Transcript Slide 1

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
100%
Overseas
Vodafone NV
Netherlands
Transferred
shares of CGP
CGP Investments
Caymans Island
100%
Show
Cause
Notice
IHC
Mauritius
67%
India
HEL / VEL
Bombay
High
Court
Indian
Income-tax
department
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Vodafone’s Key Argument
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
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
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
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
SET Singapore – Bombay Tribunal Ruling
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
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)
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
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
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
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 IndiaUK 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
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
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
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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Dell International - Contentions Before AAR
Applicant’s contention
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 IndiaUSA Tax Treaty
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Dell International - AAR Ruling
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 IndiaUSA 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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ISRO Satellite Centre (AAR)
Facts
AAR Ruling
ISRO Satellite Centre (“the Applicant
or ISRO”) entered into an contract
with Immarsat Global Ltd ,UK (IGL)
for leasing of Navigation Transponder
Capacity
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 entire operation, maintenance
through which capacity is provided to
ISRO was under control of IGL
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
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
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
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DIT (International Taxation) v Morgan Stanley and Co Inc
(2007) 292 ITR 416 (SC)
Morgan Stanley, US (MSCo)
Group Company
Engaged in the business of providing financial advisory services, corporate lending and
securities underwriting
Deputation of
Employees
Stewardship
Activities of
employees
Deputation on request
based on need for such
knowledge and skills
For ensuring quality and
Service
confidentially
Agreement
[Cost plus
Lien on overseas
mark up (29%)
employment
received by
MSAS
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
Whether MSCo has a PE in India?
Constitution of PE
Fixed Place PE
Agency PE
Service PE
Stewardship
Activities
Attribution of
Profits
Appropriateness of
TNMM Method
Deputation
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 profitlevel indicator is appropriate?
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Morgan Stanley - Ruling by AAR and SC – A snapshot
Grounds
AAR
SC
Fixed Place PE
No
Upheld
Agency PE
No
Upheld
Service PE
(Stewardship)
Yes
Disallowed
Service PE (Deputation)
Yes
Upheld
No adjudication
Yes
No
Upheld
Appropriateness of
TNMM
Attribution of further
profits
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Morgan Stanley - Supreme Court
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…)
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…)
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 !
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