TAX SCOUT FOREWORD A QUARTERLY UPDATE ON RECENT DEVELOPMENTS IN TAXATION LAW

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1 TAX SCOUT A QUARTERLY UPDATE ON RECENT DEVELOPMENTS IN TAXATION LAW JANUARY MARCH 2017 FOREWORD May 11, 2017 We are delighted to present to you, the latest issue of the Tax Scout, our quarterly update on recent developments in the field of direct and indirect tax laws for the quarter ending March The introduction of GST is now just round the corner with the enactment of the CGST Act, IGST Act, UTGST Act and GST Compensation Act. This time, as a part of the Cover Story, we have discussed at length the impact of the GST on business transfer arrangements. The article details out the key changes that GST is set to bring about on various business transfer arrangements, and also highlights the concerns that may arise thereto. Additionally, we have also analyzed some of the important rulings by the Indian judiciary and certain key changes brought about by way of circulars and notifications in the direct and indirect tax regimes during the March quarter. We hope you find the newsletter informative and insightful. Please do send us your comments and feedback taxscout@cyrilshroff.com. Regards, Cyril Shroff Managing Partner Cyril Amarchand Mangaldas cyril.shroff@cyrilshroff.com 2017 Cyril Amarchand Mangaldas

2 INDEX Cover Story Impact of GST on Business Transfer Arrangements 04 Case Law Updates - Direct Tax Ÿ Gains on indirect transfer of shares liable to capital gains tax 09 Ÿ Payments received by a non resident from its Indian agents for global telecommunication facility did not constitute FTS 12 Ÿ Loan received by HUF from a company taxable as deemed dividend 14 Ÿ Depending on the activities undertaken by a liaison office, it could constitute fixed place PE and agency PE 17 Ÿ Section 14A not applicable where the securities were held for trading purposes and not for earning interest or dividend, which were only incidental benefits 23 Ÿ Amount received from assignment of patent is taxable as capital gain and the cost of acquisition to Ÿ be taken as nil 26 Lower rate of tax specified in the certificate issued under section 197 cannot be restricted to the amount specified therein 28 Ÿ Retention money cannot be taxed as income 30 Ÿ Profit earned by airlines from their participation in a pool is not taxable in India under the India- Germany and the India-Netherlands DTAA 32 Ÿ Depreciation on buildings not allowable to lessee, although lessee has reimbursed the construction costs 34 Case Law Updates - Indirect Tax Ÿ Service tax cannot be levied on services in relation to marketing, promotion and organization of lotteries in the absence of mechanism for computation of consideration 37 Ÿ Representational rights must be conferred, along with other rights, in order to constitute franchise service for charging service tax 39 Ÿ Post sale discount through issue of credit notes to reimburse the balance of sale price to be included in taxable turnover 41 Ÿ Time bound software and beta software are not same as a fully packaged product software 43 Ÿ Levy of excise duty basis the production capacity is not unreasonable or arbitrary 45 Ÿ Foreign going vessel entering into the Indian territorial waters for repairs is not an import for home consumption 48 Ÿ Self-funded Board, even though established under a statute, is not a statutory or public authority 50 Ÿ Levy of luxury tax would arise only on the enjoyment of luxury and not on mere provision of facility which could be termed as luxury 52 Ÿ Entry tax rates have nexus with local sales tax/ VAT rates 55 Non Judicial Updates - Direct Tax Ÿ Applicability and scope of General Anti- Avoidance Rules 58 Ÿ Signing of Protocol to amend the India-Israel DTAA 60 Ÿ CBDT issues guiding principles for determination of Place of Effective Management 61 Ÿ Guidelines for waiver of interest under Section 201(1A) of the IT Act 64 Ÿ Clarification on transfer of unlisted shares by SEBI registered AIF (Category I and II) 65 Ÿ CBDT issues clarifications on Income Computation and Disclosure Standards 66 Ÿ Amendments to the Finance Bill, Glossary Cyril Amarchand Mangaldas

3 COVER STORY Cyril Amarchand Mangaldas

4 IMPACT OF GST ON BUSINESS TRANSFER ARRANGEMENTS The introduction of GST is the biggest tax and business reform that India will see since the implementation of the New Economic Policy of With the receipt of assent of the Hon'ble President of India to CGST Act, IGST Act, UTGST Act and GST Compensation Act (collectively referred to as GST Law ), and the push for the States to pass their GST legislations by end of May 2017, the GST regime finally seems to be all set for its roll out by July 01, India being a developing economy with progressive reforms being brought in, business transactions in the nature of mergers, acquisitions, amalgamations, demergers, etc., are bound to continue on a wide scale. Therefore, it is pertinent for the businesses to understand the impact of the GST Law on such transactions. Accordingly, this article intends to provide an overview of implications of the GST Law on such business transfer arrangements, while attempting to highlight certain unresolved / new issues that may arise under the GST law in relation thereto. Transfer of Business Most business transfers in India are undertaken by means of mergers / amalgamations / acquisitions / demergers etc. Depending on the business strategy and commercial understanding between the parties, business transfers are executed either by way of an itemised / asset sale or transfer of business as a going concern (slump sale). Itemised/Asset sale In the present Indirect Tax regime, an itemised sale of business assets is treated as a sale of goods, and accordingly, is governed by the State specific VAT legislations or CST Act, as the case may be. In such a transaction, the transferee is not liable for the past obligations and liabilities of the transferor in respect of such supplies in the present Indirect Tax regime. Under the GST regime, clause (a) of Entry 4 of Schedule II to the CGST Act provides that the transfer of goods forming a part of assets of the business would be considered as a supply of goods, whether or not for a consideration. Further, in terms of Entry 1 of Schedule I to the CGST Act, a permanent transfer or disposal of business assets, where input tax credit has been availed on such assets, is deemed to be a taxable supply, even if made without any consideration. Accordingly, where such a transaction is undertaken by way of an itemized sale irrespective of whether any consideration has been received by the supplier in lieu of the business assets being transferred, such transaction would be taxable under the GST regime. It is noted that where the transfer of business asset is undertaking without a consideration, the value of such supply would be determined in accordance to the draft GST Determination of Value of Supply Rules, 2017 ( Draft Valuation Rules ) for the purpose of levy of GST. Rule 1 of the Draft Valuation Rules provides for the valuation of supply where the consideration is not wholly in money. In terms of the said Rule, the value of supply would be the open market value of such supplies. However, if the open market value of such supply is not determinable, the value of supplies of like kind and quality can be considered for the valuation of such supply. If the value is still not determinable, one may determine the value in accordance with the residuary provisions i.e. Section 4 and 5 of the Draft Valuation Rules. At this juncture, it is pertinent to note that the Draft Valuation Rules have not yet been approved by the Central Government. Presently, the Draft Valuation Rules have been published by the GST Council for general public review and comments. Hence, the Draft Valuation Rules are subject to changes introduced in the final Draft Valuation Rules passed by the Government. Credit availability in case of asset sale Under the GST Law, Section 16 of the CGST Act provides that every registered person would be entitled to avail the credit of input tax charged on supply of goods or services, subject to the conditions prescribed therein. It may be noted that the input tax credit is also available on the business assets transferred before the date of GST coming into force (appointed date) under Section 140 of the GCST Act, subject to the conditions mentioned thereunder Cyril Amarchand Mangaldas

5 Further, in terms of Section 18(1)(d) of the GCST Act, where the exempt supply by a registered company becomes a taxable supply, such company would be entitled to avail input tax credit of taxes paid on inputs received and lying in its stock, in relation to such exempt supply. However, it is pertinent to note that under the GST regime, the input tax credit would not be available on the taxes paid on the inputs received by a company in relation to a taxable supply under the current regime, where such a taxable supply becomes subsequently exempt under the GST regime, except where such output supply is in the nature of a zero-rated supply. Supply of goods between related parties The VAT legislations of most States do not contemplate for a fair market valuation of transactions even in cases of related party transactions. Under the GST law, a supply between the related parties finds a specific mention in Section 15(1) of the CGST Act. In terms of the said provision, the value of the supply would be considered as the transaction value only when the parties are not related. Therefore, all related party transactions would be scrutinized to verify whether the price is set at an arms length pricing. If it is not so, then the valuation of such supply would need to be determined in accordance with the Draft Valuation Rules. Consequently, under the GST regime, every company is required to maintain the proper documentation for each transaction undertaken with a related party, in order to demonstrate that the arms length pricing for such supplies. Supply of goods for nominal value Presently, VAT treatment of transfer of goods at a nominal value differs from State to State. Under the current VAT regime, the VAT legislations of some of the States such as Delhi, Arunachal Pradesh, etc., contemplate the requirement of a fair market valuation of goods transferred to a related party for a nominal value. However, in many States, even where certain goods are transferred at a nominal value, the transfer would be completed without any valuation concerns, provided such a transfer is not between related parties. Under the GST regime, in terms of Section 15(1) of the CGST Act, for all the transactions, where the transfer of goods is undertaking between unrelated parties and price is the sole consideration, the transaction value (price) would be the consideration for such a supply. Accordingly, where the goods are transferred for a nominal value, the parties being unrelated and the value being the sole price for such supply, GST would be levied on the transaction (nominal) value without any valuation concerns. In any other scenario, where the parties are related or/and price is not the sole consideration, the Draft Valuation Rules would get attracted. However, it is pertinent to note that Question No. 9 of Chapter 6 of the Frequently Asked Questions released by the Central Board of Excise and Customs on March 31, 2017 ( FAQ ) provides that the Draft Valuation Rules would be applicable in three cases, which interalia includes a situation where the transaction value declared is not reliable. The terms used in the FAQ i.e. not reliable are very wide and vague terms. This is capable of potentially covering all such scenarios where the price may seem to be disproportional vis-avis the fair market value of the concerned asset, including a scenario where it may be the sole consideration between unrelated parties. Accordingly, the bare perusal of the aforesaid FAQ gives an impression that all cases of supply for nominal value (even where the parties are unrelated and no other consideration is derived from the recipient), the valuation would have to be determined in accordance with the Draft Valuation Rules. However, this does not seem to be the intention of the GST legislations. Therefore, although the FAQ does not have any binding value, it raises a doubt with respect to the determination of value in supplies between unrelated parties for nominal value. This would lead to interpretational issues at the time of such transactions and be the root cause of litigation, for years to come. Therefore, a clarification in this regard from the Central Government or GST Council is much required to remove such doubts. Transfer by way of slump sale Presently, slump sales are outside the ambit of Indirect Taxes, and therefore, are not eligible to tax. Similarly, under the GST regime also, the transfer of business as an ongoing concern has been expressly excluded from the ambit of supply of goods by virtue of clause 4(c) of the Schedule II to the CGST Act. Thus, the position in relation to transfer of a business undertaking on a going concern basis would continue Cyril Amarchand Mangaldas

6 to remain the same and would be outside the GST net as well. Transfer of unutilised credit and liabilities Under the current Indirect Tax regime, a company proposing to transfer its business across various States in India has to do a State-by-State analysis of the provisions under each State's VAT legislations in relation to transfer of Input Tax Credit, successor liabilities etc. In addition, the procedure for the transfer of unutilized Cenvat Credit of Service Tax/Excise Duty and successor liabilities under Service Tax and Excise laws also needed to be considered and analyzed. Further, companies are also required to obtain permission from the concerned authority for transfer of unutilised Cenvat 1 credit under Rule 10(4) of the CCR. Whereas under the GST regime, the transferor of business would be allowed to transfer the unutilised credit lying in the books of the business being transferred as a whole to the transferee, subject to the fulfilment of the following conditions. a) The transferor is required to furnish the details of the transaction, i.e. sale, merger, demerger, amalgamation, transfer of business etc., electronically on the common GST portal in the prescribed form. In case of demerger, the input tax credit shall be apportioned in the ratio of the value of assets of the new units as specified in the demerger scheme. b) Submission of a certificate from a practising chartered accountant or cost accountant certifying the sale, merger, demerger, amalgamation, transfer of business etc., has been done with a specific provision for transfer of liabilities; c) The transferee shall on the common GST portal accept the details furnished by the transferor; d) The inputs and the capital goods transferred are duly accounted for by the transferee in his books of account. Accordingly, companies would not be required to do separate analysis of the VAT legislations in specific States as well as under the CCR. The GST laws also take away the additional burden of obtaining permission from the concerned authority in order to transfer the unutilised credit which, in usual circumstances, would take around 3 months. The GST regime, thus, provides for seamless and speedy transfer of unutilised credit. Successor liabilities Under the current Indirect Tax regime, disparity exists in relation to successor liabilities. In terms of certain VAT legislations, the either the transferor or the transferee alone is accountable in relation to any pending liabilities upto the date of transfer of business. While under other States VAT legislations, the transferor and the transferee are jointly and severally liable in this regard. The above differential treatment across States is not discernible under the GST regime. As per Section 85 of the CGST Act, both the transferor and the transferee shall be jointly and severally liable to pay tax, interest or penalty due up to the time of such transfer. The said provision would therefore, bring clarity in relation to the liabilities of the parties to a business transfer transaction undertaking by way of a slump sale. Consequently, the department would have the discretion to initiate the proceeding against any or both of the parties to recover the dues under the GST regime. Court approved business transactions The GST regime brings in the much needed clarity on the contentious issue in relation to the treatment of transactions undertaken between the parties during the period between the effective date, and the date of the order of court setting such the effective date retrospective, in such cases. It has been provided under the Section 87 of the CGST Act that where two or more companies have amalgamated or merged in pursuance to the order of a court or tribunal or otherwise, and if the order of the court is to take effect from a date earlier to date of such order, the companies shall be liable to pay tax on their respective supplies to and from each other incurred d u r i n g t h e i n t e r i m p e r i o d b e t w e e n t h e commencement date of order (effective date) and the day when the order was passed. Effect on ongoing business transfer agreements In terms of Section 142(10) of the CGST Act, any ongoing transaction wherein the contract has been signed before the date of GST coming into force (appointed date) but supply of goods takes place after the appointed date, shall be governed by the new laws under GST regime. However, in terms of Section 1 As per Rule 10(4) of the Cenvat Credit Rules, 2004, the Relevant Authority shall allow the transfer of credit within three months of application Cyril Amarchand Mangaldas

7 142(11)(a) and (b) of the CGST Act, it is also provided that where applicable taxes under the previous VAT legislations or Service Tax law were leviable, no tax would be payable under the GST regime. It is important to note here that the language used is tax leviable and not tax paid. Accordingly, there may be a scenario of double non-taxation in a case where taxes which were leviable under the current VAT or Service Tax regime, were unpaid by the assessee. Such a scenario may lead to aggressive interpretation by the assessees resulting in endless litigations, and revenue loss to the government. Conclusion On a concluding note, it appears that most of the current issues revolving around business transfer arrangements may get resolved under the GST regime. However, it may be noted that that certain new issues, such as payment of taxes on ongoing transaction, valuation etc., may come to the forefront and are likely to disrupt the smooth execution of such business transfer transactions. Therefore, it is of utmost importance that these issues are addressed at the outset by the GST Council so as to ensure that the law is build up on a sound and robust foundation. Despite the above, the introduction of GST is an evolutionary change which is absolutely welcome, and the Indian businesses must keep a close watch thereon and be cognizant of the developments in this sphere Cyril Amarchand Mangaldas

8 CASE LAW UPDATES - DIRECT TAX Cyril Amarchand Mangaldas

9 GAINS ON INDIRECT TRANSFER OF SHARES LIABLE TO CAPITAL GAINS TAX 2 In the case of Cairn UK Holdings Limited, the Delhi ITAT upheld the retrospective application of the amended section 9(1)(i) of the IT Act and confirmed the demand of capital gains tax arising on account of indirect transfer of shares of Indian subsidiaries. FACTS Cairn UK Holdings Limited ( Assessee or CUHL ), a UK tax resident, had entered into a share exchange agreement with Cairn Energy Plc (Scotland) ( CEP ), under which CUHL issued shares on June 30, 2006 to CEP against the entire issued share capital of the nine subsidiaries of CEP, which were engaged in the business of oil and gas in India ( Subsidiaries ). Subsequently, CUHL entered into a share exchange agreement with Cairn India Holdings, (incorporated in Jersey) ( CIHL ), whereby, CIHL issued shares on August 7, 2016 to CUHL in exchange for the shares of the Subsidiaries. Consequently, CIHL became the wholly owned subsidiary of CUHL and the new holding company of the Subsidiaries. In addition, on September 1, 2006, a debt conversion agreement was also entered into, on the basis of which a debt owned by Cairn Energy Hydrocarbon Limited to CEP was assigned to CUHL, in consideration for issuance of shares. Subsequently, this debt was further assigned to CIHL against issuance of shares. Thereafter, on September 15, 2006 and October 12, 2006, the Assessee sold all the shares of CIHL to a newly formed group company in India, i.e., Cairn India Ltd. ( CIL ) through subscription and share purchase agreement, the consideration for which was paid partly in the form of shares and partly in cash. By virtue of purchase of 100% shares of CIHL from CUHL, CIL acquired the entire Indian business of the group. The IRA conducted a survey at the office premises of CIL and found documents in relation to the internal restructuring. Upon analysing of the documents, the AO initiated re-assessment proceedings pursuant to which held that CUHL is liable to pay tax in India on the capital gains arising from transfer of shares of CIHL to CIH, by retrospective application of the amended section 9(1)(i) of the IT Act. The DRP accepted the view taken by the AO. Being aggrieved, the Assessee approached the ITAT. ISSUES The main issues raised by the Assessee before the ITAT were as follows: a) Whether initiation of re-assessment proceedings was valid? b) Whether the gains, if any, arising to the Assessee on account of the sale of shares of CIHL to CIL are deemed to accrue or arise in India under Section 9(1)(i) of the IT Act, therefore, chargeable to tax in India? c) Whether the Assessee was liable to pay interest under sections 234B and 234C of the IT Act? ARGUMENTS The Assessee challenged the re-opening of the assessments on various factual / technical / legal grounds namely, (i) approval for re-opening the assessment under section 148 of the IT Act was not signed by the appropriate tax authority, (ii) contrary to 3 4 the SC decision, notice for tax assessment, was issued before the disposal of objections raised by the Assessee, (iii) reasons for re-opening the assessment were not signed, (iv) information regarding the impugned transaction was available with the tax authorities during the regular assessment of CIL itself, (v) survey report was received by the tax authorities after issuance of notice for re-opening the assessment, etc. However, the tax authorities on the other hand contended that the conditions stipulated under the IT Act for re-opening assessment were satisfied. The Assessee also contended that the gains arising from the transfer of CIHL shares were not amenable to tax in India, for the following reasons: Retrospective amendment to section 9(1) of the IT Act is bad in law, as the same creates substantive rights to tax a class of persons; 2 Cairn UK Holding Limited v. DCIT (2017) 79 taxmann.com 128 (Delhi ITAT). 3 GKN Driveshafts (India) Ltd. v. ITO (2002) 125 taxman 963(SC). 4 Under section 143(2) of the IT Act Cyril Amarchand Mangaldas

10 The impugned transaction was in the nature of internal restructuring of the group companies and in absence of any increase in wealth or change in the controlling interest, no capital gains tax can be levied; No real income accrued to the taxpayer as all the assets held by the Assessee continue to remain available, albeit in a different form; 5 According to the decisions of the SC, where an asset is transferred in lieu of another asset and no specific amount for consideration is agreed between the parties, then it becomes a case of transfer by way of exchange and not sale. In the instant case, the transfer of shares of the Subsidiaries by CEP was in exchange for shares of CUHL. Similarly the transfer of shares of the Subsidiaries by CUHL in exchange for the shares of CIHL was in nature of exchange. 6 Accordingly, as per the SC, the Fair Market Value ( FMV ) of the asset received in consideration for the assets transferred should be considered as the full value of consideration for the purpose of computing the capital gains. Consequently, since there is no timing difference between the acquisition and disposal of shares, the full value of consideration should be deemed to be the cost of acquisition of shares of CIHL in hands of CUHL, resulting into no chargeable capital gains for CUHL. The India- UK DTAA provides that the capital gains may be taxed by each contracting state as per their domestic laws. Further, the domestic laws should apply as they stood on the date of notification (i.e. February 11, 1994) of the India- UK DTAA (i.e. without giving effect to the retrospective amendment of section 9 of the IT Act). The IRA contended that the shares of CIHL (being the holding company of the Subsidiaries), substantially derive their value from the assets situated in India. Therefore, the CIHL share would be deemed to be situated in India and the gains arising on transfer of such shares would be deemed to accrue or arise in India. Further, even under the India-UK DTAA, the capital gains are to be taxed in accordance with the domestic tax laws. Further, the transfer of CIHL shares was a transaction in nature of sale and the price of the shares in each agreement was identifiable; therefore there was no occasion to determine the cost of acquisition/ sale consideration at the FMV of the shares. DECISION Validity of re-opening of assessment Based on the facts, the ITAT held that the objections raised by the Assessee in relation to reopening of assessment were ill-founded and proceeded to uphold the re-opening. Challenging the retrospective amendment introduced under the IT Act 7 In view of the decision of L. Chandra Kumar, it was held that the ITAT was not the appropriate forum to challenge the vires of the provision of the IT Act. Accordingly, the contention of the taxpayer that the retrospective amendment to section 9(1) of the IT Act was bad in law was rejected. Business restructuring resulted in transfer of property As regards the contention that the impugned transaction was in nature of internal restructuring and that no capital gains arose as there was no change in the controlling interest, the ITAT observed that under the retrospectively amended 8 definition of property, the right to manage and control is a property for the purposes of the IT Act. It was noted that the shareholders of the Subsidiaries had a property of right to manage and control the Subsidiaries, through their shareholdings. Thus, the transfer of property (i.e. right to control and manage the Subsidiaries held through CIHL) for consideration paid in shares and cash, would be deemed to accrue or arise in India. Further, since the part proceeds for the transfer of property were paid by CIL through proceeds of its Initial Public Offer, it could not be said that the impugned transaction was merely in nature of internal business reorganisation. Real income accrued to the Assessee The ITAT rejected the argument of the Assessee, that no real income accrued to the Assessee on account of the impugned business restructuring, 5 CIT v. Gillander Arbuthnot and Co. (1973) 87 ITR 407 (SC) and CIT v. R.R. Ramakrishna Pillai (1967) 66 ITR 725 (SC). 6 CIT v. George Henderson and Co. Ltd. (1967) 66 ITR 622 (SC). 7 L. Chandra Kumar v. Union of India 1995 SCC (1) Section 2(14) of the IT Act Cyril Amarchand Mangaldas

11 on the grounds that the Assessee itself had booked substantial gains on account of the impugned transactions, in its financial statements. FMV of the shares cannot be considered as cost of acquisition of the shares Since there was no difference in the quantum of full value of consideration as determined by the IRA and the Assessee, the ITAT held that there was no need to adjudicate upon the issue that whether the impugned transaction of transfer of CIHL shares by CUHL to CIL was in nature of sale or exchange. As regards to the cost of acquisition of the CIHL shares, the ITAT held that merely because the consideration is not stated in monetary terms in the various agreements and deeds executed, it cannot be said that the full value of consideration as well as the cost of acquisition cannot be determined for the purpose of computing the capital gains. In the instant case, the price of the shares is identified in each of the agreements and the cost of acquisition has been also recorded in the books of accounts of CUHL. Further, there is nothing in the IT Act, which provides that in such a factual matrix, the cost of acquisition in the hands of the Assessee should be considered as the cost of the previous owner. The ITAT also rejected the argument of the Assessee that since there is no timing difference between the acquisition and disposal of shares, the full value of consideration and the cost of acquisition should be the same, as nothing has been provided under the IT Act for such treatment. DTAAs cannot make the domestic laws static The ITAT also held that the DTAAs are mechanism of avoiding double taxation and the provisions in the DTAAs cannot make the domestic law static with respect to taxability of a particular income, when both the states have left it to the domestic laws of the countries. The ITAT also clarified that where the provisions of a DTAA provide that a particular income would be chargeable to tax in accordance with the provisions of domestic laws, then such article in Tax is payable in India on capital gains arising from indirect transfers. DTAA could not have the effect of limiting the domestic tax laws. Accordingly, the ITAT held that the Assessee was liable to pay capital gains tax in respect of transfer of shares from CUHL to CIL. However, it deleted the interest liability under section 234B and 234C of the IT Act on the ground that the Assessee could not be burdened with interest liability arising out of a retrospective amendment made under the IT Act. SIGNIFICANT TAKEAWAYS This is one of the first decisions dealing with the issue of indirect transfer introduced into the IT Act through a retrospective amendment. It confirms the position taken by the IRA. This decision also clarifies that internal restructuring may not be a good defence against the indirect transfer provisions, as long as capital asset is transferred pursuant to such restructuring. However, it is pertinent to note that the Government has taken various steps to rationalize and provide clarity regarding the application of the provisions of indirect transfer. Additionally, the Government has also provided exemptions from the application of indirect transfer provisions, like exemption for small investors (holding no right of management or control of such company and holding less than 5% of the total voting power/ share capital/ interest), etc. Similar exemptions have been offered to non-resident investors, who have made investments in certain categories of FPIs through Finance Act The Government has also assured that no new cases shall be picked up by the IRA without following a rigorous internal review mechanism. As per information available in the public domain, it seems that the IRA has not really initiated any new proceedings in respect of any indirect transfers undertaken prior to the introduction of this provision. The various efforts initiated by the Government to rationalise Indian tax laws are a step in the right direction to simplify and ensure certainty and predictability. Having said this, it may be noted that this issue (i.e. retrospective application of indirect transfer provisions) is also sub-judice before the International Court of Justice under the India-UK Bilateral Investment Promotion and Protection Agreement and one may have to wait for the judgment of the International Court of Justice or the Supreme Court before this issue is finally put to rest Cyril Amarchand Mangaldas

12 PAYMENTS RECEIVED BY A NON RESIDENT FROM ITS INDIAN AGENTS FOR GLOBAL TELECOMMUNICATION FACILITY DID NOT CONSTITUTE FTS 9 In A.P. Moller AS, the SC held that payments received by the Assessee from its Indian agents for global telecommunication technology facility, common facility provided to all agents enabling to discharge their roles effectively, was in the nature of pure reimbursements and not taxable as FTS. FACTS A.P. Moller AS ( Assessee ), a tax resident of Denmark, is engaged in the shipping business. Assessee had agents in India namely, the Maersk Logistics India Limited ( MLIL ), Maersk India Private Limited ( MIPL ), Safmarine India Private Limited ( SIPL ) and Maersk Infotech Services (India) Private Limited ( MISPL ), (collectively referred to as Agents ) for booking cargo, servicing customers, etc. To assist its agents across the world, the Assessee had set up a global telecommunication 10 facility called Maersk Net System ( Maersk Net ), which enabled its agents to various informations, like tracking of cargo, transportation schedule, etc., for which the agents were paying on a pro-rata basis. According to the Assessee, the payments received from the Agents was part of a cost sharing arrangement, were in the nature of pure reimbursement of expenses. The AO did not agree with this contention of the Assessee and held that such amounts constituted FTS and hence, were taxable in India under Article 13(4) of India-Denmark DTAA. The appeal preferred by the Assessee against AO's order before the CIT(A) was dismissed. However, the 11 ITAT relying on Skycell Communications Ltd. and 12 Bharti Cellular Ltd. ruled in favour of Assessee. The 13 Bombay HC dismissed the appeal filed by IRA upholding the ITAT order that utilization of Maersk Net (automated software) did not amount to rendering of any technical services and, was merely a cost sharing arrangement in the nature of cost reimbursement 9 DIT v. A.P. Moller Maersk AS (2017) 78 taxmann.com 287 (SC). 10 Maersk Net facility consisted of a communication system connected to a mainframe and other computer services in each of the countries of operation. These were all connected to Maersk Net Connecting Point ( MCP ) which was installed in each of the premises across the world. This communication network enabled the agent concerned to access via the MCP the following services inter alia Global Customer Service System (GCSS); Global Schedule Information System (GSIS); Global Transportation Systems such as Customer Information and Cargo Tracking (Star Track) etc. 11 Skycell Communications Ltd. v. Dy. CIT (2001) 251 ITR 53 (Madras HC), wherein Madras HC held that mere collection of a fee for use of a standard facility provided to all those willing to pay for it does not amount to the fee having been received for technical services. 12 CIT v. Bharti Cellular (2009) 319 ITR 139 (Delhi HC). 13 DIT v. A.P. Moller Maersk A/S (2015) 59 taxmann.com 105 (Bombay HC). 14 DIT v. A.P. Moller Maersk A/S (2016) 76 taxmann.com 143 (Bombay HC). between the Assessee and its agents to conduct its shipping business effectively. The HC also specifically observed that there was no finding by the AO or the CIT(A) that there was a profit element involved in the payments received by the Assessee from the Agents. IRA, aggrieved by such ruling of the HC, preferred an appeal before the SC. ISSUE Whether the payments received by Assessee from its Agents for use of global telecommunication facility was in the form of FTS under India-Denmark DTAA, or such payment was only reimbursement of cost by the Agents for using the Maersk Net? ARGUMENTS/ANALYSIS The Assessee contended that Maersk Net, comprising of booking and communication software, hardware and a data communications network, constituted integral and essential part of its international shipping business. Therefore, income received by the Assessee from its Agents towards Maersk Net amounted to business income and, therefore, was not chargeable to tax in India in the 14 absence of a PE in India. It was also submitted by the Assessee that Maersk Net was installed for its agents to execute their respective functions effectively, who were appointed in various countries for documentation, booking cargo and servicing customers. Further, Maersk Net was a centralized system that enabled its agents not to maintain separate systems at their places to avoid unnecessary costs. It was also contended that the arrangement was merely a system of cost sharing and payments received by the Assessee from its Agents were merely reimbursement of expenses incurred by it in setting up and maintaining the Maersk Net system. The Assessee also argued that Maersk Net was merely an automated system using advanced Cyril Amarchand Mangaldas

13 technology and no human element was involved in the rendering of services as specified under Article 15 13(4) of India-Denmark DTAA. On the other hand, the IRA argued that since Agents were using Maersk Net, it would amount to the Assessee rendering technical services and amounts paid by them to it constituted consideration for FTS rendered and accordingly, was liable to be taxed in India under Article 13(4) of India-Denmark DTAA. The IRA also referred to agency agreement which allowed the Assessee to temporarily place its employees in Agent's office for training or other purposes. The IRA also made an additional contention that payments made by the Agents for use of Maersk Net were in nature of royalty. It was also argued that arrangement of profits was not essential to qualify receipt as income from FTS. DECISION The SC, after placing reliance on Kotak Securities 16 Limited, wherein it had been held that mere use of facility did not amount to technical services unless services rendered denote technical services catering to the special needs of the service recipient and not a facility provided to all, held that no technical service was rendered by the Assessee to the Agents as the Maersk Net was a common facility installed to assist all agents of the Assessee across the world and was not catering only to the specialised, exclusive and individual requirement of the Agents. In other words, a facility provided to cater special and exclusive needs of the seeker of the service made it technical services. Therefore, payments made by the Agents for utilization of Maersk Net could not be treated as FTS and, therefore, dismissed the appeal filed by the IRA. As IRA had already accepted the treaty benefit available to the Assessee provided under Article 9 of the India-Denmark DTAA which exempted freight income generated by Assessee as it arose from the 17 operation of ships in international waters, the SC observed that Maersk Net was an integral part of the shipping business carried on by the Assessee and costs incurred for maintenance of Maersk Net constituted expenses forming part of the profit from operation of ships under Article 9 of India-Denmark DTAA. Further, the SC noted that the payment received by the Assessee was in the nature of reimbursement of cost, without any profit embedded therein, whereby each of the Agents paid their proportionate share of expenses incurred on operation of the Maersk Net. The SC also emphasized that AO did not allege any profit element embedded in the payments received by the Assessee from the Agents. Therefore, once the character of the payment was found to be in nature of reimbursement of expenses, it could not be income chargeable to tax. SC also noted that pro-rata division of costs paid was also submitted before TPO stating that there payments were reimbursements in the hands of the Assessee and the reimbursement was accepted as such at arm's length. The SC rejected IRA's contention of payment in the nature of royalty, as the same was not projected before the Bombay HC. The SC also regarded IRA's contention that arrangement of profits was not essential to qualify receipt as income from FTS untenable, because it was established that the payment made was not for reimbursement of any technical services. SIGNIFICANT TAKEAWAYS The taxability of payments made to a f o r e i g n c o m p a n y t o w a r d s reimbursement of common expenditure has been an area full of controversies and has resulted in significant amount of litigation. While in 18 some cases, it has been held by the judiciary that mere reimbursement of expenses (with no profit element involved) would not be taxable in India, in 19 some other cases, Indian judiciary has held that consideration in respect of services provided to group companies constituted FTS even though no profit element was involved. The SC has clarified this issue to some extent by holding that payments made to a non-resident towards reimbursement of expenses, which are not in the nature of FTS, would not be chargeable to tax in India. It has also been clarified by the SC that involvement of human beings is necessary to characterize the requisite services as FTS. If no human element is involved, then even though high end sophisticated technology is involved, it will not be characterized as FTS. 15 CIT v. Bharti Cellular Ltd., [2014] 6 SCC 401 (SC). 16 CIT v. Kotak Securities Ltd. (2016) 67 taxmann.com 356 (SC). 17 DIT v. A.P. Moller Maersk A/S (2016) 76 taxmann.com 143 (Bombay HC). 18 CIT v. Dunlop Rubber (1983) 142 ITR 493 (Cal); Dampskibsselskabet v. ADIT (2011) 9 taxmann.com 165 (Mumbai ITAT). 19 Timken India Limited (2005) 273 ITR 67 (AAR). Reimbursement of global telecommunication facility costs did not constitute FTS Cyril Amarchand Mangaldas

14 LOAN RECEIVED BY HUF FROM A COMPANY TAXABLE AS DEEMED DIVIDEND 20 In Gopal and Sons (HUF), the SC held that advances received by the Assessee (HUF) from the Company would be treated as deemed dividend, as Karta of the Assessee held the shares of the Company and also had substantial interest in the Assessee. FACTS Gopal and Sons (HUF), a Hindu Undivided Family ( HUF ) ( Assessee ) had received certain loans from G.S. Fertilizers Pvt. Ltd. ( Company ). The shares subscribed by the Assessee in the Company represented 37.12% of the total shareholding of the Company. The AO taxed the loan received from the Company as deemed dividend under section 2(22)(e) of the IT Act on the rationale that the Assessee was a registered shareholder as well as the beneficial owner of the shares of the Company and it was holding more than 10% of the voting power in the Company. The position taken by the AO was affirmed by the CIT(A). The ITAT allowed the appeal filed by the Assessee, holding that the elements of section 2(22)(e) of the IT Act were not satisfied, as HUF could not be said to be 21 a registered shareholder or a beneficial shareholder. 22 On appeal by the IRA, Calcutta HC reversed the judgment of the ITAT, restoring the addition made by the AO with the observation that, the Assessee did not dispute that the Karta was a member of Assessee, which had taken the loan from the Company and, therefore, the case was squarely within the provisions of section 2(22)(e) of the IT Act. Aggrieved by the order of the Calcutta HC, an appeal was preferred before the SC. ISSUE Whether in view of the settled principle that HUF could not be a registered shareholder in a company, the advances received by the Assessee (HUF) would be deemed dividend within ambit of section 2(22)(e) of the IT Act? ARGUMENTS/ ANALYSIS 23 Relying on the C.P. Sarathy Mudaliar, the Assessee contended that HUF could neither be a beneficial owner or registered owner of the shares of the Company and, therefore, the loan received cannot be taxed as deemed dividend under section 2(22)(e) of the IT Act. Further, the shares of the Company were held in the name of the Karta of the Assessee (Gopal Sanei), and not in the Assessee's name, as shares could not be directly allotted to an HUF. Based on these contentions, it was submitted that the provisions of section 2(22)(e) of the IT Act should not be attracted and the loan advanced to the Assessee by the Company should not be considered as deemed dividend. The IRA submitted that the details of shareholders as provided in audit reports and annual return of the Company (filed with registrar of companies ( ROC )) and also from the investment details of Assessee indicated that it was the registered shareholder. Therefore, Assessee was both the registered share holder of the Company & also the beneficial owner of shares holding more that 10% of voting power (actual share holding of Assessee being 37.12%) and advances received were in the nature of deemed dividend under section 2(22)(e) of the IT Act. DECISION The SC observed that section 2(22)(e) of the IT Act is a deeming provision and has fictionally considered certain kinds of receipts as dividends, it should be given strict interpretation and, therefore, unless all the conditions stipulated under the said provision were satisfied, the receipt could not be deemed as dividends. Further, in the event two interpretations were possible, the benefit should accrue in favour of the taxpayer. The SC observed that conditions prescribed under section 2(22)(e) of the IT Act, should be satisfied to bring the payments to tax as dividends in the hands of the shareholders. It was noted that section 2(22)(e) of the IT Act applies to a company giving advance or loan to a shareholder (being beneficial owner). The said section also applies to an advance or loan made by the company to any concern in which such shareholder, is a member or a partner having substantial interest. 20 DIT v. A.P. Moller Maersk AS (2017) 78 taxmann.com 287 (SC). 21 Binal Savantilal (HUF) v. DIT (IT Appeal No (Mum) of 2011, dated October 10, 2012) (Mumbai ITAT). 22 CIT v. Gopal and sons (HUF) ITAT No. 73 of 2014 (Calcutta HC). 23 CIT v. C.P. Sarathy Mudaliar (1973) 83 ITR 170 (SC) Cyril Amarchand Mangaldas

15 The SC noted that Explanation 3(a) to section 2(22)(e) of the IT Act defines the expression concern to mean HUF or a firm or an association of persons or a body of individuals or a company, and as per Explanation 3(b) to section 2(22)(e) of the IT Act person should be deemed to have a substantial interest in an HUF, if he was, at any time during the previous year, beneficially entitled to not less than 20% of the income of such HUF. It was noted that though share certificates were issued in the name of Karta, the annual return of the Company filed with ROC indicated that money towards shareholding in the Company was provided by the Assessee. Based on this, the Assessee was noted to be the registered and beneficial shareholder. Relying on Explanation 3 to section 2(22)(e) of the IT Act, SC held in the instant case even if the Assessee was not a registered shareholder of the Company, once the payment is received by the HUF (Assessee) and shareholder (i.e. Gopal Sanei) was the member of the Assessee and he had substantial interest in the Assessee HUF, the payment made to the Assessee constituted deemed dividend under section 2(22)(e) of the IT Act. Therefore, Explanation 3 to section 2(22)(e) of the IT Act negated the argument that section 2(22)(e) could not be attracted, since HUF could not be a registered shareholder. Accordingly, the appeal was dismissed. Further, it was observed that it was not necessary to ascertain as to whether the Assessee was a beneficial shareholder or registered shareholder in the Company. The contention of the Assessee based on judgment in C.P. Sarathy Mudaliar (supra) that section 2(22)(e) of the IT Act was not attracted, since HUF was not a registered shareholder was rejected. The SC clarified that in the case of C.P. Sarathy Mudaliar relied upon by the Assessee, had no application in the instant case since it was rendered in the context of Section 2(6- A)(e) of the Income Tax Act, 1922 which did not have a provision like Explanation 3 to section 2(22)(e) of the IT Act. Loans and advances given by a company to an HUF where the HUF (or it's Karta) has a substantial interest, will be taxable as deemed dividend. SIGNIFICANT TAKEAWAYS This SC ruling brings clarity in respect of cases involving loans or advances granted to an HUF by a company wherein members of the HUF hold more than 10% of the voting power in such company. The SC, in the present case, has not only held that loan advanced to the Assessee by the Company in which it holds substantial interest was deemed dividend in hands of the Assessee, but also impliedly stated that HUF can be considered as registered shareholder of a company. The decision of SC in the present case aligns with the 24 Circular No. 495 dated September 23, 1987, which stated that it is the concern which received the loan which would be liable to tax if the prescribed conditions are fulfilled. Contrary views have been expressed in some other cases such as Bhaumik Colour (P.) Ltd., Hotel Hilltop, etc. wherein it had been held that no person other than the shareholder could be held liable to pay tax under section 2(22)(e) of the IT Act. Such decisions were arrived at based on the reasoning that deeming provisions applicable to the cases of loans or advances by a company to a concern in which its shareholder has substantial interest, is based on the presumption that advances made would ultimately be made available to the shareholders of the company who can be considered to have common source of power to control the affairs of the company as well as the concern. Further, the expression shareholder referred to in section 2(22)(e) of the IT Act in these decisions was interpreted to refer to both a registered shareholder and a beneficial shareholder. The SC also affirmed the ruling of the Calcutta HC, which in turn, had reversed the order of the Kolkata ITAT. The Kolkata ITAT had ruled in favour of the Assessee by relying on Mumbai ITAT decision in Binal 27 Sevantilal Koradia (HUF), wherein it was held that the payment received by the taxpayer (HUF), i.e. Binal S Karodia (HUF), did not attract section 2(22)(e) of the IT 24 The Circular providing explanatory notes to the Finance Act, 1987 provided as follows: The new provision would, therefore, be applicable in a case where a shareholder has 10 per cent or more of the equity capital. Further, deemed dividend would be taxed in the hands of a concern where all the following conditions are satisfied : (i) where the company makes the payment by way of loans or advances to a concern; (ii) where a member or a partner of the concern holds 10 per cent of the voting power in the company; and (iii) where the member or partner of the concern is also beneficially entitled to 20 per cent of the income of such concern. 25 ACIT v. Bhaumik Colour (P.) Ltd (2009) 118 ITD 1 (Mumbai ITAT). 26 CIT v. Hotel Hilltop [2012] 18 taxmann.com 308 (Rajasthan HC). 27 Binal Sevantilal Koradia (HUF) v. Department of Income Tax, ITA No.2900/Mum/2011, AY dated (Mumbai ITAT) Cyril Amarchand Mangaldas

16 Act as the taxpayer (HUF) was not the shareholder of the concerned company and Binal S Karodia was a share holder in his individual capacity only and, therefore, taxpayer (HUF) could not be said to be a registered shareholder or a beneficial shareholder. The reliance in Binal Sevantilal Koradia (HUF) (supra) was placed on Bhaumik Colour (P.) Ltd. (supra) wherein as discussed above, ITAT held that deemed dividend could be assessed only in the hands of a person who is a shareholder of the lender company and not in the hands of a person other than a shareholder. The reliance in Binal Sevantilal Koradia (HUF) (supra) was also placed on Hotel Hilltop (supra), wherein the Rajasthan HC held that advance paid to taxpayer firm by a company, in which the partners of the firm were shareholders, would not be deemed dividend taxable in the hands of taxpayer firm as the partners were the shareholders of the company and hence, was held to be taxable in the hands of the partners on whose behalf, or for whose individual benefit, being such shareholders, amount was paid by company to the concern. Therefore, the SC has, in some ways, reversed the decisions in the cases of Bhaumik Colour (P.) Ltd. (supra) and Hotel Hilltop (supra) Cyril Amarchand Mangaldas

17 DEPENDING ON THE ACTIVITIES UNDERTAKEN BY A LIAISON OFFICE, IT COULD CONSTITUTE FIXED PLACE PE AND AGENCY PE 23 In the case of GE Energy Parts Inc., Delhi ITAT dealt with around 139 appeals filed by the General Electric Group ( GE Group ) and disposed off the same through a common consolidated order, wherein it held that expatriates along with the assistance of employees of another Indian group entity, undertook core marketing and sales services for the GE Group through the liaison office premises of an affiliate and hence, constituted a fixed place permanent establishment ( PE ) as well as a dependent agent PE. FACTS While the Hon'ble ITAT had to deal with 139 separate appeals filed by multiple GE Group entities, since the issues involved were the same and both the taxpayer as well as the tax authorities made similar arguments and there were four major issues in all the appeals, it decided to treat the appeal filed by GE Energy Parts, Inc. as the representative of all the appeals and accordingly issued a consolidated order in respect of all these appeals. GE Energy Parts, Inc. ( Assessee ), a US incorporated entity, is a part of the GE Group, which makes equipments relating to oil and gas business, energy business, transportation business and aviation business. GE Electric International Operations Company, Inc. ( GEIOC ), another US company belonging to the GE Group, had set up a liaison office ( LO ) in India to undertake liaison activities for the GE Group and provide liaison services and marketing support services to GE Group overseas entities (collectively referred to as GE Overseas ). GEIOC has also obtained the services of certain employees working in GE India Industrial Private Limited ( GEIIPL ) and GE International, Inc. ( GEII ). Pursuant to the survey conducted at the premises of LO of GEIOC, the AO initiated re-assessment proceedings on the basis of information and documents collected during the survey proceedings, since he had formed an opinion that the activities undertaken by the Indian LO were far in excess of those sanctioned by the Reserve Bank of India ( RBI ) and such activities were that of sales and marketing in nature. The AO noted that substantial activities relating to the products of the GE Group took place in India with assistance from the expatriate employees of GEII and Indian employees of GEIIPL (collectively referred to as GE India ) from the office premises occupied by the LO. Consequently, the AO held that the LO constituted a fixed place PE ( FPPE ) and the active involvement of the employees of GE India in the conclusion of contracts on behalf of GE Overseas, constituted a dependent agent PE ( DAPE ) in India as per the provisions of the double taxation avoidance agreement entered into between India and USA ( India-USA DTAA ). Being aggrieved by AO's order, the Assessee filed an appeal with the CIT(A) who confirmed AO's order against which the Assessee approached the ITAT. ISSUES The four major issues emanating from the extant case are as follows: a) Whether initiation of re-assessment proceedings was valid? b) Whether the office premises of LO constituted FPPE of the Assessee? c) Whether GE India established a DAPE of the Assessee? d) What would be the income attributable to the Indian PE of the Assessee? ARGUMENTS/ ANALYSIS a) Re-assessment IRA's primary contention was that the GE Overseas entities were carrying out their business activities in India through the office premises of the LO and employees of GE India constituted their FPPE and DAPE respectively. They also alleged that this has been confirmed, through several incriminating documents recovered during the survey proceedings carried out at the LO premises and information and 28 GE Energy Parts Inc. v. ADIT Circle 1(2), International Taxation, New Delhi (2017) 78 Taxmann.com 2 (Delhi ITAT) Cyril Amarchand Mangaldas

18 documents collected through subsequent post survey interactions with the GE Group. They also alleged that the actual nature of activities undertaken by the GE Overseas entities was never disclosed to the IRA and most of the GE Overseas entities had never filed their tax returns in India even though they earned billions of dollars of revenue. Accordingly, IRA concluded that GE Overseas entities were carrying out full-fledged business activities in India and thus, the profits attributed to the activities carried out in India should be chargeable to tax in India and hence, the AO had reasons to believe that income chargeable to tax has escaped assessment. The Assessee on the other hand contended that activities undertaken in India were preparatory and auxiliary in nature and thus, GE Overseas did not establish any PE in India. Also, the AO had failed to produce information pertaining to the specific taxpayer for the relevant period and hence, no income could be charged to tax. It was also contended that since the price charged by GE India for the marketing support services rendered to GE Overseas entities have been accepted by the IRA to be at arm's length price ( ALP ) under the transfer p r i c i n g a n a l y s i s a n d n o a d j u s t m e n t w a s recommended, no further income can be attributed to the alleged PE of GE Overseas. Thus, initiation of re-assessment proceedings should be struck down. b) Formation of PE in India The IRA contended that expatriate employees of GEII along with the employees of GEIIPL (who were working under the supervision and control of such expatriates) were working in India for the GE Overseas entities and constituted GE India, which was involved in active marketing and negotiations. Further GE India was instrumental in securing contracts/ orders for GE Overseas entities from Indian customers. Accordingly, GE Overseas entities established FPPE and DAPE in India under the India- USA DTAA. FPPE The IRA contended that the LO premises constituted a FPPE since the office premises of the LO were being used for carrying out marketing and sales activities of GE Overseas entities. In order to further buttress its arguments, the IRA relied on the information/ documents ( including, the assignment letters, selfappraisals, correspondences with customers, etc.) collected during the pre-survey and post survey operations. Accordingly, the IRA alleged that employees of GE India were engaged in the core activities of sales and marketing and played an instrumental role in getting contracts/ orders from Indian customers. Thus, such activities cannot be construed as preparatory or auxiliary activities. On the other hand, the Assessee contended that 29 no PE was constituted in view of Article 5(3)(e) of the India-USA DTAA, as the activities carried out by GE Overseas entities from the office premises of the LO were of preparatory or auxiliary character. As such activities were more in the nature of a communication link between the head office and Indian customers. It was also contended that most of the orders placed on or contracts awarded to GE Overseas had the following four steps: (i) pre-qualification; (ii) bid/ no bid and proposal development; (iii) bid approval and negotiations; and (iv) final contract development and approval. It was submitted by the Assessee that only during the pre-qualification stage, GE India played an important role and its role diminished significantly in the later three stages as the Assessee played a more important role. It was also contended that the roles and responsibilities of some of the expatriates and Indian employees were in the capacity of support functions as they were not undertaking the relevant decisions regarding marketing and sales. DAPE The IRA contended that GE India constituted DAPE of the Assessee as it was playing a very important role in securing orders for the latter and actively participated in activities relating to negotiations during the marketing and sales of the products. Relying on Article 5(5) of the India-USA DTAA, the Assessee contended that rendering of services by the employees of GE India to multiple GE Group entities would not make it a DAPE. The IRA 29 Article 5(3)(e) of the DTAA provides that the term PE excludes the maintenance of a fixed place for undertaking activities of preparatory or auxiliary character Cyril Amarchand Mangaldas

19 countered this argument by stating that as in the instant case, transaction between GE India and the Assessee were not at ALP because the activities actually performed by GE India were never taken into consideration, hence, GE India constituted DAPE of the Assessee under Article 5(4) of the India-USA DTAA. Further, IRA contended that by virtue of GE India negotiating essential elements of sales contract for GE Overseas, it also had the authority to conclude contracts on behalf of the Assessee in India. c) Attribution of income Based on the premise that the Assessee was able to procure orders and contracts from Indian customers through active participation of GE India which 30 constituted FPPE and DAPE in India, the IRA contended that a proportion of profits should be attributable to the concerned PE in India. As GE Overseas entities did not provide details of profits earned by them from the supplies made to Indian customers, the AO estimated the profit margin at the rate of 10% of the revenue. Thereafter, following the 31 decision of the ITAT in the case of Rolls Royce Plc, which was subsequently approved by the Hon'ble 32 Delhi HC, the AO attributed 35% of the profits to the PE of the Assessee in India. The Assessee on the other hand contended that since the marketing support services provided from India have already been compensated on arm's length basis, no further attribution shall be made. It also alleged that such arbitrary attribution is not valid in law. DECISION a) Re-assessment The Delhi ITAT upheld the initiation of re-assessment proceedings by noting that a prima facie case of escaping tax assessment was established by the AO, on the basis of several incriminating documents collected from the office premises of the LO during the survey and post survey operations. Moreover, the actual activities undertaken by GE India for GE Overseas entities were never disclosed to the IRA since none of the entities (excluding one) had ever filed their tax returns in India. Thus, no assessment proceedings had been initiated against them earlier. The GE Overseas entities filed their tax returns for the first time in India only in response to the reassessment notice served on them. The ITAT also observed that these facts might have never been known to the IRA but for the survey and post survey operations carried out by them. The ITAT also lucidly explained that at the time of initiation of re-assessment proceedings, the only thing that needs to be satisfied is a prima facie case of income escaping assessment, and it is not necessary to actually establish that income had, in fact, escaped assessment because income attribution is a subsequent and detailed exercise which will have to be carried out after perusal of all relevant information and documents. The ITAT also held that since the actual activities performed in India, which were evidently much more than what had been considered while calculating the compensation payable to GE India in compliance with Indian transfer pricing regulations, had never been taken into account, it cannot be argued by GE India that since the IRA had not disputed the compensation paid in respect of services rendered by GE India, it should be deemed to be the ALP and no further attribution is warranted. Further, it held that additional income should be attributed to the PE because the price paid for marketing support services rendered by GEIIPL did not take into account a number of activities 33 carried out by GE India. b) Formation of PE FPPE The ITAT observed that as per the provisions of Article 5 of the India-USA DTAA, the following three ingredients must cumulatively exist to constitute a FPPE: (i) there should be fixed place of business; (ii) business of foreign enterprise should be wholly or partly carried on from such fixed place; and (iii) the activities carried from such fixed place should not be preparatory or auxiliary. Taking into consideration the facts and circumstances of the case along with the information and document placed before it, the 30 Section 44BB and 44BBB of the IT Act are the special provisions for computing profits and gains in connection with the business of exploration, etc of mineral oils/operation of aircraft in the case of non-residents; Rolls Royce Plc v. DIT (2008) 19 SOT 42 (Delhi ITAT). 31 Rolls Royce Plc v. DIT (2008) 19 SOT 42 (Delhi ITAT). 32 Rolls Royce Plc v. DIT (International Taxation) (2011) 339 ITR 147 (Delhi HC). 33 DIT (IT) v. Morgan Stanley & Co. Inc. (2007) 292 ITR 416 (SC); LG Electronics Inc. v. Addl. CIT Writ Petition (Tax) No of 2012 & Other, dated (Allahabad HC) Cyril Amarchand Mangaldas

20 ITAT came to the conclusion that the office premises of the LO constituted FPPE of the Assessee. In relation to the first condition, the ITAT noted that the term fixed place of business envisaged that such place should be at the disposal of the enterprise with some degree of permanence. In the instant case, GE India was using the LO premises almost permanently and also observed that such premises were at the constant disposal of GE India (for instance allocation of specific rooms/ chambers to expatriates/ other employees, provision of secretarial assistance of staff, etc.). The second condition presupposes that the business of foreign enterprise should be carried on from such fixed place and carrying on of the business of enterprise need not be wholly from such fixed place. In the instant case, the expatriates worked for different business interests of GE Group and were working for one of the three major business lines, viz. Infrastructure, Industrial and Healthcare. Further, they were also managing the business, securing orders and other possible actions required for Indian operations of GE Overseas entities in India. Therefore, based on all the survey documents along with the self appraisals, manager assessments and job responsibilities given to GE India, it was held that GE India was conducting business of GE Overseas in India and was directly/ wholly involved in negotiating and finalizing the contracts. 34 As regards the third condition, the ITAT held that a preparatory or auxiliary activity merely aids the core income generating activity and does not per se lead to earning of income. In the instant case, it was observed that GE India played an active role in sourcing of customers, proposal development, negotiation and finalization of terms and conditions with the end-customers in India. The ITAT also noted that the Assessee was not dealing in off the shelf goods, rather sales were made on prior contract basis. Further, it was held that mere signing of contract by GE Overseas outside India did not undermine the occurrence of core activity of sales in India by GE India. Relying on instrumental role of GE India in the sales process and related operations of GE Overseas in India, it was held that GE India was undertaking core marketing and sales activity for GE Overseas, and that GE Overseas was doing only auxiliary activities. The ITAT placed its reliance on the OECD commentary on Article 5(3)(e) of the Model Convention and observed that if through a fixed place of business, services are rendered to more than one companies of a group, then such services could not be treated as preparatory or auxiliary. DAPE The ITAT held that a person to constitute DAPE under Article 5(4) of the India-USA DTAA, should be a person other than an agent of independent status to whom Article 5(5) of the India-USA DTAA applies. Article 5(5) of the India-USA DTAA provides that, (i) when the activities of the agent were devoted wholly or almost wholly on behalf of the enterprise; and (ii) the transactions between the agent and the enterprise were not made under arm's length conditions, the agent should not be considered as an agent of independent status. In the instant case, the ITAT rejected the contention of the IRA that GE India had lost its independent status under Article 5(5) of the India- USA DTAA since it was not compensated on ALP because it was rendering services to multiple entities belonging to the GE Group. The ITAT also observed that GE India was not acting as agents for third parties in India. Further, although a number of GE Overseas entities were functional in India, considering the fact that such entities operated within one of the three major businesses of the GE Group, the ITAT concluded GE India acted more like a DAPE of GE Overseas. The ITAT also factually distinguished the decision of the Hon'ble Mumbai ITAT in the case of Varian 35 India (P.) Ltd., relied upon by the Assessee to contend that no DAPE was constituted. Additionally, the ITAT also relied upon the decision of the Hon'ble Supreme Court of Italy in 36 Phillip Morris wherein it has been held that a 34 Relied on UAE Exchange Centre Ltd. v. UOI (2009) 313 ITR 94 (Delhi HC); National Petroleum Construction Co. v. DIT (2016) 383 ITR 648 (Delhi HC). 35 Varian India (P) Ltd v. ADIT (2013) 33 taxmann.com 249 (Mumbai ITAT). 36 Phillip Morris v. Amninistrazione Finanziaria GmbH 4 ITLR Cyril Amarchand Mangaldas

21 company having its seat in Italy may take on the role of a multiple permanent establishment of foreign companies belonging to the same group and pursuing a company strategy; in such a case, the assessment of the activity carried on by the Italian company must be done on a unitary basis with reference to the programme of the group considered as a whole. The ITAT held that a DAPE shall be established under Article 5(4) of the India-USA DTAA, if a person situated in India habitually exercises an authority to conclude contracts on behalf of the foreign enterprise, so long as his activities are not of preparatory or auxiliary nature. In other words, activities of such person should be that of core income generating and not merely subsidiary to the main activities. Given the nature of activities performed by GE India inter alia negotiating essential elements of a contract, controlling key sales and marketing activities, etc., ITAT held that GE India had the authority to conclude contracts on behalf of the Assessee. Consequently, GE India constituted DAPE of the Assessee in India. The ruling also goes on to clarify that when the activities performed by a dependent agent are core income generating and not mere auxiliary, it does not require such person to undertake each and every aspect of the contract (for instance, negotiation of all the terms and conditions of the contract) to signify that he has authority to conclude contracts so long as he is in a position to negotiate certain aspects of the contract. c) Attribution of income After taking into account the facts and circumstances of the case and based on the perusal of information and documents produced before it, the ITAT held that since GE Overseas entities did not submit details of the profits earned by them from Indian customers, the AO is well within his rights to assume a notional profit margin of 10%. It also approved of the 35% profit allocation to the marketing and sales activities by following Rolls Royce plc (supra). However, it did not agree with the AO that all of such profits should be attributed to the Indian PE because certain marketing and sales activities were carried out from outside India as well. Accordingly, the ITAT held that 2.6% on the total sales could be construed as the profits attributable to the Indian PE of the Assessee. SIGNIFICANT TAKEAWAYS Under the Indian foreign exchange control regulations, an LO is allowed to function as a communicating channel between the head office and various Indian entities. Such regulations impose severe restrictions on its activities, inter alia, to undertake trading, commercial or industrial activities or to render any services that could be construed as an income generating activity in India. However, based on the facts and circumstances and activities undertaken by the concerned LO, there have 37 been instances where it has been held that in case certain activities were performed by the LO while acting as a communication channel or in aid and support of the main activity, but not associated with any income generation activity, no income accrues in the hands of the LO. However, when activities undertaken by the LO exceeds what was sanctioned by the RBI and constitutes an income generating activity, then the LO may constitute a PE in India. The ITAT Delhi also relied on the decision of the Hon'ble Karnataka High Court in Jebon Corporation 38 India, wherein it was held that the LO constituted a PE in India since it undertook commercial activities like procuring purchase orders, negotiating and concluding the price and other important aspects of the order, etc. Further, merely because the buyers placed orders and made payments directly to the head office, would not refute from it being constituted 39 as PE. In the instant case, the ITAT also reaffirmed that merely because no action was initiated by RBI it should not lead to a presumption that only the designated activities sanctioned to LO by RBI were carried on. Whether the LO would constitute a PE will have to be carefully examined based on the facts and circumstances of each specific case. It will be extremely important to examine whether the LO is carrying out any income generating business activity or not. As per Indian foreign exchange regulations, an LO is primarily required to function as a communication channel between potential Indian customers and its head office, and is not allowed to indulge in any revenue generating business activity. 37 ACIT v. Nike Inc. (2014) 264 CTR 508 (Karnataka HC); Varian India (P) Ltd v. ADIT (2013) 33 taxmann.com 249 (Mumbai ITAT); DIT v. Western Union Financial Services (2012) 18 taxmann.com 306 (Delhi ITAT). 38 Jebon Corpn. India, LO v. CIT (2012) 206 Taxman 7 (Karnataka HC); Brown and Sharpe Inc. v. CIT (2014) 51 taxmann.com 327 (Allahabad HC). 39 Id Cyril Amarchand Mangaldas

22 This is also enshrined in most of the tax treaties signed by India wherein any activity which can be construed as preparatory and auxiliary in nature, has been specifically excluded from the definition of a PE. However, like the ITAT held in the present case, merely because RBI has not found any defaults in connection with its approval or served any notice to revoke its approval to set up the LO, it cannot be contended by the taxpayer that no PE has been constituted. The In context of agency PE, person is said to have a u t h o r i t y t o c o n c l u d e contract, if the person primarily has: (i) sufficient authority to bind the foreign enterprise and to decide the final terms of the contract; (ii) power to act independently in concluding contract on his own without control from principal; (iii) authority to negotiate all details of the contract. Further, if it is shown that the agent concludes contract without any protest or dissent, it indicates that there is a lack of involvement on the part of principal and principal has agreed implicitly to the agent exercising such powers. Therefore, foreign companies need to be extremely cautious in assigning roles and responsibilities (such as ability to determine terms of contract without approval of principal) to their LOs to prevent the risk of them being characterized as PEs. expatriates deputed in India undertaking sales and marketing functions for the group entities from one of the group entities' liaison office in India constituted dependent agent PE and fixed place PE. The ITAT has also lucidly explained how reassessment proceedings can be construed as valid or invalid in addition to the constitution of FPPE and DAPE. Taking these considerations into account, foreign multinational corporations operating in India, should examine their business activities very carefully so as to ensure that they are not construed to have established any form of PE in India. Moreover, they should also take note of the fact that the IRA have become very aggressive and they try to gather information from all possible s o u r c e s i n c l u d i n g t h e a p p o i n t m e n t l e t t e r s, performance appraisal f o r m s, i n t e r n a l communications as well as the profiles posted by the concerned employees in p u b l i c p l a t f o r m s l i k e linkedin, etc. They also carry out survey operations at the office premises of Indian offices to ascertain whether the information submitted by the taxpayers match with the actual activities carried out on the ground. With them being armed with a number of additional anti-abuse provisions like transfer pricing, General Anti-Avoidance Rule ( GAAR ), thin capitalisation, place of effective management ( POEM ), etc., they could be even more aggressive! It was a bit disappointing though to note that the ITAT did not really explain the rationale of attribution of profits to the Indian PE and just summarized its conclusions in a couple of paragraphs Cyril Amarchand Mangaldas

23 SECTION 14A NOT APPLICABLE WHERE THE SECURITIES WERE HELD FOR TRADING PURPOSES AND NOT FOR EARNING INTEREST OR DIVIDEND, WHICH WERE ONLY INCIDENTAL BENEFITS 40 In State Bank of Patiala the HC held that section 14A of the IT Act is totally inapplicable in a case where the Assessee held securities as stock-in-trade as part of its business activities, and not to earn dividend or interest. FACTS State Bank of Patiala ( Assessee ) filed its return of income where the total exempt income from dividend and interest was claimed as INR crores. According to the Assessee, the investment in shares, bonds, etc. constituted its stock-in-trade and had not been made for earning tax free income, which was only incidental to its main business of sale and purchase of securities. Therefore, no expenditure had been incurred for earning such exempt income. The Assessee also contended that in any event, it had acquired the securities from its own funds and, therefore, section 14A was not applicable. The AO applying section 14A read with rule 8D of the IT Rules restricted the disallowance to the amount claimed as exempt income and added the same to Assessee's income. CIT(A) on appeal held that the entire exempt income should have been disallowed by the AO as there was no legal provision either in section 14A or rule 8D to limit the disallowance to the amount of dividend received. On further appeal, the ITAT allowed the appeal and reversed the orders of the AO and the CIT(A) by deleting the disallowance made under section 14A. The ITAT relied on a CBDT Circular which clarified that shares held by banks should be characterised as stock in trade and not as investments. It was held that if shares were held as stock-in-trade and not as investment, even the disallowance under rule 8D would be nil as disallowance to be made under rule 8D(2)(i) would be confined to direct expenses for earning the tax exempt income. Being aggrieved by the ITAT order, the IRA preferred an appeal with the Punjab & Haryana HC. ISSUES a) Whether in the facts and circumstances of the case, the ITAT was right in law in deleting the addition made on account of disallowance under section 14A? b) Whether under section 14A, expenditure can be disallowed only if it is incurred by Assessee in relation to income exempt from tax? c) Whether section 14A will be applicable to Assessee carrying on business of sale and purchase of securities which constituted his stock-in-trade and were not held to earn dividend or interest and dividend or interest accruing thereon was only a by-product or an incidental benefit? ARGUMENTS/ANALYSIS Assessee contended that it was engaged in the purchase and sale of shares as a trader with the object of earning profit and not with a view to earn any interest or dividend. It does not have an investment portfolio and the securities are held as stock-in-trade and hence, the provisions of section 14A should not be applicable. The IRA agreed that the said securities were held by the respondent as stock-in-trade. However, the IRA submitted that the plain language of section 14A makes it applicable to any income, which does not form part of the total income. Therefore, it is immaterial which head of income of section 14 the income falls under. Under section 14A, no deduction is to be allowed in respect of the expenditure incurred by the Assessee in relation to income, which does not form part of the total income under the IT Act. He emphasised on the term income and submitted that the nature of the income is not specified. DECISION Discussing section 6 of the Banking Regulation Act, 1949 under which the forms of business in which 40 Principle Commissioner of Income Tax v. State Bank of Patiala (2017) 78 taxmann.com 3 (Punjab & Haryana) Cyril Amarchand Mangaldas

24 banking companies may engage are enlisted, in addition to the business of banking and which includes permission to deal, inter alia, in scrips and other instruments and securities, the HC observed that any profit or loss arising from such activities is liable to be shown either as a business income or business loss for the purposes of computation of income under the IT Act. The HC observed that there is a distinction between stock-in-trade and investment. The object of earning profit from trading in securities is different from the object of earning income, such as dividend and interest arising therefrom. The object of trading in securities does not constitute the activity of investment where the object is to earn dividend or interest. It was held that income arising from trading in the securities is attributable to the business of the Assessee falling under the head Profits and gains of business and the securities dealt with in the course of such trading constituted Assessee's stock-intrade. The HC held that the CBDT Circular relied upon by the Assessee, carves out a distinction between stock-intrade and investment and provides that if the motive behind purchase and sale of shares is to earn profit then the same would be treated as trading profit whereas if the objective was to earn dividends, then income earned from such activities would be said to have accrued from the investment. If the shares and securities were treated as stock-in-trade, the income earned therefrom would be construed business income and a loss as business loss. Thus, any assessee may have two portfolios, namely, investment portfolio and a trading portfolio. In the case of the former, the securities are to be treated as capital assets and in the latter as trading assets. HC further held that section 14A is applicable only to income arising from investment portfolio. Relying on the SC decision in the case of CIT v. Walfort 41 Share & Stock Brokers (P.) Ltd., the HC held that the intention of the Parliament with respect to section 14A was not to allow deduction in respect of any expenditure by the Assessee in relation to income not forming part of the total income under the IT Act. Section 14A clarifies that expenses incurred can be No disallowance of expenses under section 14A can be made when securities are held for trading purposes. allowed only to the extent they are relatable to the earning of taxable income. It was further held that the mandate of section 14A is to curb the practice to claim deduction of expenses incurred in relation to exempt income against taxable income and, at the same time, avail the tax incentive by way of exemption of exempt income without making any apportionment of expenses incurred in relation to exempt income. The income by way of dividend and interest received on the securities held by the Assessee is, admittedly, not taxable income and an exemption in respect thereof was, in fact, claimed by the Assessee under section 10(34) and (35). Had any expenditure been incurred in earning such income, it would have to be disallowed in view of section 14A. The HC also held that as securities in question constituted the Assessee's stock-in-trade and the income that arises is its business income, such income is not exempt from tax and, therefore, the expenditure incurred in relation thereto does not fall within the ambit of section 14A. Answering the question (of whether the Assessee can be said to have incurred any expenditure at all or any part of the said expenditure in respect of the exempt income viz. dividend and interest that arose out of the securities that constituted stock-in-trade) in the negative, the HC held that the purpose of the purchase of the said securities was not to earn income in the nature of interest and dividends, but to earn profits from trading i.e. purchasing and selling the same. Irrespective of whether the securities yielded any income arising therefrom, such as, dividend or interest, no expenditure was incurred in relation to the same. Moving further, the HC observed that once it is found that no expenditure was incurred in earning the income, there would be no further expenditure in relation thereto that falls within the ambit of section 14A. All that the Assessee does after dividend and interest is received is to protect, preserve and utilize the same. The expenditure incurred in that regard would be to administer and manage the same. In other words, such expenditure cannot be said to be for the purpose of earning the same. An amount once received as income loses its character as income and 41 CIT v. Walfort Share & Stock Brokers (P.) Ltd. (2010) 326 ITR 1/192 Taxman 211 (SC) Cyril Amarchand Mangaldas

25 constitutes a part of the assets or wealth of the Assessee. There is no concept in tax laws like once an income always an income! SIGNIFICANT TAKEAWAYS The decision clarifies the applicability of section 14A in cases where the assessee is a trader in securities and holds the securities as stock in trade for purposes of purchase and sale. The Mumbai Special Bench of ITAT in the case of ITO 42 v. Daga Capital Management P. Ltd. while dealing with a similar issue had held that section 14A shall be applicable to an assessee who was engaged in the business of dealing in securities and held the securities as stock-in-trade. However, in the instant case the HC has taken a contrary view and held that when securities are held for trading purposes section 14A shall not be applicable as under section 14A, expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income and the income by way of dividend and interest received on the securities held by the Assessee is not taxable income. It was also explained by the HC that once established that no expenditure was incurred in earning the income, further expenditure in relation thereto would also not fall within the ambit of section 14A. The HC has agreed with the Karnataka HC's decision 43 in the case of CCI Ltd. v. JCIT wherein it was held that when securities were held as stock-in-trade and not with the intention of earning dividend income which was merely incidental, it cannot be said that the expenditure incurred in acquiring the shares has to be apportioned to the extent of dividend income and that it should be disallowed. 42 ITO v. Daga Capital Management P. Ltd. (2008) 312 ITR (AT) 1 (Mumbai) (SB). 43 CCI Ltd. v. JCIT (2012) 250 CTR (Karn.) Cyril Amarchand Mangaldas

26 AMOUNT RECEIVED FROM ASSIGNMENT OF PATENT IS TAXABLE AS CAPITAL GAIN AND THE COST OF ACQUISITION TO BE TAKEN AS NIL 44 In Bharat Serums and Vaccines Ltd. the Mumbai Bench of ITAT held in favour of the IRA that the patent of the Assessee was for the purposes of having a right to manufacture /produce/ process some article/thing and was registered for commercial exploitation in India and the international market. It was transferred to the assignee for commercial exploitation and section 55(2)(a) of the IT Act deals with right to manufacture, produce or process any article or thing and, therefore, such a right would be taxable under capital gains and cost of acquisition shall be taken as Nil. FACTS B h a r a t S e r u m s a n d Va c c i n e s L t d. ( Assessee ) engaged in the business of research and development, manufacturing, wholesale trading and licensing of biopharmaceuticals, bio-technology products serums and process related technology, sold a patent for INR 1.5 crores. During assessment proceedings, Assessee claimed that no expenditure was incurred for acquiring the patent, it was a capital asset and the entire receipt on assignment of patent was not taxable. The AO was of the view that process of developing a patent was a part of the business of the Assessee and the amount received from sale of the patent was a revenue receipt. The CIT(A) was of the opinion that the Assessee had developed an invention which was patented in India and the international market for the purposes of commercial exploitation. The same was transferred and assigned to the assignee, for its commercial exploitation. The CIT(A) held that section 55(2)(a) covered a right to manufacture/produce/process any article or thing and that the Assessee's case was squarely covered by these provisions. Hence, the receipt had to be taxed as capital gains. ISSUES Whether amount received from assignment of patent is taxable as capital gain under section 55(2)(a) and what shall be the cost of acquisition? ARGUMENTS/ANALYSIS The Assessee contended that it had not claimed any exempt income in the return of income and that in absence of claim of tax free income no disallowance could be made u/s 14A of the IT Act. The Assessee argued that it had transferred know-how and patent and that section 55(2) did not talk of the assets in q u e s t i o n. M o r e o v e r, e v e n i f expenditure was incurred for developing the patent no cost was ascertainable. Assignment of patent taxable as capital gain. The IRA on the other hand argued that the AO had rightly applied section 14A read with rule 8D of the IT Rules. It was also submitted that the sole object was earning profit and the Assessee had incurred huge expenditure for the same. It was wrong to claim that no expenditure was incurred and the receipt in question was a trade receipt. DECISION Adjudicating inter alia on taxation of the receipts from patent assignment, the ITAT emphasized on the importance of making a distinction between cases where consideration is paid to acquire the right to use a patent or a copyright, and cases where payment is made to acquire patented or a copyrighted product or material. In cases where payments are made to acquire products which are patented or copyrighted, the consideration paid would have to be treated as a payment for purchase of the product rather than consideration for use of the patent or copyright. The ITAT also drew a distinction between a trademark and a patent by observing that in case of the former, the property and the right to protection are in the 44 Bharat Serums and Vaccines Ltd. v ACIT (2017) 78 taxmann.com 188 (Mumbai ITAT ) Cyril Amarchand Mangaldas

27 device or symbol adopted to designate the goods sold, and not in the article which is manufactured and sold. The article is open to the whole world to manufacture and sell and all that the owner of the trademark is entitled to prevent is the use of his trademark by other traders. On the other hand, a patent right protects the substance of the article, i.e., the stock-in-trade and any unauthorised manufacture is prohibited. The ITAT went on to explain that before getting a patent of medicine, such as the item under consideration, the Assessee has to carry out a lot of research analysis and experimentation. This would naturally require incurring of expenditure for both the activities and the same was adopted by the Assessee to have a right to manufacture / produce / process the item under consideration. Relying on the relevant terms of the assignment agreement, it was concluded that the right was held for commercial exploitation. The ITAT observed that the patent was for the purpose of right to manufacture /produce/ process some article/thing, and was registered for commercial exploitation of the same in India as well as in the international market. It was transferred to the assignee for commercial exploitation. Section 55(2)(a) talks of right to manufacture, produce or process any article or thing. Therefore, as per the amended provisions, the right to manufacture/ produce/ process would be taxable under the head capital gains and the cost of acquisition shall be taken as Nil. The reliance placed by the Assessee in the case of CIT 46 v. Fernhill Laboratories and Industrial Establishment is also misplaced because in that case the issue was regarding the date of applicability of amendments to section 55(2)(a) of the IT Act, which was not of relevance. Accordingly, the ITAT held that the treatment of the disputed amount as capital receipt and taxing it as capital gain under section 55(2) of the IT Act was correct because the Assessee was not in the business of purchase and sale of patents. It was also held that the sale proceeds of the assignment agreement could not be treated as revenue receipt. SIGNIFICANT TAKEAWAYS With this ruling, the ITAT has provided clarity in treatment of the consideration received from assignment of a patent and explained that as the Assessee was not in the business of purchase and sale of patents, the amount could not be treated as a business receipt. It was also decided by the ITAT the patents are developed during the ordinary course of business of the Assessee who has to spend a significant sum of money towards research and development and hence, it will be incorrect to claim that no expense was incurred for the development of a patent. It was also held that since the patent was for the purpose of right to manufacture/process an article and was for commercial exploitation, it squarely falls under section 55(2)(a) and was taxable under the head of capital gains. The ITAT also distinguished the case of Kwality 45 Biscuits (P) Limited relied upon by the Assessee because in that case, the assessee had continued to carry on the manufacturing and trading of biscuits and hence, it was a case dealing with the transfer of trade mark and brand name. While in case of Kwality (supra), the assessee had not transferred the right to manufacture product / process, in the instant case, the patent, being a right to manufacture / produce / process any article / thing, was assigned. 45 Kwality Biscuits (P) Limited v. ACIT (2012) 135 ITD 35/19 taxmann.com 106 (Bang.) (TM). 46 CIT v. Fernhill Laboratories and Industrial Establishment (2013) 33 taxmann.com 533 (Bom.) Cyril Amarchand Mangaldas

28 LOWER RATE OF TAX SPECIFIED IN THE CERTIFCATE ISSUED UNDER SECTION 197 CANNOT BE RESTRICTED TO THE AMOUNT SPECIFIED THEREIN 47 In Twenty First Century Securities Ltd., the Kolkata ITAT held that the provisions of section 197 of the IT Act, in relation to deduction of tax at lower rate, are not restricted to amounts specified in the certificate and the same is person specific. In other words, certificate under section 197 of the IT Act is with reference to a person to whom income is paid and not in reference to any sum as may be specified in the certificate. FACTS Twenty First Century Securities Ltd. ( Assessee ) paid interest to two entities and was under an obligation to deduct tax at source under section 194A of the IT Act on the interest payments. The said entities had obtained a certificate under section 197 of the IT Act from their respective tax officers, authorizing the Assessee to deduct tax at a lower rate. The amount specified in the certificate was lower than the amount of interest actually paid. However, the Assessee deducted tax at source at a lower rate on the entire interest paid. In view of the same, the AO held that there has been short deduction of tax as lower rate of tax specified in the certificate under section 197 of IT Act was valid only in respect of the amount specified in said certificate and in respect of the remaining sum, the Assessee ought to have deducted tax at source at normal applicable rate. Accordingly, the AO levied interest under section 201(1A) of the IT Act. The assessment order was upheld by the CIT(A). Aggrieved by the said order, the Assessee preferred an appeal to the ITAT. ISSUE Whether, the lower rate of tax withholding provided in the certificate under section 197 of the IT Act shall be restricted only to the amount specified in the certificate or the same can be extended to the entire amount of interest paid? 47 Twenty First Century Securities Ltd. v. ITO (TDS) (2017) 78 taxmann.com 152 (Kolkata Tribunal). 48 Hindustan Coca Cola Beverage (P.) Ltd. v. CIT (2007) 293 ITR 226 (SC). 49 Circular No. No. 275 dated Statutory provision of deduction of tax at source at lower rate is person specific and not amount specific ARGUMENTS/ANALYSIS The IRA contended that the deduction of tax at the rate specified in the certificate under section 197 of the IT Act was valid only in respect of the amount specified in the certificate and in respect of the remaining sum, the Assessee ought to have deducted tax at source at the normal applicable rate. Further the IRA placed reliance on the decision of SC in the case of Hindustan 48 Coca Cola Beverage (P.) Ltd. to contend that the amount liable to lower deduction was specifically mentioned in the Annexure of the certificate and hence the Assessee was liable to pay interest under section 201(1A) of the IT Act. 49 Further the IRA also relied on a CBDT Circular, to argue that the interest would be chargeable even if the deductee had nil income or was claiming a loss, as the charging of interest under the said section is mandatory and compensatory in nature. The Assessee, on the other hand, argued that the certificate issued by the AO under section 197(1) of the IT Act clearly specifies that the Assessee was authorised to pay any sum by way of interest as referred to in section 194A of the IT Act after deducting the tax at source at the rate of 1% (plus surcharge and education cess thereon). The said certificate was issued only with reference to the person by whom income is payable and any mention of the quantum of income in the annexure to the certificate would not enhance the liability of the Assessee for deduction of tax at source at the higher rate, in so far as it relates to the income paid over and above the amount specified in the annexure to the certificate under section 197 of the IT Act. DECISION A reading of section 197(2) of the IT Act shows that once the AO issues a certificate for deduction of tax at a lower rate or no deduction of income tax, then the Cyril Amarchand Mangaldas

29 person making the payment is at liberty to deduct tax at rates specified in the certificate or deduct no tax as the case may be. The ITAT observed that the provision of section 197(2) of the IT Act does not make any reference to any income specified in such certificate. A perusal of Rule 28AA(2) of the IT Rules also shows that the certificate issued under section 197 of the IT Act will be valid for the assessment year specified in the certificate. Even in the rules, there is no reference to the payment without TDS or at lesser rate should be on the sums specified as payable in the certificate. The ITAT pointed out that it is clear that the statutory provision of deduction of tax at source at lower rate is person specific and cannot be extended to the amounts specified by the recipient of the payment while making an application for grant of certificate under section 197 of the IT Act in Form No.13. SIGNIFICANT TAKEAWAYS The present judgment is significant in laying down the rule that the provisions relating to lower deduction shall not be restricted to the amount mentioned in the certificate obtained under section 197 of the IT Act. This will help in reducing a lot of TDS related litigation as companies receive notices in relation to short deduction of TDS on account of lower deduction in excess of the amount specified in the certificate. The tax authorities failed to understand that the amount specified in the certificate were based on estimations and the actual amounts could vary. This judgement could help the taxpayer in avoiding unnecessary litigation if the IRA accepts this position and does not challenge it Cyril Amarchand Mangaldas

30 RETENTION MONEY CANNOT BE TAXED AS INCOME 50 In McNally Bharat Engineering co. Ltd., the Kolkata Bench of the ITAT held that the retention money cannot be treated as income in the hands of the tax payer, either under the normal provisions of the IT Act or for the purposes of computing MAT under section 115JB of the IT Act, until the contractual obligations are fully performed by the tax payer to the satisfaction of the customer. It was held that the tax payer gets the right to receive the amount only upon completion of the work or submission of work thereof. FACTS McNally Bharat Engineering Co. Ltd. ( Assessee ) is engaged in the business of manufacturing of metallurgical machinery, materials handling and conveying plant/machinery/spares and coal washing plant on a turnkey basis. During the year under consideration i.e. AY , the Assessee executed certain turnkey contracts and in accordance with the terms of the contract, a certain percentage of the value of the contract is retained by the customers till the successful trial and final acceptance. The Assessee credited the said retention money to its profit and loss account, as per mercantile system of accounting. During the scrutiny proceedings, the AO held that the retention money ought to have been included in the revenues while computing book profits under the provisions of section 115JB of the IT Act and on appeal, the CIT(A) held that MAT cannot be levied on notional income, which had not accrued to the Assessee and that it can only be levied on the real book profits, which have been earned by the company. ARGUMENTS/ANALYSIS Before the ITAT, the Assessee contended that the right to receive the retention money was contingent till the time trial run was successfully concluded and final settlement was obtained by relying on the Retention money is neither taxable under the normal provisions of the IT Act nor under the MAT regime decision of Calcutta HC in the case of Simplex 51 Concrete Piles India P. Ltd.. Therefore, until and unless all the obligations under the contract were fulfilled, the retention money could not be regarded as income. The Assessee further relied on the decisions in the cases of Syndicate Bank, Hitkari Fibres Ltd. and 54 Frigsales (India) Ltd. to contend that if a receipt was not in the nature of income, it could not be considered for the purposes of computing book profits under the MAT regime, even though it was credited to the profit and loss account. The IRA, on the other hand, contended that the Assessee was following mercantile system of accounting and had to account for all receipts on accrual basis. Accordingly, the retention money could not be excluded from the Assessee's income. Further, the provisions of section 115JB clearly laid down the sums that had to be excluded from, and included in, the profits as per the profit and loss account prepared in accordance with Companies Act, 1956 and only those sums are eligible to be reduced from the book profit while computing MAT under section 115JB of the IT Act and the retention money is not one of them. It relied on the decision rendered by the Special Bench of the ITAT in the case 55 of Rain Commodities Ltd. herein it was held that the amounts exempt under the provisions of the IT Act, must be included while computing book profits for the purposes of levying MAT under section 115JB of the IT Act. DECISION The ITAT concurred with the arguments of the Assessee and the reliance placed by it in the case of 56 Simplex Concrete Piles India Private Limited to conclude that the retention money could not be regarded as income, for the purposes of computation 50 DCIT v. McNally Bharat Engineering Co. Ltd. [TS-80-ITAT-2017(Kol)]. 51 CIT v. Simplex Concrete Piles India Private Limited (1989) 179 ITR 8 (Calcutta). 52 Syndicate Bank v. ACIT (2006) 7 SOT 51 (Bangalore). 53 Hitkari Fibres Ltd. v. JCIT (2004) 90 ITD 654 (Mumbai). 54 ITO v. Frigsales (India) Ltd. (2005) 4 SOT 376 (Mumbai). 55 Rain Commodities Ltd. v. CIT (2010) 131 TTJ 514 (Hyderabad) (SB). 56 CIT v. Simplex Concrete Piles India Private Limited (1989) 179 ITR 8 (Calcutta) Cyril Amarchand Mangaldas

31 of income under the normal provisions of the IT Act, as it would become legally due to the Assessee only upon the successful completion of trial run. As regards computation of book profits for the purposes of section 115JB of the IT Act, it held that levying MAT on receipts which were not in the nature of income would defeat two fundamental principles, viz., it would levy tax on receipts, which was not in the nature of income at all, and secondly, it would not result in arriving at real working results of the company. It further distinguished the decision of the Special Bench of the ITAT, relied on by the IRA, in the case of Rain Commodities Ltd. (supra). and held that it is only the income which is exempt under the specific provisions of the IT Act that should be included while computing book profits for the purposes of levying MAT under section 115JB of the IT Act, and not when the receipt was not in the nature of income. Therefore, the retention money could not be regarded as income even for the purposes of computing book profits under MAT regime, though it was credited to profit and loss account. SIGNIFICANT TAKEAWAYS The ruling of the ITAT reaffirms the principle that unless the taxpayer has a right to receive an amount, the same cannot be taxed as income. The Assessee gets the right over the retention money only upon successful completion of the trial run and the customer had the right to forfeit the retention if the deliverables were not upto it's satisfaction. Therefore, retention money does not par take the character of the income. This ruling could also be used to contend that no notional income is taxable under the IT Act, unless specifically provided for. It is worthwhile to highlight here that the Income Computation and Disclosure Standards ( ICDS )-III dealing with construction contracts provides for recognition of retention money as a part of the 57 contract revenue. While there are SC decisions to support the contention that tax is leviable only on the income and not on hypothetical income, the FAQ released by the CBDT vide Circular No. 10/2017 dated March 23, 2017 (discussed in this issue of Taxscout) explicitly states that certain judicial pronouncements were pronounced in the absence of authoritative guidance and since certainty has now been provided by the ICDS, its provisions shall be applicable to the transactional issues in relation to AY onwards. Thus, the ITAT's ruling must be read with principles put forth under ICDS at least for the AYs going forward. Also, it will be interesting to see what will be the views of the higher judiciary. 57 E.D. Sassoon & Co. Ltd. (1954) 26 ITR 27 (SC) and CIT v. Shoorji Vallabhdas & Co. (1962) 46 ITR 144 (SC) Cyril Amarchand Mangaldas

32 PROFITS EARNED BY AIRLINES FROM THEIR PARTICIPATION IN A POOL IS NOT TAXABLE IN INDIA UNDER THE INDIA-GERMANY AND THE INDIA-NETHERLANDS DTAA The Delhi HC in the case of KLM Royal Dutch 58 Airlines held that the income earned from rendering services to the IATP members by Lufthansa and KLM airline, in furtherance of participation in the pool (i.e. IATP), would be taxed in the country in which the place of effective management of such airlines is situated. FACTS Lufthansa and KLM ( Assessees ) were international airlines with headquarters in Germany and Netherlands respectively and branch offices in India. The Assessees by the virtue of their membership of the International Airlines Technical Pool ( IATP ) provided technical services to other International Air Transport Association member airlines at the Indian airports. The Assessees filed their tax returns and claimed the income from the impugned activities to be exempt under Article 8 of the India-Germany and India-Netherlands DTAA respectively, which provides that profits from the operation of ships or aircrafts in international traffic (including profits derived from participation in a pool) shall be taxable only in the contracting state in which the place of effective management of the enterprises is situated. The AO observed that the impugned activities did not fall within the ambit of the term air transport services, to take the benefit of the provisions of Article 8 of the relevant DTAAs and held that branch office of the Assessees constituted PE in India, therefore, the profits relating to the services rendered were taxable as business income. The CIT(A) upheld the order of the AO. The aggrieved Assessees appealed before the ITAT, which reversed the findings of the CIT(A). Being aggrieved, the IRA preferred an appeal before the Delhi HC. ISSUE Whether profits of the Assessees accruing from providing technical services to other airlines are covered by Articles 8(1) and 8(4) of the India-Germany DTAA, and by Articles 8(1) and 8(3) of the India- Netherlands DTAA? ARGUMENTS The IRA relied upon the ITAT decision in the case of 59 British Airways Plc., where in a similar factual matrix, the ITAT had negated the claim of the British Airways under Article 8 of the India-UK DTAA. Thus, it was argued by the IRA that British Airways Plc. (supra). case was a relevant precedent, since the language of the India-UK, the India-Germany and India- Netherlands DTAAs are pari materia. It was further argued by the IRA that IATP would not constitute a pool for the purposes of the relevant DTAAs, as exemption under the DTAA is based on reciprocity between two members of the pool for extending/obtaining the facilities and such reciprocity should be direct. In the instant case, the services rendered under IATP agreements did not constitute services on reciprocal basis, as it could happen that the Assessees could receive services from another airline, but may not render any services to that airline. In addition the IRA sought to contend that, contrary to the functioning of IATP, the term pool under the Article 8 of the relevant DTAAs have to be understood as an organisation that pools the resources of various airlines at the airports, renders services to willing airlines and distributes profits to the participants thereafter. The Assessees on the other hand argued that both the DTAAs provide that the provisions of Article 8(1) (which provides profits from the operation of aircrafts in international traffic shall be taxable only in the contracting state in which the place of effective management of the enterprises is situated) also apply to the profits from the participation in pool joint business of an international operating agency. It was argued that the Assessees had entered into an 58 DIT v. KLM Royal Dutch Airlines (2017) 78 taxmann.com 1(Delhi HC). 59 British Airways Plc. v. DCIT (2002) 80 ITD 90 (Delhi ITAT) Cyril Amarchand Mangaldas

33 agreement with the IATP and rendered certain technical services to other airlines, in addition to receiving the similar services from other airlines, as per the said agreement. Therefore, the profits from the impugned activities would not be taxable in India. In addition, the Assessees also tried to differentiate the case of British Airways Plc. (supra). on the ground that British Airways was operating on commercial basis as it was using its excess personnel to render services to other airlines for a fee while it was not availing services from any other airline. DECISION The HC while differentiating the British Airway Plc. decision observed that the India-UK DTAA uses the phrase pools of any kind which is absent in the India-Netherlands and India-Germany DTAAs. The Court observed that the phrase was interpreted by the ITAT in the case of British Airways Plc. (supra), by taking into account the dictionary meaning of the word pool. According to the ITAT, the term pool means a managing entity that administers the pool (to which the participants are members) and facilitates services. The HC further observed that only pool known to the aviation industry is IATP and the revenue has failed to mention to any other internationally recognized pool in this regard. Thus, having regard to these observations, the HC held that a pool cannot be given a limited meaning, as argued by the IRA, as it would amount to controlling the manner in which industries set up or organize their businesses. Further, the HC disagreeing with approach of the ITAT in the British Airways Plc. added that the court should interpret DTAAs to give effect to the intentions of the contracting parties and hence, the courts cannot resort to the dictionary meaning or DTAAs between one State and another in the interpretation of such convention with third-party states. The HC further differentiated the British Airways Plc. case and observed that in this case, the services provided by the British Airways Plc. to other airlines were not on reciprocity basis. Rather the nature of the activities was commercial in nature as the British Airways Plc. was using its excess/ idle resources to provide services at a price, while in the instant case, the Assessees did not receive any consideration (though it received credits under IATP credit system). Income earned by an airline from participation in IATP, would be taxable only in the country in which the airline has its place of effective management. In addition the HC pointed out that the India-UK DTAA (applicable in the British Airways Plc. case) defines profits from operations of aircrafts for the purpose of Article 8(1) of the DTAA (which provides profits from the operation of aircrafts in international traffic shall be taxable only in the contracting state in which the place of effective management of the enterprises is situated), while such explicit phrase is absent in the India-Germany and India-Netherlands DTAAs. The HC also held that since all the activities undertaken by the Assessees were in accordance with the IATP manuals and bye-laws, it could be said that the Assessees were participating in the pool. Moreover, the HC observed that in the instant case there was reciprocity of services as the individual Assessees not only rendered services to other airlines but they also availed services from other airlines. In view of the above discussions, the HC held that the receipts of the Assessees from the rendering of technical services were in the nature of participation in a pool and, therefore, were exempt under Article 8 of the India- Netherlands and India-Germany DTAAs. SIGNIFICANT TAKEAWAYS This decision clarifies the scope of Article 8 of the India-Germany and India-Netherlands DTAAs and seeks to extend the benefit of Article 8 to the activities carried on by various airlines under the umbrella of the IATP. It is public knowledge that the airline industry is very capital intensive and pooling of resources, as contemplated under the IATP, only becomes more pertinent in order to make the airline industry economically and commercially viable. It is for such reasons that various DTAAs across the world have incorporated beneficial provisions for taxation of profits from operations of aircrafts. Thus, the HC by upholding the intention of the impugned provisions has provided a great sigh of relief to the airlines industry and has also cleared the clouds of uncertainty that had been created post the British Airways Plc. decision Cyril Amarchand Mangaldas

34 DEPRECIATION ON BUILDINGS NOT ALLOWABLE TO LESSEE, ALTHOUGH LESSEE HAS REIMBURSED THE CONSTRUCTION COSTS 60 In the case of Mother Hospital Pvt. Ltd., the SC held that since the Assessee did not own the property, it could not claim depreciation under section 32 of the IT Act. Further, as lessee had reimbursed the expenditure incurred on the construction of a building carried on by the owner-lessor, it cannot get the benefit under explanation 1 to section 32(1). FACTS Mother Hospital Pvt. Ltd. ( Assessee ) is a company running a super speciality hospital, whose shares are held by seven persons closely related to each other. Some of these members had earlier formed a partnership to run a super speciality hospital and, accordingly, the firm started construction of the hospital building. Thereafter, a company (Assessee) was incorporated for this purpose and an agreement was signed between the firm and the Assessee to pay the expenses. Assesssee thereafter paid the amount of expenditure incurred on the building to the firm and the balance unpaid amount was treated as liability of the Assessee, creating a lien on the building in Reimbursement favour of the firm. The one time building tax payable by the owner of a building under the Kerala Building Tax Act was also paid by the Assessee. However, the firm retained the ownership of the land and the same was given on lease to the Assessee. In its first AY ( ), the Assessee filed its tax return and claimed depreciation on the building part of the property under section 32, on the ground that it had become the owner. The AO rejected the claim after construing the provisions of the aforesaid agreement and concluded that the Assessee had not become the owner of the property in relevant AY. The appeal preferred before the CIT(A) met with the same fate. In further appeal before the ITAT, the Assessee of expenditure by lessee incurred on construction of building by owner/lessor, not enough to avail depreciation. succeeded. However, it proved to be temporary in nature as the appeal of the IRA against the order of the ITAT filed before the HC was allowed reversing the aforesaid order of ITAT. The HC held that the Assessee had not become the owner of the property in the relevant AY and clause of the agreement could not confer any ownership rights on the Assessee. Being aggrieved by the order, the Assessee approached the SC. ISSUE Whether depreciation under section 32 shall be available to the Assessee, when the construction was carried out by owner-lessor and such construction expenditure is reimbursed by the Assessee-lessee? ARGUMENTS/ANALYSIS The Assessee contended that having regard to the relevant clause of the agreement between the Assessee and the firm, it had become the lessee of the property and as the construction was made by the Assessee from its funds, 61 by virtue of explanation 1 to section 32 it was, in any case, entitled to claim depreciation. DECISION The SC while upholding the HC ruling, reiterated that a building which was constructed by the firm belonged to the firm. As it is an immovable property, the title in the said immovable property cannot pass when its value is more than INR 100, unless it is executed on a proper stamp paper and is also duly registered with the sub- Registrar. In the absence thereof, it could not be said that the Assessee had become the owner of the property. The SC observed that it is only when the Assessee holds a lease right or other right of occupancy and any capital expenditure is incurred by the Assessee on the 60 Mother Hospital (P.) Ltd. v. Commissioner of Income-tax, Trichur [2017] 79 taxmann.com 375 (SC). 61 Explanation 1- Where the business or profession of the assessee is carried on in a building not owned by him but in respect of which the assessee holds a lease or other right of occupancy and any capital expenditure is incurred by the assessee for the purposes of the business or profession on the construction of any structure or doing of any work in or in relation to and by way of renovation or extension of or improvement to the building, the provisions of this clause shall apply as if the said structure or work is a building owned by the assessee Cyril Amarchand Mangaldas

35 construction of any structure or doing of any work in or in relation to and by way of renovation or extension of or improvement to the building and the expenditure on construction is incurred by the Assessee, that Assessee would be entitled to depreciation to the extent of any such expenditure incurred. Further, it was held by the SC that records showed that the construction was made by the firm and even though the Assessee had reimbursed the amount, the construction was not carried out by the Assessee. Therefore, the explanation also would not come to the aid of the Assessee. SIGNIFICANT TAKEAWAYS The SC disallowed the depreciation in the hands of lessee, as it was not the owner of the property and further clarified that to get the benefit of Explanation 1 of section 32(1), mere reimbursement of expenses is not sufficient. The SC observed that in order to be able to claim depreciation, it is imperative that the Assessee itself should have carried out the construction work. It appears that the SC has taken a literal interpretation to say that for claiming the benefit of Explanation 1, the construction work should be undertaken by the lessee itself. It would be important to note that the SC in the cases 62 of Poddar Cement Pvt. Ltd. and Mysore Minerals 63 Ltd. had held that for a valid claim of depreciation, it is the beneficial ownership that is relevant and not the titular ownership. However, these decisions have not been considered by the SC in the instant case. It will become tougher for taxpayers to claim depreciation unless (i) they own the building; or (ii) the building was taken on lease on the basis of a duly registered lease agreement and the construction is carried on by the taxpayer itself. 62 CIT v. Poddar Cement Pvt. Ltd. (1997) 226 ITR 625 (SC). 63 Mysore Minerals Ltd. v. CIT (1999) 239 ITR 775 (SC) Cyril Amarchand Mangaldas

36 CASE LAW UPDATES - INDIRECT TAX Cyril Amarchand Mangaldas

37 SERVICE TAX CANNOT BE LEVIED ON SERVICES IN RELATION TO MARKETING, PROMOTION AND ORGANIZATION OF LOTTERIES IN THE ABSENCE OF A MECHANISM FOR COMPUTATION OF CONSIDERATION 64 In Future Gaming & Hotel Services (P) Ltd, the Sikkim HC upheld the constitutional validity of levy of service tax on services in relation to marketing, promotion and organizing of lotteries. However, the HC quashed the concerned amendment introduced to Notification No. 30/2012- ST dated June 20, 2012 vide Notification No. 18/2016- ST dated March 1, 2016, stating that the said amendment is incapable of implementation in the absence of appropriate computation methodology. FACTS Future Gaming & Hotel Services and M/s Summit Online Trade Solutions ( Petitioners ) were engaged in business of buying and selling of lottery tickets organized by the Government of Sikkim. The Petitioners had executed agreements with the Government of Sikkim to purchase lottery tickets in bulk and re-sell the same through authorized agents, stockists, resellers etc. Vide the Finance Act, 2016, an amendment was introduced to Explanation 2 to Section 65B(44) of the FA which sought to cover an activity carried out by a lottery distributor or selling agent on behalf of the State Government, in relation to promotion, marketing, organizing, selling of lottery or facilitating in organizing lottery in accordance with the provisions of Lottery (Regulation) Act, 1998, within the definition of service. In furtherance to the said amendment, Notification No. 18/2016- ST dated March 1, 2016 was issued by the CBEC to amend Notification No. 30/2012- ST dated June 20, The said notification inter alia sought to levy service tax under reverse charge on the following services the taxable services provided or agreed to be provided by a selling or marketing agent of lottery tickets in relation No service tax can be levied without ascertaining the consideration for such services. to a lottery in any manner to a lottery distributor or selling agent of the State Government under the provisions of the Lottery (Regulations) Act, Post the amendments introduced vide Finance Act, 2016 and Notification No. 18/2016- ST dated March 01, 2016, a letter was issued to the Petitioners on June 10, 2016 seeking payment of service tax. The Petitioners, therefore, challenged the legality and validity of the aforesaid amendments. ISSUES 1. Whether the concerned amendment made in the FA vide Finance Act, 2016 is ultra-vires the Constitution of India? 2. Whether Notification No. 18/2016-ST dated March 1, 2016 imposing service tax on services in relation to marketing, promotion and organization of lotteries under reverse charge mechanism is legal and valid? ARGUMENTS/ANALYSIS The Petitioners contended that the subject lottery was covered within the definition of betting and gambling which would fall in the List II (State List) of the Seventh Schedule of the Constitution of India. Therefore, the amendment introduced for imposition of service tax on the same was ultra vires the Constitution of India, as the Parliament could neither enact nor amend legislations pertaining to lottery. The Petitioners further, relying on the decisions of this Court, wherein it was held that the Parliament was not competent to impose service tax on lottery, argued that there was no change in the legal position in this regard since lottery continues to be covered under the State List of the Seventh Schedule of the Constitution of India. 64 Future Gaming & Hotel Services (P) Ltd vs. UOI & Ors VIL-174-SIK-ST Cyril Amarchand Mangaldas

38 The Petitioner further contended that in the instant case, the invoices raised by the State Government clearly demonstrated that the procurement of lottery tickets by the Petitioners was an outright sale, and therefore, no service tax could be levied on such sale. On the other hand, UOI and other respondents ( Respondents ) argued that the service tax (vide the amendment) was not imposed on lottery per se, but on the services rendered by the distributors or selling agents in relation to marketing, promoting and organizing lottery. Lottery as an activity was conducted by the State of Sikkim and the State of Sikkim was not liable to pay any service tax in this regard. Relying on the order of Federation of Hotels and 65 Restaurant Association of India, the Respondents further argued that the Parliament was competent to levy service tax on the services rendered in relation to organizing lottery for sale of lottery under Entry 92C in List I (Union List) of the Seventh Schedule, inserted vide Article 268A of the Constitution of India. The Respondents also relied on United Nation- Central Product ( UN-CPC ) classification to argue that the conduct of lottery would amount to service in the international context and was classifiable under the Heading No of the UN-CPC classification. DECISION The HC observed that a Division Bench of the same Court had earlier held that lottery is purely a transaction of sale and purchase, and did not involve any element of service. The HC further observed that the FA has been time and again amended to impose service tax on lottery through earlier notifications issued in 2012 and 2015, and have been repeatedly held as unconstitutional by the previous Division Benches of the HC. However, the HC differentiated the present writ from others and held that unlike the earlier amendments, the amendment in dispute was dealing with service tax on activities related to the distributions and sale of lottery tickets, and not the activity of distribution and sale of lottery per se. Therefore, it was held by the HC that the Union was well within its power and competence under Article 268A read with Entry 97, List I (Union List) of the Constitution of India to impose and levy service tax on activities related to lottery. Hence, the amendment introduced vide Finance Act, 2016, which sought to include the activities carried out by lottery distributors and selling agents in relation to marketing, promotion and organization of lotteries within the definition of service, was upheld. The HC also observed that in the instant case, no consideration is being paid by the Government for activities undertaken by the Petitioners. Therefore, the HC held that when consideration in the instant case was unascertainable and no appropriate valuation mechanism has being provided in this regard, the amendment to the notification in relation to reverse charge payments was liable to be set aside. In light of the above, the HC quashed the letter dated June 10, 2016 issued by the Respondent for recover of service tax as well as Notification No. 18/2016-ST dated March 01, SIGNIFICANT TAKEAWAY It is significant to note that since service tax is a central legislation, the judgment of HC in the instant case may also trigger similar litigation in other states such as Nagaland, Goa, Assam etc. Further, the Central Government's intention of levying service tax on the activities related to lottery has been clear for long now, and therefore in our view, it wouldn't be long that a new notification would be issued to notify the mechanism for computation of consideration for lottery related services. However, doing this would not be a very easy task for the Central Government. The Central Government may require cooperation from the States for the determination of valuation provisions for levy of service tax on the same. Additionally, if this judgment is challenged by the Government before the SC, the final fate of the levy would depend upon the outcome before the SC. Further, with the introduction of GST round the corner, this issue would become academic, since under the GST regime, lottery has been defined as an actionable claim covered within the definition of goods. Therefore, GST would bring about the much needed clarity in relation to taxability of lottery. 65 Federation of Hotels and Restaurant Association of India v. UOI (1989) 3 SCC Cyril Amarchand Mangaldas

39 REPRESENTATIONAL RIGHTS MUST BE CONFERRED, ALONG WITH OTHER RIGHTS, IN ORDER TO CONSTITUTE FRANCHISE SERVICE FOR CHARGING SERVICE TAX 66 In Delhi International Airport (P) Ltd, the Delhi HC held that any agreement, conferring various rights inter alia including the right to undertake a process or provide various services, but not conferring any representational rights, would not constitute a franchise agreement. Therefore, annual fee paid to the Airport Authority of India ( AAI ) by the Delhi/Bombay International Airport Pvt. Ltd. ( Petitioners ) in lieu of the aforesaid rights, would not be exigible to service tax under the heading of franchisee services. FACTS The AAI had entered into Operations, Management and Development Agreements ( OMDAs ) with the consortium led by GMR Group and GVK Group for maintenance of the Delhi and Bombay airports. In terms of these OMDAs, the Petitioners were given the exclusive rights and authority to undertake some of the functions of the AAI, such as operation, maintenance, development, design, construction upgradation, modernization, finance, and management etc., of the said airports. In lieu of the grants of the aforesaid rights, the Petitioners were required to pay inter-alia an annual fee to AAI. The upfront fee and annual fees was payable to the AAI by way of revenue sharing through an escrow bank account. Under the escrow bank account mechanism, all the receipts from various sources of income for the Petitioners were deposited in a Receivable Account from where they were transferred to a Proceeds Account. From the Proceeds Accounts, post the payments of statutory dues etc., the upfront fee and annual fees were paid to AAI. The remaining balance post this was transferred to a Surplus Account belonging to the Petitioners as their share of the revenue. Provision of franchise service requires complete divesting of representational rights. In the instant writ petition before the Delhi HC, the Petitioners challenged the order of the Adjudicating Authority confirming the demand of service tax on the upfront fee and annual fee paid to AAI under the taxable service category of franchise service. ISSUES Whether the OMDAs constitute franchise agreements, and if so, whether the upfront and annual fee payable by the Petitioners is chargeable to services tax under the taxing entry franchise service? ANALYSIS/ ARGUMENTS The Petitioners contended that the upfront fee and annual fee were in the nature of revenue share, which was received by AAI even before any part of the revenue was received by the Petitioners. Therefore, the same would not amount to a consideration for any service. Hence, no service tax could be levied on the said fees. The Petitioners further contended that the OMDAs were not franchise agreements but were entered for divesting of certain rights and functions of the AAI on the Petitioners, in order to effectively maintain the airports. The Petitioners further argued that the applicable service tax was already being paid on the annual fee by them under the taxing entry Airport Services. The Petitioners also argued that under a franchise agreement, a representational right to sell or manufacture goods or to provide services, in the name of franchisor, was granted, whereas in the instant case, the Petitioners were performing services in their own name and were not granted any representational rights by AAI to render services. On the other hand, the UOI ( Respondent ) contended that the upfront fee and annual fee paid by the Petitioners was chargeable to service tax under the 66 Delhi International Airport (P) Ltd v. UOI 2017-VIL-106-Del-ST Cyril Amarchand Mangaldas

40 taxing entry Franchise Services. It was further argued that the phrase representational rights was used in the OMDAs, which would essentially mean conferment of rights by the franchisor to the franchisee to do the activities, which were otherwise solely identified with it. The Respondent also argued that various clauses of the OMDAs clearly reflected that the relationship between the parties squarely fall within the definition of the term franchise services as used under the FA. DECISION The HC held that merely conferring rights on a party to sell or manufacture goods or provide services or undertake a process, would not ipso facto bring the agreements within the ambit of franchise services. What was also required for franchise service, was to e s t a b l i s h t h a t t h e r i g h t s c o n f e r r e d w e r e representational rights. The HC further held that a representational right would typically mean a right to represent the franchisor. The HC noted that AAI had completely divested its rights (except exclusive rights) to the Petitioners, however, the airports were being operated, maintained and developed by the Petitioners in their own right and in their own names. The Petitioners ran their own operations using their own processes, policies, methods, designs, techniques etc. Accordingly, the HC held that unless the functions of AAI were completely divested by it and assigned to the Petitioners, and the Petitioners were representing AAI in performance of those functions i.e. acting on behalf of AAI while carrying out those functions, it could not be said that representation right had been assigned to the Petitioners by AAI. The HC further held that for a transaction to be taxable, it is necessary that the service should be provided by the AAI to the Petitioners. However, in the instant case, no service was being provided by AAI to the Petitioners. On the contrary, services were under provided by the Petitioners, on which the service tax was duly paid under the head airport services. Accordingly, the HC held that the since, conferment of representational rights and provision of service by AAI to the Petitioners were absent in the present transaction, the OMDAs would not fall within the ambit of franchise agreements, and therefore, no service tax would be payable on annual fee paid by the Petitioners. SIGNIFICANT TAKEAWAY Though this judgment relates to an issue pertaining to the positive regime of service tax (pre-2012), the pronouncement of the HC would have an impact on all such agreements especially between the brand owners and dealers. The parties to the agreement may, in light of this judgment, compare the pros and cons of the franchise arrangement and mutually agree upon whether they wish to enter into a franchise agreement. Where the parties intend to transfer merely the exclusive rights, such as intellectual property rights, one can explore the option of transfer of license by way of transfer of right to use such goods. Transfer of right to use such goods is excluded from the ambit of service tax. Such transfer is covered under VAT laws, wherein the same is taxable at a lesser rate as compared to rate of service tax. However in the current regime, such agreements are also prone to the risk of being subject to double taxation since service tax authorities also seek to levy tax on the same. Similarly, in supply related transactions, one can also consider the option of Distributorship Arrangement, wherein the distributor merely functions on behalf of the other party for a commission, and service tax is merely charged on the commission. Thus, depending on the commercials of each transaction, one can compare various arrangements, and opt for the most favorable one. Also, even after the introduction of GST, this aforesaid judgment would have a valid precedent value as the goods and services under the GST regime would be taxed at different rates. Accordingly, GST implications may vary for different business arrangements. Additionally, if the GST Council decides for multiple tax rates for services also, the nature of business arrangements would have to be further examined Cyril Amarchand Mangaldas

41 POST SALE DISCOUNT THROUGH ISSUE OF CREDIT NOTES TO REIMBURSE THE BALANCE OF SALE PRICE TO BE INCLUDED IN TAXABLE TURNOVER 67 In M/s Vettathil Agency, the Kerala HC held that post sale discounts, in the nature of reimbursement of balance of the sale price, provided by way of credit notes would not be excluded from the taxable turnover for the purpose of charging VAT on the same. FACTS M/s Vettahalli Agencies ( Petitioner ) was engaged in trading of cement wherein goods were purchased from the manufacture's local depot and sold to the retailers within the State. The Petitioner was receiving certain post sale discounts under various schemes from the suppliers by way of credit notes. Such discount was passed on to the Petitioner after raising the tax invoice by suppliers, and VAT on such discounted amount was duly paid by the supplier in terms of the Kerala Value Added Tax Act, 2003 ( KVAT Act ). The Petitioner was issued a notice under Section 25(1) of the KVAT Act for reassessment on the ground that the sales turnover of the goods was below the cost of purchase of those goods. After adjudicating the aforesaid matter, the Assessing Authority passed an order in favor of the VAT department. The Petitioner challenged the aforesaid order in the present writ petition. ISSUES Whether the aforesaid post sale discounts given to the Petitioner by way of credit notes should be allowed as deduction from the taxable turnover under the KVAT Act? ARGUMENTS/ANALYSIS The Petitioner argued that inclusion of discounts received by way of credit notes would fall outside the scope of levy contemplated under the KVAT Act, Reimbursement of balance of sale price will be included in the taxable turnover. especially when the turnover of discount had already suffered tax in the hands of the seller. In this regard, the Petitioner relied upon the Fifth proviso to Section 68 11(3) of the KVAT Act. The Petitioner argued that the aforesaid proviso was further amended in 2008 to provide that the discounts provided by way of credit notes by the supplier, which do not impact the input tax credit already availed, shall not be reckoned for the purpose of assessment under the KVAT Act. Therefore, the Petitioner argued that the levy of tax on discounts received through credit notes was not valid. On the other hand, the Commercial Tax Officer, Cherthala ( Respondent ), relying on the judgments 69 in the cases of State of Kerala and Tenny 70 Devassy argued that any reimbursement of price received by a dealer was liable to be included in his turnover, whereas the discount allowed to the customer and shown separately in the invoice was to be excluded. The Respondent contended that in the instant case, the amount received in the name of discount by the Petitioner was nothing but a reimbursement of balance of sale price, which would attract tax in terms of Explanation VII to Section 2(lii) of the KVAT Act. The said explanation provides that where the goods are sold at a price less than cost of purchase, and the seller recovers the amount as reimbursement of balance of price, the amount so received would be covered under turnover. The Respondent further argued that Fifth proviso to Section 11(3) of the KVAT Act had no relevance to the factual aspects involved in the matter. DECISION The HC held that the amendment to the Fifth Proviso to Section 11(3) of KVAT Act, on which the Petitioner had relied upon, was issued only to clarify that the 67 M/s Vettathil Agencies v. CTO, Cherthala 2017-VIL-110-KER. 68 Fifth Proviso to Section 11(3) indicates that the input tax credit shall not be available in respect of tax paid on the turnover subsequently allowed as discount, and shall be disallowed where it is found that the dealer has claimed input tax credit under this section on such turnover or of such goods used in the manufacture of goods sent outside the State. 69 State of Kerala v. Syed Muhammed 2016 (4) KLT Tenny Devassy v. State of Kerala 2015-VIL-593-KER Cyril Amarchand Mangaldas

42 amount covered under credit notes issued by a supplier would not be reckoned for the purpose of assessment under the KVAT Act. The same could not be extended to mean the assessment of turnover for the purpose of levy of tax. The HC therefore, held that the said amendment had no relevance to the present case. The HC further held that the rational given in Syed Muhammed (supra.) stands valid, wherein it was held that reimbursement of balance of the sale price in the form of post sale discounts passed on to the buyers by way of credit notes would be included in the turnover for the purpose of levy of tax. SIGNIFICANT TAKEAWAY In the instant judgment, it was clarified that not all discounts are allowed for deduction from the taxable turnover. Any discount which is passed on to the buyers subsequently in the form of reimbursement cannot partake the nature of actual discount which is allowed for deduction. The judgment, thus, leaves no gap for the trader to misuse benefit provided to them in the name of discount. However, as VAT is a State legislation, the binding impact of the aforesaid judgment would be limited to the State of Kerala. However, the States having similar provision in their VAT legislation may also adopt similar interpretation, till the matter is adjudicated by the HC of the particular State. The issue of allowing the deduction of discounts being offered from the taxable turnover would no longer remain an issue under the GST regime, since the CGST Act, 2017 clearly provides that the any discount provided before or at the time of supply shall be allowed for deduction as long as the discount has been duly recorded in the invoice. Further, if the discount is given post the supply, the same must be established in terms of the agreement which should directly link to the discount. It has also been clarified that and no ITC shall be availed on such discounts or the same shall be reversed, if availed Cyril Amarchand Mangaldas

43 TIME BOUND SOFTWARE AND BETA SOFTWARE ARE NOT SAME AS A FULLY PACKAGED PRODUCT SOFTWARE 71 In M/s Microsoft Corporation, the CESTAT held that Time Bound Software and Beta Software, imported and distributed for trial purposes for a limited period of time and for testing purposes, respectively, cannot be regarded as the Fully Packaged Product Software. Hence, the value of such Software shall also not be determined in accordance with Rule 4 but under Rule 9 of the Customs Valuation Rules, 2007 ( Valuation 72 Rules ). FACTS M/s Microsoft Corporation (India) Private Limited ( Appellant ) was engaged in the importation of the Time Bound Software and Beta S o f t w a r e f r o m M / s M i c r o s o f t Corporation, USA and Microsoft Operation Pte. Ltd., Singapore. The Time Bound Software were imported and distributed for demo/trail purpose for a limited period of time i.e days. Such Software was also available for free download. Further, Beta Software was released to developers, coders, etc., for testing and fixing bugs/making improvements before the launch of Fully Packaged Product ( FPP ) Software. The Customs Authority valued such Software on the basis of the value of a Fully Packaged Product ( FPP ) Software, considering the same as identical to the software in question, basis Rule 4 of the Valuation Rules. The valuation was further confirmed by the Commissioner (Appeal) vide an order dated May 25, The Petitioner filed an appeal against the aforesaid order before the CESTAT, Delhi. ISSUES Whether the Time Bound Software and Beta Software are similar to FPP Software, and therefore, liable for valuation under Rule 4 of the Rules? Time Bound and Beta Software are different from Fully Packaged Product Software in terms of character, content and usage. ARGUMENTS/ANALYSIS The Appellant argued that Time Bound Software was imported only for the purposes of demonstration and trial for a limited period of 90 to 180 days and no royalty was paid on such software. The Appellant further contended that the import of such software should have been considered as non-commercial shipment as the same was meant for free distribution and no license fee was charged for it. The Appellant also argued that Time Bound Software was physically different from FPP Software in terms of character, content and usage. Accordingly, the Appellant argued that the cost of the media (including replication cost) alone should have been taken as the transaction value for the purpose of levy of import duty, and the same would not be liable for valuation, basis the value of an identical goods under Rule 4 of the Valuation Rules as computed by the Customs Authority. Further, with regards to Beta Software, the Appellant argued that Beta Software was available in the market only for testing purposes, usually through free download or physical CD/ media. The Appellant further contended that such software requires undergoing several key changes until it reached the final version. The Appellant also contended that there could also be a situation where the final version was never launched. Hence, the Beta Software was not comparable to FPP Software, which was capable of being bought or sold in the market. Therefore, the Appellant contended that the software imported by them should have been assessed independently on the basis of cost of media (including replication cost) value in terms of Rule 9 of the Valuation Rules. 71 M/s Microsoft Corporation (India) Private Limited vs. CC, New Delhi 2017-VIL-224-CESTAT-DEL-CU. 72 Rule 4 of the Rules provides for determination of transaction value of identical goods; Rule 9 of the Rules provides for residual method for determination of value of imported goods Cyril Amarchand Mangaldas

44 DECISION The CESTAT held that since the Time Bound Software had got the life of only 90 days to 180 days, the same cannot be compared with FPP Software which has got no time limit for usage. Therefore, both could not have same values or cannot be called identical or similar products. Therefore, the determination of value of the same would not be carried out in terms of Rule 4 of the Valuation Rules. Further, the CESTAT observed that Rule 7 of the Valuation Rules which provided for deductive value with reference to identical goods, and Rule 8 of the Valuation Rules which provided for computed value on the value of material, fabrication or other processing employed and amount of profit were also not applicable in the instant case. Hence, the valuation of the same had to be done in accordance with Rule 9 of the Valuation Rules. Similarly, with regards to Beta Software, the CESTAT held that the same was a moveable property which had been put into media- CD/DVSs and was being transacted/ passed over/ traded as such. Hence, the same would amount to goods in terms of Section 2(22) of the CA. The CESTAT further held that the valuation of the Beta Software would also not be determined under Rule 4 of the Valuation Rules, for the aforementioned reasons and the valuation had to be done in accordance with Rule 9 of the Valuation Rules. Accordingly, the CESTAT remanded back the matter to the lower authorities for valuation. SIGNIFICANT TAKEAWAY The instant judgment of the CESTAT is an important judgment since it lays down the test for determining the value of software, when no similar software is available in the market for comparison for valuation purposes. The CESTAT held that the nature, feature and time span of software is an important element for the determination of its value. Further, it was held that the customs authorities cannot arbitrarily compare any software to a FPP software, merely on the ground that the software is imported in a form of media. Accordingly, this judgment is a welcome respite for importers who are engaged in the import of unique kinds of software Cyril Amarchand Mangaldas

45 LEVY OF EXCISE DUTY BASIS THE PRODUCTION CAPACITY IS NOT UNREASONABLE OR ARBITRARY 73 In the case of Prabhat Zarda Factory India (P) Ltd., the Patna HC held that the levy of excise duty basis the manufacturing speed of the packing machine could not be said to be violate the fundamental right 74 enshrined under Article 19(1)(g) of the Constitution of India. FACTS Prabhat Zarda Factory India (P) Ltd. ( Petitioner ) was engaged in the manufacturing and exporting of zarda and chewing tobacco (scheduled tobacco products) ( Product ) from the State of Bihar. The Petitioner had an extensive market in India and abroad. The Central Government ( Respondent ), vide Notification dated February 27, 2010, declared chewing tobacco as a notified good, thereby attracting Excise Duty ( Duty ) thereon,under the CEA. In this regard, the Chewing Tobacco and Unmanufactured Tobacco Packaging Machines (Capacity Determination and Collection of Duty) Rules, 2010 ( Rules ) were also notified. The Rules provided for the levy of Duty, not on the basis of actual production, but on the basis of the total manufacturing capacity of the unit. In terms of the Rules, the manufacturing capacity of Unit was determined basis the number of packing machines therein. The Rules were amended vide Notification dated January 24, 2014 and the rates of duty levieable per packing machine per month were substantially increased. The Rules were further amended vide Notification dated March 1, 2015 ( Impugned Notification ), the maximum packing speed at which a packing machine could be operated was included as a co-determinative factor, along with the number of such machines installed in a unit, for arriving at the manufacturing capacity of a unit. In this regard, the Petitioner had preferred the instant writ petition before the Hon'ble HC praying for the quashing of Impugned Notification in so far as it violated the fundamental right of the Petitioner to carry any occupation, trade or business. ISSUE Whether the Impugned Notification violated the fundamental rights of the Petitioner guaranteed under Article 19(1)(g) of the Constitution of India. ARGUMENTS/ANALSYS The Petitioner submitted that on one hand, the Respondent was significantly raising the Duty on the Product, but on the other hand, even the manufacturing and trading was being prohibited treating the Product to be food product. Thus, on account of issuance of Notifications by the State Government one after the another, the market trend, with respect to the Product had become very uncertain. The actual production had declined many times on account of loss of market, and simultaneously, the manufacturers were required to pay the Duty as per the original deemed production. Such increase in the rates of Duty by the Respondent had triggered significant increase in the price of the Product in the market, thereby decreasing the demand for the Product. This had resulted in a sharp decline in the production of the Product on account of heavy losses incurred by the Petitioner. Accordingly, the Petitioner had alleged that the Impugned Notification affects the Petitioner's right to carry on any occupation, trade or business guaranteed under Article 19(1)(g) of the Constitution of India. The Petitioner then contended that the levy of Duty on the basis of maximum speed of utilization of the machine was arbitrary and unreasonable as the machine could not always be operated at its optimum capacity. The Petitioner had also placed reliance on the case of 75 Moti Laminates (P.) Ltd. and contended that in view of the said judgment, excise duty was leviable only if the goods of marketable or capable of being marketed. Accordingly, since the manufacturing of the Product 73 Prabhat Zarda Factory India (P) Ltd. v. Union of India (2017) 80 taxmann.com 348 (Patna). 74 Right to practice any profession, or to carry on any occupation, trade or business. 75 Moti Laminates (P.) Ltd. v. Collector of Central Excise (1995) taxmann.com Cyril Amarchand Mangaldas

46 had been prohibited in some States, the Product could not be said to be a marketable product. The Respondent, in its counter affidavit, stated that the CEA had empowered the Respondent to levy and collect Duty on the notified goods basis the production capacity. Section 3A of the CEA empowered the Respondent to use alternative schemes for levy of Duty on certain goods/class of goods, inter alia levy on the basis of quantum of production where the excisable commodity was prone to evasion. The Respondent asserted that huge quantity of the production of the Product was going unaccounted by many unscrupulous manufacturers. Therefore, the Respondent asserted that the rationale for notifying such goods was to prevent the evasion of Duty. Further, the Respondent pointed that the Cigarettes and Other Tobacco Products (Prohibition of Advertisement and Regulation of Trade and Commerce, Production, Supply and Distribution) Act, 2003 ( Tobacco Regulation Act ), as well as the Rules, prescribed s a f e g u a r d p r o c e d u r e f o r abatement of Duty levied, subject to fulfillment of conditions. Such abatement of Duty was available w h e r e t h e p r o d u c t i o n w a s suspended for more than 15 continuous days in any Product manufacturing unit. In view of the aforementioned safeguard procedures, the Respondent contended that there was no unreasonable burden on the Petitioners. Even if the manufacturing was suspended pusruant to prohibition or ban of production by State legislation, the Petitioner could have availed the abatement. The Respondent also pointed out that considering the hazardous impact of the Product on the health of the citizens, its consumption and use was also to be discouraged. Therefore, in view of the said fact, the Duty with respect to such goods had been raised from time to time. DECISION The HC noted that the scheme of the Rules contemplated for the cases where the manufacturer The manufacturing speed of a machine is relevant for determining the production capacity of a factory. The levy of Excise Duty on such basis is not unreasonable or arbitrary. did not want to operate a packing machine or the unit as a whole, or where the notified goods were not manufactured for any continuous period of 15 days. The Rules provided for proper safeguard for the abatement of Duty in all of the aforementioned cases. The HC also noted that the Tobacco Regulation Act was enacted in pursuance of the resolutions at World th rd Health Organization's ( WHO ) 29 and 43 World Health Assemblies, where the members States, including India, were urged to plan legislations with a view to strategically control tobacco for protecting the various risk groups such as pregnant woman and children from involuntary exposure to tobacco smoke. With regards to the levy of Duty computed on the basis of the speed of manufacturing of the packing machine, the HC observed that production speed of the machines varied from manufacturer to manufacturer and levy on such manufacturing speed was not unreasonable or arbitrary and had a nexus with the objective to be achieved. In relation to the Petitioner's reliance on the case of Moti 76 Laminates (P.) Ltd., the HC noted that merely because some States had prohibited the manufacturing of the Product, the Product would not cease to be a marketable commodity if the manufacturing process in the unit had been continuing. The HC reiterated that the legislative intent in terms of the WHO was to discourage the consumption of tobacco progressively. In view of the aforementioned, the HC held that the levy of Duty on the basis of the manufacturing speed of packing machine was not in violation of the Petitioner's fundamental right under Article 19(1)(g) of the Constitution of India. Therefore, the writ petition was dismissed. SIGNIFICANT TAKEAWAY The said ruling has ruled on a significant legal principle, in so far as it holds that the levy of excise duty on notified goods on the basis of production capacity is not unreasonable or arbitrary. Such legal principle will stand good, not for just tobacco products, but all notified goods under the CEA, where 76 Moti Laminates (P.) Ltd. v. Collector of Central Excise (supra.) Cyril Amarchand Mangaldas

47 the Government may levy tax on the basis of production capacity. Going forwards under the proposed GST regime, in terms of the second edition of the Frequently Asked Questions (FAQs) released by the CBEC on March 31, 2017, tobacco and tobacco products would be subject to GST. In addition, the Centre would have the power to levy Central Excise duty on these products. Further, in terms of the recent news article on the latest developments on the GST front, the GST th Council in its 13 meeting, held at New Delhi on March 16, 2017, had capped the cess on tobacco at 290% ad valorem. In addition, the Union health ministry has recommended the Ministry of Finance to levy tax on all tobacco products including Bidis at maximum rate plus high cess under the new GST regime Cyril Amarchand Mangaldas

48 FOREIGN GOING VESSEL ENTERING INTO THE INDIAN TERRITORIAL WATERS FOR REPAIRS IS NOT AN IMPORT FOR HOME CONSUMPTION 77 In M/s Aban Loyd Chiles Offshore Ltd., the SC held that entry of a foreign going vessel in the Indian territorial waters ( Taxable Territory ), merely for the purpose of repairs to be carried on, would not tantamount to import for home consumption of the foreign going vessel, for the levy of customs duty thereon. FACTS M/s Aban Loyd Chiles Offshore Ltd. ( Respondent ) was engaged in the business of exploratory drilling of offshore oil and gas and related activities on a contract basis. In February, the Respondent sought the permission from the Custom Authorities 78 ( Petitioner ) for the duty-free import of the rig for the purpose of carrying out repairs on the rig, in terms of Notification No. 153/1994 dated July 13, 1994, where under exemption from the levy of customs duty was granted to goods of foreign going origin, imported into India for the purpose of repairs. Thereafter, the said rig was again towed into the Taxable Territory for repairs in November 1996 and in December In September, 1999, a notice was issued by the Petitioner to the Respondent, which alleged that the three imports were undertaken in contravention of the 79 provisions of the Customs Act and sought the confiscation of the rig. Vide the said Notice, the 80 Petitioner sought to levy interest on the duty amount 81 and the penalty amount under the provisions of the Customs Act. The Respondent contested the allegations made in the notice of the Petitioner in its reply filed before the Commissioner of Customs ( CC ). In concurrence with the notice, the CC passed 82 an order ( Adjudication Order ) for confiscation of the rig on the grounds that the compliances / requirements under the Act, such as, filing of the bill of entry, declaration in the import general manifest of the towing rigs etc. were not fulfilled by the Respondent. The CC also ordered that the rig had been imported 83 for the purpose of home consumption. Aggrieved by the said Adjudication Order, the Respondent preferred an appeal before the 84 CESTAT. The Respondent placed it's reliance on 85 plethora of legal precedents and contended that a foreign going vessel does not cease to be so when it enters into the Taxable Territory only for the purpose of repair. Whereas, the Petitioner placed reliance on the 86 case of Pride Foramer, wherein it had been held that the rigs operating in designated areas were not foreign going vessels, as such areas were deemed to be Taxable Territory. Nevertheless, once the rig was brought into the Taxable Territory, the rig ceased to be a foreign going vessel. Subsequently, the CESTAT passed an order ( Impugned Order ), and held that the rig had lost its character of foreign going vessel the moment it entered the Taxable Territory for the purpose of repairs. However, the CESTAT ordered that, the rig resumed its character of foreign going vessel, as and when it left the Taxable Territory and resumed 87 operations. Further, the tribunal held that the rig was not intended to be used in India as it was only brought 77 Commissioner of Customs, Mumbai v. M/s Aban Loyd Chiles Offshore Ltd. & Ors VIL-08-SC-CU. 78 A drilling rig is a machine that creates holes in the earth sub-surface. The rig is used to drill oil wells or natural gas extraction wells. 79 Confiscation of improperly imported goods under Section 111(a) Goods unloaded at a place other than a customs port; Section 111(b) Goods imported through a route other than route specified; Section 111(g) Goods unloaded from a conveyance without mention in the import manifest or import report; Section 111(h) Goods unloaded at an unapproved place and/or without supervision of customs officer; Section 111(j) Dutiable goods removed from a customs area or a warehouse without the permission of proper officer; Section 111(o) conditions not observed for the exempted goods that are subject to conditions and confiscation of goods attempted to be improperly exported under Section 113(a) Goods attempted to be exported by sea from any place other than a customs port. 80 Section 28AA of the Act Interest on delayed payment of duty. 81 Under Section 112 of the Act Penalty for proper importation of goods. 82 Confiscation of improperly imported goods under Section 111(f) dutiable goods not mentioned in the import manifest or import report; Section 111(g) (supra.); Section 111(h) (supra.); Section 111(j) (supra.). 83 In terms of section 46 of the Act, in case of goods for home consumption, bill of entry is necessary and has to be presented and subsequently goods are required to be cleared on payment of duty. 84 Application Nos. C/MA (Ors.) 945/01-Mum in C/716, 781, 782, 814/01-Mum. 85 Amership Management Pvt. Ltd. v. UOI 1996 (86) ELT 15; Scindia Steamship Co. Ltd. v. CC 1988 (36) ELT 581; Sedco Forex International Drilling Inc. v. CC 2001 (135) ELT 625 (Tri Mumbai). 86 Price Foramer v. UOI & Ors. AIR 2001 Bom Cyril Amarchand Mangaldas

49 88 into India for the purposes of necessary repairs. Hence, it could not be said that the rig was in the nature of goods imported for home consumption and was covered under Section 46(1) of the Act and Bill of Entry was not required for the import of such foreign going vessel. Therefore, in view of the above, the CESTAT concluded that the payment of duty on the rig did not arise even if the rig was liable to duty. However, the tribunal held that the rig was liable to confiscation pertaining to the establishment of contravention of the provisions alleged by the Petitioner under the Customs Act. not tantamount to import for home consumption, as the vessel was not utilised within the territory of India. The repairs were carried on the vessel and not to utilise the vessel. Therefore, the SC, in the instant case observed that the Adjudication Order was faulty and unacceptable in so far as it held that the repairs undertaken in the Taxable Territory would complete the act of import for the requirement of home consumption to be satisfied. Accordingly the SC held that the rig, when brought into the Taxable Territory for the purpose of repair, would not amount to import as the element of home consumption is missing. Aggrieved by the decision of the CESTAT, the Respondent and the Petitioner filed cross appeals in the SC. ISSUES Whether a foreign going vessel, which enters Indian territorial waters for the purpose of repairs, should be treated as goods for home consumption? DECISION The SC, in its ruling noted that a rig, which was engaged in operations outside territorial waters of India, would be a foreign going vessel under the Customs Act. In this regard, the SC placed reliance on the case of 89 Chowgule & Co. Pvt. Ltd., where the SC had observed that the goods which were imported into India, from a place outside India, or entered India, could be classified as (i) goods entered for home consumption; (ii) goods entered for warehousing; (iii) goods in transit; and (iv) goods for transhipment. In case of goods in transit and goods for transhipment, the bill of entry was not to be presented before the customs authorities, as no duty was required to be paid, subject to fulfilment of conditions. However, bill of entry was necessary and had to be presented in case of goods for home consumption for the clearance of goods. As in the said case, the vessel was in operation and primarily used within the Taxable Territory, it was not used as an ocean going vessel. Therefore, the SC had held that the vessel was in the nature of goods imported into India for home consumption in terms of the provisions of the Customs Act. In view of the aforementioned ruling the SC was of the opinion that entry of a foreign going vessel in the Taxable Territory for mere repair of the vessel would Repairs carried on a vessel/rig in the territorial waters of India, does not tantamount to utilisation or operation of such vessel/rig in India. Further, the SC held that even though there was no import per se, it could not be held that the Respondent had not violated the provisions of the Act. The Act regulated and mandated certain compliance by the foreign going vessel when it had entered the Taxable Territory, and the provisions of the Customs Act were required to be fulfilled and complied with even when no goods were to be unloaded for import into India or the vessel was not a good meant for home consumption. Therefore, in view of the above, the appeals were. SIGNIFICANT TAKEAWAYS The taxability of a foreign going vessel, when it enters the Taxable Territory, has not been directly addressed in the fasciculus of the Chapter for provisions relating to conveyance carrying imported or exported goods under the Customs Act. This anomaly was also noted by the SC in its ruling. However, it is pertinent to note that the in the instant case, the SC remained silent with respect to the Notification under which the Respondent had sought permission from the Petitioner for the duty-free import of the rig into Mumbai for carrying out repairs. The aforesaid notification explicitly exempted articles of foreign origin from whole of the duty of customs, when such foreign origin goods are imported for repairs and returns, subject to fulfilment of conditions. Nevertheless, this ruling of the SC is a landmark ruling, in so far as it settles the law that there is no duty leviable on goods which are imported into the Taxable Territory, but are not utilised or operated in the Taxable Territory, i.e., the element of home consumption is missing. This ruling of the SC is relevant across various sectors and industries in so far as their foreign goods are imported in India but not utilised for home consumption. 87 Placed reliance on the case of Salgaonkar Engineering v. OJF Games 1984 (86) Bom LR Placed reliance on the case of Chowgule & Co. v. UOI (1987) 1 SCC 730 and UOI v. Salgaonkar & Bros. Pvt. Ltd. (1998) 4 SCC Chowgule & Co. v. UOI (1987) 1 SCC 730 and UOI v. Salgaonkar & Bros. Pvt. Ltd. (supra.) Cyril Amarchand Mangaldas

50 SELF-FUNDED BOARD, EVEN THOUGH ESTABLISHED UNDER A STATUTE, IS NOT A STATUTORY OR PUBLIC AUTHORITY In Security Guards Board for Greater Bombay & 90 Thane Dist., the CESTAT held that the Security Guards Board established under the Maharashtra Private Security Guards (Regulation of Employment & Welfare) Act, 1981 is not discharging any statutory function and charges collected by it for the provision of services shall be exigible to service tax. FACTS Security Guards Board for Greater Bombay & Thane Dist. ( Appellant ) was constituted under Section 6 of the Maharashtra Private Security Guards (Regulation of Employment & Welfare) Act, 1981 ( Act ). The Appellant was engaged in providing manpower services, in the nature of security guards, to various clients. For the aforementioned services, the Appellant was collecting wages and allowances for the security guards along with a 5% administration charge for itself from the clients. The Central Excise Authorities ( Respondent ) issued a show-cause notice ( Notice ) to the Appellant alleging that the 91 Appellant had provided security agency and 92 manpower recruitment agency service to the clients. Basis this, the Respondent raised a demand for service tax on the entire amount, i.e., allowance, wages and administration charges, collected by the Appellant from the clients. On appeal, the Commissioner affirmed the entire demand and imposed a penalty of an equal amount 9 3 under Section 76 of the FA. Further, the Commissioner also imposed penalty under Section and 78 of the FA. Aggrieved by the order-in-original issued by the commissioner ( OIO ), the Appellant had filed the instant appeal before the CESTAT. ISSUES 1. Whether the Appellant, established under the Act, can be said to be a public or statutory authority. 2. Whether the Appellant was discharging a taxable service. ARGUMENTS/ANALYSIS The Appellant asserted that its function was limited to delivering statutory functions and it could not be deemed to be a service provider. The Appellant further contended that the Appellant board was a statutory body established by the Government of Maharashtra under the Act with the objective of regulating the employment of security guards in the State. The function of the Appellant was to ensure for employee friendly provisions and terms and conditions pertaining to employment and welfare of the security guards. Therefore, the Appellant could not be alleged to be a business in terms of definition of security agency under the FA. The Appellant then placed 96 reliance on various judicial precedents in support of its arguments that governmental functions were analogous to trade or industry. Further, the Appellant laid emphasis on a CBEC 97 Circular, which provided that the fee collected by any sovereign/public authorities for performing any activity which was in the nature of compulsory levy as per the provisions of the relevant statute, and 90 Security Guards Board for Greater Bombay & Thane Dist. V. Commissioner of Central Excise, Thane-II TS-593-CESTAT-2016-ST. 91 Under the erstwhile Section 65(94) of the FA, the term security agency has been defined to mean any person engaged in the business of rendering services relating to the security of any property, whether moveable or immoveable, or of any person, in any manner and includes the services of investigation, detection or verification, of any fact or activity, whether of a personal nature or otherwise, including the services of providing security personnel. 92 Under the erstwhile Section 65(94) of the FA, the term manpower recruitment or supply agency has been defined to mean any person engaged in providing any service, directly or indirectly, in any manner for recruitment or supply or manpower, temporarily or otherwise, to any other person. 93 Penalty for failure to pay service tax. 94 Penalty for contravention of Rules & provisions of Act for which no penalty is specified elsewhere. 95 Penalty for failure to pay service tax for reasons of fraud etc. 96 Hussain Mithu Mhasvadkar v. Bombay Iron & Steel Labour Board and Ors (62) FLR 199 Reliance was also placed on the case of Vizagpatnam Dock Labour Board v. Stevedores Association Vishakhapatnam AIR 1970 SC 1626 wherein it was held that the Vizagapatam Dock Labour Board, functioning under Dock Workers Regulation of Employment Act, 1948, could not be considered as an industry. 97 Circular No. 89/7/2006-ST dated December 18, Cyril Amarchand Mangaldas

51 subsequently deposited into the Government Treasury, did not constitute a taxable service. The Respondent, in this regard, placed reliance on the allegations made in the OIO that, in terms of the FA, the Appellant was providing security agency and manpower recruitment agency service to the clients. DECISION The CESTAT, in its ruling, had analysed various relevant provisions from the Maharashtra Private Security Guards (Regulation of Employment & Welfare) Scheme, 2002 ( Scheme ) and the Act. The 98 CESTAT noted that the under Clause 40 of the Scheme the cost of operations and different benefits, facilities and amenities provided to the registered security guards of the Appellant were to be expensed by the Appellant itself and were not to be charged to the Government's consolidated fund. Further, the CESTAT noted that in terms of section 6(8) of the Act, the expenses, salaries etc. of the members of the Appellant were compensated independently by the Appellant from the a d m i n i s t r a t i o n c h a r g e s collected by it. The CESTAT concluded that the Appellant was not a public authority or a s t a t u t o r y a u t h o r i t y. Consequently, the functions discharged by the Appellant were not a statutory functions and charges collected by the Appellant were exigible to service tax. 99 However, in terms of Clause 31 of the Scheme, the CESTAT noted that wages and allowance were collected by the Board as an agent and on behalf of the security guards from the clients. The amount so collected, was to be disbursed to the security guards on specified days of every month. The said provision The expenses and the salaries of the Appellant are not charged to the Consolidated Fund but are charged to the amount recovered under the Scheme. Therefore, it cannot be said that the Appellant is a Public Authority or Statutory Authority. under the Scheme also allowed for the client to directly pay the wages and allowances to the security guard after making deductions as specified in the Scheme. Therefore, in view of the aforementioned provision, the CESTAT held that the wages and allowances collected by the Appellant were to be excluded from the taxable value and the service tax shall be levied only on the amount of administration charges retained by the Appellant for itself. SIGNIFICANT TAKEAWAYS The instant case pertains to the FA provisions prior to 100 the negative list regime. Under the current regime, services provided or agreed to be provided by way of supply of manpower for any purpose or security services provided by any individual, HUF or partnership Firm to any body corporate in the taxable territory are chargeable under the reverse charge mechanism, i.e., all of the service tax is chargeable in the hands of the service recipient. G o i n g f o r w a r d, i n t h e u p c o m i n g G S T r e g i m e, Section 7(2)(b) of the CGST Act provides that activities or transactions undertaken by the Central Government, a State Government or any local authority in which they are engaged as public authorities, as may be notified by the government, shall be treated neither as supply nor a supply of services. The term local authority has been defined under Section 2(69) of the CGST Act to include Panchayat, Municipality, Municipal Committee, Cantonment Board, Regional Council etc. However, it does not cover the Appellant board. Therefore, under the GST regime, the supplier of such service shall remain liable to pay goods and services tax on supply of such services. 98 Cost of operating the Scheme and provisions for amenities and benefits to the registered security guards of the Board. 99 Disbursement of wages and other allowances to registered security guards of the Board. 100 In terms of Entry No. 8 under Notification No. 30/2012-ST dated June 20, 2012 (as amended) Cyril Amarchand Mangaldas

52 LEVY OF LUXURY TAX WOULD ARISE ONLY ON THE ENJOYMENT OF LUXURY AND NOT ON MERE PROVISION OF FACILITY WHICH COULD BE TERMED AS LUXURY 101 In M/s Mahindra Holidays and Resorts India Ltd., the Kerala HC held that for the purpose of levy of luxury tax in case of time-share arrangements, the enjoyment of luxury would be occasioned when the person availed the facility accommodation in the resort. FACTS M/s Mahindra Holidays and Resorts India Ltd., M/s Sterling Holidays and Resorts India Ltd. and The Goan Beach Resorts Pvt. Ltd. ( Petitioners ) were engaged in the business of supplying hotel services and owned several resorts in Kerala. The Petitioners offered the option of membership to their customers on a time-share basis, for a fixed consideration along with recurring annual subscription charges. In lieu of such membership, the members were entitled to avail free of cost accommodation, every year, for specific number of days, for the span of 10/25/33 years. The eligibility depended upon the category of membership subscribed by the member and the availability of the choice of apartment, at any given point, in the resorts of the Petitioners. Pertaining to the said membership, the members also became entitled to bundle of other rights, like exchanging and splitting up of holidays, carrying forward etc. Further, the said membership provided the members with a right to an alternate accommodation, for the members, if a preferred location was not available. In case of a default in providing an alternate accommodation by the resort, the resort was liable to pay liquidated damages, equivalent to the existing rent/tariff as was applicable to non-members, for the allotted apartment and destination, during the period for which the confirmation voucher was issued. The Petitioners were registered under the Kerala Tax on Luxuries Act, 1979 ( Luxury Tax Act ) and paid luxury tax on the luxuries provided in its resorts under the provisions of the Luxury Tax Act. However, the Petitioners did not pay luxury tax on the consideration received from the members for the services provided by the resorts to its members under the time-share arrangement in the resorts with them. The Luxury Tax Authorities ( Respondent ), on the basis of the books of accounts produced by the Pe t i t i o n e r s, d e t e r m i n e d t h e c h a r g e s f o r accommodation on notional basis, as applied to the non-members on their stay, and passed an assessment order ( Order ). The Respondent also imposed penalty on the Petitioners for filing incorrect returns. Thereby, the Respondent, in its Order, levied luxury tax on the stay of members in the resorts on the notional amount, computed on the rent / tariff prevalent during the time of exercise of the benefits by the members, in the nature of free of cost accommodation, under the time-share agreement. Aggrieved by the Order and the penalties levied by the Respondents, the Petitioners filed the instant writ petition before the Kerala HC. ISSUES Whether the facilities availed by the members of the time-share arrangement can be brought under the definition of luxuries under the Luxury Tax Act. ARGUMENTS/ANALYSIS The Petitioners contended the Luxury Tax Act contemplated levy of tax only on rent/tariff on a perday basis and did not provide specific provision for luxury tax on the enjoyment of holiday under timeshare arrangement. In this regard, the Petitioners placed reliance on the Article 265 of the Indian 102 Constitution and on the judgment of SC in the case 103 of Orient Fabrics (P) Ltd., which provides that authority of law has to be specific, explicit and express and there cannot be interpretative process in applying the charging section. 101 M/s Mahindra Holidays and Resorts India Ltd. & Ors. v. The Intelligence Officer & Ors. TS-72-HC-2017(KER)-VAT. 102 Article 265: Taxes not to be imposed save by authority of law. 103 CCE v. Orient Fabrics (P) Ltd. (2004) 1 SCC Cyril Amarchand Mangaldas

53 The Petitioners submitted that the Goa Tax on Luxuries Act, 1988 ( Goa Luxuries Tax Act ) and the Himachal Pradesh Tax on Luxuries (in Hotels and Lodging Houses) Act, 1979 ( Himachal Pradesh Luxuries Tax Act ) explicitly contemplate taxing of timeshare agreements under the respective Acts. Therefore, in the absence of such provision under the Luxury Tax Act, there could not be valid computation of charges on the notional amount under the Luxury Tax Act. The Petitioners also argued that the measure or value, on which the tax is charged, is one of the necessary components for the purpose of levy of any 104 tax. The Respondent had resorted to artificial computation by taking room charges applicable to the non-members to determine the charges for accommodation for levy of luxury tax. Such computation of measure for levy of luxury tax would be illegal. On the other hand, the Respondent contended that the Petitioners had not produced any material to show the basis on which the accommodation is granted to the members and how the membership fees are arrived at. The Respondent submitted that luxury tax is levied on the luxury enjoyed by the members when they are staying in the resort and not on the membership fees. If a member does not stay at the Resort, no luxury tax was leviable. The Respondent argued that the services enjoyed by the members on such accommodation were the same as that were enjoyed by the non-members and the membership fees paid by the members were in lieu of the charges for accommodation, as applied to nonmembers by the Petitioners. Further, the Respondent contended that, the inclusion of specific provision in the Goa Luxuries Tax Act and the Himachal Pradesh Luxury Tax Act, relating to the time-share arrangement, was in the nature of explanation under the respective Acts. The Respondent submitted that, explanation in a statute was only to ensure removal of anomalies. The Respondent asserted that there was no such anomaly under the Luxury Tax Act and the time-share arrangement, provided by the Petitioners, would always come under the definition of Hotels under the Luxury Tax Act. Therefore, in view of the above, the Respondent submitted that luxury tax was leviable on the rent/tariff prevalent at time of stay of the members at the resort. DECISION The HC held that the members were entitled to assured facility of accommodation, enjoyment of which was relative, and hence the time-share arrangement was squarely covered under the 105 definition of luxury. The HC observed that the accommodation provided and availed by members or non-members, for monetary consideration, were the taxable event and not the event at which the charges were collected. Further, the HC held that the luxury tax under the Act was leviable on the charges of accommodation on a per day basis. Even in a case where a non-member stayed for more than one day, the levy of luxury tax on the basis of per day charges could not be held as an artificial levy. Furthermore, the HC observed that the membership fee was based on various factors that w e n t i n t o d e t e r m i n i n g t h e c h a r g e s f o r accommodation. Hence, the four necessary components for the purpose of levy of taxation, i.e., a c c o m m o d a t i o n p r o v i d e d f o r m o n e t a r y consideration, taxable event, taxable person and rates were held to be present in the instant case. The HC then placed reliance on the Membership Rules, which provided for liquidated damages, equivalent to the prevalent rent/tariff for nonmembers, to the members in a case where the Petitioners failed to provide an alternate accommodation after issuing a confirmation voucher to the member. Therefore, the HC observed that the enduring benefit could be measured by the liquidated damages to which the member was entitled in case of default in providing alternate accommodation. The HC held that the levy of tax on luxury would arise only on the enjoyment of luxury. The enjoyment of luxury was occasioned when the member availed the accommodation and the measure could only be the prevalent per-day charges of the accommodation. Therefore, the HC held that the accommodation provided for residence in the resort was measureable on the prevalent tariff, i.e., also the rate adopted in determining the liquidated damages. With regards to the provision for time-share arrangement under the Himachal Pradesh Luxury Tax 104 Govind Saran Ganga Saran v. CST 1985 Supp SCC Luxury, under the Luxury Tax Act, had been defined to mean a commodity or services that ministers comfort or pleasure Cyril Amarchand Mangaldas

54 Act and the Goa Luxury Tax Act, the HC affirmed Respondents submission that explanation under the said Acts could not enlarge the scope of a Section and it only filled the gap, so as to supress the mischief and advance the object of the Act. The absence of any such provision under the Luxury Tax Act could not lead to the conclusion that Luxury Tax Act does not covers time-share arrangement. Therefore, in view of the above observations, the HC held that the luxury tax was to be levied on the fixed rent/tariff prevalent for the corresponding period. The fact that the members had paid in advance could not lead to the conclusion that accommodation had been provided free of cost. With regards to the imposition of penalty, 106 the HC placed reliance on judgments and held that debatable issue of such nature could lead to presumption of any contumacious conduct or finding of attempt to evade taxes so as to warrant imposition of penalty. The Petitioners bona fide believed that there was no tax payable with respect to stay of members. Therefore, the HC held that the penalty could not be imposed. SIGNIFICANT TAKEAWAYS This is a landmark ruling that throws light on to issue of levy of luxury tax on time-share arrangements on which there is a very little jurisprudence available. The instant judgment had clarified that the levy of luxury tax would arise only on the enjoyment of luxury and the measure for such luxury could only be the existing rent/tariff prevalent that day instead of the factoring the consideration provided by the members. However, it is pertinent to note that, unlike Luxury Tax Act, some acts like the Himachal Pradesh Luxury Tax Act and the Karnataka Tax on Luxuries Act, 1979, explicitly contemplate and provide for factoring of consideration received, into per-day basis, where a lumpsum consideration is received by a hotel instead of per-day charge for accommodation. Therefore, in view of the said clause, the authorities under the aforementioned Acts may take a stand that membership fees paid under the time-share arrangement could be factored, in to per-day basis, for the The enduring benefit to which the member is entitled can be measured by the liquidated damages existing at any time, which is the rent/tariff fixed by the Petitioners. number of days, the right of stay is exercised by the customer to determine the measure for levy of luxury tax. Further, no matter however significant, the ratio of instant judgment is short-lived, as going forward, the luxury tax shall be subsumed by the upcoming GST. Under the proposed GST regime, the time of supply of services would be the date of issue invoice. Therefore, a single goods and service tax shall be levied on the issue of invoice, for the one-time consideration and/or annual subscription fees for the time-share arrangement, by the supplier of service. Nevertheless, the hoteliers like the Petitioners are well advised to examine their luxury tax liability under timeshare arrangements in view of the ratio of the aforementioned judgment and provisions of their respective luxury tax act, till the time GST is enforced. 106 Cement Marketing Co. of India Ltd. v. Asst. Commissioner of Sales Tax (1980) 1 SCC 71, E.I.D. Parry (I) Ltd. v. Asst. Commissioner of Commercial Taxes (200) 2 SCC 321 and Sree Krishna Electricals v. State of Tamil Nadu & Ors. (2009) 11 SCC Cyril Amarchand Mangaldas

55 ENTRY TAX RATES HAVE NEXUS WITH LOCAL SALES TAX / VAT RATES 107 In Tractors and Farm Equipment Ltd. the Gujarat HC held that the levy of entry tax, at the rate of 15%, by treating tractors as motor vehicles was illegal, discriminatory and violative of Article 304(a) of the Constitution of India. The levy was also held to be against the object and purpose of the Gujarat Tax on Entry of Specified Goods into the Local Areas Act, FACTS Tractors and Farm Equipment Ltd. ( Petitioner ) was engaged in the manufacturing of tractors. The manufacturing units of the Petitioner were located in the city of Madurai and Bangalore. The Petitioner had many depots located in various States of the country inter alia the State of Gujarat. The Petitioner had imported tractors into the State of Gujarat from its manufacturing units in India. On the said import of the tractors, the Petitioner had paid entry tax at the rate of 4% under the Gujarat Tax on Entry of Specified Goods into the Local Areas Act, 2001 ( Act ). On a s s e s s m e n t, t h e E n t r y Ta x A u t h o r i t i e s ( Respondent ) had levied entry tax at the rate of 15% under Entry 1 of the Schedule of specified goods under the Act, treating the same as entry of motor vehicles. The Entry Tax Authorities had also levied penalty at the rate of 20% under the provisions of the Act. Aggrieved by the Assessment Order, the Petitioner had preferred the instant writ before the Gujarat HC. ISSUE Whether levy of entry tax on entry of tractors in the State of Gujarat, at the same as to motor vehicles, was constitutionally valid? ARGUMENTS/ ANALYSIS The Petitioners contended that the purpose for enacting the Act was to prevent loss of sales tax revenue due to diversion of trade, as a result of lower sales tax rates in the other States as compared to the State of Gujarat. The Petitioners argued that tractors were always covered by a separate entry, i.e. Entry 178 of Schedule IIA under the erstwhile Sales Tax Act, 1969 ( Sales Tax Act ), taxing the sale of tractors at the rate of 4%. Similarly, the tractors were covered under a separate entry, i.e. Entry 77 of Schedule II under the Gujarat Value Added Tax Act, 2003 ( VAT Act ), taxing the sale at the rate of 4% + 1% additional tax. Further, the Petitioners contended that the legislative history of the Act, as well as the amendments made to the Act, demonstrated a clear nexus was maintained between the rates applicable under the Act and the applicable rates for the respective goods under the Sales Tax Act/ VAT Act. Therefore, the purpose of the Act was not to levy additional tax but to provide level playing field between the goods entering into the local areas from any place outside the State and the goods manufactured or produced in the State. The Petitioners, on the basis of Notification dated May 12, 2016 ( Notification ), that the said Notification explicitly exempted tractors from levy of entry tax in excess of 5%, and the levy of entry tax at the rate of 15% on tractors by considering them as motor vehicles under the Act is dehors the object and scheme of the Act and contrary to the legislative intention and violated Article 304(a) of the Constitution of India, in so far as the Department had discriminated between goods imported from outside the State and similar goods manufactured within the 109 State of Gujarat. Lastly the Petitioners contended that, the object of the Act, i.e. to prevent loss of revenue in case of goods where the rate of tax in other State was lower than the State of Gujarat, did not hold good since the rate of VAT in the states where the Petitioner had manufacturing units had the VAT rate either of 5% or slightly higher. On the other hand, the Respondent contended that the tractors were squarely covered under the definition of the term motor vehicle as defined under Section 2(44) read with Section 2(28) of the Motor Vehicles Act, Therefore, the IRA argued that 107 Tractors and Farm Equipment Ltd & Ors. v. State of Gujarat (Special Civil Application No & 3797 of 2016 Gujarat HC). 108 Article 304. Restrictions on trade, commerce, and intercourse among States. 109 Eagle Corporation v. State of Gujarat (2007) 6 VST 56 (Guj.) and Jindal Stainless Ltd. v. State of Haryana & Ors. (Civil Appeal No of 2002) Cyril Amarchand Mangaldas

56 entry tax on the entry of tractors in the State of Gujarat should have been levied at 15%. Further, the Respondent submitted that the Notification would be applicable only prospectively and Petitioner would be liable to pay entry tax for the period prior to the said Notification. The Respondents lastly submitted that the Petitioners remained unaffected from levy of entry tax since could also claim refund for the amount of entry tax paid by way of Input Tax Credit. DECISION The Gujarat HC noted that the statement of objects of the Act confirms that the Act was enacted with a view to compensate the loss of sales tax revenue. The HC held that the mechanism of levy of entry tax on imported goods at a differential rate had placed the importer at par with the local persons and was aimed at achieving level playing field. Therefore, the levy of entry tax under the Act was held to be nondiscriminatory and constitutional. However, in so far as the Petitioners were required to pay entry tax beyond the applicable rate of VAT, it was held to be discriminatory and directly in violation of Article 304(a) of the Constitution of India. Further, the HC noted that the legislative history of the Act and the o b j e c t a n d r e a s o n s b e h i n d enactment and amendments of the Act clearly established that the entry tax was sought to be levied at the rates prescribed under the Sales Tax/ VAT Act. Therefore, the HC held that the tractors have always been covered by a separate entry under the Sales Tax/ Vat Act and the entry tax levied at the rate of 15% was dehors the scheme of the Act. The HC held that exemption vide the Notification would be levied where tax was leviable/ payable at the first place. However, in so far as the levy of entry tax on tractors beyond 5% is held unconstitutional, there can be no question of exemption under the Levy of entry tax beyond the VAT required to be paid by the local dealer shall be discriminatory and directly in violation of Article 304(a) of the Constitution of India. before the SC. Notification. Thus, the HC held that once the levy was held to be illegal, the Petitioners could not be forced to pay entry tax and later claim refund for the same. SIGNIFICANT TAKEAWAYS This is a very important decision since it clarifies that in order to determine the rate of entry tax for a particular product, the rate for that product shall have to be examined under the VAT Act as well. This ensures the object of level playing field between the local goods and the goods being imported into the State of Gujarat, as envisaged under the Act. While the levy of entry tax at the rate under the Act could be construed a proper levy under the Act, it may not be considered a proper levy after taking into account the legislative history and nexus of rate under the Act with rates under the Sales Tax Act and the VAT Act. A nine-judge bench of the SC in the case of Jindal 110 Stainless Steel Limited, adjudicated on the constitutional validity of Entry Tax laws in various states including Gujarat and upheld the constitutional validity of Entry Tax levy by States. However, on the question regarding the validity of each state legislation imposing entry tax, the Larger Bench decided to let the issue be determined by the smaller benches o f the S C. Accordingly, the question of the constitutional validity of the Act is currently pending adjudication Importers like the Petitioner are well advised to examine the rate under VAT Act, along with the rate under the Act, to determine the correct rate of liability under the Act. Going forward under the proposed GST regime, the Entry Tax Acts will be subsumed under the goods and services tax. The supply of tractors from one State to another would be taxable under the IGST Act. 110 Jindal Stainless Steel Limited v. State of Haryana (Civil Appeal No of 2002) Cyril Amarchand Mangaldas

57 NON-JUDICIAL UPDATES - DIRECT TAX Cyril Amarchand Mangaldas