International Taxation

Case Law Update

1. Non-resident – Individual – Salary in Indian rupees received in India – Services rendered in Norway for period exceeding 182 days – Salary taxable in India and Norway – Individual not claiming that he was taxed in Norway – No relief from Indian tax available under DTAA

Authority for Advance Rulings – Application for Ruling – That applicant had returned income without claiming exemption – Does not disentitle him from seeking ruling to determine legal liability

S. Mohan, In re [2007] 294 ITR 177 (AAR) : 212 CTR 100 (AAR)

Assessee, an employee of an Indian company working on deputation in Norway, having not paid any tax to the Norway Government on the salary received by him for services rendered by him in that country, is not eligible for any relief in terms of the DTAA and therefore, his salary income is taxable in India.

Facts

1. The applicant, an individual, received salary income in India in Indian rupees for services rendered by him in Norway for a period exceeding 182 days during the financial year 2005-06.

2. He returned the income without claiming any exemption. However, thereafter he applied to the Authority for a ruling on the taxability of his income from employment in view of the Agreement for Avoidance of Double Taxation between India and Norway.

The Authority ruled:

1. That the fact that the applicant had returned his income without claiming exemption did not disentitle him from seeking a ruling to determine his legal liability to pay income-tax;

2. That paragraph 2 of article 16 of the Double Taxation Avoidance Agreement did not come into play for the reason that the applicant’s stay in Norway was for a period exceeding 182 days. The taxability of his employment income had to be determined in the light of paragraph 1.

3. That it was clear under article 16(1) that unless employment was exercised in the other Contracting State the remuneration derived was taxable only in the State of residence. However, if the employment was exercised outside the usual State of residence, the remuneration derived therefrom "may be taxed" in the State in which the employment was exercised. It was open to the State in which the employment was exercised to subject the remuneration derived by a resident of a Contracting State. That meant that Norway could have taxed the applicant, but it was not the case of the applicant that he was taxed in Norway or that he had voluntarily or otherwise paid tax to the Norway Government. In such a situation no relief was available to the applicant. The expression "may be taxed" was used in article 16(1) in contradistinction to the expression "shall be taxable" used in article 16(2). The right of taxation was available to both the Contracting States in regard to the employment income of the applicant in accordance with the relevant domestic laws.

4. That, therefore, the salary income of the applicant had been rightly taxed in India and he was not eligible to get any relief under the Double Taxation Avoidance Agreement.

Cases referred to

CIT vs. P. V. A. L. Kulandagan Chettiar [2004] 267 ITR 654 (SC)

British Gas India P. Ltd., In re [2006] 285 ITR 218 (AAR)

British Gas India P. Ld., In re [2006] 287 ITR 462 (AAR)

2. Capital gains – Non-resident – Acquiring shares listed on stock exchange in Indian company with foreign currency – Bonus shares also allotted to Non-resident – Sale of original as well bonus shares after 12 months – Capital gains – Rate of tax – Only lower rate of 10 per cent under proviso to section 112(1)

Timken France SAS, In re [2007] 294 ITR 513 (AAR) : 164 Taxman 354 (AAR)

Under the proviso to section 112(1) the benefit of the lower rate of tax could not be denied to non-residents in respect of long-term capital gains arising from the transfer of the original shares. And by the same reasoning the benefit of the lower rate of tax was available also in respect of the bonus shares.

Facts

1. The applicant, a non-resident French company, was engaged in the business of manufacturing anti-friction bearings and allied products and providing services relating thereto.

2. It acquired shares in an Indian company paying therefor in French francs. The shares of the Indian company were listed on the Bombay Stock Exchange and the National Stock Exchange.

3. Over the years the applicant also received bonus shares from the Indian company. Both the original shares and the bonus shares were held by the applicant for more than 12 months. The applicant sold the entire shareholding consisting of the original and the bonus shares.

4. On these facts the applicant sought the ruling of the Authority on the following questions of law: (a) whether the rate of tax payable on the capital gains on the sale of the original shares would be 10 per cent under the proviso to section 112(1) of the Income-tax Act, 1961, and (b) whether the rate of tax payable on the capital gains on the sale of the bonus shares would be 10 per cent under the proviso to section 112(1).

Ruling

1. That in the case of the applicant the first proviso to section 48 was applicable for the computation of the capital gains arising from the transfer of shares because the original shares were purchased by utilizing foreign currency;

2. That the proviso to section 112(1) was not merely a proviso to clause (d);

3. That the benefit of the proviso to section 112(1) could not be denied to non-residents/foreign companies who were entitled to a different relief in terms of the proviso to section 48. The proviso to section 112(1) was a special provision in relation to transfer of certain long-term capital assets, viz., listed securities, units and zero coupon bonds. There was no warrant to limit the 10 per cent effective rate provided therein, as against the normal rate of 20 per cent; only to the three categories of resident assessees specified in clauses (a), (b) and (d).

4. That the bonus shares just as the original shares of the applicant were listed securities. The proviso to section 112(1) did not make any distinction between the original shares and bonus shares. Under the proviso to section 112(1) the benefit of the lower rate of tax could not be denied to non-residents in respect of long-term capital gains arising from the transfer of the original shares. And by the same reasoning the benefit of the lower rate of tax was available also in respect of the bonus shares.

5. That, therefore, in respect of the long-term capital gains arising from the sale of the original and bonus shares of the Indian company the applicant was entitled to the benefit of the proviso to section 112(1) and, therefore, the quantum of tax payable should not exceed 10 per cent of the amount of capital gains.

6. That, however, the cost of acquisition of the bonus shares had to be taken as nil. The proviso to section 112(1) limits the rate of tax on long-term capital gains from the transfer of listed securities to 10 per cent, but with an important rider that the quantum of capital gains should be arrived at without taking into account the formula laid down in the second proviso to section 48 based on the indexed cost of acquisition.

7. The second proviso to section 48 is only a mode of computation of capital gains: it cannot be construed as words of exclusion of a category of assessees, i.e., non-residents who cannot avail of indexation benefit.

8. The protection in terms of the first proviso to section 48 made available to a non-resident might be a justification to deny the benefit of cost of indexation but the same cannot be said of the application of a lesser rate.

Case referred to

Basf Aktiengesellschaft vs. Deputy DIT (International Taxation) [2007] 293 ITR (AT) 1 (Mumbai)

3. Non-resident – Agent of non-resident – Notice of appointment – Provisions of s. 163(2) are mandatory – Even though S had filed return on behalf of his non-resident brother P declaring himself to be his agent, in view of AAC’s orders directing the AO to pass a specific order under s. 163(2) appointing S as agent of his non-resident brother P which had attained finality as no appeal was preferred thereagainst, order was required to be passed under s. 163(2) – Tribunal was justified in cancelling the assessment

CIT vs. Prem Kumar Bhagat [2007] 212 CTR (P&H) 130

Even though S had filed return on behalf of his non-resident brother P declaring himself to be his agent, in view of AAC’s orders, directing the AO to pass a specific order under s. 163(2) appointing S as agent of his non-resident brother P which had attained finality as no appeal was preferred thereagainst, Tribunal was justified in cancelling the assessment in the absence of order under s. 163(2).

Facts

1. The assessee filed return as an agent of his NRI brother Shri Prem Kumar Bhagat. The ITO completed the original assessment under s. 144 of the Act.

2. The AAC set aside the assessment order with a direction that the ITO should first of all record a finding whether Shri Prem Kumar Bhagat is an NRI. Thereafter he was to consider whether Shri Sudershan Kumar has got no objection to be appointed as an agent of his brother Shri Prem Kumar Bhagat and then to frame the assessment order after giving due opportunity to Sudershan Kumar of being heard.

3. The ITO issued notice under s. 143(2) but the assessee did not reply to the notice. Consequently the ITO proceeded to frame the best judgment assessment under s. 144 of the Act, but no findings on the status of NRI or his agent brother Sudershan Kumar were recorded. Assessment order passed by the ITO was confirmed by AAC.

4. On further appeal before the Tribunal, Third Member opined that matter in controversy was fully covered by the decision of the jurisdictional High Court in the case of Kanhaya Lal Gurmukh Singh 87 ITR 476 (P&H) and it was concluded that before assessment proceedings, the ITO was required to pass order under s. 163(2) of the Act treating the assessee as an agent of non-resident and it had not been done in the present case. He further opined that the ITO was given two opportunities to comply with the directions of the AAC under s. 163(2) to appoint Shri Sudershan Kumar as an agent of non-resident Shri Prem Kumar Bhagat. The orders thus were not complied. The assessment order was found to be vitiated and bad in law for non-compliance of the provisions of s. 163(2) of the Act.

5. Feeling aggrieved, Revenue sought reference under s. 256(1) of the Act.

Held

1. Provisions of s. 163(2) are mandatory in character because in s. 163(2) the expression ‘shall’ has been used and therefore an order was required to be passed by the ITO declaring S as an agent of his assessee brother.

2. The fact that he had signed and filed the return holding himself out as an agent of his NRI brother could not adversely affect his legal obligation because on two occasions the AAC had asked the ITO to pass a specific order on that issue and those two orders had attained finality as no appeal by the Revenue was preferred.

3. It is true that S himself held out by his conduct that he was agent of his NRI brother when he filed the return and paid tax and, therefore, failure to serve notice under S. 163(2) may not have invalidated the assessment order but in the present case, the aforementioned view cannot be taken for the reason that the AAC vide his order had directed the ITO to pass a specific order on the issue of appointing S as agent of his brother.

4. Those two orders had attained finality because no appeal against those orders was filed by Revenue or by assessee. Therefore, in the facts and circumstances of this case, a specific order under s. 163(2) was required to be passed by the ITO.

Cases referred to

CIT vs. Balapur Sugar & Allied Industries Ltd. 141 ITR 404 (Bom)

CIT vs. Express Newspapers (P) Ltd. 111 ITR 347 (Mad)

CIT vs. S. G. Sambandam & Co. 242 ITR 708 (Mad)

H L Sud ITO vs. Tata Engineering & Locomotive Co. Ltd. 71 ITR 457 (SC)

Harakchand Makanji & Co. vs. CIT 16 ITR 119 (Bom)

4. Non Resident UAE Bank – Computation of profits of Branch in India – Whether to be determined in accordance with tax laws of India – Whether subject to all restrictions on allowance of various business expenses – Whether it is discriminatory to levy tax on Indian PEs of Foreign Banking Companies. Sections 36, 37(1), 37(2A), 37(3) and 43B of IT Act and Articles 7, 24, 25 & 26 of India – UAE Tax Treaty

Mashreqbank PSC vs. Deputy Director of Income-tax (International Taxation), [2007] 14 SOT 1 (Mum.) Assessment Year 1996-97

Assessee, a non-resident banking company incorporated in UAE, was carrying on business in India through its PE and was assessable to tax in India in respect of profits attributable to PE. The A.O. disallowed some of expenses claimed by assessee under sections 37(2A), 37(3) and 43B and also made certain addition to income of assessee under sections 36(1)(va) and 40A(3)

It was held that the profits attributable to PE of assessee in terms of article 7(3) would have to be determined in accordance with domestic laws of India and all restrictions on allowance of various business expenses, as contained in Act, would, accordingly, apply.

Unless there is a specific provision to effect that restrictions under domestic tax laws on deduction of expenses are to be ignored, same would have application in computation of profits of permanent establishment (PE). Whether limitations under domestic tax laws are to be taken into account for purposes of computing profits of a PE under article 7(3) of India-UAE Tax Treaty.

Just because Indian PEs of foreign banking companies are taxed at a rate higher than rate at which Indian co-operative societies carrying out same business activity are taxed, provisions of article 24(2) of India-UAE Tax Treaty dealing with non-discrimination in taxation of PE, cannot be invoked.

Facts

1. The assessee, a non-resident banking company incorporated in the United Arab Emirates (UAE), was carrying on business in India through its permanent establishment (PE) and was assessable to tax in India in respect of the profits attributable to the PE.

2. For the assessment year 1996-97, the Assessing Officer disallowed some of the expenses claimed by the assessee under sections 37(2A), 37(3) and 43B and also made certain addition to the income of the assessee under sections 36(1)(va) and 40A(3).

3. On appeal, the assessee contended that in view of the provisions of article 7(3) of India-UAE Tax Treaty, all expenses attributable to business carried on in India by the assessee were allowable as deduction, without restricting the allowance of such expenses under various provisions of the Act.

4. The Commissioner (Appeals) held that the profits attributable to the PE of the assessee in terms of article 7(3) would have to be determined in accordance with the domestic laws of India and all restrictions on allowance of various business expenses, as contained in the Act, would, accordingly, apply.

5. Further, the assessee claimed that its income was chargeable to tax at the rate of 46%. The A.O. charged to tax the assessee's income at the rate of 55%, the rate applicable to the foreign companies. On appeal, the Commissioner (Appeals) upheld the impugned order. Before the Tribunal, the assessee contended that in view of article 26 of the tax treaty, i.e., non-discrimination clause, read with section 90(2), the business income is chargeable to tax at the rate or 46% as is applicable to domestic companies.

Decision

On Second Appeal, the Tribunal held in favour of the Revenue as follows:

1. Article 25(1) of the India-UAE Tax Treaty specifically provides that the laws in force in either of the contracting State will continue to govern the taxation of income in respective contracting State except where express provisions to the contrary are made in the agreement. In view of this specific provision being a part of the India-UAE Tax Treaty, it could not be said that by virtue of article 7(3) which provides that 'in determining the profits of a permanent establishment, there shall be allowed as deduction expenses which are incurred for the purposes of the business of the permanent establishment, including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere, the provisions of Income-tax Act would not apply with regard to deductibility of expenses. Following the decision of the co-ordinate bench of the instant Tribunal in the case of Dy. CIT vs. Mitsubishi Heavy Industries Ltd. [1999] 102 Taxman 301 (Delhi)(Mag.) it was held that the provisions of domestic tax laws in India as also in the UAE would continue to apply except to the extent specific contrary provisions are set out in the India UAE Tax Treaty. The assessee would, thus, derive no advantage from the provisions of article 7(3) so far as freedom from artificial disallowances under section 40A(3), section 40A(12), section 37(2A) and section 43B were concerned. As there is no specific contrary provision in the treaty, these and similar other restrictions on deductibility of expenses under the Indian Income-tax Act continue to be applicable, in computation of profits attributable to the Indian PEs of the UAE tax residents.

2. The Canadian Federal Court in the case of Utah Menes vs. Queen 92 DTC 6194, [1992] 1 CTC 306 had an occasion to deal with the question whether a tax treaty, when providing that 'in determining the profits of a PE, there shall be allowed as deduction, expenses which are incurred for the purposes of the PE, including executive and general administrative expenses so incurred, whether in the State in which the PE is situated or elsewhere enable the deduction of items not permitted by domestic law, so that non-residents are better off than residents. Even without the aid of a provision similar to one which exists in article 25(1), the Court answered this question in negative and decided the issue against the taxpayer.

3. In a situation in which a specific provision like the one in article 25(1), exists there cannot be any occasion to ignore the limitations on deduction of expenses under the domestic tax legislation. That would be a case of, what can be termed as, reverse discrimination. Just as much a discrimination against a non-resident assessee is undesirable, a discrimination against the resident assessee is also not desirable.

4. Non-taxability of any of an alien's income sourced in the host country cannot be viewed as discrimination in his favour. It is, therefore, too far fetched to suggest that availability of certain tax exemptions to aliens shows that reverse discrimination is generally permissible under the scheme of the Income-tax Act.

5. The comparison of lower tax rates u/s 115A, for the non-resident taxpayers, with higher tax rates under the Finance Act, for resident taxpayers, is irrelevant. In case of non-residents, there were restrictions for deduction of expenses incurred for earning dividend, interest and royalty incomes. When the restrictions under section 44D ceased to be effective from 1-4-2003, the corresponding income, i.e., income from royalties and fees for technical services, was also taken out of the ambit of lower tax rate u/s 115A. When tax base is not the same, the comparison of tax rates is meaningless.

6. One of the basic principles governing the interpretation of tax treaties is that a tax treaty must be interpreted in good faith. Article 31(1) of the Vienna Convention governing the interpretation of tax treaties also lays down that, 'a treaty shall be interpreted in good faith, in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its objects and purpose'. It is, therefore, important that undue emphasis should not, in any event, be given to a legalistic and literal approach in interpreting a tax treaty; the effort should always be made to harmonise the interpretation of the words of the treaty with its object and purpose. Therefore, it is not possible to proceed on the basis that a discrimination in favour of the non-resident taxpayer by the host country, without any specific provision to that effect, can be inferred. It is only elementary that a tax treaty is required to be read as a whole and, when the India-UAE Tax Treaty is read as a whole, the scheme of non-discrimination is clearly discernible from the scheme of things. It would, therefore, be quite inappropriate to read the provisions of the treaty in such a manner so as to result in discrimination against residents of one of the Contracting States; there cannot be any justification for exception to this underlying object of the treaty by reading the provisions of tax treaty in such a manner as to permit discrimination against residents of the PE host country. When a treaty explicitly seeks to ensure that there is no discrimination by the host country against a non-resident, who is resident of the other Contracting State, it is really incongruous to interpret the treaty in such a manner that host country has to discriminate against its own residents vis-a-vis the residents of the other Contracting State. Such an interpretation will not only be contrary to the provisions of the Vienna Convention but also contrary to the law laid down by the Hon'ble Supreme Court of India, which, in turn, has concurred with the Canadian Federal Court on the principles governing tax treaties.

7. Therefore, unless there is specific provision to the effect that restrictions under domestic tax laws on deduction of expenses are to be ignored, the same would have application in computation of the PE's profits. Therefore, the limitations under the domestic tax laws are to be taken into account for the purpose of computing profits of a PE under article 7(3). The plea of the assessee was incompatible with overall scheme of the tax treaties, particularly India-UAE Tax Treaty. Accordingly, the conclusion arrived at by the Commissioner (Appeals) was to be upheld.

8. The provisions of a tax treaty override domestic tax laws in India, by virtue of specific provision to that effect in the Income-tax Act. Therefore, this superior position of the tax treaties vis-a-vis domestic law is subject to the conditions so laid down in the enabling provision set out under section 90. Now, this enabling provision itself clarifies that differential tax rate between a domestic company vis-a-vis foreign company shall not be construed as discrimination against the foreign companies. To that extent, therefore, overriding effect of the tax treaty provisions is nullified, and the provisions of article 26(2) of the India-UAE Tax Treaty, have to
   be construed in the light of this limitation.

9. Therefore, just because Indian PEs of foreign banking companies are taxed at a rate higher than the rate at which Indian co-operative societies carrying out the same business activity are taxed, the provisions of article 24(2) dealing with non-discrimination in taxation of the PE, cannot be invoked. Therefore, the impugned order was to be upheld.

Cases referred

1. ITO vs. Degremont International [1985] 11 ITD 564 (Jp.)

2. Banque Indosuez [IT Appeal Nos. 2089 to 2091 (Bom.) of 1991]

3. Banque National de Paris [IT Appeal Nos. 1341 (Bom.) of 1987 and 1380 (Bom.) of 1989]

4. Dy. CIT vs. Mitsubishi Heavy Industries Ltd. [1999] 102 Taxman 301 (Delhi) (Mag.)

5. ABN Amro Bank NV vs. Asstt. DIT [2005] 97 ITD 1989 (Kol.) (SB)

6. Siemens Aktiengesellshaft vs. ITO [1987] 22 ITD 87 (Bom.) (SB)

7. Utah Mines vs. The Queen 92 DTC 6194

8. Dy. CIT vs. Boston Consulting Group Pte. Ltd. [2005] 94 ITD 31 (Mum.)

9. Union of India vs. Azadi Bachao Andolan [2003] 263 ITR 706/132 Taxman 373 (SC)

10. N. Gladden vs. Her Majesty the Queen 85 DTC 5188 (FC)

11. United Kingdon Revenue's International Tax Handbook (IH 859)

12. Chohung Bank vs. Dy. Director of Income-tax [2006] 102 ITD 45/6 SOT 144 (Mum.)

5. Company incorporated in Mauritius – Residential status – Whether control and management of affairs situated in India – Whether Resident in India – Article 4 of India – Mauritius DTAA and section 6(3) of the Income-tax Act, 1961

Saraswati Holding Corpn. Inc. vs. Deputy Director of Income-tax, International Taxation, New Delhi [2007] 16 SOT 535 (Delhi) Assessment Year 2000-01

Assessee, a company incorporated in Mauritius, made investments in Indian capital market and derived capital gain. The A.O. held that place of effective management of assessee was only in India and, accordingly, assessed capital gain in hands of assessee - However, it was found from record that control and management of affairs of assessee-company was not wholly in India as decisions regarding investments were taken only by directors of company, who were stationed at Mauritius or United States. In such circumstances, the A.O. was wrong in concluding that place of effective management of assessee was situated in India.

Facts

1. The assessee, a company incorporated in Mauritius, was a tax residence of Mauritius. It was incorporated with the purpose of carrying on business of dealing and making investment in shares and securities, etc. The assessee made investments in Indian capital market and derived capital gain.

2. The assessee claimed that the said transactions were covered by the provisions of DTAA between India and Mauritius and as per article 13 of the DTAA and Circular Nos. 682, dated 30-3-1994 and 789 dated 13-4-2000, the capital gain derived by it was not taxable in India.

3. The Assessing Officer concluded that the place of effective management of the assessee was only in India. He, therefore, treated the assessee-company as resident of India and taxed the capital gain accordingly. On appeal, the Commissioner (Appeals) confirmed the impugned order.

Decision

On Second Appeal, the Tribunal held in favour of the assessee as follows:

1. A reading of article 4(1) of the DTAA shows that to determine the residential status of an assessee in a Contracting State, one has to necessarily look into the relevant laws of that State and see if the assessee is a resident of that Contracting State within the meaning of the laws of that State. In the instant case, the assessee was a company incorporated in Mauritius. Therefore, the residential status of the assessee had to be determined on the basis of the test laid down in section 6(3)(ii) of the Act, which provides that during the previous year, the control and management of the affairs of the company should be situated wholly in India. It is only when the above test is satisfied that the provisions of article 4(3) of the DTAA would stand attracted.

2. It was not in dispute that the assessee purchased and sold shares of Indian companies through the stock markets in India through different share brokers. The assessee had authorized three persons, viz., 'M', 'S' and 'R' as its authorized representatives in India to carry on activities on its behalf through a specific power of attorney. It was in the light of the said evidence that the A.O. came to the conclusion that the place of effective management of the assessee was only in India. The reasons assigned by the A.O. were not enough even to come to a conclusion that the place of effective management of the assessee was in India. The law is well-settled that control and management of affairs does not mean the control and management of the day-to-day affairs of the business. The fact that discretion to conduct operations of business was given to some person in India would not be sufficient. The words 'control and management of affairs' refer to head and brain, which direct the affairs of policy, finance, disposal of profits and such other vital things consisting the general and corporate affairs of the company.

3. The terms of the power of attorney by which persons in India were authorized to conduct the business on behalf of the assessee merely empowered the persons in India to conduct the day-to-day affairs of the company. Further, the copy of the boards resolution filed by the assessee clearly showed that the decisions regarding investments were taken only by the directors of the company, who were stationed at Mauritius or United States. The above evidence prima facie indicated that the control and management of the affairs of the assessee was not wholly in India.

4. The A.O. did not choose to examine the persons in India, who were stated to be in effective control and management of the affairs of the assessee in India. Therefore, the reasons assigned by the Assessing Officer for coming to the conclusion that the place of effective management of the assessee was situated in India could not be sustained.

5. The assessee was not a resident in India. Therefore, the capital gain on sale of shares fell within the ambit of article 13(4) of the Indo-Mauritius DTAA and it was taxable only in the State of Mauritius. Therefore, the impugned order was set aside.

NOTE:

In this case, the Tribunal, following the order of the Delhi Bench of the Tribunal in the case of Dy. CIT vs. Finally Corpn. Ltd. [2003] 86 ITD 626, also held that the Assessing Officer was wrong in treating the money brought in by the assessee for purchase of investments from time-to-time through international banking channels as unexplained cash credit under section 68, as there was no basis for coming to the conclusion that any income of the assessee accrued, arose or was received in India.

Cases referred

1. Shiva Kant Jha/Azadi Bachao Andolan vs. Union of India [2002] 122 Taxman 952 (Delhi)

2. Union of India vs. Azadi Bachao Andolan [2003] 263 ITR 706/132 Taxman 373 (SC)

3. Dy. CIT vs. Finlay Corpn. Ltd. [2003] 86 ITD 626 (Delhi)

6. Non Resident Company – Acquired shares in Indian company prior to 1-4-1981 – Sold the shares – Computed Capital Gains by adopting Fair Market Value (FMV) as on 1-4-1981 by exercising option available u/s 55(2)(b)(i) – Whether correct

Alcan Inc. vs. Deputy Director of Income-tax (International Taxation) Mumbai [2007] 16 SOT 8 (Mum.) Assessment Year 2001-02

Assessee, a non-resident company, which had acquired certain shares of an Indian company prior to 1-4-1981, sold said shares The assessee, in exercise of option available u/s 55(2)(b)(i) adopted fair market value of shares as on 1-4-1981 as cost of acquisition of such shares for computing capital gain/loss arising on transfer of said shares. The Tribunal held that the assessee had rightly exercised option available u/s 55(2)(b)(i).

Facts

1. The assessee, a non-resident company, acquired certain shares of an Indian company prior to 1-4-1981 in Canadian dollars.

2. The assessee sold the said shares. The assessee, for working out the capital gains arising on sale of said shares, adopted the fair market value [FMV] of the shares as on 1-4-1981 as the cost of acquisition of such shares under section 55(2)(b)(i).

3. The A.O. held that the assessee in respect of shares acquired prior to 1-4-1981 could not take the benefit of FMV provided in section 55(2)(b)(i), because the assessee was a non-resident and being a non-resident, it was required to compute the capital gain in terms of the foreign currency conversion as per first proviso to section 48. In other words, the A.O. held that the capital gains in the case of assessee being a non-resident had to be computed on conversion of the foreign currency and simultaneously the assessee could not avail the benefit of FMV as on 1-4-1981. On appeal, the Commissioner (Appeals) confirmed the impugned order.

Decision

On Second Appeal, the Tribunal held in favour of the assessee as follows:

1. Section 55 deals with the meaning of expressions 'adjusted', 'cost of improvement' and 'cost of acquisition'. These definitions have been given in section 55 for the purpose of sections 48 and 49. Section 48 deals with the mode of computation and section 49 refers to cost with reference to certain modes of acquisition. Therefore, these provisions are machinery provisions meant for computing the capital gains under different circumstances. Therefore, sections 48, 49 and 55 are not charging sections.

2. Section 55(2) deals with the cost of acquisition for the purpose of sections 48 and 49. Sub-clause (i) of section 55(2)(b) deals with the capital asset which became the property of the assessee before 1-4-1981. In such cases, the law provides that the cost of acquisition of the asset can be taken as the FMV of the asset as on 1-4-1981 or at the actual cost incurred by the assessee, at the option of the assessee. This option is really given to an assessee to come out of an unfair situation. That is, in respect of assets acquired in the old past, if a reasonable value is not assigned to it as cost of acquisition, the cost would always be the historical cost for which the assets were acquired, which would be having no relevance at all in a contemporary computation of capital gains. Therefore, to bring out such assets acquired long back in the past, the law has provided the assessee to opt for the FMV as on 1-4-1981 if it is beneficial to it so that the said value would be more reasonable and realistic. This option is an independent provision provided by the statute in section 55. It is independent of section 48. Section 48 deals with the mode of computation. Section 55 deals with the meaning of cost of acquisition which is only one limb in the computation. The difference is obvious. It is only after working out the cost of acquisition within the meaning of section 55 that the capital gains could be computed under section 48.

3. First proviso to section 48 permits a non-resident to compute the capital gain, after converting the concerned variables into the foreign currency in which the shares were first acquired. This facility of conversion is provided for the reason that the conversion rate difference between Indian currency and foreign currency is different from currency to currency and fluctuate from time to time and is not stable and also not comparable. Therefore, if no conversion is made and the capital gain is computed in Indian currency, the computation would not reflect the 'real capital gain'. If the facility of currency conversion is not available and if the capital gain is computed throughout in Indian currency, the computation would be distorted and unrealistic. It is a rule of income taxation that what is to be taxed is real income. For that matter, capital gain is also treated as income. Accordingly, it is necessary that what is assessed is real capital gain. It is for that purpose that proviso to section 48 is provided in this section. The said proviso does not restrict or undo the option available to an assessee under section 55(2)( b)(i). They are operating in two different realms.

4. The plain reading of the language of the provisions contained in section 55, nowhere makes the said section 55 subservient to section 48. In fact, section 55 defines the value of the variables necessary for computing the capital gain as provided in section 48.

5. Therefore, the assessee was entitled to the benefit of the option available under section 55(2)(b)(i) and the assessing authority was to be directed to compute the capital gains attributable to the shares acquired by the assessee-company before 1-4-1981 after giving the benefit of FMV as on 1-4-1981.

[The Tribunal also held that –

1. On capital gains arising on sale of aforesaid shares, the assessee was required to pay capital gains tax at the concessional rate of 10% under section 112(1) and the Assessing Officer was wrong in charging the same @ 20%

2. Following the decision of the Tribunal in the case of Heinrich De Feries GmbH vs. Joint CIT [2006] 281 ITR (AT) 18, it was to be held that in the case of bonus shares issued prior to 1-4-1981, the assessee had the option to take the cost of acquisition at the fair market value as on 1-4-1981.]

Cases referred

1. Novartis AG Basle vs. Asstt. CIT [IT Appeal No. 537 (Mum.) of 2002]

2. University Superannuation Scheme Ltd., In re [2005] 275 ITR 434/145 Taxman 141 (AAR - New Delhi)

3. Heinrich De Fries GmbH vs. Joint CIT [2006] 281 ITR (AT) 18 (Mum.)

7. Reimbursement of expenses to a non–resident without an element of income – Whether liable to TDS u/s 195 – Held : No

ACIT vs. Modicon Network (P.) Ltd. [2007] 14 SOT 204 (Delhi) Assessment Year 1998-99

The assessee-company was created as a joint venture vehicle of three companies, which formed a consortium for purpose of bidding for operation GSM-based cellular services in India. Respective consortium members undertook to bear their own pre-bid expenses till such time bid was successful, which were to be reimbursed out of capital of assessee-company – HK company incorporated in Hong Kong, which was one of three companies, had engaged services of another consultancy agency to draw up pre-bid documents. The assessee reimbursed to HK company, amount paid by it to consultancy agency. The Tribunal held that since there was no income element in remittance made by assessee to HK company, assessee was not required to deduct tax at source u/s 195 from amount remitted to HK company.

Facts

1. The assessee-company was created as a joint venture vehicle of three companies, viz., 'M' (a company incorporated in India), 'HK' (a company incorporated in Hong Kong), and 'MI' (a company incorporated in the USA) which formed a consortium for the purpose of bidding for operation GSM-based cellular services in India.

2. The respective consortium members undertook to bear their own pre-bid expenses till such time the bid was successful. The understanding was that as soon as the joint venture vehicle was created, the respective members of the consortium would become entitled to get their share of the pre-bid expenses reimbursed out of the capital of the assessee-company.

3. Since the HK company lacked the expertise to draw up the pre-bid documents, it had engaged the services of another consultancy firm. The consultancy firm, therefore, rendered services to the assessee-company. The HK company, therefore paid certain amount to the consultancy agency and raised an invoice for the amount on the assessee-company, under the terms of the consortium arrangement, to get reimbursed.

4. The assessee-company was permitted by the RBI to make a remittance to the HK company. The assessee, thereafter, made an application under section 195(1) to the A.O. seeking permission to remit the amount without deduction of income-tax and also submitted before the that since the amount was being remitted only towards reimbursement of pre-bid expenses, there was no income element embedded therein and that the remittance could not also be considered as fees for technical services ('FTS') because no technical services of any kind were rendered by the HK company.

5. The A.O. refused to accept the claim of the assessee on the grounds that the provisions of section 9(1)(vii), read with Explanation 2 thereto, defining the expression 'fees for technical services' were applicable to the case and that the assessee-company was getting the technical services through the HK company which was acting as its agent in Hong Kong and had made the payment on behalf of the assessee-company. He, therefore, held that the payments made by the assessee to the HK company towards professional and consultancy fees to the consultancy agency would be treated as income and tax would be charged @ 30% as per section 115A.

6. On appeal, the Commissioner (Appeals) upheld the action of the Assessing Officer. He, however, held that the assessee was liable to deduct tax under section 195(1) only on the income embedded in the remittance and that the Assessing Officer was not right in directing the assessee to deduct tax at 30% on the entire amount remitted. He estimated the income element embedded in the remittance at 20% of the same and directed tax to be deducted at 30% on 20% of the amount remitted.

Decision

On appeal by the Revenue, the Tribunal held in favour of the assessee as follows:

1. Under section 195(1), the obligation to deduct tax is only with reference to the income element embedded in the remittance.

2. The main question that arose for consideration in the instant case was as to whether the amount remitted by the assessee to the HK company contained any income element so as to fasten liability upon the assessee to deduct tax thereon at the appropriate rate. The A.O. had taken the view that the amount represented FTS in terms of Explanation 2 below section 9(1)(vii) and, therefore, the assessee was liable to deduct the tax. A look at the above Explanation shows that it contains a definition of FTS and says that FTS means any consideration for the rendering of any managerial, technical or consultancy services including the provision of services of technical or other personnel, but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head 'Salaries'. The content of the Explanation unmistakably is that the payment must be made as quid pro quo for such services rendered as have been enumerated therein. It postulates that the remitter of the amount has received the benefit of the technical services and that the technical services have been rendered by the recipient of the amount.

3. In the instant case, the HK company had not rendered any services, let alone technical services, to the assessee-company for which the amount was remitted. The services were rendered by a consultancy firm engaged by the HK company. The HK company paid the consultancy agency and sought reimbursement of the same from the assessee-company in terms of the consortium arrangement. Thus, the amount remitted by the assessee-company was only by way of reimbursement of the expenses incurred by the HK company and not by way of consideration for rendering any services which were technical services.

4. There was no evidence on record to show that the HK company and the agency firm engaged by it were connected in any manner or that the entire transaction was a pre-planned or pre-meditated arrangement devised in order to avoid the provisions of tax deduction at source. Therefore, it could not be said that the remittance was, in truth and reality, consideration for technical services disguised as reimbursement of the expenses.

5. In the very nature of things, reimbursement of expenses cannot be considered as having an income element embedded therein so as to attract section 195(1). If under a bona fide arrangement, there is a provision for reimbursement of expenses to the parties, which they incur in furtherance of a common objective, such reimbursement cannot be considered as bearing the character of income. In the instant case, there was no dispute about the genuineness or bona fide of the terms of arrangement between the partners of the consortium. Since the HK company lacked the expertise to draw up the pre-bid documents, it had to engage the services of another consultancy firm. It paid the consultancy firm and raised an invoice for the amount on the assessee-company, under the terms of the consortium arrangement, to get reimbursed. The argument of the department was that the nature of the remittance as FTS did not change merely because the HK company had to engage another agency to prepare the pre-bid documents. The argument could not be accepted having regard to the objective of the consortium and the agreement between the partners of the consortium to the effect that the pre-bid expenses incurred by them would be reimbursed by the joint venture vehicle. The reimbursement per se cannot bear the character of income. Thus, the preliminary question, namely, whether the amount remitted would in its entirety or partly be considered as income of the HK company had to be resolved in favour of the view that it being a mere reimbursement, it could not be so considered.

6. The evidence brought on record by the assessee showed that what it wanted to remit abroad to the HK company was only by way of reimbursement without any element of profit or income embedded therein. No material had been brought on record to show that the expenses included an income element.

7. Section 44D had no relevance in the instant case, as it is concerned with the computation of income by way of royalties, etc., in the case of foreign companies. It is relevant at the assessment stage and not at the stage of remittance. The reference made by the revenue in the course of arguments to the fact that the investment by the HK company in the assessee-company was routed through a Mauritian subsidiary, did not turn the case in any manner in favour of the revenue.

8. Since there was no income element in the remittance made by the assessee to the HK company, the orders of the lower authorities were to be set aside.

Cases referred

1. Transmission Corpn. of AP Ltd. vs. CIT [1999] 239 ITR 587 (SC)

2. CIT vs. Industrial Engg. Projects (P.) Ltd. [1993] 202 ITR 1014 (Delhi)

3. Hyderabad Industries Ltd. vs. ITO [1991] 188 ITR 749/59 Taxman 202 (Kar.)

4. CIT vs. Neyveli Lignite Corpn. Ltd.[2000] 243 ITR 459/109 Taxman 36 (Mad.)

5. DECTA, In re [1999] 237 ITR 190/103 Taxman 525 (AAR)

6. Rolls Royce India Ltd. vs. ITO [1988] 25 ITD 136 (Delhi)(TM)

7. CIT vs. S.G. Pgnatale [1980] 124 ITR 391/4 Taxman 79 (Guj.)

8. SEDCO Forex International Drilling Inc. vs. Dy. CIT [2000] 72 ITD 415 (Delhi)