Taxation
The Income Tax Appellate Tribunal (Mumbai Bench) recently announced a significant development in the law relating to transfer pricing regulations. The tribunal stated that a default by non-residents relating to Indian transfer pricing regulations does not disentitle them from claiming benefits under a tax treaty. The order was passed after an appeal filed by the Income Tax Department in the matter of DDIT v M/s Sun Chemicals BV.
Sun Chemicals is a leading supplier of graphic arts products. Incorporated in the Netherlands, it acquired the shares of Coates of India in two tranches on 20 April 2000 and 29 June 2001. These shares were subsequently sold by Sun Chemicals on 21 September 2001. While there was a long-term capital loss in relation to the shares acquired on the earlier date, there was a short-term capital gain earned from the transfer of shares acquired on 29 June 2001. The net capital loss declared by Sun Chemicals in the return filed was Rs15,167,050 (US$350,000).
Subsequently, questions arose regarding the calculation of the transfer price as the shares were acquired from an associate enterprise. By taking the cost of the shares at Rs73 per share, as compared to the Rs113.19 per share paid by Sun Chemicals, the assessing officer determined that there was a short-term capital gain of Rs150,611,574.
In addition, the assessing officer denied Sun Chemicals tax benefits under the India-Netherlands double tax avoidance agreement (DTAA). If the DTAA was applied according to Article 13(5) of the agreement, the capital gains of Sun Chemicals would only be taxable in the Netherlands, not in India. The issue before the Income Tax Appellate Tribunal (Mumbai Bench) was whether the definition of “tax” in the DTAA included any amount payable with respect to a default or omission in relation to the taxes to which the DTAA applies.
The tribunal concluded in favour of Sun Chemicals and held that defaults or omissions applied only to tax, and therefore, could not be extended in the capacity of defaults or omissions with regards to the determination of the total income of Sun Chemicals or the arm’s length price under the Income Tax Act, 1961, (ITA).
The tribunal also found that the phrase “default or omission in relation to taxes”, under the definition of “tax”, would include any interest payable by the taxpayer. The appeal of the Income Tax Department was consequently dismissed as it was concluded that defaults or omissions relating to the provisions of section 92 to 92F of the ITA would not be covered by those mentioned in Article 3(d) of the DTAA.
In another major development, on 18 July the Authority for Advance Rulings (AAR), while considering an application by Dell International Services (India), decided that payments made to a nonresident service provider for the provision of two-way transmissions of voice and data through telecom bandwidth, could not be considered as royalty payments or payments made for included services, and were hence not taxable in India. Dell India provides call centres, data processing and information technology support services to its group companies.
Dell India’s parent company, Dell USA, entered into a master services agreement with BT America (BTA), a company incorporated in the US, for the provision of two-way transmissions of voice and data through telecom bandwidth. Under the agreement, Dell India makes recurring monthly payments to BTA for the international half-circuit between the US and Ireland and for the Indian half-circuit between Ireland and India which is provided by Indian telecom company VSNL, with which BTA has a tie-up. The significant questions considered by the AAR were whether the recurring charges paid to BTA would be considered as “royalty” within the meaning of: (i) Article 12(3) of the India USA double tax avoidance agreement; (ii) Explanation 2 to section 9(1)(vi) of the Income Tax Act, 1961; and whether the charges paid to BTA could be categorized as “fees for included services” under the umbrella term “fees for technical services” in Article 12 of the DTAA, or under Explanation 2 to clause (vii) of section 9(1) of the ITA.
The AAR held that the emphasis of the agreement was on the service element and nowhere was the use of equipment, or the grant of rights for such use contemplated. Usage of equipment connotes that the grantee of right has possession and control over the equipment, but no part of the present arrangement could lead to such an inference. It was plainly a case of BTA utilizing its own network to provide a service that enables Dell India to transmit voice and data through telecom bandwidth. Therefore, the payments made were held not to be royalty payments.
The AAR rejected the recurring charges as “fees for included services”, because the technical knowledge, experience, skill, etc., required by Article 12(4) of the DTAA to be “made available” for recipients of the service to access, had not been satisfied.
Moreover, since Dell India benefits from the DTAA, the applicability of the relevant ITA provision does not arise.
In line with various earlier judgments, the present AAR decision differentiates between the consideration paid for the use of equipment or for availing of a service. The AAR concludes that unless Dell India is involved in the act of operation or control of the equipment in order to avail of the facility, the payment under consideration cannot qualify as a royalty payment for the use of equipment. This decision removes ambiguities surrounding the taxation of payments for leased lines, particularly in the case of call centres and other business process outsourcing units.
Intellectual Property
Section 92-A of the Patents Act, 1970, dealing with compulsory licensing for exports to underdeveloped countries, came under the scanner once again on 4 July. The Patent Office rejected Natco Pharma’s petition opposing the Patent Office’s move to seek Pfizer’s say on Natco’s application for a compulsory licence.
Section 92-A was introduced in a 2005 amendment to the Patents Act, when the product patent regime was introduced. This is the only provision of the compulsory licensing chapter that specifically deals with pharmaceutical patents and enunciates that a compulsory licence can be issued for the manufacture and export of patented “pharmaceutical products” to any other country with insufficient or no capacity to manufacture a similar product. This provision was inserted with a view to addressing the health problems of poor and economically weak countries. Hyderabad-based pharmaceutical company Natco is the first and so far the only generic drug maker that has sought to apply for a compulsory licence under section 92-A.
Natco had applied for the grant of a compulsory licence to manufacture and export the generic version of Pfizer’s patented cancer medicine Sunitnib Malate, sold with the brand name Sutent, to Nepal. While considering Natco’s application, the Patent Office gave the patentee (Pfizer) an opportunity to be heard. Natco contended that section 92-A of the Patents Act does not prescribe that an opportunity of hearing should be given to the patentee. However, the Patent Office believed that hearing the patentee would not only serve as an aid in deciding upon the application, but would also prevent any abuse of the provisions of section 92-A.
The decision of the controller to grant an opportunity to the patentee clearly demonstrates an inclination to support the interests of patentees and to ensure that section 92-A is not abused.
Banking and Finance
The Reserve Bank of India (RBI) on 11 July took a step further in liberalizing India’s banking sector with the release of AP (DIR Series) Circular Number 1, through which it relaxed the existing procedures for creating a charge on assets for an external commercial borrowing (ECB).
Instead of going through the entire approval process, the RBI has now allowed AD Category I banks to convey “no objection” under the Foreign Exchange Management Act, 1999, (FEMA) for the creation of charges on immovable assets and financial securities and the issue of corporate or personal guarantees in favour of an overseas lender or security trustee, in order to allow the ECB to be raised by the borrower.
Earlier, provisions for affording guarantee and security were provided under the approval route. The borrower was liable to ensure security was provided to the overseas lender/supplier for securing the ECB and creation of charge over immovable assets and financial securities in favour of overseas lenders was subject to FEMA notifications. Thus, proposals for creation of charge were considered by the RBI on a case-by-case basis.
The circular will have several implications. Firstly, the underlying ECB should strictly comply with the extant ECB guidelines; secondly, there should be a security clause in the loan agreement requiring the borrower to create charge on immovable assets and financial instruments and furnish a corporate or personal guarantee; thirdly, the loan agreement should be signed by both the lender and the borrower; and finally, the borrower should obtain a loan registration number (LRN) from the RBI. There are also specific conditions regarding “no objection” for the creation of charge on immovable assets and financial securities and the issue of corporate or personal guarantees.
However, the “no objection” certificate issued by AD Category I banks does have certain caveats. For example, it should not be construed as an approval under other laws and regulations, nor as an approval by the government or other statutory authorities.
Although the procedure for securing ECBs by an Indian borrower has been simplified, the ease in rules may not be significant from a global perspective. In many instances overseas companies with wholly owned subsidiaries in India, or companies and funds that have invested in India, wish to pledge their holdings in Indian companies for overseas borrowings.
Currently, transfers by pledge of any Indian securities still require the prior approval of the RBI.
Employment law
In a recent case that addressed the problem of assault and misconduct, the Delhi High Court has ruled that sexual harassment in the workplace includes acts committed outside the physical office premises.
In March 2007, a director of the National Academy of Audit and Accounts (NAAA), an academy imparting training services, was allegedly drunk and entered a female officer’s room in the Glen Officers’ Mess and assaulted her. The female officer filed a First Information Report the next day and also informed her senior officials of the misconduct. A criminal case was filed against the director, who was also suspended from his position following a departmental inquiry.
The director approached the Central Administrative Tribunal, principal bench, New Delhi, seeking to stay the departmental inquiry, contending that the alleged misconduct could not be categorized as sexual harassment at the workplace because the incident occurred in the female officer’s residence. The tribunal did not agree with the director’s reasoning and refused to stay the departmental inquiry.
India still lacks a codified law prohibiting sexual harassment in the workplace. The Supreme Court of India, in the landmark judgment of Vishaka v State of Rajasthan (1997) laid down a set of guidelines to be followed by all employers, prohibiting sexual harassment in the workplace. Until the enactment of legislation on the subject, these guidelines have a binding effect.
In order to determine whether the site classified as a “workplace”, the tribunal considered factors such as its proximity to the workplace, the management control over the place or residence and whether the residence was an extension or contiguous part of the workplace.
However, the tribunal also clarified that these parameters are general guidelines, not determinative factors. Therefore, the manner in which a “workplace” is construed will depend on the facts and circumstances of each case.
The legislative and regulatory update is compiled by Nishith Desai Associates, a Mumbai based law firm that provides legal and tax counselling. The authors can be contacted at nishith@nishithdesai.com. Readers should not act on the basis of this information without seeking professional legal advice.
