New Delhi: The Delhi Supreme Court has raised some key legal questions over a tax case between telecom equipment supplier ZTE Corp. and the income tax department, which could affect similar cases brought by the tax authorities against other Chinese companies as well.
The Supreme Court, which admitted late last year ZTE‘s appeal against the findings of the tax authorities and the order of an appellate body partially in favor of the company asked whether taxable income could be attributed to the permanent subsidiary of a Chinese company in India because of supplies from the foreign parent company. If so, she asked what the degree of attribution of the profit could be. The court also wanted to know whether a Chinese company was entitled to set off costs against payment to an Indian entity for marketing services.
In an earlier appeal in another tax assessment case filed by the company in 2017, the Supreme Court had asked whether the assessing income tax officer was justified in setting different profit attribution rates as opposed to those in the Indochinese double taxation agreement.
The questions of law formulated by the court are at the heart of the income tax assessment of the local entities of Chinese companies, including some of ZTE’s rival huawei as well as handset manufacturers Vivo and Xiaomi are controlled by Indian authorities. Some of these cases also involve transfer pricing and payment of royalties to their Chinese parents, in addition to how the income and profits were accounted for in India.
ZTE Corp had been challenging the Income Tax Department’s assessments for two fiscal years (2016-17 and 2017-18). After the Income Tax Appellate Tribunal (ITAT) only partially awarded the company’s challenge in June last year, it took it to the Supreme Court. The appeal submitted earlier in 2017 related to assessment years 2004-05 to 2009-10. The appeals have yet to come before the regular treatment.
According to the orders of ITAT and the case in Delhi High Court adjudicated by ET, ZTE Corp, during the assessment years 2016-17 and 2017-18, supplied telecommunications equipment – network equipment, terminal equipment and software – to Indian telecom operators. its subsidiary, ZTE Telecom India Pvt Ltdprovided installation, commissioning and testing services for the equipment supplied by the Chinese parent company.
The tax inspector sent notices to the company for both tax years based on a 2009 investigation conducted by the department at the Indian subsidiary’s offices in Gurgaon and Mumbai. According to the appraiser, various incriminating documents were found and inventoried during the investigation. Statements from senior executives were also recorded.
The documents led the reviewing officer to believe that the Chinese company, ZTE Corp, had a business connection in India and that the business was conducted through its permanent facility in India, according to the order passed by ITAT in June last year. The appraiser claimed tax on this basis.
With regard to the dispute of “attribution of profit”, the Chinese telecom company based on a 2016 ITAT ruling, in which the tribunal ruled that “almost all sales functions including marketing, banking and after-sales were performed by the permanent establishment in India”.
In the latter case, the company argued before the tribunal that “none of the activities identified (by the IT department) related to the permanent establishment (the Indian branch of ZTE) generate income and therefore no part of the revenues in terms of such activities in India should be taxed”.
It also argued that activities identified by the reviewer, such as negotiation, the place of signature of the contract, formal acceptance of the contract, or general oversight by the reviewer were irrelevant factors.
“When the principal activity of the assessee (ZTE China) is different, the incidental activities which are only intended to assist and support the principal activity are subject to the exclusion clause of DTAA (India-China) have a preparatory and supportive character,” argued ZTE’s counsel.
It argued that since the transactions between the valuer and its Indian subsidiary were already subject to transfer pricing, no further allocation was warranted. The company also objected to the allocation of 35% of its profits from software/technology services, calling it “far too high” and demanding that it be reduced to 20%.
ZTE argued that since the sale of software was inextricably linked to the hardware and assuming a permanent establishment of the valuer in India, such revenue from the sale of software could not be taxed as royalty.
The tribunal previously ruled that “the question of profit allocation depends on the facts in the particular case and is wholly dependent on the level of activity of the activities conducted in India”.