In M/s Adidas India Marketing (P.) Ltd. v. Income Tax Officer, the Delhi Bench of the Income Tax Appellate Tribunal (ITAT) held that the insurance compensation received by the foreign parent due to loss of financial interest in its Indian subsidiary is not the subsidiary's income as alleged by the tax officer and, therefore, is not taxable in India.
Adidas India Marketing (P.) Ltd. (Assessee) is an Indian company engaged in the business of sourcing, distributing and marketing products of the brand 'Adidas'. Nearly all (98.99 %) of the Assessee's equity is held by another Indian company, Adidas India Private Ltd. (Adidas India), which, in turn, is a subsidiary of a German company, Adidas AG, Germany (Adidas Germany).
The Assessee had taken out an insurance policy with Bajaj Allianz General Insurance (Bajaj Allianz) to cover loss caused by fire to its stock-in-trade and fixed assets. Upon suffering loss to its stock-in-trade and fixed assets due to fire in its premises, the Assessee recovered a claim of approximately INR 47 crores for stock-in-trade and INR 1.5 crore for fixed assets.
Separately, Adidas Germany had also taken a Global Insurance Policy (GIP) with Zurich Insurance against the "loss of financial interest due to erosion of economic value of subsidiaries". On account of the loss of financial interest caused by the fire at the Assessee's premises, Adidas Germany made a claim on its GIP and received compensation of approximately INR 91 crores from Zurich Insurance, after subtracting the amount that the Assessee had received from Bajaj Allianz.
The Assessing Officer (AO) in his scrutiny raised several issues in relation to transfer pricing and Advertising, Marketing and Publicity (AMP) expenses, and in relation to the insurance claim received by Adidas Germany. The AO alleged that:
- The Assessee was entitled to receive reimbursement from Adidas Germany for significant expenditure on AMP, etc.
- The insurance claim received by Adidas Germany in respect of the diminution in its financial interest in the Indian subsidiary for the loss suffered by the subsidiary due to fire should be treated as the income of the Assessee and be taxed in the hands of the Assessee.
Aggrieved by the final assessment orders, the Assessee appealed before the ITAT. The ITAT set aside the orders of the lower authorities with respect to issue (a) and restored it to the file of the AO, or Transfer Pricing Officer, and gave its opinion on issue (b) after analysing it threadbare.
Arguments by the AO and the Assessee
The AO argued that the income received by Adidas Germany was income accrued to the Assessee under Section 5 of the Income Tax Act, 1961 (IT Act) as the insurance is in respect of the stock-in-trade of the Assessee. He substantiated this submission, referring to the correspondence between the Assessee and Adidas Germany in which they were trying to discern ways to infuse the compensation amount into the Assessee.
AO also claimed that the income is deemed to be accrued due to Adidas Germany's business connection in India under Section 9(1)(i) of the IT Act as the compensation received was due to the loss caused by fire to the stock.
The Assessee argued that the income received by Adidas Germany arose out of a separate and distinct insurance contract between the foreign insurance company and Adidas Germany. The Assessee was not a party to this contract. Also, the subject matter of the contract was the loss of financial interest due to erosion of economic value of subsidiaries, and not for loss caused by fire.
On the alleged accrual or deemed accrual, the Assessee argued that the term "accrual" means having an enforceable right, but in the present case, the Assessee did not have any right over the amount and, therefore, there was no accrual.
Further, it was also argued that Section 25 of the General Insurance Business Act, 1972, prohibits having an insurance with an insurer located outside India. The insurance contract entered into by Adidas Germany clearly read that the contract did not cover group entities of Adidas Germany, which are residents of those countries that prohibit entering into contract with insurers from Zurich. Therefore, the Assessee could not have been covered by that contract.
Considerations and Ruling of the ITAT
The ITAT opined that the Assessee's insurance was against the loss in respect of stock-in-trade and fixed assets, which are tangible assets. On the other hand, the insurance by Adidas Germany was against loss of financial interest due to erosion of economic value of subsidiaries, which is an intangible asset. Accordingly, the ITAT held that the two insurance policies were separate and distinct. This was substantiated by the fact that the insurance contract entered into by Adidas Germany clearly mentioned that "the subsidiary companies are neither entitled nor obligated by this part of the contract and are not additionally insured companies." Therefore, the insurance claim received by Adidas Germany was held not to be the income of the Assessee and, therefore, was not taxable.
The ITAT rejected the Assessing Officer's reliance on the correspondence between the Assessee and Adidas Germany for bringing the compensation to tax in India. It opined that this correspondence only explored the mode of transfer of money because Adidas Germany wanted to restore the loss that was caused to the Assessee. The ITAT also held that if such an amount was sent to the Assessee, it was the application of the compensation received by Adidas Germany after it had paid German taxes on the compensation received. The ITAT rejected AO's allegations that the two separate policies were entered into to avoid tax in India.
This is a very welcome decision dealing with several tricky issues and providing guidance on their interpretation:
- When income is said to be 'accrued' or 'deemed accrued', there must exist a "right to receive that income or income must vest" in someone. Therefore the fact that a particular receipt may have connection with something that happens in India does not automatically result in that receipt being accrued to an Indian resident. The contracts, and the intention and manner of dealing with the transaction, would all contribute to determining such accrual.
- Every contract and arrangement between parent and subsidiary that has the impact of either reducing tax in India or not attracting a receipt to tax in India, cannot be regarded to be a subterfuge or device entered into for avoiding tax. The facts and circumstances must be carefully examined.
1 M/s Adidas India Marketing (P.) Ltd. v. Income Tax Officer, ITA No. 1431/Del/2015 (July 29, 2019).
2 ED Sassoon & Co. Ltd. v. CIT, 26 ITR 27 (SC).
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