India: Tax Street – June 2023

We are pleased to present the latest edition of Tax Street – our newsletter that covers all the key developments and updates in the realm of taxation in India and across the globe for the month of June 2023.

• The 'Focus Point' sheds light on aspects of UAE corporate tax.
• Under the 'From the Judiciary' section, we provide in brief, the key rulings on important cases, and our take on the same.
• Our 'Tax Talk' provides key updates on the important tax-related news from India and across the globe.
• Under 'Compliance Calendar', we list down the important due dates with regard to direct tax, transfer pricing and indirect tax in the month.

We hope you find our newsletter useful and we look forward to your feedback.

You can write to us at taxstreet@nexdigm.com. We would be happy to hear your thoughts on what more can we include in our newsletter and incorporate your feedback in our future editions.

Focus Point

An overview of UAE Corporate Tax and Transfer Pricing

The UAE Corporate Tax law was introduced in December 2022 and is effective from 1 June 2023. All entities with financial years beginning on any date post 1 June 2023 shall have to comply with the Corporate Tax regime.

All resident judicial persons incorporated in UAE shall be liable to Corporate Tax. Furthermore, natural persons carrying on business activities and non-residents as well, under certain circumstances, shall be liable to UAE Corporate Tax.

The UAE Corporate Tax shall:

• Apply at 9% on taxable income above AED 3,75,000;
• For free zone entities, Corporate Tax shall be at 0%, subject to the satisfaction of conditions.

For free zone entities, it had been mentioned in the tax law that as long as they derive 'Qualifying Income,' the tax will be 0%. However, qualifying income had not been defined in the corporate tax law and the clarification in this regard has been long awaited. Recently, the cabinet finally came out with Ministerial Decision No. 55 and 139 of 2023, where the meaning of 'Qualifying Income' has been finally provided.

Free zone taxation regime in UAE

Entities established in a free zone in UAE can avail the 0% corporate tax regime provided that they become a Qualifying Free Zone Person (QFZP). In order to qualify as a QFZP, the free zone entity has to satisfy the following conditions:

What is Qualifying income?

Qualifying income shall comprise of the following:

• Income derived from transactions with another free zone person from activities that are not 'Excluded Activities';¹
• Income derived from transactions with any other person (including outside of UAE) only form 'Qualifying Activities';²
• Any other income subject to the satisfaction of De minimis requirements.

The entire Qualifying Income of a free zone entity shall be subject to a 0% Corporate Tax rate, subject to the satisfaction of other conditions.

Points to consider for all UAE entities (including free zone entities)

• To ensure that UAE Corporate Tax registration is complete. Currently, the procedure for registration of certain entities (like a branch of a foreign company) are yet to be prescribed.
• The appropriate evaluation of incomes and expenses to be made in order to determine the taxability;
• The free zone entities need to be mindful of substance requirements, Transfer Pricing (TP) compliance and evaluate whether its income meets the definition of 'Qualifying Income.'
• The entities should maintain appropriate books of accounts and get them audited wherever required;
• The entities need to evaluate the timelines for the first tax return filing based on the tax periods followed.

From the Judiciary

Direct Tax

Whether pre-clinical lab services fall under FTS and whether 'make available' benefit can be claimed under the treaty?

Charles River Laboratories Inc TS-296-ITAT-2023(Bang)

Facts

The taxpayer is a tax resident of the USA, and a Tax Residency Certificate (TRC) has been issued to it. It is in the business of providing pre-clinical laboratory services to enable the determination of a safe dose and assess the potential toxicity of new drugs. These pre-clinical services are provided through reports containing a generic protocol of the test procedure and results to conclude the testing phase.

The Revenue contended that the taxpayer provides a report to the companies in India, which would involve the technical expertise of the taxpayer and accordingly, it would be taxed in India as Fees for Technical Services (FTS).

The taxpayer contended that while the services qualify as FTS under the Income-tax Act( the Act), the Revenue has not appreciated the true impact of the word 'make available' used in the treaty while arriving at a conclusion. Test reports generated do not transfer any technology knowledge to the customers, nor do they grant any right to access or use.

Held

The Bangalore Tribunal discussed that make available would only be satisfied when the service recipient can independently provide/transfer the skill or knowledge after it is acquired from the service provider. In the given case, the Tribunal held that the taxpayer has complete knowledge and know-how/ expertise to carry out the research and to issue reports, and this knowledge has not been transferred to its customers. Accordingly, it would not satisfy the make available clause under the tax treaty. The Tribunal also relied upon the decision of the Hyderabad Tribunal wherein Dr. Reddy's Laboratories Ltd entered a similar transaction. In that case, it was held that such services are not to be considered as FTS.

Our Comments

The 'make available' clause under the tax treaty would involve careful consideration on whether an assessee would be eligible for claiming the benefit or not. In this case, Bangalore Tribunal has denied that the services provided do not 'make available' technical know-how.

Whether payment made by the Indian company to its sister concern would be taxable in India in case no element of profit is involved in it?

Trusted Aerospace Engineering Pvt. Ltd TS-324-ITAT-2023(CHNY)

Facts

The taxpayer (TASE India) is engaged in the business of manufacturing. TASE India entered into a project agreement with Hamilton Sundstrand Corporation, USA (Hamilton USA) for manufacturing products for their new engine program. As per the agreement, Hamilton USA is responsible for the design of the product, which will be provided to TASE India, and TASE India will manufacture it and provide after-sales support services to Hamilton USA.

TASE India, as an entity, is not equipped with the necessary parts/components to manufacture the product. TASE India outsourced the manufacturing to its sister concern TASE USA. TASE India would then make payment to TASE USA for manufacturing the product.

The Revenue was of the contention that the design that was being developed in the USA was supposed to be used in India. Since the design was to be used in India, income earned by the NonResident (NR) Company is taxable in India.

Hence, provisions of Tax Deducted at Source (TDS) are attracted, and TDS should be withheld in India, consequent to which disallowance was made under Section 40(a)(ia) of the Act.

The taxpayer contended that the amount remitted has no income element involved and has been paid to the NR company, which has no Permanent Establishment (PE) in India, and since the expenses were incurred outside India for the manufacture of design, etc., for sale outside India, no TDS is required to be deducted under Section 195.

Held

The Chennai tribunal held that the Commissioner of Income Tax (Appeals) [CIT(A)] has rightly held that Section 195 applies only when the payment made to the NR has an element of income embedded in it. If the sum paid or credited is not chargeable to tax, then the obligation to deduct tax does not arise. It has also relied upon the decision of Hon'ble Supreme Court in the case of GE India Technologies Pvt. Ltd. Vs. CIT wherein it was held that when a remittance is made to a NR, an obligation to deduct tax at source under Section 195 of the Act does not arise immediately. It arises only when such remittance is a sum chargeable to tax under the Income Tax Act under Sections 4, 5, and 9 of the Act.

Our Comments

The Chennai ITAT upheld the decision of CIT(A) and relied on the decision of the Hon'ble Supreme Court in the case of GE India Technologies Pvt. Ltd. Vs. CIT, where it has held that if no income element has been involved in payment made to NR, no income will accrue/ arise in India and accordingly no need to withhold tax as per Section 195.

Transfer Pricing

Whether taxpayer can resile from the method used for the determination of Arms Length Price (ALP) during the course of assessment proceedings?

Star India Private Limited ITA No. 7872/MUM/2019

Facts

The taxpayer engaged in the business of broadcasting and distribution of various satellite channels entered into a Master Rights Agreement (MRA) with its associated enterprise (AE) to purchase a Bundle of Sports Broadcasting Rights (BSB). The said BSB was purchased by the AE for lumpsum consideration from various Independent Sports Bodies (ISBs) in erstwhile years. However, the same was transferred to the taxpayer on a novation basis (75%) and the balance (25%) was sub-licensed. Overall, the BSBs were purchased at a discount of 9.5% (from the AE) vis-à-vis the value paid by the AE to the ISBs. The taxpayer claimed a deduction of INR 3,075 (approximate) for such purchases. It was determined to be at ALP using Other Method (OM) as the most appropriate method (MAM) basis the value determined by the independent valuer using Discounted Cash flow (DCF) method.

The Transfer Pricing Officer (TPO), in the case of the taxpayer for the preceding assessment year, had disregarded the valuation report on the grounds of the projections used in the valuation being inflated and also assigned the terminal value in the valuation to be nil. Considering the facts of the case being akin to last year, the TPO made an adjustment of INR 20.31 billion for the year under consideration. During the assessment proceedings, the taxpayer changed the MAM to Comparable Uncontrolled Price (CUP) method stating that the amount paid by the taxpayer to AE is lesser than the amount paid by AE to third parties.

The Income Tax Appellate Tribunal (ITAT) disagreed with the predecessor bench, which decided the earlier year (AY 2014-15), thereby, a Special Bench (SB) was constituted.

Issues before the SB and SB Ruling

• Can taxpayers resile from the MAM adopted in the TP study - SB held that taxpayers may resile from the MAM selected in the Transfer Pricing Study Report (TPSR). However, the onus of proving whether the new method substantiates the ALP is on the party that resiles from the originally selected MAM.
• Which is the MAM - The SB highlighted the critical differences between the application of the CUP method and OM and stated that the CUP method emphasizes the actual price paid for the property transferred, unlike OM considers the price which has been paid or would have been paid for same or similar uncontrolled transactions. Thus, while selecting OM as the MAM, quotations and valuation reports assist in determining the ALP of the underlying transaction. Also, in order to apply for CUP, there has to be a comparable uncontrolled transaction with an independent party. In the instant case, the price paid by the AE to ISB cannot be construed as a comparable transaction to the purchase consideration paid by the taxpayer to the AE. Thus, the SB held that in the absence of CUP only method that can be applied as MAM is OM.
• Determination of ALP - The matter was directed to be placed before the Division Bench using OM as MAM.

The ruling provides respite to the taxpayers wherein they may resile from the MAM selected at the time of concluding the TP study report at a later point during the course of assessment proceedings.

Footnotes

1. Meaning of Excluded Activities has been provided in the Cabinet Decision No. 139 of 2023

2. Meaning of Qualifying Activities has been provided in the Cabinet Decision No. 139 of 2023

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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.