International Tax Updates

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Direct Tax – International Tax Updates

ITAT allows DTAA benefits despite SEP threshold breach (Zerodha)

Taxpayer, a consultant with Zerodha Broking Limited (‘ZBL’), provided business advisory services and received an amount after deduction of tax under section 195 of the ITA, which he claimed as exempt under the India–UAE DTAA and sought a tax refund. Revenue authorities noted that the taxpayer was earlier an employee of ZBL and later continued as a consultant performing similar functions and therefore concluded that the taxpayer had changed the nature of income from salary to consultancy to avoid tax in India. Revenue authorities thus invoked section 9(1)(i) of the ITA on the basis of SEP provisions, stating that the prescribed threshold under Rule 11UD of the Income Tax Rules 1962 (‘Rules’) was exceeded and that the taxpayer had a business connection in India. Revenue authorities also denied the applicability of Article 14 of the DTAA. The taxpayer’s objections before the Dispute Resolution Panel (‘DRP’) were rejected due to delay, and the Revenue authorities passed the final assessment order treating the entire amount as taxable business income.

On appeal, ITAT held that the change from employment to consultancy was based on a valid agreement between the parties and could not be disregarded. It observed that although the income may be deemed to accrue in India due to SEP provisions, the services provided by the taxpayer qualified as “professional services” under Article 14(2) of the India–UAE DTAA. Accordingly, under section 90(2) of the ITA, the taxpayer is entitled to claim DTAA benefits, and since there is no permanent establishment or fixed base in India, the income is not taxable in India.

ITAT: Design income not FTS under India-Germany DTAA

The taxpayer is a tax resident of Germany and was engaged by Delhi Metro Rail Corporation (DMRC) for the design, manufacture, supply, testing, and commissioning of 340 passenger rolling stock units (trains). As per the agreement, a lump sum price was agreed for the entire scope of work, however, the payment from the lump sum price was apportioned to various cost centers and were disbursed to the taxpayer upon achieving certain specified milestones.

Revenue authorities contended that the contract was divided into cost centers and milestones with separate pricing, therefore, the activities were severable and independent and thus, not inextricably linked to the supply of goods. Further, it was argued that rendering of technical and managerial services by various cost centers led to development of plans, designs and drawings thus services rendered would qualify as FTS as per Indian tax laws read with India-Germany DTAA. Revenue authorities submitted that in case of composite contract for supply of goods/equipment/machinery and for providing technical services, if the bifurcation is already made in the contract, the income has to be considered and taxed accordingly.

The taxpayer argued before the ITAT that the plans and designs were not independent services but were “inextricably linked” to the supply of the trains. They were mere “stepping stones” to ensure the requirements were understood before manufacturing began. Accordingly, ITAT ruled in favor of the taxpayer and held as follows:

• Description and nature of activities provided for the milestones such as organizational structure or work programs were merely “preparatory” in nature and did not amount to rendering managerial, technical, or consultancy services within the meaning of the Article 12(4) of India-Germany DTAA.
• The activities performed for these milestones are incidental and “inextricably linked” to the ultimate supply of rolling stock.
• Furnishing these plans, drawings, and designs is not an independent activity but rather a “stepping stone” to achieve the final objective of supply, installation, and maintenance.

ITAT: Interest disallowance under sec 94B deleted

In the instant case, the taxpayer was an Indian company, incorporated as a wholly owned subsidiary of a Danish company, engaged in manufacturing, assembly, installation and sale of wind turbine generators in India and supply of components of wind turbine generators to group entities.

The case pertained to Financial Year (‘FY’) 2017-18, which was the first year during which section 94B of the ITA became applicable. The taxpayer had suo moto disallowed INR 93.40 million of interest paid to its foreign AE, under section 94B of the ITA. However, in the course of assessment proceedings, wherein reference was made to the Transfer Pricing Officer (‘TPO’), the TPO made no transfer pricing adjustments, but made an additional disallowance of INR 91.30 million under Section 94B of the ITA. The additional disallowance was upheld in the first appellate proceedings by the Commissioner of Income-tax (Appeals) [‘CIT(A)’]. The order of the CIT(A) was challenged by the taxpayer before the Chennai ITAT.

ITAT ruled in favor of the taxpayer. In doing so, it made the following observations:

• Article 24(4) of the India-Denmark DTAA mandates parity in deductibility of interest paid to residents and non-residents, except where Article 12(7) becomes applicable.
• Judicial precedents have consistently held that domestic law provisions resulting in adverse deductibility conditions for payments made to non-residents violate the non-discrimination clauses.
• Since the arm’s length nature of interest has been upheld, Article 12(7) shall not be attracted. In the absence of a specific carve-out for thin capitalization provisions, as in the case of India-Australia DTAA, thin capitalization rules exclusively applicable to non-residents are violative of Article 24(4) of the India-Denmark DTAA.
• Since the legal ground is allowed, adjudication of grounds relating to computation of disallowance is academic. However, EBITDA computation must consider actual depreciation and not accounting netting, and only deductible interest must be considered for computation of disallowance under section 94B of the ITA. Notional interest and capital interest already disallowed cannot be considered again.

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