LOCATION SAVINGS

The objective of any corporate enterprise is to maximise profits. The options available are to either reduce costs or to generate additional revenue by capturing a higher market share. Aided by today’s globalized economic atmosphere, advances in telecommunications and science, at times Multi National Enterprises (“MNE”) pursue the route of cost reduction, as it results in higher profits despite a stagnant market share.

Many MNEs have set up their operations in low cost jurisdiction to reap the inherent benefits of acquiring the talent at lower costs. India and China are two of the economies well known for providing low cost benefits, as evident from their presence in the list of top outsourcing destinations in the world. It is no surprise that the tax authorities in such countries demonstrate a very aggressive and rigid approach towards the issue of location savings and have expressed an intention of bringing back the maximum of the benefits of location savings accruing from operating in these geographies to their respective economies.

Location Savings

In common parlance, location savings can be understood as savings in cost that accrue to an organisation on account of operating in a low-cost jurisdiction vis-a-vis a high cost jurisdiction. According to OECD guidelines, location savings are the net savings that accrue to the MNE on account of relocation of its business to a location where the costs are lower than what would have been incurred in the former jurisdiction.

The United Nations (UN) manual defines location savings as “the cost savings or benefits such as cheaper production or service costs resulting from locating a manufacturing or other operation in a low cost jurisdiction”. The UN guidelines also state that there may be certain location specific handicaps, which could lead to an increase in certain cost items for the MNE. If the operations are relocated to a low cost jurisdiction, such incremental costs have been termed as ‘dis-savings’. Examples of such dis-savings are – irregularity of power supply, poor quality of raw materials, training cost of labour etc. Hence in order to determine the “net” locations savings (in terms of reduced costs) which has accrued to the MNE, it is important to consider the location specific dis-savings as well.

Location Savings and Transfer Pricing

The interconnection between location savings and attraction of transfer pricing laws on it is the crux here. The transfer pricing issue around location savings is that whether a portion of benefit derived by an MNE on account of operating in a low cost jurisdiction vis-a-vis in another high cost jurisdiction, should be allocated to and consequently taxed in low cost jurisdiction. Indian Transfer Pricing authorities are of the opinion that MNEs continuously search for alternatives to lower their costs in order to increase their profits and India provides operational advantages to the MNEs such as reduced labour costs, raw material costs, infrastructure costs, tax incentives etc. Thus India should also get a share in such profits.

Location Specific Advantages and Location Rent

The concept of Location Savings cannot be analysed on a standalone basis. There is a need to consider Location Specific Advantages (‘LSA’) and Location Rent. To identify benefits of operating in one jurisdiction vis-a-vis another, Location Savings, Location Specific Advantages and Location Rent needs to be considered. These three concepts are interlinked and have a direct bearing on each other.

LSAs are specific characteristics of a particular location that make it possible for companies operating there to take advantages of those specific characteristics to earn higher profits. It may not necessarily lead to a reduction in cost, but still be advantageous to the operations of MNE. Examples of LSAs are specialized and skilled manpower, large customer base, proximity to growing markets, distribution channels etc.

It is not necessary that entire location savings get reflected in terms of incremental profits. In these competitive times, it is quite possible that a portion of the location savings would be passed on to the customers in the form of reduced prices and only a portion is retained with the MNE as incremental profit. This incremental profit is known as Location Rent.

Apportionment of Location Savings

Where significant location savings are derived, the question arises whether it should be shared among the parties and in particular whether part of the location savings should be allocated to the entity in the low cost jurisdiction, i.e. whether an entity operating in a low cost jurisdiction should receive additional compensation on account of location savings. Secondly, the issue is in what manner the benefit derived by operating in a low-cost jurisdiction should be computed and then allocated to the associate enterprise. Under arm’s length pricing, allocation of location savings between associated enterprises should be made by reference to what independent parties would have agreed in comparable circumstances.

The general principle stated across guidelines is to apportion the benefit amongst parties on the basis of functions performed, risks assumed and assets employed (“FAR”) by each of the enterprises.

Legal Jurisprudence

Li and Fung’s Case

In Li and Fung’s case, the taxpayer was engaged in providing sourcing services to clients worldwide, including its AE in Hong Kong and was remunerated on a cost-plus mark-up of 5 percent by its AE. On the allegation that the taxpayer was performing all critical functions, was assuming significant risk and had created valuable intangibles over a period of time, the TPO rejected FAR profile submitted by the taxpayer. Considering that the AE was being remunerated on a commission-on-FOB value basis, the TPO proceeded to compute the transfer pricing addition by considering a 5 percent commission on FOB value of goods sourced by the taxpayer for its AE. TPO alleged that taxpayer should be entitled to the location savings enjoyed by AE due to the taxpayer.

Ruling against the taxpayer, the Appellate Tribunal concluded that the taxpayer was not a low-risk service provider, it performed critical functions, had incurred time and expense in creating valuable intangibles which were beneficial to the group. It was further noted that the AE did not perform any critical functions. The Appellate Tribunal noted that the taxpayer’s conduct and operations in India did create Location Savings for the AE, the benefit of which the taxpayer is entitled to. Given the facts, the Appellate Tribunal ruled that the commission received by the AE (5 percent of FOB value of goods sourced) was to be shared in the ratio of 80:20 to India. Although the case discusses Location Savings, it has not provided a definitive ruling on the aspect. The core issue was the FAR profile and remuneration model.

Conclusion

The issue of location savings is in a very nascent stage in India and would be a bone of stress for the MNE groups operating in India. The tax authorities have clearly stated their rigid views and are sure to approach this issue in a much stricter manner. Location savings and its apportionment will be unique in every case and it seems difficult that industry specific methodology can be formulated for it. It can be said that in coming times location savings would be an interesting issue to track, especially the statements of Indian Tax Authorities in this regard.

Advertisements

RBI grants Bank Licenses to IDFC & Bandhan Financial Services

RBI grants Bank Licenses

IDFC & Bandhan Financial Services get “in-principle” approval

After much speculation, today, RBI gives in principle banking licences to IDFC & Bandhan Financial Services to start banking within 18 months. Both IDFC and Bandhan had been recommended by the High Level Advisory Committee (HLAC) set up by RBI.

After withdrawal of 2 applications, 25 applications were considered by HLAC. India Post’s application to become a bank is also under consideration and discussions are on with the Government of India for the same.

RBI Governor Raghuram Rajan said “The process to award new bank licences was initiated in 2011 and it has spilled over to the election season because the due diligence process took a little longer, all regulatory processes have to come to an end.”

Click here for RBI Press Release.

Urgent Update: Letterhead Format for Companies

Letterhead & other Business Stationary Format

Mandatory Details –

  • CIN Number
  • Registered Office Address
  • Telephone Number & Fax Number (if any)
  • Email & Website address (if any)

Section 12(3)(c) of Companies Act, 2013, which will be effective from 01.04.2014, provides that every company shall get its name, address of its registered office and the corporate Identity Number along with telephone number, fax number, if any, e mail and website addresses, if any printed in all its business letters, bill heads, letter papers and in all its notices and other official publications.

Please Ensure Compliance of the same with immediate effect. KDA team will soon share a complete dossier on the Companies Act, 2013.

Corporate law highlight on Corporate Social Responsibility

Corporate Social Responsibility (CSR) becomes mandatory with effective from April 1, 2014

Corporate Social Responsibility

On 27th February, 2014, The Ministry of Corporate Affairs of India (MCA) has notified and made applicable the provisions of Section 135 (Corporate Social Responsibility) of the Companies Act, 2013, Schedule VII of the said Act and the Rules thereon effective from 1st April, 2014.

As per Section 135 of the Companies Act, 2013, every company having net worth of rupees five hundred crore or more, or turnover of rupees one thousand crore or more or a net profit of rupees five crore or more during any financial year shall constitute a Corporate Social Responsibility Committee of the Board consisting of three or more directors, out of which at least one director shall be an independent director. The Board of every company to whom section 135 applies, shall ensure that the company spends, in every financial year, at least two per cent of the average net profits of the company made during the three immediately preceding financial years, in pursuance of its Corporate Social Responsibility Policy.

Highlights of notified CSR rules:

  • CSR activities to include preventive healthcare, sanitation, providing safe drinking water, protection of national heritage, rural development projects and measures to benefit armed forces veterans. Promoting rural sports, nationally recognized sports, setting up homes and hostels for women, orphans and senior citizens and measures to reduce inequalities faced by socially and economically backward groups and support to technology incubators in academic institutions have also been included in the CSR ambit.
  • Net profit will not include dividend income received from another Indian company which is covered under and complying with the provisions of Section 135 of the Companies Act, 2013 or from profits of its own overseas branches.
  • In the case of unlisted public companies and private limited companies covered under Section 135(1) of the Act and which are not required to appoint an independent director pursuant to sub-section 149 (4) of the Act, shall have its CSR committee without such director. Also, if the private limited company has only two directors, shall constitute its CSR committee with two such directors.
  • The CSR activities need to be undertaken as per approval of the company’s board in accordance with its CSR policy and the decision of its CSR committee.
  • A company can also carry out CSR works through a registered trust or society or a separate company.
  • The CSR spending will have to be undertaken in India and should not benefit any employees of the company.
  • Contribution of any amount directly or indirectly to any political party, shall not be considered as CSR activity.
  • The Board’s annual report of a company shall include report on CSR and the company shall be required to display CSR activities on its website.

Source: Notification dated February 27, 2014 issued by MCA.

Monthly Update – December 2013

Taxation

Direct Tax

Notification: 96 Date of Issue: 23/12/2013

Employee Certificate, Bank Certificate, Aadhaar Card for PAN / TAN , Revised Form 49A, 49AA.
http://law.incometaxindia.gov.in/DIT/File_opener.aspx?page=NOTF&schT=&csId=b8a24ea2-8b56-48fe-bae8-7a05ff1a7dbf&NtN=&yr=ALL&sec=&sch=&title=Taxmann%20-%20Direct%20Tax%20Laws
 

Important Case Laws

IT/ILT

In view of CBDT’s Circular No. 715, dated 08-08-1995, services rendered by NR for production of programmes for purpose of broadcasting and telecasting shall be specifically characterized as ‘work’ for the purpose of section 194C – When such services are categorized as ‘work’ for Sec. 194C the income therefrom would be treated as ‘business income’ – Held, Yes – Therefore, payment to a non-resident for production of programmes for the purpose of broadcasting and telecasting shall not be treated as ‘Fees for Technical Service’ – Held, Yes

Platinum Asset Management Ltd. v/s Deputy Director of Income-tax (International Taxation), Range -4(2)
Unabsorbed depreciation and business loss of same 10A/10B unit brought forward from earlier years have to be set off against the profits before computing exempt profit.
Loss incurred from transaction in derivative by assessee, being sub-account FII, could not be treated as business loss rather it was to be considered as short-term capital loss which was eligible for adjustment against short-term capital gain arising from sale of shares.Karnataka High court v/s Dynamic Enterprise.
Money Paid to retiring partners on retirement is not taxable in Firm’s Hands.Service Tax

Service provided by One Unit to another Unit is not taxable.

SEZ unit and DTA unit of a company are not separate legal entities in general law (even though invoices have been issued and agreements have been entered) or under the definition of ‘person’ under section 2(v) of the SEZ Act read with Rule 19(7) of the SEZ Rules, and hence services provided by SEZ unit to DTA unit is not liable for service tax. [L&T Ltd. vs. CCE, Vadodara-II, 2013(32) STR 113].

Cargo Handling Service

The activity of moving coal from various quarries to the railway siding (within the mining area) using payloaders would not be liable for service tax under the category of “Cargo Handling Service” since for classifying an activity as Cargo Handling Service it must be proved that it is a service adjunct to the actual transportation of goods i.e. services just before transportation of goods or post transportation services when cargo has been discharged The movement of goods within a mine from one place to another is not such a service. [Anupama Coal Carriers Pvt. Ltd. vs. CCE 2013(32) STR 41 (Tri-Del)].

 

Regulatory Updates

SEBI

 

Financial Conglomerates under Regulatory Oversight

SEBI has identified certain business groups as ‘Financial Conglomerates’ and they will be monitored by SEBI for systemic risks they may pose to Indian economy.”Going by the size of our economy and our markets, there are institutions that are quite big. We need to keep an eye on them and, through our coordination mechanism, certain institutions have been identified and they are being monitored regularly,” capital markets regulator SEBI Chairman U K Sinha said.The practice is similar to monitoring of ‘too-big-to-fail’ banks by regulators in USA.

IPO Grading now voluntary

The SEBI’s board approved the proposal to make the IPO grading system voluntary as against the current provision of being mandatory. The move is part of the regulator’s effort to boost the dormant primary market and reduce the reliance on rating agencies, who have been under scanner globally for their role in overall financial sector.

Self-Prospectus allowed for Corporate Bond Issues

The SEBI’s board has allowed shelf‐prospectus for corporate bond issues. A shelf‐prospectus enables companies to issue corporate bonds utilizing the same documents more than once, which will help cut costs and save time.

The SEBI has extended the facility to file shelf prospectus for issuing non‐convertible debt securities for non‐banking finance companies, including infrastructure debt funds (IDFCs), besides public sector financial institutions, public sector banks and scheduled banks.

Further, companies filing a shelf prospectus with the Registrar of Companies are not required to file prospectus afresh at every stage of offer of securities, within the period of validity of such shelf prospectus i.e. one year. They are required to file only an information memorandum, containing material updations, with respect to subsequent issues.

Monthly Update – November 2013

Taxation

Direct Tax

Notification: 92 Date of Issue: 29/11/2013

Central Board of Direct Taxes hereby notifies Multi Commodity Exchange of India Limited, Mumbai as a recognised association for the purposes of clause (e) of the proviso to clause (5) of the section 43 of Income Act, 1961, with effect from the date of publication of this notification in the Official Gazette.
http://law.incometaxindia.gov.in/DIT/File_opener.aspx?page=NOTF&schT=&csId=e147012a-1c73-4d46-b51b-d69ba9115812&NtN=&yr=ALL&sec=&sch=&title=Taxmann%20-%20Direct%20Tax%20Laws
 

Notification: 91 Date of Issue: 27/11/2013

In exercise of the powers conferred  by clause (iii) of the Explanation 2 of clause (e) of the proviso to clause (5) of section 43 of the Income-tax Act, 1961 (43 of 1961) read with sub-rule (4) of rule 6DDD of the Income-tax Rules, 1962, the Central Government hereby notifies the Universal Commodity Exchange Limited, Mumbai as a recognised association for the purposes of clause (e) of the proviso to clause (5) of the said section, with effect from the date of publication of this notification in the Official Gazette

Notification: 90 Date of Issue: 27/11/2013

In exercise of the powers conferred by clause (iii) of the Explanation 2 of clause (e) of the proviso to clause (5) of section 43 of the Income-tax Act, 1961 (43 of 1961) read with sub-rule (4) of rule 6DDD of the Income-tax Rules, 1962, the Central Government hereby notifies the National Commodity and Derivatives Exchange Limited, Mumbai as a recognised association for the purposes of clause (e) of the proviso to clause (5) of the said section, with effect from the date of publication of this notification in the Official Gazette.

http://www.taxmann.com/topstories/104010000000040566/cbdt-amends-i-t-rules-for-furnishing-of-info-of-sum-paid-to-nrs-revised-forms-15ca-and-15cb-notified.aspx
 

Section 90 of the Income-tax Act, 1961

DoubleTaxation agreement – agreement for Avoidance of double taxation and prevention of fiscal evasion with foreign countries – Latvia

http://www.wirc-icai.org/law-update-detail.aspx?id=906

Important Case Laws

CIT vs. DLF Commercial Developers Ltd. (2013) 261 CTR (Del.) 127.

Definition of speculative transaction in section  43(5) is confined in its application and cannot be extended to section 73; derivatives are based on stocks and shares, which fall squarely within the Explanation to section 73 and therefore Tribunal erred in law in holding that the assessee was entitled to carry forward  its losses on account of derivatives transactions.

Himatasingike Seide Ltd vs. CIT (Supreme Court).
Unabsorbed depreciation and business loss of same 10A/10B unit brought forward from earlier years have to be set off against the profits before computing exempt profit.CIT vs. Vijay M. Mahtaney (2013) 261 CTR (Mad.) 635
For taking benefit u/s 54EC it is not necessary that assessee should first apply s. 70(3) and thereafter only, he could invest the capital gain arising from the long term capital asset into any specified bond as specified u/s 54EC.CIT vs. Petroleum India International (2013) 260 CTR (Bom.) 418.
In view of finding of fact arrived by the Tribunal that the seconded personnel were not the employees of the assessee, the amount paid as foreign allowances to the seconded personnel was not liable for deduction of tax, hence the occasion to apply s. 40(a)(iii) did not arise. The object of Section 91 (1) of the Act is to give relief from taxation in India to the extent that the taxes have been paid abroad for the relevant tax year This deduction/relief is not dependent upon the payment also being made in the tax year.Service Tax

Service Tax liable to be Reimbursed from the Service Receiver in case of no Terms of Payment of Service Tax is mentioned in the Agreement.

Service tax is imposed upon the person to whom service is being provided and the same service provider is merely a collecting agency. Thus, where the agreement did not contain terms for payment of service tax by the service recipient and the service provider was made to pay service tax by the department, the High Court held that service provider was eligible to be reimbursed by the service recipient. [Bhagwati Security Services (Regd.) vs. UOI, (2013) 31 STR 537 (All.)]

Construction of complex service

On facts, where under a development agreement with a society, the assessee was ‘entitled’ to construct a residential building on the society’s land using its own finances and thereafter sell the units in the constructed building to the members of the society by executing a sale deed after receiving all payments and completion of construction, the High Court held that the developer was not a contractor who was executing the construction work on behalf of the society but was selling flats and the construction of residential complex till the execution of such sale deed, would be in the nature of “self-service” and consequently would not attract service tax. [CST vs. Sujal Developers, (2013) 31 STR 523 (Guj.)]

 

Regulatory Updates

Companies Act

Removal of Difficulties order & Clarification regarding applicability of Section 372A

The Companies Act 2013 received an assent of President on 29.08.2013 and also 96 Sections are made effective from 12.09.2013 , there are certain difficulties to understand the New Sections and its implications hence a Companies (Removal of Difficulties) Order, 2013 has been issued. The Circular No.18/2013 is issued for clarification regarding applicability of Section 372A consequent upon Notifying of Section 185 of The Companies Act, 2013.

 

Foreign Exchange Management Act

 

Definition of ‘Group Company’ for FDI :

RBI vide circular RBI/2013-14/356 A.P. (DIR Series) Circular No.68 has reviewed the FDI policy and decided to incorporate the definition of group company as under:
‘Group company’ means two or more enterprises which, directly or indirectly, are in position to:
(i) exercise twenty-six per cent, or more of voting rights in other enterprise; or
(ii) appoint more than fifty per cent, of members of board of directors in the other enterprise.’

Foreign Direct Investment in Financial Sector – Transfer of Shares

It has now been decided that the requirement of obtaining NoC(s) will be waived from the perspective of Foreign Exchange Management Act, 1999 and no such NoC(s) need to be filed along with form FC-TRS in regards to the subject as required earlier. However, any ‘fit and proper/ due diligence’ requirement as regards the non-resident investor as stipulated by the respective financial sector regulator shall have to be complied with.

Third party payments for export / import transactions :

With a view to further liberalising the procedure relating to payments for exports/imports and taking into account evolving international trade practices, it has been decided as under:
i. EXPORT TRANSACTIONS
AD banks may allow payments for export of goods / software to be received from a third party (a party other than the buyer) subject to conditions as under:

  1. Firm irrevocable order backed by a tripartite agreement should be in place;
  2. Third party payment should come from a Financial Action Task Force (FATF) compliant country and through the banking channel only;
  3. The exporter should declare the third party remittance in the Export Declaration Form;
  4. It would be responsibility of the Exporter to realize and repatriate the export proceeds from such third party named in the EDF;
  5. Reporting of outstandings, if any, in the XOS would continue to be shown against the name of the exporter. However, instead of the name of the overseas buyer from where the proceeds have to be realised, the name of the declared third party should appear in the XOS; and
  6. In case of shipments being made to a country in Group II of Restricted Cover Countries, (e.g. Sudan, Somalia, etc.), payments for the same may be received from an Open Cover Country.

Note: Restricted cover Group II country is country which experiences chronic political and economic problems as well as balance of payment difficulties.
ii. IMPORT TRANSACTIONS
AD banks are allowed to make payments to a third party for import of goods, subject to conditions as under:

  1. Firm irrevocable purchase order / tripartite agreement should be in place;
  2. Third party payment should be made to a Financial Action Task Force (FATF) compliant country and through the banking channel only;
  3. The Invoice should contain a narration that the related payment has to be made to the (named) third party;
  4. Bill of Entry should mention the name of the shipper as also the narration that the related payment has to be made to the (named) third party;
  5. Importer should comply with the related extant instructions relating to imports including those on advance payment being made for import of goods; and
  6. The amount of an import transaction eligible for third party payment should not exceed USD 100,000. This limit will be revised as and when considered expedient.

The aforesaid instructions shall come to effect immediately.

Participation of NBFCs in Insurance sector

In the operation of Insurance Company, very often, the IRDA requires an insurance company to expand its capital taking into account the stipulations of the Insurance Act and the solvency requirements of the insurance company. The restriction of a group limit of the NBFC to 50% of the equity of the insurance JV company prescribed in the above mentioned circular may act as a constraint for the insurance company in meeting the requirement of IRDA. It has hence been decided that in cases where IRDA issues calls for capital infusion into the Insurance JV  company, the Bank may, on a case to  case basis, consider need based relaxation of the 50% group limit. The relaxation, if permitted, will be subject to compliance by the NBFC with all regulatory conditions as specified in the earlier circulars.