From Yatin’s Desk: Impact on oilfield service providers-Delhi High Court rules on deemed tax regime applicability u/s 44BB on software service contracts

The Delhi Court in a significant decision on applicability of Sec. 44BB of the Income Tax Act, 1961 (Act) has ruled that income in the nature of “royalty” would not be covered under the deeming provisions applicable to non resident taxpayers engaged in prospecting, extraction or production of mineral oil. However in relation to fee for technical services (FTS), where the dominant purpose of the agreements is prospecting, extraction or production of mineral oils, based on the doctrine of “pith and substance” the activities would fall within the ambit of “mining or like projects”, which are specifically excluded from the scope of FTS.  Such technical services would be subject to deemed profit tax under Sec. 44BB.

To set the context, u/s 44BB of the Act, income of a non resident engaged in providing services or facilities in connection with prospecting, extraction or production of mineral oil is subject to tax at deemed profit rate of 10%. However, income falling within the purview of section 44DA [which covers Royalty and FTS connected with the Permanent Establishment (PE) in India] is excluded from the ambit of deemed tax regime and is subject to net basis taxation. While at first instance, the provisions seem innocuous, the interpretation has been subject to much litigation over years. Tax payers have often argued that income earned by non resident taxpayer engaged in oilfield service will fall within the scope of Sec. 44BB being a specific provision applicable to oilfield service.

The Delhi High Court (HC) in the recent case of PARADIGM GEOPHYSICAL PTY LTD. had the occasion to examine taxability of software related service contracts under the deeming provisions. In the case before the court, the taxpayer was engaged in the business of developing and providing customized software enabled solutions and annual maintenance services used in oil and gas industry in relation to prospecting, extraction, production and seismic analysis. The tax payer, placing reliance on the decision of the Hon’ble Supreme Court in the case of Oil and Natural Gas Corporation Ltd (ONGC) v. CIT (2015) 376 ITR 306 contended that Sec. 44BB of the Act being a special provision, its income being in connection with prospecting, extraction or production of mineral oils, should be taxed under deeming provision.

The HC took note of the changes effective 01.04.2011 whereby through parallel amendments in Sec. 44BB and Sec. 44DA it was stipulated that provisions of Sec. 44BB shall not apply in respect of income falling under the provisions of Sec. 44DA and vice-versa. The court went on to hold that both provision (Sec. 44BB and Sec. 44DA) are special in nature and operate in their own clearly defined spheres.  Accordingly once a receipt of income qualifies as Royalty/FTS, it cannot be taxed u/s 44BB and has to be taxed u/s 115A/44DA of the Act. The court held that the controversy surrounding the interplay of the two provisions stands resolved by virtue of the amendments and further the question of interplay of the two provisions was not dealt with in the case of ONGC (supra).

The court went on to hold that it was incumbent on the tax authorities to determine whether the nature of income was Royalty or FTS. This aspect has importance since FTS has a restricted scope on account of specific carve out of “payment received for construction, assembly, mining or like project”. In other words, if the consideration received falls within the exclusion, the payments would not be regarded as FTS and hence outside the scope of Sec. 44DA but taxable u/s 44 BB. It is the proximity of the work contemplated under an agreement executed with a non-resident taxpayer with mining activity or mining operations that would be crucial for the determination of the question whether the payments made is to be assessed u/s 44BB or otherwise. If the services provided by the taxpayer constitute services for “mining or like project”, the consideration thereof would be excluded from the scope of FTS and would be taxable u/s 44BB.

Importantly, the HC rejected the arguments of the tax authorities that the scope of expression “mining or like project” has to be confined only to situations where services are performed onsite i.e. at the site of mining/drilling. Relying on the doctrine of “pith and substance”, the court opined that the same has to be applied in respect of each contract/agreement, to ascertain whether the dominant purpose of the agreements was prospecting, extraction or production of mineral oils, in which case the same would fall within the ambit of “mining or like project”.

In context of specific facts of the case, the HC has ruled that if the income from services provided by the taxpayer from the supply of software as well as ancillary services such as maintenance and installation is regarded as “Royalty”, deeming provision of Sec. 44BB would not apply. On the contrary, if the payments are for technical service, the income would be taxable under section 44BB since it is excluded from the definition of FTS being covered under the exception relating to “mining or like” activities (basis dominant purpose of the contract). The court however did not examine the nature of income in absence of any such determination by the tax authorities.

The decision of the court has significant bearing on the oil & gas industry. The ruling does provide clarity and to an extent certainty for oilfield service providers engaged in provision of technical service (whether on-site or remote) having dominant purpose of prospecting, extraction or production of mineral oil with respect to taxability under Sec. 44 BB. However service providers providing software license and incidental services or receiving other payments which may fall under the purview of “Royalty” under the Act will have to brace for re-calibrated tax positions. Importantly, where the tax payer now argue non taxability of software related payment under favorable Double Tax Avoidance Agreement (DTAA) provisions, it may still have to deal with business profit tax where the taxpayer has a PE in India. The ruling perhaps make it incumbent for tax payers to evaluate the possibility of restructuring software licence and incidental contracts (typically impacting data processing and analysis activities) as technical service contracts.

All in all a sound judgement on interpretation of deeming provisions u/s 44BB of the Act.

From Yatin’s Desk: Delhi High Court favorably rules on alternate Writ remedy against DRP directions

The Delhi High Court (HC), in a recent ruling in the case of P.D.R SOLUTIONS FZC has allowed the Writ petition filed by the petitioner and set aside the order of the Dispute Resolution Panel (DRP) holding that the DRP erred in not taking into consideration all the material and contentions furnished by the petitioner before the DRP. The matter was remanded back to the DRP for considering the objections raised by the petitioner in detail and for passing a fresh order on merits by giving reasons and findings. To put in perspective, the petitioner was a UAE tax resident company engaged in the business of selling domain names, providing web hosting services & server space to clients. The petitioner had claimed a non-taxable position under India-UAE DTAA , which was one of the objection raised before the DRP. The DRP however, without examining the objection, passed an adverse direction following the decision of the Income Tax Appellate Tribunal (ITAT) in case of, taxability in which case was determined only under the domestic tax laws.

As a norm, Writ remedies are generally not entertained when there is alternate appellate remedy available to the taxpayer. However, in this case the HC observed that since no assessment order had yet been passed by the Assessing officer (AO), the alternate remedy was not available as yet. Further, the DRP did not adjudicate petitioner’s categorical objections on the taxability under the India-UAE DTAA which violated the principles of natural justice, there was a fundamental error relating to the exercise of jurisdiction and the approach of the DRP rendered the entire process of the dispute resolution as per the scheme of law farcical.

In the ordinary course, a taxpayer would be required to go through the tedious process of litigation – filing appeal before the next level appellate forum (ITAT) against the final order once issued by the AO (based on DRP direction). In a matter like this where the DRP has not examined the technical merits of the case, generally the ITAT would remand the matter back to  AO/DRP for consideration on merits. Procedurally, this may take substantial time, perhaps years, before appeal is considered by the ITAT. Given the favourable consideration by HC at the draft order stage (where only DRP direction has been passed), there may now be another opportunity for tax payer to perhaps explore the Writ option and expedite their litigation where there is a blatant non considerations of the objection raised before the DRP. Having said that, one needs to take note (as observed by the HC) that not every order, where there is a non-application of mind, would become open to challenge under Writ jurisdiction, but only fundamental error which are glaring and noticeable.

The HC has made a fine balance in all fairness and brings forth an alternate remedy where the taxpayer is aggrieved against DRP direction, albeit which may be considered judiciously in exceptional circumstances.

From Yatin’s Desk: Government clarifies on proposed residency rule for Indian Citizens

The Finance Bill (FB) 2020 has proposed a significant change by regarding an Indian citizen (who otherwise is not resident in India under the basis stay rule of 182/120 days or more) as ‘deemed resident’ if the individual is ‘not liable to tax in any other country’ by reason of his domicile or residence or other criteria of similar nature. Memorandum to the FB 2020 explains the intent by stating that the change is proposed to address the practice by individuals to arrange affairs in a fashion such that he is not liable to tax in any country or jurisdiction during a year. Such arrangements are typically employed by high net worth individuals to avoid paying taxes to any country/ jurisdiction on income they earn. The change, at first sight, is bound to give jitters to certain category of citizens who are genuinely employed in tax free countries, for instance UAE which does not have personal income tax.

It will be interesting to take note of the text proposing the change which states as follows – “an individual, being a citizen of India, shall be deemed to be resident in India in any previous year, if he is not liable to tax in any other country or territory by reason of his domicile or residence or any other criteria of similar nature.”;

The use of the expression “by reason of his domicile or residence” is intriguing given the effect could have perhaps been achieved simply by specifying that ‘a citizen of India shall be deemed to be resident in India if he is not liable to tax in any other country’. One wonders whether the use of expression “by reason of his domicile or residence” gives some scope for argument that the deeming residency rule may not apply to citizens where non-taxability is on account of general exclusion of ‘Individual’ from taxation and not on account of lack of meeting threshold of domicile/residence? The debate may have just begun and will certainly open another area of protracted litigation.

While the analysis continues, one way to wriggle out of this conundrum is to take shelter of ties breaker rule under tax treaties, which is again a complex exercise involving interpretations. It will further be pertinent to take note that individuals qualifying as “resident but not ordinarily resident” (RNOR) are not taxable in relation to income which accrues or arises outside India unless it is derived from a business controlled or a profession setup in India. As further proposed in FB 2020, a person will qualify as “RNOR” in India in any previous year, if he has been a non-resident in India in 7 out of 10 previous years preceding that year. Thus, even if an individual is regarded as a “deemed resident” under the new framework from FY 2020-2021, he may still qualify as “RNOR“ thereby safeguarding income accruing outside India from India taxation during the years “RNOR” status is maintained. The 7/10 rule for RNOR status while provides some comfort to citizens who have been settled overseas for over 7 years, this will have far reaching implications for recent emigrants.

The government is ceased of the issue and to its credit has issued a press release clarifying that in case of an Indian citizen who becomes ‘deemed resident’ of India under this proposed provision, income earned outside India by him shall not be taxed in India unless it is derived from an Indian business or profession. Further clarification is expected to be incorporated in the relevant provision of law. Hope the government also ensures there is no associated filing/reporting burden cast on the overseas citizens.

Whether it is at all worthwhile to change the status quo only for targeting a few HNI’s misusing the law..perhaps not!

From Yatin’s Desk: Non-resident taxpayers get partial breather from filing Indian tax returns

Filing of Indian income tax return by non-residents earning passive income in the nature of royalty, fee for technical services (FTS) and interest, subjected to WHT in India, has been a sore point for non-resident tax payers. Such taxpayers either being oblivious of the requirement or otherwise regarding such compliance as an unnecessary burden, in many instances have not been filing the tax return in India. The Government over the last 2-3 years has been focusing on ensuring compliance, even going to the extent of issuing notices for reassessment and making penal provisions stringent to enforce compliance by delinquent tax payers. In a reversal, the Finance Bill (FB) 2020 now proposes to exempts non-residents from tax filing obligation, though with limitations.

Under the extant provisions, non-resident tax payers earning interest and dividend income are exempted from filing tax returns provided appropriate WHT has been deducted [at rate applicable under Double Tax Avoidance Agreement (DTAA) or domestic tax law – as beneficial]. Tax payers earning FTS & royalty income are mandatorily required to file tax return, even if income has been subject to WHT. FB 2020 proposes to materially change this requirement by providing the non-residents an exemption from tax filing in relation to FY 2019-2020 and subsequent years. The exemption will be available where the income is in the nature of royalty/FTS (taxable on gross basis), interest and dividend and WHT has been deducted at the rate prescribed under the domestic tax law (Act), if higher than the rate applicable under DTAA.

For instance, WHT rate for Royalty/FTS in most DTAA is 10% vis-à-vis 10.92% (for foreign companies) under the Act. The exemption from filing will be applicable if WHT has been made at 10.92%. While difference is not stark with respect to Royalty/FTS and non-residents may perhaps consider WHT deduction at higher rate to avail the benefit, adopting the same approach for interest and dividend income will have its limitation. General rate of WHT applicable on interest/dividend income is  21.84% (peak rate for foreign companies) as against 10%/15% applicable under most DTAA [certain categories of interest income is subject to lower WHT of 5% under Act e.g. interest on foreign currency loan, rupee denominated bonds, etc.]. Significant difference in WHT rates would be a dampener leaving non-resident tax payers with limited scope of benefiting from the proposed non-filing regime.

The budget proposal has made a cross-over perhaps benefiting non-resident tax payers earning FTS/royalty income (given lower arbitrage between domestic and DTAA WHT rates) while obligating those earning interest/dividend income to file tax return if they wish to take benefit of lower rates under DTAA. The provisions also leave another area unaddressed i.e. with regard to undertaking transfer pricing compliance even where there is no filing obligation (in absence of specific carve out). Non compliance has significant penal implications.

The Government has apparently taken back, to an extent, what it proposed to give by way of relief to non-resident taxpayers. It may not be ease of compliance yet !

From Yatin’s Desk: Income Tax Settlement Scheme – An opportunity to close tax litigation

Update: 22.02.2020 – The tax settlement scheme which was initially proposed to cover litigation pending before Commissioner (appeals), Tax Tribunal, High Court, Supreme Court and international arbitration as on 31 January 2020 is expected to also cover matters under review by Dispute Resolution Panel (DRP), Revision applications before Commissioner and orders for which timeline for filing appeal has not expired as on 31 January 2020. The Government is going all guns blazing to make this scheme a success. A great opportunity for litigants.


The Finance Minister, in her budget speech introducing the Finance Bill 2020 had announced bringing a direct tax settlement scheme with the intent of reducing over 4.8 lacs direct tax cases pending before various appellate authorities. In furtherance of the announcement, “The Direct Tax Vivad Se Vishwas Bill, 2020” has been introduced in the Parliament for consideration. The same will become effective from the date to be notified post approval by the parliament and presidential assent.

The scheme provides an opportunity to settle arrears of tax against appeals pending as on 31 January 2020 before the appellate forums [Commissioner (Appeal), Income Tax Appellate Tribunal, High Court and Supreme Court]. Where the arrears relates to disputed tax and interest & penalty on such disputed tax, there is a complete waiver of interest and penalty on payment of disputed tax by 31 March 2020. Payment beyond 31 March 2020 but within the last date (to be notified), will require additional payments of 10% of the disputed tax. Further where the tax arrears relates to disputed interest, penalty or fee, there will be a waiver of 75% of such amount if paid by 31 March 2020 and 70% where payment made beyond 31st March 2020 till the last date to be specified. The scheme further provided for immunity from prosecution.

The scheme requires the taxpayer to file a declaration before the designated Commissioner of Income tax who will within a period of 15 days from the date of receipt grant a certificate containing particular of tax arrears and the amount of tax to be paid. The taxpayer will thereafter be required to pay the tax determined within 15 days from the date of receipt of the certificate and intimate the payment thereof to the authorities. On issue of certificate, pending appeal before the Commissioner (Appeal) and Income tax Appellate Tribunal will be deemed to be withdrawn. With regard to appeals before High Court/Supreme Court or where proceedings for arbitration, conciliation or mediation have been initiated, the taxpayer will be required to withdraw the appeals. Rules and forms in relation to the scheme are yet to be notified.

The scheme leaves some open questions such as eligibility of tax payers who are yet to file appeal as on 31 January 2020 (within the timeline prescribed), impact on appeals deemed to be withdrawn before the appellate authorities upon issue of certificate where the taxpayer is unable to pay the liability with the 15 day timeline, adjustment of past pre-deposits, etc. Hopefully some FAQ’s will clarify on such aspect. Further, given the 15 days payment timeline, this may be a challenge for foreign companies not having operative bank account in India to facilitate money transfer. The Government may consider a mechanism to facilitate this.

Overall the tax settlement scheme is a welcome move by the government to reduce pending litigation. Tax payers should critically review their litigation exposure and avail the opportunity to get closure specifically where exposure of interest (due to long pending disputes), penalty and prosecution is high.

From Yatin’s Desk: MAT credit dilemma under 25% corporate tax rate option

In light of last week’s historical reduction in the corporate tax rates applicable during FY 2019-20, existing domestic companies (not availing tax exemptions/specified deductions) have the option to avail reduced corporate tax rate of ≈25%. Such companies have also been exempted from applicability of Minimum Alternate Tax (MAT). Companies not opting for such scheme will continue to be taxed at the current rate (≈29%/35%) and subject to MAT, albeit at the reduced rate of ≈ 17.5% vis-a-vis 21.5%.

In absence of MAT application to such companies or any change in MAT credit provisions specifically permitting set-off of MAT credit against 25% liability, the debate will continue for the next few days on the entitlement to set of unutilized MAT credit. However, if the view emerges against the set-off, it will be vital for companies to consider their MAT credit position before jumping into the perceptibly lucrative 25% tax regime. As a big picture, so long the companies have sufficient MAT credit, the liability can be restricted to 17.5% (MAT liability) by setting off excess liability computed (at general rate of 29%/35%) against MAT credit entitlement. Accordingly, it may be beneficial for companies to continue with the existing regime till the MAT credit is completely absorbed. There is always the option to exercise the 25% regime in future.

While the taxpayers do their math, it will be worthy if the government clarifies its position.

SC weighs in on interplay of labour laws and IBC

By Abhishek Dutta and Vineet Shrivastava, Aureus Law Partners

India as a welfare state has enacted various labour laws in order to ensure the protection and promotion of the social and economic status of workers and the elimination of their exploitation.

Under the Indian constitution, trade union, labour and industrial disputes are included in the concurrent list, where both the central and state governments are competent to enact legislation, with certain matters reserved for the central government. In addition to these, the preamble of the constitution has secured social, economic and political justice, equality of status and opportunity. There have been some recent court decisions under the Insolvency and Bankruptcy Code, 2016, (code) that deal with the interpretation of labour legislation.

labour laws
Abhishek Dutta
Founder and managing partner
Aureus Law Partners

Recently, the Supreme Court, in the case of JK Jute Mill Mazdoor Morcha v Juggilal Kamalpat Jute Mills Company Ltd, upheld the insolvency application filed under section 9 of the code by a registered trade union considering it to be an operational creditor for the purposes of the code.

The National Company Law Tribunal (NCLT), while adjudicating the application filed by the trade union on behalf of nearly 3000 workers of the debtor, had held that the trade union was not covered as an operational creditor and had dismissed the insolvency application. In the appellate proceedings, the NCLAT had also dismissed the trade union’s application by stating that each worker could file an individual application before the NCLT.

The Supreme Court, after studying various provisions of the Trade Unions Act, 1926 (act), observed that a trade union being an entity established under the provisions of the act would fall under the definition of a person under section 3(23) of the code.

Further, rule 6, form 5 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, also recognizes that claims can be made not only in an individual capacity but also conjointly.

labour laws
Vineet V Shrivastava
Aureus Law Partners

Also, a trade union that is recognized under section 8 of the act can sue or be sued in its name. The Supreme Court relied on the judgment of the division bench of Bombay High Court in the case of Sanjay Sadanand Varrier v Power Horse India Pvt Ltd, where a winding-up petition by a trade union under section 434 read with 439 of the Companies Act, 1956, was held to be maintainable. On the basis of these observations, the Supreme Court was of the view that filing individual petitions would be burdensome as each worker would, therefore, have to pay insolvency resolution process costs, costs of the interim resolution professional, costs of appointing valuers, and so on.

It observed that since a trade union is formed for the purpose of regulating the relations between employees and their employer, it can surely maintain a petition as an operational creditor under the code. On the basis of this, the Supreme Court remitted the petition to the NCLAT to decide the matter on its merits.

In another case, Alchemist Asset Reconstruction Co Ltd v Moser Baer India Limited, an application was filed by the workers of the debtor in liquidation, praying for a direction to the liquidator to exclude the amount that is due towards their provident fund, gratuity fund and pension fund from the waterfall mechanism provided for under section 53 of the code. The liquidator was of the view that as per explanation II to section 53 of the code, “workmen’s dues” have the same meaning as that assigned to it under section 326 of the Companies Act, 2013, and therefore gratuity shall be included for the purposes of section 53 of the code.

The NCLT observed that “liquidation estate” as defined under section 36 of the code clarifies in unequivocal terms that all sums due to any employee from the provident fund, pension fund and gratuity fund are not to be included in the expression “liquidation estate”.

Accordingly, the NCLT relying on the judgment of the NCLT Bombay bench in the case of Asset Reconstruction Company (India) Ltd v Precision Fasteners Ltd held that employees’ dues towards pension, provident fund and gratuity were not to be included in the liquidation estate and would not, therefore, be recovered by way of waterfall mechanism provided for under section 53 of the code. It further issued directions to make available funds to the provident fund, gratuity fund and pension fund of the debtor company in case of deficiencies in the said funds.

NCLAT says statutory dues also operational debt

By Abhishek Dutta and Sayli Petiwale, Aureus Law Partners

The National Company Law Appellate Tribunal (NCLAT) on 20 March 2019 dismissed a batch of appeals in the matter of PR Director General of Income Tax (Admn & TPS) v Synergies Dooray Automotive Ltd & Ors, which claimed taxes to be an exception to the definition of operational debt under section 5(21) of the Insolvency and Bankruptcy Code, 2016 (IBC).

The NCLAT held that taxes were subsumed within the definition of operational debt and tax authorities were operational creditors under IBC.

Abhishek Dutta id
Abhishek Dutta
Founder and managing partner
Aureus Law Partners

Section 5(21) of IBC: The appellants challenged section 5(21) of the IBC stating that the word “or” before the sentence “…a debt in respect of the payment of dues arising under any law for the time being in force payable to the Central Government…” should be interpreted as “and”. Therefore, they argued that: (i) debt would be related only to supply of goods or services rendered to the corporate debtor; and (ii) tax does not qualify as either, and would not be an operational debt.

Discussing the scope and nature of the term operational debt, the NCLAT, based on the precedents in statutory interpretation, considered the positioning of the words “or” as well as “and” in the provision. It observed that there was no ambiguity in the IBC and that the legislature has intentionally used the words “or” and “and” at different places in the provision.

The NCLAT, relying on the judgment in the Swiss Ribbons Pvt Ltd & Anr v Union of India & Ors (2018) case, held that “and” had to be read conjunctively while “or” had to be read disjunctively in the said provision. On the basis of this, the NCLAT held that statutory dues were operational debt.

The appellants argued that because the corporate debtors’ operation did not rely on statutory dues, the question of tax being an operational debt would not arise. The NCLAT, instead, observed that taxes had a direct nexus with the corporate debtor’s operation as they would not arise if the corporate debtor was not in operation.

Sayli Petiwale
Aureus Law Partners

Based on the above, it held that statutory dues such as taxes were an operational debt; and tax authorities as such would qualify as operational creditors.

What the NCLAT did not discuss: Another argument made by one of the appellants was that liability under the tax statute is a first charge and therefore cannot be a part of the resolution plan. Although the NCLAT did not discuss this point, the case of Pr Commissioner of Income Tax v Monnet Ispat And Energy Ltd, is seminal in this regard, where the Supreme Court categorically adjudged that section 238 of the IBC overrides any statute inconsistent with it, including the Income Tax Act, 1961. Therefore, it would appear that having a first charge (under another statute) may become immaterial if a company enters the ambit of insolvency under IBC.

Ambiguity over tax statutes and IBC: This decision raises significant questions regarding the status of the tax authorities’ claims in light of the overriding effect of the IBC provisions.

In August 2018, High Court of Andhra Pradesh and Telangana, in Leo Edibles and Fats Limited v The Tax Recovery Officer case, permitted liquidation of assets of a company undergoing liquidation under IBC despite ongoing recovery proceedings by the income tax authorities.

The high court said in no uncertain terms that the income tax authorities could not be considered at par with secured creditors. The court also said that because the income tax authorities are not secured creditors, they must take recourse under section 53 of the IBC with regards to the distribution of assets and they would come fifth in the order of the disbursal of claims as taxes are a contribution to the Consolidated Fund of India. It is interesting to note here that section 53 of the IBC does not mention the term operational creditor.

With the NCLAT’s decision declaring the tax authorities as operational creditors, the ambiguity exists in the interplay between tax (dues) and the IBC. The tax department in October 2018 was reported to have prepared a proposal seeking the intervention of the Ministry of Finance to resolve the issue.

Recently, the Insolvency and Bankruptcy Board of India has reconstituted the Insolvency Law Committee as the Standing Committee to review the implementation of the IBC. It will be interesting to see what recommendations the committee will make on the issue of the ambiguity regarding tax and the IBC.

From Yatin’s Desk: Withholding tax (TDS) default, no more business as usual

Indian tax laws mandate payers to withhold taxes at source on payments to residents (in case of specified payments) and also non-residents (where their income is taxable in India). Non-compliance has penal consequences. While failure to withhold tax has interest and penalty implications (i.e. financial costs), consequences are severe in case of non-deposit or late deposit of tax collected leading to additional prosecution implications (financial+ criminal implications). Given the humongous amount of data collated by the Revenue Authorities and use of data analytic, it is not unusual to find show cause notices being issued to defaulter now days. However what should raise alarm for the defaulters is the fact that where the default relates to non/delayed deposit of taxes leading to prosecution proceedings, the Magistrate Courts are taking a serious view on the matter with defaulters being sentenced to imprisonment.

One recent case before the Ballard Pier Magistrate Court (Mumbai), related to a delayed payments of approx. INR 850K, which was paid with interest and also penalty. The Magistrate Court disregarded the plea of financial constraint and proceeded to convict the defaulter sentencing to 3 months imprisonment. Though, the decision is appealable before higher Appellate Courts, one needs to take note that such proceedings are highly complex, time consuming and financially expensive. Take for instance this specific matter – it related to withholding default in financial year 2009-10, criminal complaint before Magistrate Court was filed in 2004 and after almost 30 odd hearings/adjournments before the Magistrate Court, the proceedings concluded in April 2019; a 10 year saga, which will further continue for years before higher Courts.

It is also relevant to take note that where the defaulter is a Company, the direct impact is on the directors, who generally are proceeded against leaving it for them to defend their innocence. A clear message – by no means delay or fail to deposit taxes deducted if you want to be on the right side of law, else don’t complain of government action!!

From Yatin’s Desk: Changes proposed to the rules for attribution of income to Permanent Establishment

Attribution of profits to a Permanent Establishment (PE) of a Multinational Enterprises (MNE) in India has been a commonly ligated matter and marred with uncertainty. The Indian tax administration has placed for public comments report of the Committee constituted to examine the existing scheme of profit attribution to PE, with the intent of framing guidelines for profit attribution, bringing certainty and transparency. While the debate on the proposals will surely continue for long, the document is a valuable read for India’s position which highlight India reservation to the authorized OECD approach for PE income attribution.

The Committee in its report emphasizes the fact that the Indian tax treaties are predominantly based on UN Model Convection which under Article 7 legitimizes attribution of profits to a PE on the basis of apportionment of the total profits of the enterprise to its various parts. Such methods is adoptable where profits cannot be determined through a direct method i.e. based on verifiable books of accounts prepared as per acceptable accounting standards. In contrast, Article 7 of OECD model convention post 2010 advocates the approach of allocation taking into account the functions performed, assets used and risks assumed (FAR analysis) by the enterprise through the permanent establishment and through the other parts of the enterprise.

The Committee has observed that business profits are contributed by both demand and supply of the goods. Article 7 of the OECD Model Tax Convention and approach recommended by OECD (based on FAR) is purely supply side approach towards profit attribution and disregards the role of demand in contributing to profits attributable to PE. Further, the Indian tax treaties have not included the concept of Income attribution based on FAR as advocated by OECD model convention, thereby permitting attribution of profits in a manner different from the authorized OECD approach i.e. by resorting to the direct accounting method and where that may not be possible, by apportionment of profits.

Accordingly, the Committee has suggested PE profit attribution based on a combination of (i) profits derived from Indian operations and (ii) three factor method based on equal weight accorded to sales (representing demand), manpower and assets (representing supply including marketing activities). In other words, profits of the multinational enterprise will first be apportioned for India sales (amount arrived at by multiplying the revenue derived from India x Global operational profit margin). As a second step, such profits will be attributed proportionately to (a) sales within and outside India; (b) employees and wages within and outside India; and (c) assets deployed within and outside India for Indian operations, each with 33% weightage. Further to address a situation whether the multinational enterprise suffers losses or has profit margin less than 2%, a margin of 2% of revenue derived from India sale is proposed to be regarded as deemed profit for India operation, thereby recommending minimum base level taxation. With regard to digital economy, where nexus to taxation is attributed to the concept of significant economic presence, considering the role of users, a fourth factor (i.e. user intensity) needs to be further built into the income attribution formulae.

The OECD approach for income attribution based on FAR analysis, which the Committee regards as factoring only supply side attributes (and not demand) finds favour with the Committee where no sales takes place in India. For instance, where a multinational enterprise constitutes a PE in India and compensates the PE at arm’s length basis FAR analysis and further such enterprise does not have any sales in India, no further income will be attributable to India (in absence of any play of demand side factor). However, where sales are made in India, the reading of the Committee report suggests formulae based attribution would become the rule and additional income attributable would become taxable in India (post allowance of income apportioned to supply factors and offered to tax in India).

Given the development, there will be a significant transformation to the concept and impact on income attribution to permanent establishments in India, should the proposed recommendation be formulated into mandatory rules. The demand side factors which the Committee consider as an important consideration would seemingly lead to attribution of 33 percent of the profits derived from sale in India even if no further attribution is required to be made in absence of other factors. It will be interesting to see how the courts view the principles around income attribution in light of the divergence in OECD approach and Indian tax administration position.