Friday, June 23, 2017

Timing of India Withholding Tax on Royalty/Technical Service Fees for overseas entities– the Dichotomy continues?

Withholding Tax in India is often perceived to be a challenging matter by many overseas entities having operations/activities in India. This may be on account of various reasons like lock up of funds in India (on account of taxes withheld) where a position of non taxability of income is adopted, mismatch between the year in which taxes are withheld by the Indian payer of income vs. the year in which the income is offered to tax in India, challenges with claiming credit for taxes withheld in India in the home country. 

One of the issues on which there has been some judicial debate is the point of time when withholding tax obligation triggers for an Indian payer of income in relation to a Royalty/Technical Service fee ('Service fee') payment proposed to be made to an overseas entity.

So as to set a context to the issue which is discussed in this article, to start with, it may be relevant to make a quick note of the fact that Sections 5 and 9 of the Income-tax Act, 1961 ('IT Act') are provisions dealing with scope of incomes chargeable to tax in India in principle, whereas, Section 145 of the IT Act governs the timing of taxation of the incomes in India (i.e. based on the cash or mercantile system of accounting regularly followed). Section 195 of the IT Act deals with withholding tax obligations in relation to payments proposed to be made to non-residents which are chargeable to tax in India.

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IFRS Exposure draft: Sales proceeds during testing of fixed asset to be recognised as other income

The International Accounting Standards Board (IASB) has proposed narrow-scope amendments to International Accounting Standards (IAS) 16 Property, Plant and Equipment. IAS 16 provides principles for recognition and measurement (initial & subsequent) of items of Property, Plant and Equipment (PPE) as assets. The proposed amendments include modification to the definition of directly attributable costs as cited in the para 17 of IAS 16.

As per clause (e) of para 17, directly attributable costs include costs of functionality testing of assets after deducting the net sale proceeds from items produced while bringing the asset to the location & condition necessary for it to be capable of operating in the manner as intended by the management.

Now, IASB has proposed amendments to the above component of directly attributable cost. As per the amendment, the net sale proceeds from such items produced should not be deducted from the costs of functionality testing of assets. To establish principle for treatment of such sale proceeds, a new para 20A has been proposed to be added to IAS 16.

According to the proposed new para 20A, the proceeds from selling such items produced while bringing the asset to that location & condition and production costs of such items should be recognised to profit or loss as per respective IAS/IFRS (International Financial Reporting Standards).

The above amendments have been proposed to reduce diversity in application of para 17 of IAS 16. These amendments would be applied both prospectively and retrospectively. An entity shall apply these amendments retrospectively only to the items property, plant & equipment brought to use as intended by the management only in the year in which the entity first applies these amendments. The Exposure Draft of proposed amendments would be open for public comment until October 19, 2017.

Not Really a Seamless Credit Mechanism – The Story of ‘Blocked Credits’

A seamless credit flow is the bedrock of an efficacious GST mechanism whereby cascading effect of taxes is eliminated through a chain of tax credits allowed for set off against output tax liability at each stage. With the introduction of GST regime in India, expectations were high on seamless availability of Input Tax Credits ('ITCs) on various business expenses such as employee insurance, business travel, rent-a-cab etc., that are
currently 'blocked' under the 'existing law'. Strangely enough, expectations were belied as these ITCs continue to be 'blocked' under the imminent GST regime. In brief, the taxpayer cannot avail ITCs on following important categories of expenditure under the GST regime: 

1) Motor vehicles (except for a few taxpayers like transporters, vehicle dealers etc);

2) Food & beverages and outdoor catering etc;

3) Health treatment, membership of fitness club etc;

4) Taxi/cab service, Insurance (except when required by law); and

5) Works contract services;

A perusal of the above list reveals that the situation has remained unchanged or become stricter as regards 'blocked credits' under the GST Regime.

Final notification on Sec. 10(38) brings clarity

Under the existing provisions of the Section 10(38) of the Income-tax Act ('the Act') income arising from a transfer of long-term capital asset, being equity share of a company, is exempt from tax if the sale has been undertaken on or after 1st October, 2004 and is chargeable to Securities Transactions Tax (STT).

It has been noticed that such exemption is being misused by declaring unaccounted income as exempt long-term capital gains (LTCG) after entering into sham transactions. With a view to prevent this abuse, Section 10(38) has been amended to provide that exemption shall be available only if the acquisition of share is chargeable to STT. Further, powers have been given to the CBDT to notify transactions which would be eligible for capital gains exemption even if no STT was paid on purchase of such shares. The CBDT then issued the draft notification and brought out the negative list of transactions on which such exemption would not be available. Now the CBDT has issued the final notification considering the representations of various stakeholders for entitlement to the capital gain exemption in genuine cases.

The final notification is similar to the draft notification in terms of prescribing negative list of transaction. However, relaxation has been given in interest of exemption in genuine cases.

Following three type of transactions will not enjoy capital gain exemption under Section 10(38):

a) Acquisition of listed equity share through a preferential allotment in a company whose equity shares are not frequently traded in stock exchange.

b) Acquisition of listed equity shares not through a recognized stock exchange.

c) Acquisition of equity shares of a company during the period of its delisting.

Ind AS 110: In case of mergers of subsidiaries, book values is to be taken as per standalone books

Query

A company, say P Ltd. is a parent company of two companies, say Q Ltd. & R Ltd. Q Ltd. & R Ltd. are under common control of P Ltd. In case of common control business combination, the assets, liabilities and reserves of the transferor (acquired) company is recognised at their book values in the books of the transferee(acquiree) company in accordance with Appendix C of Ind AS 103, Business Combinations.

Now, CBDT has notified new Rule 10CB which prescribes computation of interest income pursuant to secondary adjustment. Rule 10CB also provides that repatriation of excess money shall be made on or before 90 days from the:-

(A) Whether the book values should be as per the books of the companies merged or as per the consolidated books of parent company in following situations:

1. Q Ltd. merges with R Ltd.

2. Q Ltd. merges with P Ltd.

(B) Further, whether P Ltd. shall require to eliminate the effect of business combination in above two situations in the consolidated financial statement?

Response

(A)

Situation 1 : Appendix C, Business Combinations of Entities under Common Control of Ind AS 103 provides that accounting of merger of common control companies should be done as per the pooling of interest method. Under this method, assets, liabilities and reserves of the transfer or should be recognised in the books of the transferee at their carrying amounts without any adjustments except harmonisation of accounting policies of both companies in accordance with para 9 of Appendix C.

Para 11 of Appendix C states that the balance of retained earnings of the transferor is aggregated with that of the transferee. Further, the name of reserves, like general reserve, revaluation reserve etc. of the transferor should remain same in the book of transferee also in accordance with para 12 of Appendix C. Any difference between purchase consideration and share capital of the transferor is recognised as capital reserve separately from other capital reserves.

Accordingly, the book values or carrying amounts of assets, liabilities and reserves should be combined on the basis of standalone books of Q Ltd. and R Ltd., i.e. the merged companies.

Situation 2 : P Ltd. is holding company of Q Ltd. So, merger of P Ltd. with Q Ltd. will not have any effect. The assets, liabilities and reserves which were appearing in the consolidated financial statement of P Ltd. will not be part of standalone financial statement of P Ltd. Therefore, it would be appropriate to take carrying amounts of assets, liabilities and reserves of Q Ltd. as appearing in the consolidated financial statement of P Ltd.

(B)

As per para B86 of Ind AS 110, Consolidated Financial Statements, in consolidation procedure intra group assets and liabilities, equity, income, expense and cash flows relating to transactions between group companies should be eliminated in full. So, in the present case in both situations, P Ltd. should eliminate all effects of mergers in its consolidated financial statement.

Reference

Issue 2 of Ind AS Transition Facilitation Group Clarification Bulletin 9