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Learning from Recent International tax decisions . Hitesh Gajaria Chartered Accountant. Conference on International Taxation & Transfer Pricing IFA - Hyderabad 12 December 2008. Vodafone International Holding B.V., Writ Petition No. 2550 OF 2007: 2008-TIOL-602-HC-MUM. HTIL Hong Kong.

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Learning from Recent International tax decisions

Hitesh Gajaria

Chartered Accountant

Conference on International Taxation & Transfer Pricing

IFA - Hyderabad

12 December 2008


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Vodafone International Holding B.V., Writ Petition No. 2550 OF 2007: 2008-TIOL-602-HC-MUM

HTIL

Hong Kong

Vodafone NV

Netherlands

100%

Transferred shares of CGP

Writ Petition

CGP Investments

Caymans Island

Overseas

100%

Show Cause Notice

IHC

Mauritius

67%

Bombay

High

Court

HEL / VEL

Indian

Income-tax department

India


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Vodafone’s Key Argument OF 2007: 2008-TIOL-602-HC-MUM

  • Section 201 – Vodafone is not an ‘Assessee in Default’ as:

    • It had not failed to deduct and failed to pay tax

    • HTIL was not called upon to pay tax

    • The 2008 retrospective amendment was unconstitutional

  • Section 195 – Territorial Operations

    • Section 195 has only territorial applicability

    • It does not apply to non-resident having no presence in India

  • Section 9(1)(i) – There is no income chargeable to tax in India

    • The transfer is between two Non-residents of a Foreign Company’s shares with payment received / settled outside India

    • There is no transfer of capital asset situated in India

    • Share capital is situated at the registered office i.e. overseas

    • Controlling interest is not distinct from shares but incidental

    • The words indirectly in Section 9(1)(i) do not apply to Capital Asset Transfer


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Vodafone - Tax Authorities key arguments OF 2007: 2008-TIOL-602-HC-MUM

  • Writ Petition is not maintainable at the stage of SCN as:

    • It cannot be said that the SCN was totally non-est

    • Withholding tax is provisional and does not infringe the right of Vodafone

    • Writ was pre-mature since Vodafone had an efficacious remedy

  • Section 201

    • Vodafone is an ‘assessee in default’ as the condition of deduction and payment are not cumulative

  • Section 195

    • Provisions of Section 195 and SCN are not extra-territorial in this case as the transaction has a clear nexus to income or property or asset in India

    • The essential facts i.e. agreement dated 11 February 2007 have not been produced and thus the constitutional validity of the provisions cannot be determined on hypothetical situations


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Vodafone - Tax Authorities key arguments OF 2007: 2008-TIOL-602-HC-MUM

  • Section 9(1)(i) – There is income chargeable to tax in India

    • The subject matter of the transaction is not shares of a shell overseas company but transfer of interests, tangible and intangible in an Indian company

    • There is no need to pierce the corporate veil as Vodafone itself has not disputed the above fact before various authorities and now could not take a separate stand for income-tax purposes


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Vodafone - High Court Ruling OF 2007: 2008-TIOL-602-HC-MUM

  • The Tax Authorities made out a strong prima facie case that :

    • The transaction was one of transfer of capital asset situate in India

    • It would be too simplistic to hold that Vodafone merely acquired the shares of an unknown Cayman Island Company

    • The purpose of acquiring shares in the Cayman Island Company was to acquire controlling interest in the Indian Company and hence there seems to be a transfer of a capital asset situated in India

  • The ‘Effects Doctrine” has been approved and relied upon by the Supreme Court of India

  • Vodafone has not been able to demonstrate that the SCN is ‘non-est’ in the eyes of law for absolute want of jurisdiction of the authorities

  • Vodafone’s interest are fully safeguarded by Section 195 / 197 of the Act

  • Vodafone has failed to produce the relevant agreement / document without which it is impossible to appreciate the true nature of the transaction

  • The High Court dismissed the Writ Petition with costs to the Tax Authorities


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SET Satellite (Singapore) Pte Ltd. v. DCIT [2008] 218 CTR 452 (Bom)

  • Facts of the case

    • SET Singapore was engaged in broadcasting TV channels

    • SET had appointed agent in India - SET India Pvt. Ltd to market air time slots

      • Agent constituted SET’s Dependant Agent Permanent Establishment (DAPE) in India

    • SET paid remuneration to the agent at an Arm’s Length Price (ALP)

    • SET contended that even if the Dependant Agent (DA) was its PE:

      • Only earnings attributable to DA was taxable income of the PE

      • Income was taxable under Article 7 of India-Singapore Tax Treaty

      • Since the DA was remunerated at arm’s-length price, no further profits could be taxed in India


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SET Singapore – Bombay Tribunal Ruling 452 (Bom)

  • The Tribunal allowed the appeal in favour of the Tax Authorities and held that:

    • DA and DAPE are two distinct taxable entities;

    • Profits attributable to PE are profits of SET and not that of DA; and

    • Mere payment of arm’s length remuneration to DA does not extinguish tax liability of SET in India


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SET Singapore - Bombay High Court ruling 452 (Bom)

  • If correct ALP is applied and paid then nothing further to be taxed in the hands of SET

    • Morgan Stanley and Co. [2007] 292 ITR 416 (SC)

  • Taxable income @ 10 percent is fair and reasonable

    • CBDT Circular 742 followed

  • For marketing services more than 10 percent has been paid i.e. more than ALP

  • SET’s income is not attributable to the PE and it cannot be brought to tax - CBDT Circular 23, dated 23 July 1969 followed

  • HC set aside Tribunal’s order and held that advertisement revenue received by SET was not taxable in India


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Rolls Royce Plc v. DDIT (2008) 113 TTJ 446 (Del) 452 (Bom)

  • Facts of the Case

    • The taxpayer company was incorporated and Tax Resident of the United Kingdom (UK)

    • It was a foreign company for the purpose of tax assessment in India and had not filed any income tax returns in India

    • The taxpayer was supplying aeronautical engines and spare parts to Hindustan Aeronautics Ltd. (HAL), the Indian Navy, and the Indian Air Force

    • The taxpayer also had a UK wholly owned subsidiary Rolls Royce India Ltd. (RRIL) which had offices in India (Taken as Branch Offices paying taxes in India which were contended to be an arm’s-length income)


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Rolls Royce - Issues before ITAT 452 (Bom)

  • Whether there is a business connection in India within the meaning of Section 9(1)(i) read with Section 5(2) of the Act ?

  • Whether there is a PE in India under Article 5 of Indo-UK DTAA ?

  • If there is business connection / PE in India –

    • What is the extent of income earned in India ? and

    • Can it be contended that income paid by RR Plc to RRIL is adequate for the business activities carried out in India and hence, no further income can be attributable to India ?


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Rolls Royce - Assessee’s Contentions 452 (Bom)

  • No business connection in India

  • No fixed place PE since the premises did not belong to assessee neither they exercised any control over it

  • No agency PE since RRIL a mere facilitator of information not having any authority in India; hence activities merely preparatory / auxiliary

  • Even if there is a business connection / PE in India –

    • Arms’ length service charges paid to RRIL offered to tax in India and hence no further profits attributable to tax in India.

    • Even transfer pricing officials have accepted the arms’ length price and not made any adjustments for additional profits

    • 75% apportionment by revenue not justified. At the most 10% can be attributed to Indian operations


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Rolls Royce - Revenue’s Contention 452 (Bom)

  • Business Connection

    • The appellant had a business connection in India under section 9 of the Act in form of persons of and activities carried on by RRIL

  • Permanent Establishment

    • Marketing, liaisoning, market analysis, technical support, customer relationship/interface, strategic planning activities carried out by RRIL – Fixed place PE

    • Employees have authority to conclude contracts and secure orders – Agency PE

  • Profits Attributable to PE as per the provisions of Article 7(2) of the India-UK tax treaty

    • 75% of global profits attributed to the Indian PE of the assessee contending that marketing is the prime activity to earn these profits


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Rolls Royce - ITAT Ruling 452 (Bom)

  • Business Connection

    • Exists due to extensive nature of activities carried out

  • Permanent Establishment

    • Fixed Place PE

      • RRIL premises at the disposal with a degree of permanence and used for the purpose of business of the assessee;

      • Activity carried on at RRIL’s premises is not preparatory or auxiliary. The decisive criterion is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole;

      • Premises although in name of RRIL, were occupied by the assessee for the purpose of business operations.

    • Agency PE

      • RRIL habitually secures orders for the assessee in India

      • RRIL and its employees work wholly and exclusively for the group and accordingly RRIL is economically dependent upon the assessee


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Rolls Royce - ITAT Ruling 452 (Bom)

  • Attribution of profits to PE

  • The profits to be computed as if the PE is a distinct and separate enterprise and dealing wholly independently with the enterprise of which it is a PE

  • Direct as well as indirect income connected to marketing activities carried on in India would be chargeable to tax in India

  • The ITAT apportioned the global profits of the assessee as under:

    • Manufacturing Activity : 50 % (not taxed in India)

    • R & D : 15% (not taxed in India)

    • Marketing : 35% (taxed in India)


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Dell International Services India Private Limited (2008) 305 ITR 37 (AAR)

  • Facts of the Case

    • Dell, USA parent of Dell India entered in to a Master Service Agreement with BTA,USA for two-way transmission of voice and data through telecom bandwidth for the Dell Group as a whole (including Dell India)

    • BTA,USA jointly with VSNL to provide telecom services to Dell India to carry voice and data traffic from US and Ireland to India and back through dedicated private telecom lines

    • Dell India would pay installation and fixed monthly charges directly to BTA, USA.

    • No equipment were installed in Dell India premises.

    • The space of cable network was not dedicated to the Dell India alone but also used by other customers of BTA,USA


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Dell International - Issues before AAR ITR 37 (AAR)

  • Whether amount payable by Dell India to BTA, USA will be construed as ‘Royalty or Fees for Technical Services’ as per India - US tax treaty?

  • Whether income received by BTA, USA would accrue or arise or deem to accrue or arise in India and will be covered within the exception carved out in Section 9(1)(vi)(b)or 9(1)(vii)(b) of the Act?

  • Whether BTA would be construed to have any PE in India?

  • Whether Dell India will be required to withhold tax under Section 195 of the Act?


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Applicant’s contention ITR 37 (AAR)

The agreement with BTA, USA does not provide for the right to use any equipment

The possession and control of the leased circuit and related equipments is only in the hands of BTA,USA and not with Dell India

No equipment or machinery has been installed in India

No technology is made available to Dell India by BTA, USA

Accordingly the rendition of services by service provider using its own equipment does not attract the definition of royalty or fees for included services

Revenue’s contention

The access line through which the required bandwidth is provided is a electrical component and it is undoubtedly an ‘equipment’

Dell India is in possession of the equipment even though the ownership rests with BTA,USA

The consideration has been paid for right to use or use of an equipment or a secret process

Accordingly the consideration charged partakes the character of ‘Royalty’ as defined in Section 9 of the Act and Article 12(4) of the India-USA Tax Treaty

Dell International - Contentions Before AAR


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Dell International - AAR Ruling ITR 37 (AAR)

  • The charges paid to BTA USA do not constitute Royalty

    • The provision of ‘telecom bandwidth facility by means of dedicated ‘circuits’ and other network installed and maintained by BTA, USA does not amount to lease of an equipment or use of any process or secret process

      • DCIT v. Panamsat International System Inc (2006) 103 TTL 861

  • The charges paid to BTA USA do not constitute fees for included services

    • Dell India is not enabled to apply any technology by itself and therefore the services are ‘not made available’ as per Article 12(4) of the India-USA treaty

  • Payment are not made for earning income from any source outside India

    • The income earned by data processing and other software export activities cannot be said to be from source outside India.

  • The question of BTA, USA constituting PE in India and thereby chargeable to tax to the extent of appropriate profits attributable to PE left open


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Facts ITR 37 (AAR)

ISRO Satellite Centre (“the Applicant or ISRO”) entered into an contract with Immarsat Global Ltd ,UK (IGL) for leasing of Navigation Transponder Capacity

The entire operation, maintenance through which capacity is provided to ISRO was under control of IGL

ISRO paid a fixed annual charge to IGL

The issue before AAR was whether payment by ISRO to IGL would be taxable as royalty under the India – UK Tax Treaty and under the provisions of the Act

AAR Ruling

The payment by ISRO to IGL could not be regarded as use of or right to use of equipment of IGL as the applicant had no right or control over the equipment

The telecom bandwidth services are not taxable as Royalty as the payment is made for availing the services and not for the use of equipment

Recent ruling in the case of Dell International Services Private Limited followed

The payment cannot be construed as Royalty under the Tax Treaty or under the Act

ISRO Satellite Centre (AAR)


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DIT (International Taxation) v Morgan Stanley and Co Inc (2007) 292 ITR 416 (SC)

Morgan Stanley, US (MSCo)

Engaged in the business of providing financial advisory services, corporate lending and securities underwriting

Deputation of Employees

Stewardship

Activities of employees

Group Company

Deputation on request based on need for such knowledge and skills

For ensuring quality and confidentially

Service Agreement [Cost plus mark up (29%) received by MSAS

Lien on overseas employment

Morgan Stanley Advantage Services India Pvt Limited (MSAS)

Provides support to the group’s front office functions such as statistical and financial analysis, market gathering, account reconciliation, etc


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Morgan Stanley - Issues before AAR and SC (2007) 292 ITR 416 (SC)

Whether MSCo has a PE in India?

Constitution of PE

Fixed Place PE

Agency PE

Service PE

Stewardship Activities

Deputation

Attribution of Profits

If MSAS is remunerated at arms’ length, whether further profits can be attributed to MSCo in India ?

  • Whether Transactional Net Margin Method (TNMM) is the most appropriate method for determining arms’ length price?

  • Whether 29% mark-up based on operating costs as profit- level indicator is appropriate?

Appropriateness of TNMM Method



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Morgan Stanley - Supreme Court (2007) 292 ITR 416 (SC)

  • There is no Fixed Place PE under Article 5 (1) read with Article 5 (3)(e)

    • Business of the foreign enterprise not carried out through the place of business of the subsidiary

    • Back office functions performed by MSAS have a “preparatory” or “auxiliary” character

  • There is no Agency PE under Article 5(4)

    • MSAS did not have authority to conclude contracts, secure orders or deliver goods on behalf of MS & Co

    • Mere legal and economic dependence of a service provider is insufficient to constitute a PE under the “Agency PE” Rule


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Morgan Stanley - Supreme Court (Contd…) (2007) 292 ITR 416 (SC)

  • There is no Service PE under Article 5(2)(l)

  • Stewardship Service

    • Stewardship activities involve briefing and monitoring of outsourcing operations at MSAS to ensure output meets requirements of MS & Co

    • No involvement in day to day management or specific services of MSAS

    • Object is to protect the interest of MS & Co

  • Deputation

    • lien on employment with MSCo; hence control over employee’s terms of employment

    • employees continues to be on the payroll of MSCo

    • on completion of tenure, employee is ‘repatriated’ to parent

    • responsibility for risks and rewards of service with MSCo

    • request for deputation from MSAS based on need for those skills in India


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Morgan Stanley - Supreme Court (Contd…) (2007) 292 ITR 416 (SC)

  • Attribution of profits to the PE constituted in India

    • Income attribution to be based on functional analysis and application of transfer pricing methods

    • PE to be treated as an independent enterprise de hors the head office which deals with head office on arm’s length

    • Nothing further to be attributed to PE if arm’s length price to associated enterprise takes into account “all the risk-taking functions of the enterprise”

    • Where the transfer price (for the associated enterprise) does not appropriately reflect the functions performed and risks assumed, there would need to be attributed, profits for those functions and risks

    • Concept of “economic nexus” – an important feature of income attribution


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THANK YOU ALL FOR YOUR ATTENTION ! (2007) 292 ITR 416 (SC)


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