News Alert* pwc. Tax & Regulatory Services. 2 March, *connectedthinking

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1 Tax & Regulatory Services News Alert* 2 March, 2010 Taxability of consideration received upon assignment of rights and obligations under an assignment agreement - held to be business profits not taxable in India in the absence of a Permanent Establishment ( PE ) in India Background In a recent ruling, the Authority for Advance Rulings ( AAR ), in the matter of Laird Technologies India Pvt. Ltd. 1 (Laird India) ( the Applicant ) has held that the amount of consideration received by Laird Technologies Inc., USA ( Laird USA ) is in the nature of business profits that have accrued or arisen in India, which are not taxable in India in the absence of a PE in India in terms of the Double Taxation Avoidance Agreement between India and the US ( tax treaty ). Accordingly, there is no liability to withhold tax under section 195 of the Income-tax Act, 1961 ( the Act ) while making remittance to Laird USA as there is no income chargeable to tax in India. Facts The applicant is a group company of Laird Plc., UK ( Laird Plc ). The applicant s holding company is Laird Technologies, Singapore. Laird Plc. is a leading international supplier of customdesigned electronic components and solutions to the global electronic industry and the applicant is the first manufacturing facility of Laird Plc. in India to be located in the Nokia SEZ at Sriperumbudur near Chennai. Laird USA, headquartered in the USA, is a unit of the Laird Group Plc, UK, and is stated to be a globally known designer and manufacturer of antennae, EMI, data communications, etc. Laird USA has manufacturing plants and technical support operations in the USA and various other countries. Laird USA is a tax resident of the USA. Laird USA, under a Product Purchase Agreement ( PPA ) dated 25 June, 2003, negotiated an arrangement with Nokia Corporation, Finland, to manufacture and supply products to Nokia Corporation globally. The PPA, covered, among other things, the supply of products in relation to Nokia s manufacturing requirements in India. 1 Larid Technologies India Pvt Ltd. In re [2010-TIOL-06-ARA-IT] *connectedthinking pwc

2 Laird USA also signed a Letter of Intent ( LOI ) dated 16 May, 2006, with Nokia India for facilitating the setting up of the manufacturing facilities of Laird India on the developed industrial land within the SEZ with all the infrastructural facilities. Pursuant to the LOI, a sub-lease agreement was entered into by Laird India with Nokia India. In order to assign its rights and obligations under the PPA in connection with the supplies of its products to Nokia India Pvt. Ltd. ( Nokia India ) for a period of 5 years in favour of the applicant, Laird USA entered into an Assignment Agreement ( Agreement ) with the applicant on 17 December, Under the Agreement, Laird USA irrevocably assigned all its beneficial rights, title, interest, obligations and duties in connection with supply to Nokia India under the PPA in favour of the applicant. Under the Agreement, the applicant would act in an independent status and supply the products to Nokia India at its own risk and obligations. Further, the applicant could not assign its rights and obligations under the Agreement. The applicant would not have any right under the Agreement after the expiry of 5 years unless the Agreement is extended on mutually agreed terms. A consideration of USD 5,300,000 was payable by the applicant to Laird USA by means of a wire transfer to the account of Laird USA maintained at Wachovia Bank, NA. Issues The Applicant sought a ruling, on the following questions: Whether the amount receivable by Laird USA under the Agreement is taxable in India under the Act or having regard to the provisions of the tax treaty. If yes, then to what extent and in which year would the receipt be taxable in the hands of Laird USA under the Act and having regard to the provisions of the tax treaty. If the amount is not taxable in India, whether tax is required to be withheld while making remittance to Laird USA. Applicant s contentions The applicant has primarily put forth two contentions, as follows: a) The PPA constitutes a capital asset representing the right acquired by Laird USA to manufacture and supply the specified products to Nokia Corporation globally, and the situs of the PPA contract is outside India as it was signed in Finland. The consideration of USD 5,300,000 was remitted to a bank account of Laird USA outside India. Therefore, under the assignment, a transfer of capital asset by Laird USA to Laird India has taken place, however, no capital gains tax can be levied in India as the capital asset is situated outside India. b) Also, even if the consideration is treated as business profits, the charge to tax fails both on account of the absence of business connection in India under section 9(1)(i) of the Act, as Laird USA was not carrying on any business activity in India and also in the absence of a PE of Laird USA in India. Further, Laird India was not acting as an agent of Laird USA in any capacity and the supply of products to Nokia was on a principal-to-principal basis, where Laird India was bearing the risk and responsibility of its business transactions. Revenue s contentions The Revenue did not dispute that in the case of a capital asset, where the receipt of consideration had taken place outside India, the capital gains would not be taxable in India. However, the Revenue contended as follows: a) Laird USA and the applicant are affiliates, being sub-subsidiaries of Laird Plc., UK and therefore the applicant is a party to the PPA, as the Agreement was entered into by Nokia and its affiliates on the one hand and Laird USA and its affiliates on the other. Hence, the question of assignment of rights and obligations under the PPA to its affiliate does not arise.

3 b) There was no legally enforceable contractual right to manufacture and supply (any of Laird s products to Nokia) accrued to Laird USA in the first place and hence, there was no question of assignment of any rights in favour of the applicant. Hence, there was no transfer outside India. c) Under law, there can be an assignment only of the rights and benefits under a contract but not of burden and obligations which would require a novated tripartite agreement and the consent of the contractee to an agreement. To counter this contention, the applicant placed reliance upon a letter written to Nokia Corporation asking to confirm their acceptance of the Agreement. d) Under the PPA, Laird USA was obliged to deliver its products to Nokia and provide the services of a domestic Logistics Service Provider ( LSP ). The business network of the LSP would constitute the PE of Laird USA in India. e) The Revenue, through many arguments, contended that Laird India was dependent upon and formed an agency PE of Laird USA in India. f) The Revenue also contended that Laird USA had acquired valuable rights from Nokia India under the LOI and the consideration was received for these legal rights accruing under the LOI. AAR Ruling a) The first contention was negated by the AAR by observing that even if Laird Plc. is the ultimate holding company of the applicant and Laird USA, that does not bring the applicant within the scope of an affiliate company as defined in the Agreement. The element of control implied by the definition was lacking and common control of the two entities was also missing. b) The AAR rejected the second contention based on the Agreement, which indicated that legally enforceable contractual right existed for the manufacture and delivery of certain products. c) The contention of the Revenue that this was not an assignment under law, however, found favour with the AAR, which observed that there is no foolproof evidence of acceptance of the Agreement and hence it held that there was no valid assignment under law. Hence, the contention that there was a legal transfer of a capital asset and the consideration constitutes capital gains was rejected. However, considering the binding nature of the Agreement, whereby consideration passed was for parting with certain rights in favour of the applicant, and that Laird USA was also instrumental in paving the way for provision of infrastructural facilities by Nokia India to Laird India, the AAR concluded that the said consideration was certainly business profits. d) As regards the role of Laird USA in the set-up, the AAR made the following observations: Laird USA was only instrumental in making the developed land available for setting up of the unit by Laird India. There was nothing to show that the manufacturing plant was set up under the auspices of Laird USA or that its personnel were deputed to supervise and monitor the activities of Laird India. e) The AAR ruled out as unreasonable that the LSP could be a PE of Laird USA in India. f) The AAR also ruled out that Laird India was an agency PE of Laird USA as it was clear from the terms of the Agreement and the activities of the applicant that it was not required to act as an agent of Laird USA in any sense while conducting the business. The LOI also did not lead to a conclusion that Laird India was a dependent agent of Laird USA. g) It was not elaborated as to how and in what manner the Applicant depended on Laird USA after assignment of rights, as Laird USA could not carry on the same business in India nor interfere with Laird India s business after assignment and was bound by the Agreement. h) As regards the guarantee given by Laird USA for risk in volume of sales, the AAR held that similar clauses were dealt with in the case of ABC Ltd 2 and it was held that this did not lead to a business connection of the non-resident. 2 ABC Ltd, In re [2006] 289 ITR 438 (AAR)

4 i) Minimum insurance cover supposed to be provided by Laird USA was being paid for by Laird India. j) The contention that the payment was made for acquiring technical know-how or for obtaining patent rights of the products from Laird USA was also rejected as Laird USA did not own the patent rights. k) The LOI did not confer any legal rights or interests in respect of the land and infrastructure, therefore, no part of the consideration was paid for any services of Laird USA in facilitating the sub-lease of land or for giving up any claims under the LOI because the LOI was a non-binding expression of intention of parties and no assets situated in India were transferred thereunder. Conclusion The ruling has thrown light upon various issues involved in an assignment agreement and will provide guidance in similar kinds of arrangements entered into by assessees. The ruling also clarifies that where a Indian company is guaranteed against business risks by a foreign company, that by itself would not create a dependent agency relationship and would not adversely impact the principal-to-principal relationship of the parties. Recently, there has been a controversy regarding the withholding tax liability of a resident while making payments to a non-resident. This ruling has however affirmed that where the payment is not taxable in India, there is no obligation to withhold tax in India. It is to be noted, however, that a ruling by the AAR is binding only on the Applicant in respect of the transaction in relation to which the ruling is sought and on the tax authorities in respect of the Applicant and the said transaction. It however does have persuasive value.

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