2017-TII-25-ITAT-KOL-INTL

HITT HOLLAND INSTITUTE OF TRAFFIC TECHNOLOGY BV Vs DDIT: KOLKATA ITAT (Dated: February 8, 2017)

Income Tax – Sections 9(1)(vi) - India-Netherlands DTAA - Article 5(3).

Keywords - non resident AE – project office - installation PE – fee for technical services – royalty.

The Assessee is a subsidiary of HITT N.V., which is a company incorporated as per the laws of Netherland operating in the international market for safety, security and efficiency of nautical and air traffic. The assessee had entered into contracts with ONGC, DGLL and AAI for rendering services and supply of equipments. The Assessee received payments in respect of performance of services and supply of equipment. The assessee had established a Project Office (PO) in India in the year 2005 for the GOK Project, However, it has not performed any activity in relation to any of its contracts in India from the said PO. The project office has only been used to collect money and pay certain expenses on behalf of the Assessee through its bank account. Therefore, no part of the contract execution has been carried out through the PO in India. Therefore the Assessee did not have a PE in India. Assessee filed its return of income for the subject AY declaring income pertaining to training income received from AAI (Mumbai, Chennai and Kolkata Airport) Project as 'Fees for technical services', taxable on a 'gross' basis at the rate of 10 percent as per the provisions of Article 12(2) of the India-Netherlands DTAA. The assessee's return was selected for regular assessment u/s 143(2) and the draft assessment order was forwarded by AO. The AO was of the view that Assessee has a functional Permanent Establishment in India for the AAI projects, which has been involved in the execution of the project in India and also has 'Installation PE' in India as per the provisions of Article 5(3) of the India-Netherlands DTAA, on account of existence of the GOK and ONGC projects for a period exceeding 6 months AO by applying various ad-hoc attribution methods, attributed income to the PE in India. On appeal, the DRP partly accepted assessee's objections.

On appeal, the ITAT held that,

Whether income earned by foreign company from sale of equipments with embedded software to Indian entity, can be taxed in its hands as 'business income' in absence of its PE in India - NO: ITAT

Whether consideration towards software and license embedded in an equipment can be bifurcated from combined sale consideration of the equipment, and hence can be brought to tax as 'royalty' as envisaged u/s 9(1)(vi) – NO: ITAT

+ though "Software and Licenses" is shown as a separate item, it cannot operate independently and had to be regarded as part of the Hardware. The software and licenses were part of the hardware and imbedded therein. The sale of equipment and its accessories with software imbedded in the equipments cannot be taxed in the hands of the assessee as business income as the Asssessee does not have a PE in India to which the profits can be said to be attributable. Revenue cannot bifurcate the consideration towards software and license embedded in the equipment from the combined sale value of the equipment and accessories and seek to bring to tax the amount bifurcated for software as in the nature of "Royalty" as envisaged under section 9(l)(vi) of the Act. The software in question was embedded in the equipment that was supplied, it cannot be regarded as giving any independent right to use software and therefore cannot be treated as royalty;

Whether consideration received for providing installation & management services, can be taxed as 'FTS', when such services did not include 'make available' clause in the stipulated technical agreement – NO: ITAT

+ the assessee as part of the supply of equipments to ATC System Project, AAI New Delhi Airport Project, provided project management services, installation, testing and commissioning services etc. to AAI. This included tuning of the radar and its integration and commissioning with the systems of Delhi airport. From the invoice, it can be seen that the net consideration for these services is EUR 154,655 (equivalent to INR 9,222,093) which has been assumed as FTS in the assessment order. The consideration amount is for various other services and training of employees is only for ½ day, which is only to familiarize the customer with the use/ operation of the equipment supplied under this project;

++ the action of the DRP in directing the treat the sum of Euro 154655 as FTS cannot be sustained. A perusal of the invoice in this regard together with the purchase order clearly shows that what the Assessee did was installation, testing and commission and training. The training was half-day training and was intended to familiarize the Assessee with the operation of the equipment. It cannot be said that the services rendered "make available" technical knowledge, experience, skill, know-how or process etc. It cannot be said that the sum in question was in the nature of FTS chargeable to tax under the Treaty;

Whether installation PE can be said to have been established by a non-resident entity, when no installation activity was carried out during the previous year – NO: ITAT

+ the DRP considered the PO of the Assessee established for the GOK project as not constituting a PE within the meaning of Article 5(1) of the India-Netherlands DTAA. The basic rule in Article 5(1) of India- Netherlands DTAA requires a "fixed place of business" for constitution of a PE. That has been found to be not in existence by the DRP. For constituting Installation PE within the meaning of Article 5(3) of the India-Netherlands DTAA the test of duration of time for which the activities are carried out in India becomes relevant. The supply of equipments that have to be installed by the consortium could be said to be a direct preparation for coming into existence of an Installation PE. The DRP's direction clearly holds the view that no installation activity happened during the relevant previous year. Unless installation activities commence an installation PE cannot be said to have been constituted. Since the Assessee did not have a PE in India, such profits cannot be brought to tax in India;

+ no installation activity was carried out during the previous year and therefore the question of an installation PE of the Assessee existing during the previous year does not arise for consideration at all. Since the VATMS equipment was already accepted and handed over to the customer in the year 2007 and no installation activity was carried out in India during the subject year, it cannot be held that the Assessee had an 'Installation PE' in India in the subject year. Since no activities have been carried out by the Assessee in India with respect of such maintenance activity, it is unreasonable to conclude that the business of the Assessee was carried out in India through such subcontractor, to constitute its PE in India. Receipts in the form of AMC fees from ONGC on VATMS cannot be brought to tax in India as business income;

+ the sale of equipment and its accessories with software imbedded in the equipments cannot be taxed in the hands of the assessee as business income as the Asssessee does not have a PE in India to which the profits can be said to be attributable. Revenue cannot bifurcate the consideration towards software and license embedded in the equipment from the combined sale value of the equipment and accessories and seek to bring to tax the amount bifurcated for software as in the nature of "Royalty" as envisaged u/s 9(l)(vi). There was no installation PE in existence in so far as the ONGC VATMS AMC project is concerned. Therefore, the receipts in question cannot be brought to tax India.

2017-TII-54-ITAT-KOL-TP

PHILIPS INDIA LTD Vs DCIT: : KOLKATA ITAT (Dated: February 8, 2017)

Income tax - Sections 92, 92CA, 143(3), 144C.

Keywords - ALP - software development services - profit margin - segmental level - TNMM.

The assessee is engaged in the business of rendering software development services to its various group companies. During AY 2006-07, the Assessee had a turnover of Rs.381.3 crores in respect of such services rendered to its AE. The assessee justified its transactions with its AE as one at an arm’s length on the basis of TNMM. For this, operating margin data in respect of comparable Indian companies were identified by the assessee. Based on the above analysis, 20 companies were selected by assessee and the average operating margin on operating costs percentage of these companies was between (-) 61.5% to 46.4%. The arithmetic mean of the above mentioned companies was 9.6%. The AO on consideration of the TP study conducted by the Assessee was of the view that the assessee had included loss making companies in the list of comparable companies. The TPO however was of the view that loss making companies should be excluded from the list of comparable companies. The TPO also found that the turnover of the Assessee from rendering software services to its AE was Rs.381.3 crores whereas the companies having turnover as low as Rs.1.5 crores has been included in the list of comparable companies. Similarly companies having very huge turn over ranging from Rs.9449 crores and Rs.4792 crores were also included in the list of comparable companies by the Assessee. The TPO finally accepted six out of 20 comparables chosen by the Assessee, and added three more companies namely M/s. Mphasis BFL Ltd., M/s. Visual Soft Technologies Ltd and M/s Blue Star Infotech Ltd., as comparable companies. By taking the operating profit on operating cost percentage as 18.41 % as the benchmark, the ALP of international transactions representing provision of software development services by the assessee company to its AEs during the year 2004- 05 were re-determined at Rs.62.29 Crores and accordingly, an addition of 1.79 crores was made to the total income of assessee. The AO thereafter proposed to make the additions suggested by the TPO as TP adjustment. On appeal, the DRP refused to allow any adjustment towards working capital adjustment and risk adjustment. When the matter reached ITAT, the issue was remanded to the DRP to adjudicate afresh, who then directed the AO to recalulate ALP adjustment and finally the AO proposed an adjustment of Rs.32.81 crores as per the directions of DRP.

On appeal, the ITAT held that,

Whether distinguishing feature of any comapny itself is enough to exclude the same from final list of comparables - YES: ITAT

Whether a company having substantial IPR can be selected as comparable, to a captive service provider - NO: ITAT

+ as far as Aftek InInfosys Ltd. is concerned, it is found that the objections by the assessee before the DRP after remand by the Tribunal was that this company had IPR in the Schedule of fixed assets and therefore its business model was completely different which rendered this company as not comparable with the assessee for the reason that the assessee does not have any IPR in the schedule of its fixed assets. On this issue we find that the DRP has accepted that this company had shown significant IPRs but since the details of the nature and profile of the IPR was not available this company need not be excluded. In our view when the fact that this company had significant IPRs is accepted and the fact that the Assessee does not have any IPR is also accepted then that distinguishing feature itself is enough to exclude this company from the list of comparable companies. In fact it was brought to notice by the counsel for assessee that in A.Y.2009-10 the DRP in its directions has accepted this aspect and excluded Aftek Infosys Ltd as not comparable with that of the assessee company. The DRP held that Aftek Infosys Ltd was not comparable with the assessee because it was functionally not a comparable entity nor on FAR in view of the details filed before the panel. The functional comparability was also challenged by the assessee on the ground that this comparable company owned substantial IPRs and this was accepted by the Tribunal. In the light of this discussion, Aftek Infosys Ltd., is excluded from list of comparables;

Whether profit margin at entity level of a company should be preferred over the segmental level, in case of increasing trend in the profit margin, for purposes of deciding comparability - YES: ITAT

Whether such profit margin is required to be computed after allocating 'corporate expenses' - YES: ITAT

+ as far as Sasken Communication Technologies Ltd is concerned, has to be included as a comparable. The TPO has excluded this company chosen by the assessee from the list of comparables. The only limited prayer of the counsel for assessee is that the DRP had given direction to take a profit margin at the segmental level whereas it should be taken at the entity level. In this regard it was pointed out by the counsel that the TPO himself has taken the entity level margins in A.Y.2007-08 to 2009-10 as the same. However, this Tribunal is of the view that the profit margin at the entity level of this comparable company Sasken ought to be taken and not at the segmental level. The claim of Assessee that without allocating ‘Corporate expenses‘ the margins have been computed and hence it needs verification by the TPO/AO. Therefore, the TPO/AO is directed to verify this claim and allow the same, if the figures are found to be correct.

Assessee's appeal partly allowed