant any consideration for the rendering of any managerial, technical or SECTION 9 OF THE ACT READ WITH consultancy services. He, therefore, held that ‘U’ ARTICLE 13(4) OF INDO-FRANCE DTAA - had rendered technical services to the assessee ROYALTY AND FEES FOR TECHNICAL and, thus, the assessee was liable to deduct tax SERVICES - INCOME DEEMED TO AC- at the rate of 10 per cent from the payments CRUE OR ARISE IN INDIA being made at the time of remittance to ‘U’. STATUTORY TEST FOR DETERMINING On appeal, the assessee contended that the THE PLACE OF THEIR ACCRUAL IS NOT payments were made to ‘U’ for evaluation of THE PLACE WHERE THE SERVICES FOR cars manufactured by it, which had to be got WHICH THE PAYMENTS ARE BEING done in the course of business to ensure the safe MADE, ARE RENDERED BUT THE PLACE running of cars; that the evaluation of cars was WHERE THE SERVICES ARE UTILISED, done by conducting impact tests on instrument THUS WHERE THE IMPACT TESTING RE- panels fitted in the cars; that for conducting the PORTS ON CARS WERE SUBMITTED TO impact tests it had to send vehicles to France, THE ASSESSEE WHICH WERE UTILISED and at the time of conducting the impact tests, its representatives were also present; and that FOR THE PURPOSES OF MODIFICATION after conducting the impact tests, ‘U’ furnished OF THE PRODUCTS IN INDIA, THIS the impact testing reports to it which contained WOULD AMOUNT TO RENDERING OF test results only and did not make available or TECHNICAL SERVICES/INFORMATION provide any technical know-how, knowledge or AND CHARGEABLE TO TAX IN INDIA. expertise to it. Maruti Udyog Ltd. v. Asstt. DIT [2009] 34 SOT The Commissioner (Appeals) on the basis of the 480 (Delhi - Trib.) reports made available by ‘U’ held that the testing The assessee-company was engaged in the reports were made available to the assessee in manufacture of cars. The competent authority India for making necessary improvements, etc. held that the payments made by the assessee to He further held that the presence of the

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representatives of the assessee at the time of u The assessee contended that in view of the testing would help them in gaining or enriching protocol paragraph 7 of the DTAA, the their technical knowledge or expertise. The scope of expression ‘fees for technical ser- transaction-in-question was not an isolated vices’ under article 13(4) could not be wider transaction and there was a continuity. The test than the scope of most restrictive DTAA reports were detailed reports covering detailed that India had entered into with any OECD specifications of various charts of the cars which member after 1-9-1989: that after the cut- were very useful to the assessee for product off date of 1-9-1989 referred to in para- development and modifications. The Commissioner graph 7 of protocol attached to and form- (Appeals), therefore, held that testing charges ing a part of Indo French DTAA, India had paid were fees for technical services within the signed DTAAs with at least three OECD meaning of section 9(1)(vii) and article 13 of the member countries, which had narrower scope DTAA between India and France, as the same of the expression ‘fees for technical ser- were paid in consideration for services of technical vices’; and that in all these DTAAs, fees for nature. technical services did not include the fees received for services that were ancillary HELD THAT : and subsidiary, as well as inextricably and u Article 13(4) of DTAA defines the expres- essentially linked to the sale of property. sion ‘fees for technical services’ and means From a close reading of the Double Taxa- payment of any kind to any person other tion Avoidance Agreements entered into than payment to an employee of the person between India and three OECD Members, making the payment and to any individual it is clear that one of the discernible com- for independent personal services mentioned mon factors in Indian DTAAs with UK, in article 15, in consideration for services USA and Switzerland is that in all these of a managerial, technical or consultancy treaties, ‘fees for services that are ancillary nature. Explanation 2 to section 9(1)(vii) defines and subsidiary, as well as inextricably and the expression ‘fees for technical services’. essentially linked, to the sale of property’ Hence, article 13(4) excludes payment to is outside the scope of ‘fees for technical an employee of the person making the services’ liable to separate treatment under payment and to any individual for inde- the respective DTAA. In other words, in all pendent personal services mentioned in article these treaties, unless the ‘fees for services 15. On the other hand, Explanation 2 to that are ancillary and subsidiary, as well section 9(1)(vii), excludes the consideration as inextricably and essentially linked, to for any construction, assembly, mining or the sale of property’ is attributable to PE like project undertaken by the recipient or and fulfils the other requirements laid down consideration which would be income of under the relevant article dealing with the recipient chargeable under the head business profits, the same cannot be taxed ‘Salaries’. There was no dispute that ‘U’ in the source country. The scope of expres- did not fall in the category of persons excluded sion ‘fees for technical services’, in these under article 13(4) or Explanation 2 to section treaties, appears to be far more restricted 9(1)(vii). After exclusion of such persons, than the scope of the same expression in the definition of the expression ‘fees for Indo-French DTAA, which broadly defines technical services’ would be the same under ‘fees for technical services’ as to mean both the provisions. In other words, the payments in consideration for services of expression ‘fees for technical services’ under a managerial, technical or consultancy nature. provisions of article 13(4) as well as Expla- Therefore, whereas payments for all kind nation 2 to section 9(1)(vii), would mean of technical services are to be treated as the payment made to any person in con- ‘fees for technical services’ for the purpose sideration of managerial, technical or consultancy services.

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of article 13(4), such payments cannot be hanced the capability of the product devel- treated as to be in the nature of ‘fees for opment of the assessee. The presence of the technical services’, under respective articles assessee’s representative was with an in- in Indo-UK, Indo-US and Indo-Swiss DTAAs tention of getting experience about testing. in case the same constitutes ‘fees for ser- Thus, the impact tests to be conducted by vices that are ancillary and subsidiary, as ‘U’ were purely technical in nature. After well as inextricably and essentially linked, carrying out the impact tests in the above to the sale of property’. manner, testing reports were submitted to the assessee which were utilised for the u It is a settled position in law that protocol purposes of modification of the products. is an indispensable part of the treaty with This would amount to rendering of tech- the same binding force as the main clauses nical services/information in the form of therein; as protocol is an integral part of impact testing reports by ‘U’ to the asses- the treaty and its binding force is equal to see. Accordingly, the amounts paid by the that of the principal treaty. The provisions assessee to ‘U’ would be in nature of tech- of the aforesaid DTAAs are, therefore, required nical or consultancy services. to be read with the protocol clauses and are subject to the provisions contained in u Now the question would arise as to whether such protocol. Examined in the light of the payment made would be taxable in DTAAs between India and UK, USA and India under article 13(4) read with Expla- Switzerland, it was found that, in the instant nation 2 to section 9(1)(vii). The test reports case, the assessee had not purchased any had been used by the assessee in India in property from ‘U’. Therefore, none of the manufacturing of cars. It has been laid down fees, i.e., impact testing fees or fees paid in Steffen, Robertson & Kirsten Consulting for test reports were ancillary and subsid- Engineers & Scientists In re, [1998] 230 ITR iary, as well as inextricably and essentially 206/[1997] 95 Taxman 598 (AAR - New linked, to the sale of a property. Delhi) that the statutory test for determin- ing the place of their accrual is not the u The impact tests conducted by ‘U’ were not place where the services for which the in nature of managerial services. The as- payments are being made, are rendered, sessee was to define the area and points but the place where the services are utilised. to be tested. The tests were to be per- Therefore, the payments made to ‘U’ were formed by ‘U’ using a vehicle front unit chargeable to tax in India. In view of the on which the dashboard and its interior above, the assessee was liable to deduct tax parts were mounted. Further, the dashboard at source on payments made to ‘U’. and its interior parts were to be changed for each test. The above tests were carried out in France and bills were raised for the tests carried out by ‘U’. According to the SECTION 172 OF THE ACT - SHIPPING assessee, no technical knowledge, exper- BUSINESS OF NON-RESIDENTS tise, skill, knowledge, technical plan or FOR BRINGING A CASE UNDER SECTION technical decision had been made available 172, ONE HAS TO ESTABLISH A CASE to it by ‘U’. It was not the case of the OF PROFITS OF NON-RESIDENT FROM assessee that every vehicle produced un- OCCASIONAL SHIPPING BUSINESS AND derwent the testing. The testing was done IN A CASE WHERE ASSESSEE HAD NOT so as to pass the quality test of a particular specification, which was based only on test EARNED PROFIT FROM OCCASIONAL reports given by ‘U’. Therefore, the impact SHIPPING AND WAS NOT A NON-RESI- testing reports were in the nature of tech- DENT, SECTION 172 DID NOT HAVE ANY nical services rendered by ‘U’, which en- APPLICATION IN RELATION TO ASSESSEE

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CIT v. Orient (Goa) (P.) Ltd. [2009] 185 Taxman the assessee was an Indian company incor- 131 (Bom.) porated under the provisions of the Com- The assessee-company claimed deduction of certain panies Act, 1956. The Tribunal had recorded amount on account of demurrage payable to a a perverse observation/finding regarding non-resident company ‘M’. As no tax had been application of sections 44B and 172. deducted on that amount, the Assessing Officer u The Commissioner (Appeals) and the Tri- considered said amount as non-deductible claim bunal had wrongly interpreted the circular in view of section 40(a)(i). On appeal, the Commis- dated 19-9-1995 issued by the CBDT. That sioner (Appeals) observed that demurrages debited circular could not be considered in the facts by the assessee in the hands of the recipient and circumstances of the instant case, in were in the nature of profits of non-resident aid of the assessee. The Assessing Officer, from occasional shipping business under section in fact, had passed a legal, proper and 44B, read with section 172. He also referred to reasoned order, holding that the provisions the provisions of section 172(8) which had been laid down under section 40(a)(i) applied to brought on the statute by the Finance Act, 1997 the case in hand. with effect from April 1, 1976 and the CBDT In the instant case, there were no pleadings Circular No. 723, dated 19-9-1995 and allowed u or material brought on record to show that the assessee’s appeal holding that disallowance the case was governed by occasional ship- made by the Assessing Officer under section ping within the meaning of section 172 and 40(a)(i) was incorrect. The Tribunal dismissed said section applied. the revenue’s appeal. The facts of the instant case were governed HELD THAT : u by section 40(a)(i). The order passed by the u Section 172 comes under sub-title ‘H - Profits Assessing Officer was legal, proper and in of non-residents from occasional shipping accordance with the scheme of the Act. business’. Title of section 172 is ‘Shipping Therefore, the appeal deserved to be al- business of non-residents’. For bringing a lowed by quashing and setting aside the case under Chapter XV-H, one has to establish orders passed by the Commissioner(Appeals) a case of profits of non-residents from and the Tribunal. occasional shipping business. ‘Non-resident’ is defined under section 2(30), as a person who is not a ‘resident’ and for the purpose SECTION 92 OF THE ACT - TRANSFER of sections 92, 93 and 168, includes a person PRICING - TNM METHOD who is not ordinarily resident within the meaning of clause (6) of section 6. The TNM METHOD REQUIRES COMPARISON assessee, being a company incorporated under OF NET PROFIT MARGINS AND NOT the provisions of the Companies Act, 1956, OPERATING MARGINS OF ENTERPRISES could not be said to be a non-resident. The Addl. CIT v. Tej Diam [2010] 37 SOT 341 assessee could not lay fingers on section (Mum. - Trib.) 172, since profits of non-residents were not to be dealt with. The other aspect is that The assessee was a partnership firm and was in such profits of non-residents should be from the business of import and export of diamonds. occasional shipping business. It was not During the year under consideration, the assessee the case that the assessee had earned some had entered into an international transaction with profits from occasional shipping business M/s Harizon Diamond B. V. Bedlgium which and was a non-resident. The tax liability was owned and controlled by M/s Jitendra Shah of the foreign company, i.e., ‘M’, Japan who was the brother of the partners Mr. Vinit which was recipient of demurrages was Shah of the firm. The assessee filed an audited not being examined. Section 172 did not report in Form No. 3CEB. It adopted the Cup apply to the facts of the instant case wherein method for computing the arms length price of

INTERNATIONAL TAXATION I VOL. 2 I MAY 2010 I 129 117 JUDICIAL SNIPPETS the international transaction. The TPO on the Intimate Fashions (India) Pvt. Ltd. v. Jt. CIT ground that the assessee had not given any [Writ Petition No. 24623 of 2009 & M. P. No. comparables had rejected the method followed 1 of 2009, dated 23-12-2009] (Mad.) by the assessee and he used the Transaction Net In this writ petition, the petitioner challenged Margin Method (TNMM). In the TPO’s order the order under section 92CA(3) of the Income- under section 92A(3), adjustment of Rs. 44 lakhs tax Act, 1961 on the ground that the order passed has been suggested while adopting the Transaction was in violation of the provisions of the Act in Net Margin Method. The Assessing Officer not granting the personal hearing to the petitioner. considered operating margins to sale of various The petitioner stated that the said order passed enterprises and arrived at a conclusion that an was in violation of the provisions of the Act and adjustment was called for under the Transfer contrary to the decision reported in Moser Baer Pricing Regulation. The Assessing Officer simply India Ltd. v. Addl. CIT [2009] 316 ITR 1/176 adopted the report of the TPO. On appeal, the Taxman 473 (Delhi). On the other hand, the first appellate authority held that if non-operational learned standing counsel appearing for the profits are excluded, the price variation would respondents pointed out that having regard to be less than 5% and, in view of the Board’s the Dispute Resolution Board constituted as per Circular, no adjustment is called for. He deleted the Income-tax Dispute Resolution Panel, if the the addition. petitioner had a grievance, the proper course HELD THAT : would be for the petitioner to agitate the assessment either before the appellate authority or before u A plain reading of the provisions shows the Dispute Resolution Panel. that TNMM requires comparison of net profit margins realised by an enterprise from an HELD THAT : international transaction or an aggregate of u It is no doubt true that as per section 92CA international transactions and not compari- of the Income-tax Act, when the assessee sons of operating margins of enterprises. goes before the authority concerned on

u For arriving at this conclusion, the Tribu- transfer pricing, an opportunity of personal nal draws strength from the decision of hearing should be granted to the assessee. Mumbai ‘I’. Bench of the Tribunal in the u As far as the present case was concerned, case of UCB India (P.) Ltd. v. Asstt. CIT the notice dated August 25, 2009 was sent [2009] 121 ITD 131 wherein it was held that by the Transfer Pricing Officer intimating section 92C read with Rule 10B(1)(e) deals the date of personal hearing on September with transactions Net Margin Method 4, 2009, on which date the petitioner was (TNMM) and it refers to only net profit to file its reply. Admittedly, the petitioner margin realised by an enterprise from an sought for an adjournment by 15 days. The international transaction or a class of such petitioner was intimated that the case was transaction, but not operational margins of posted on September 15, 2009, which meant, enterprises as a whole. the petitioner should have filed its reply along with availing of the personal hearing on September 15, 2009. Although the pe- SECTION 144C OF THE ACT - DISPUTE titioner had filed its objections on Septem- RESOLUTION PANEL ber 16, 2009, yet nothing further happened from the side of the petitioner seeking personal AS PER SECTION 144C, IT IS ALWAYS hearing or, for that matter, the Department OPEN TO AN ASSESSEE TO GO BEFORE intimated later on that the petitioner had DRP TO AGITATE ON ALL ASPECTS OF not availed of the opportunity of personal ASSESSMENT INCLUDING THE QUES- hearing. However, as seen from the en- TIONS RELATING TO THE TRANSFER dorsement in the letter seeking adjourn- PRICING ASPECT.

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ment that the proceedings were posted on the petitioner to go before the panel to November 15, 2009, it stood to reason that agitate on all aspects of assessment includ- the petitioner should have availed of the ing the questions relating to the transfer personal hearing on the date on which the pricing aspect. Learned standing counsel reply was filed. Having thus failed to avail informed the Court that a Board had al- of the same, the Court did not find any ready been constituted. In this background, justification in the plea of the petitioner the Court held that it was but proper for that the order had been passed on transfer the petitioner to avail of the remedy avail- pricing aspect without affording any per- able under the Income-tax Act. There were sonal hearing. no extraordinary circumstances for the Court to interfere with the proceedings. u Leaving that as it may, it was not as though the petitioner was remedyless in this re- u In the face of the limitation given under gard. Even though the order of the transfer section 153 thus taken care of under sec- pricing is binding on the assessing author- tion 144C and that it provides for service ity, yet as rightly pointed out by the learned of a draft assessment order, it was open to standing counsel as per section 144C of the the assessee to exhaust the remedies as Income-tax Act, with the Dispute Resolu- provided for under section 144C of the Act. tion Panel available, it is always open to

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RNI NO. : DELENG/2009/32076 D. NO. DL (C) - 01/1322/2010-12

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