India: Significant Rulings Pronounced In The Last Year And Their Impact On Tax Positions

Last Updated: 17 February 2017
Article by Maulik P. Doshi

India is considered to be the land of tax litigation. The Indian litigation landscape assures a plethora of court rulings; 24 High Courts and over 70 benches of the Tribunal pronouncing verdicts on a regular basis. It is a daunting task for tax professionals and taxpayers to keep track of the rulings pronounced by the judicial authorities and to evaluate their impact on their tax positions.

We discuss some of the key judicial pronouncements of 2016 which are expected to significantly impact the Indian tax environment below:

Depreciation of goodwill arising on amalgamation – situation after the Supreme Court's verdict

The 'allowability' of depreciation on goodwill generated in the course of merger was subjected to substantial litigation until the Supreme Court recognised goodwill as an eligible intangible asset and allowed depreciation thereon for tax purposes.1

After the Supreme Court ruling, the litigation on the 'allowability' of depreciation on goodwill was expected to be put to rest. Courts and Tribunals began ruling in favour of the taxpayer without deliberating on any principles of allowability. However, recently the Bangalore Tribunal has interpreted the Supreme Court ruling differently2 and disallowed the taxpayer's claim of depreciation on goodwill on the principle that tax advantage cannot be derived out of a tax neutral transaction. The Tribunal's ruling suggests that depreciation is allowable only where goodwill is supported by material evidencing the benefit derived by the taxpayer. If goodwill is merely an arithmetic difference between the consideration paid and assets acquired, it is not eligible for depreciation.

This ruling is likely to reignite litigation around depreciation on goodwill arising from business restructuring transactions.

Tax withholding on Export Commission to non-resident agents – parameters of taxability being laid down

Tax withholding on commission paid to non-resident agents has become an issue of litigation in recent times, with the Tax Authorities seeking to consider the commission as fees for managerial/technical/consultancy services.

Recently, the Bombay High Court ruled that even after the withdrawal of the Central Board of Direct Taxes (CBDT) Circular No. 23 of 1969, the commission paid to non-resident agents continues to remain non-taxable in India

where services are rendered, used and paid for outside India and the agent does not have a business connection or a permanent establishment in India. The Ahmedabad bench of the Income Tax Appellate Tribunal (Tribunal) has also ruled on similar lines and has stated that "Just because a product is highly technical, it does not change the character of the activity of the sale agent".

If the principles laid down in these rulings are followed by other judicial authorities, the litigation around the taxability of export commission could be laid to rest. It goes without saying that the tax payers must take due care while drafting the agency agreements to bring out the true commercial intention and avoid the risk of litigation.

Mumbai Tribunal3 discusses re-characterisation of share application money as a loan under transfer pricing regulations

The issue of re-characterisation of share application money as a loan comes up when the share application remains pending for allotment for a long period of time. If it is considered a loan, a transfer pricing adjustment can be made for the notional interest on such a loan and added to the income of the person paying the share application money.

In this regard, the Mumbai Tribunal held that the share application money cannot be considered as a loan due to the delay in the allotment of shares. However, if no share allotment was made and if the money was eventually refunded, the transaction will be considered to be a loan, and accordingly an international transaction. The Tribunal emphasised on the overall substance of the transaction and not its form. The imputed interest on the share application money was six months Libor plus 150 basis points.

This ruling should provide relief in ongoing litigation where there is a delay in the allotment of shares against the share application money.

Special bench discusses Base Erosion argument under transfer pricing provisions

The Special Bench of the Tribunal has dealt with the applicability of transfer pricing provisions where there is no erosion of India's tax base. This case4 involved a situation where income paid by an Indian company to a foreign enterprise was also liable to tax in India; hence the taxpayer's argument of no base-erosion.

The Special Bench held that while deciding the applicability of transfer pricing provisions, the existence of base erosion needs to be seen for the taxpayer alone and not in aggregate of the taxpayer and its associated enterprises overseas. Even if the arm's length nature of the transaction is demonstrated from the Indian company's point of view, the flip side of the same transaction may or may not continue to satisfy the principles of arm's length necessarily.

This ruling could expose foreign enterprises to transfer pricing adjustments on the income earned from India and could open up a new area for litigation.

Supreme Court upholds the constitutional validity of Entry Tax

The constitutional validity of Entry Tax laws of several states has been a subject matter of litigation for more than 50 years. This issue was placed before a nine Judge Constitution Bench of the Supreme Court of India and was led by the Chief Justice of India5.

After numerous rounds of submissions, arguments and hearings, the Supreme Court, by a majority of 7:2, upheld the validity of the state legislations imposing entry tax on the import of goods from other states.

This judgment settles the constitutional challenge to the levy of Entry Tax in favour of the government. Taxpayers challenging this levy will now have to comply with the Entry Tax requirements.

Supreme Court rules that sale of goods by an importer to the end customer in India qualifies to be covered under 'sale in course of import'

The Supreme Court held that the movement of goods by way of imports was in pursuance of the conditions and/or as an incident of the contract between the importer and the end customer in India6. Hence, sales made by importers to end customers in India should qualify as 'sale in the course of import'. The Supreme Court further held that the privity of contract between the foreign supplier and the end consumer in India was not mandatory to qualify as 'sale in the course of import'.

This judgment comes as a significant relief to importers, and particularly to taxpayers engaged in large scale turnkey contracts.

Ahmedabad Tribunal allows CENVAT credit on commission paid to overseas marketing agents

The Gujarat High Court in an earlier case had held that the commission paid to overseas marketing agents would not qualify for Central Value Added Tax (CENVAT) Credit .

The definition of the term 'input service' was later amended, vide notification number 2/2016-CX (NT) dated 3 February 2016, to provide that the sales promotion includes the services by way of sale of dutiable goods on a commission basis. The Ahmedabad Tribunal8 held that this notification has to be construed as having a retrospective effect and accordingly allowed CENVAT credit of service tax paid on commission paid to overseas agents.

This judgment provides relief to exporters who have appointed overseas commission agents who will help them in reduce their tax liability by availing CENVAT credit on such payments.

Footnotes

1 CIT v Smifs Securities Limited [2012](24 taxmann.com 222)(SC)

2 United Breweries Limited v DCIT [TS-553-ITAT-2016](Bang)

3 Taurian Iron and Steel Co Pvt Ltd v ADIT [ITA No. 5920/Mum/2012)

4. Instrumentarium Corporation Limited v DIT (I.T.A. Nos.1548 and 1549/Kol/2009) – ITAT Special Bench

5. M/s Jindal Stainless Steel Limited &Anr v State of Haryana &Ors [2016](11) TMI-545-SC

6. Commissioner Delhi VAT v M/s ABB Limited [TS-155-SC-2016-VAT]

7. Cadila Healthcare Limited [2012-VIL-119-Guj HC]

8. M/s Essar Steel India Limited V/s Commissioner of Central Excise & Service Tax, Surat-I [2016-VIL-155-CESTAT-AHM]

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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