Friday, February 28, 2014

Shadow Banking systems woes in China.

Looks like everyone's out to prove that China is going to be the next big tremor to rock the boat that is the world economy. And the origin point of choice for nearly all of them is the country's shadow banking system. Take this latest article on Bloomberg for example. It talks about how a credit risk measuring metric is hitting new highs perhaps indicating that credit risk and leverage have reached levels in China that are not sustainable. And the worst part is that the shadow banking system is out of reach of the conventional central bank policies as most of it is underground. So even if the Chinese central bank were to take some measures to curb the risk, there's no guarantee that the risk will go away. Besides, the measures that have so far been taken are very tiny compared to the size of the economy. Consequently, there's a great deal of uncertainty out there. One way to deal with this is to closely monitor which way US treasuries head. If they go higher, then there's flight to quality for sure; which in turn would mean further worsening of the Chinese situation.

Budget deficit falls at sharpest pace since WWII.

The budget deficit dropped to the lowest level since 2008 last year, falling to $680B from $1.1T in 2012. The rate of the drop was the sharpest since the end of World War II. The fall was due to an increase in federal tax revenues amid economic growth and tax hikes, and to a fall in spending. A slowdown in health costs also helped.

Eurozone inflation remains in Draghi's "danger zone."

Eurozone inflation has held steady at 0.8% on year in February, but remains below what European Central Bank President Mario Draghi has called a "danger zone" of below 1%. Draghi yesterday warned of inflation getting stuck in that zone, although he repeated his assertion that there is no deflation. Meanwhile, eurozone unemployment held steady at 12% in January, as expected.

Japanese economic activity bumps up ahead of sales-tax hike.

Japanese industrial production grew at the fastest pace since June 2011 in January, jumping 4% on month after a drop of 0.9% in December. Retail sales leapt 4.4% vs +2.5%. The strong figures are not a total surprise, as a bump in economic activity has been expected ahead of a rise in sales tax in April, which is forecast to then drag on the economy. Core inflation held steady at 1.3% on year in January, while the unemployment rate was unchanged at 3.7%.

Thursday, February 27, 2014

Unlike good old days the corporate borrowers today would find it difficult to dodge bad loans. For RBI now has raised the red flags. And gone stringent with respect to ensuring swift repayment of such loans! The governor has tightened the rules to fight against bad loans. The promoters of the company would now be made more accountable towards the debt. They would be asked to suffer the first loss instead of the banks that extended the loan. Moreover, the promoters would have to bring in more equity into the company in the event of restructuring of the asset. The lenders can also take action against the troubled companies producing clean balance sheets. Also decisions with respect to projects to be referred to the CDR (corporate debt restructuring) cell would be expedited faster. In cases of viable businesses, banks would take an extra mile in financing such entities but with prudence. For once even auditors who audit such bad loans will not be spared too. Such
provisions would apply for loans exceeding Rs 1 bn.

Well, this does not come as a surprise. That's because the stressed assets (non-performing plus restructured assets) number has surpassed 10% of total advances. Lurking bad assets has taken few banks down in the dumps. While corporates have partied hard, now it's time they bear the brunt too.

BofA ups estimate of possible legal liabilities to $6.1B.

Bank of America (BAC) has added $1B to its estimate of its potential litigation liabilities, bringing the total to $6.1B vs a year-ago estimate of $3.1B. BofA also said that the U.S. Attorney's Office is investigating the bank's compliance with the Federal Housing Administration's direct endorsement program. Meanwhile, authorities in North America, Europe and Asia are probing BofA's conduct and practices in forex markets.

Tuesday, February 25, 2014

China's iron and steel industry is looking down the abyss. Plagued by over-capacity and high competition, profits have plunged. And this situation is not likely to change anytime soon. Steel companies in China enjoy huge subsidies from local governments, whose main focus is to meet job and growth targets. Encouraged by easy financing and cheap energy supplies, the country has steadily built more steel mills than needed. Currently, the world's second-largest economy has about 300 m metric tons of excess steel capacity, equivalent to nearly twice the steel output of the whole European Union last year. According to China Iron & Steel Association (CISA), overcapacity in the sector is unlikely to reduce anytime soon and that the sector was facing an extremely complicated situation as a result of slowing growth, structural adjustments in the economy and policies to close old capacity.

S. 10A/ 10B: Interest income out of surplus funds in Banks and sister concerns & EEFC account is eligible for exemption.

CIT vs. Motorola India Electronics (P) Ltd (Karnataka High Court)

Though s. 10(B) speaks about deduction of such profits and gains as derived from 100% EOU from the export of articles or things or computer software, sub-section (4) explains what is the profit derived from export of articles as mentioned in Subsection (1). Therefore, profits and gains derived from export of articles is different from the income derived from the profits of the business of the undertaking. The profits of the business of the undertaking includes the profits and gains from export of the articles as well as all other incidental incomes derived from the business of the undertaking. It is clear that what is exempted is not merely the profits and gains from the export of articles but also the income from the business of the undertaking.

Monday, February 24, 2014

German corporate optimism increases again.

The German Ifo institute's business climate index has increased to its highest level in 2 1/2 years, rising to 111.3 in February from 110.6 in January and topping consensus that was also 110.6. The current-situation reading rose and exceeded forecasts, although the expectations print slipped. "The German economy is holding its own in a changeable global climate," says Ifo.

Eurozone consumer prices tumble.

Eurozone CPI dropped a record 1.1% on month in January after rising 0.3% in December, with the fall much sharper than the 0.4% decline that was expected. The index was dragged down by a tumble in the cost of non-energy industrial goods. On year, inflation was +0.8%, as in December. The sharp monthly fall in CPI comes amid concerns about deflation in the eurozone, although the ECB has so far been sanguine.

Deutsche Bank to cut U.S. balance sheet by up to 25%.

Deutsche Bank (DB) intends to slash its U.S. balance sheet to $300B from $400B in order to meet tough new capital and leverage requirements from the Federal Reserve. The figure doesn't include $200B that Deutsche holds at its U.S. branch and doesn't fall under the new rules. The German bank will implement the changes mainly by reassigning some operations that are located outside the U.S. to other parts of the business.

Sunday, February 23, 2014

The biggest threat for India at the moment is ....?

We have a question for you. What, according to you, is the biggest threat to the economic stability of India? Is it high inflation? Or is it budgetary and current account deficits? Here is something shocking. If the International Monetary Fund's latest annual assessment (as reported by Mint) of the Indian economy is to be believed, the biggest threat for India is excessive corporate leverage. In other words, the balance sheets of Indian companies and banks are sitting on a huge debt pile. Indian companies are in the worst financial health in almost a decade. In fact, the IMF goes on to point out that Indian companies are way more leveraged than other emerging markets. Indian companies rely on foreign funding for about 20% of their debt finance. It must be noted that the debt risks are concentrated in certain sectors such as construction and infrastructure. As such, investors must exercise prudence while investing in these sectors. The same would hold true for investor s looking to invest in the recently beaten down banking sector stocks given that they have a significant exposure to such sectors that are dong through tough phases at the moment.

Transfer Pricing: Unaudited segmental accounts can be relied upon for comparing profitability of controlled transactions with uncontrolled transactions. While size is relevant in entity level comparison, it is not relevant in transaction level comparison within the same entity

Lummus Technology Heat Transfer BV vs. DCIT (ITAT Delhi)

(i) In applying the Transactional Net Margin Method (TNMM) under Rule 10B(1)(e) it is not necessary that the net profit computations, in the case of internal comparables (i.e. assessee’s transactions with independent enterprise), have to be based on the audited books of accounts or the books of accounts regularly maintained by the assessee. All that is necessary for the purpose of computing arm’s length price, under TNMM on the basis of internal comparables, is computation of net profit margin, subject to comparability adjustments affecting net profit margin of uncontrolled transactions, on the same parameters for the transactions with AEs as well as Non AEs, i.e. independent enterprises, and as long as the net profits earned from the controlled transactions are the same or higher than the net profits earned on uncontrolled transactions, no ALP adjustments are warranted. It is not at all necessary that such a computation should be based on segmental accounts in the books of accounts regularly maintained by the assessee and subjected to audit.

Thursday, February 20, 2014

FOMC minutes: chance of rate hikes "relatively soon."

In the last FOMC meeting chaired by Ben Bernanke, a few policy makers saw a chance of rate hikes "relatively soon." As for forward guidance in which the Fed promised to hold Fed Funds near 0% after the 6.5% unemployment rate threshold was crossed - that's pretty much done with. The minutes also show little concern about the string of soft economic data at the start the year.

Japanese trade deficit soars to record, shares slump.

Japan's trade deficit more than doubled to a record ¥2.79T ($27.3B) in January from ¥1.3T in December and exceeded consensus of ¥2.49T. Export growth slowed while imports soared 25%. In Q4, a large trade deficit contributed to GDP expanding at a lower-than-expected 1%. However, the latest figures may have been affected by a rush to purchase foreign-made goods before a sales-tax increase in April and by the Chinese New Year.

Eurozone business activity softens.

Eurozone flash manufacturing PMI has slipped to 53 in February from 54 in January and undershot forecasts that were also 54. German growth slowed and France's contraction accelerated. The eurozone's services print has edged up, but the composite output has fallen to 52.7 from 52.9. "A dip in the eurozone PMI provides a reminder that the region's recovery continues to be uneven and fragile, but it's too early to read too much into one month's data."

Chinese factory activity contracts at faster pace.

China's flash manufacturing PMI has tumbled to a seven-month low of 48.3 in February from 49.5 in January and missed consensus of 49.4. The sub-indexes for output, new orders, new export orders and employment contracted. The fall in overall PMI adds to other data that provides a mixed picture for China's economy, although the latest figures may have been hampered by the Chinese New Year.

Facebook to buy WhatsApp for up to $19B.

The sound of jaws collectively crashing onto the floors of trading rooms was heard across Wall Street yesterday - and probably far beyond - after Facebook (FB) said it has agreed to acquire WhatsApp for $19B in cash and shares. Although the mobile-messaging application has 450M monthly active users, the valuation is higher than that of 235 S&P 500 components. Still, as with Instagram, one theory seems to be that Facebook has paid heavily to head off what it sees as a potential major threat. Shares were -2.4% premarket.
India's infrastructure story has become a laughing stock for global investors. Despite featuring prominently in successive 5-year plans, the sector never really took off despite billions being ear marked. Riddled in policy bottlenecks, poor execution, cost overruns, inadequate funding and corruption, the sector has become a dark spot in India's economic history. Even the large banks in the country that were so long riding on India's infra growth have given up on the sector's future. So much so that projects have halted midway for want of funds. But it seems all is not lost! And a ray of hope seems to be coming from the most unexpected quarters.

China, which has become the benchmark for infrastructure development globally, seems to be keen on replicating its success in India. In the past too the neighbouring country has shown interest in infrastructure financing. However, the attempts have been rebuffed by a government due to security issues in sectors such as telecom and power. But that has not discouraged the Chinese from making a concerted bid. It is has once again offered to fund 30% of India infra outlay for the 12th 5 year plan. One that envisages involvement in upgrading India's decrepit rail, road and power infrastructure besides telecom. So far Japan has been the only major economy offering funds for ambitious infra projects in India. However, China's interest in India infra funding pie is not difficult to understand. The dragon economy has US$ 3.8 trillion in its kitty. And with US Treasuries no long looking appealing, the economy is on the lookout for attractive investment opportunities.

Since India is in desperate need for long term external funds to realize the infra dreams, a helping hand from China could be a boon in disguise. That apart, China could also offer some technological and operational inputs. Whether the two neighbours can make it a win-win situation remains to be seen.

India eases market share rules for telecom deals.

India will allow mergers between telecommunications carriers with up to 50 percent combined market share, easing rules to spur deals in the crowded telecommunications sector.
 
The government, however, retained a plan to levy a fee on carriers if the merger involved low-priced government allocated airwaves, making deals costlier, in long-awaited mergers and acquisition guidelines released on Thursday.
 
Currently companies are allowed to merge if their combined market share does not exceed 40 percent in any of the country's 22 telecommunications service areas. The market share includes their share of the customers as well as the revenue generated in a service area.
 
 

Wednesday, February 19, 2014

U.K. unemployment rate unexpectedly edges up.

U.K. unemployment for the three months to December rose to 7.2% from 7.1% previously and topped estimates that were 7.1% also. However, the number of those out of work dropped by 125,000 to 2.34M. Meanwhile, the Bank of England's Monetary Policy Committee voted unanimously - as expected - to keep interest rates at 0.5% and against more quantitative easing at a meeting earlier this month. The pound slid after the release of the data and BOE minutes, and was -0.1% at $1.6671 at the time of writing.
The debacle of United Bank of India is just the tip of the iceberg. As Equity Master  estimates, the bad loans and restructured loans put together may lead to a total write-off of Rs 3.5 to 4 trillion for the Indian banking sector! And what is the FM's response to it? Well, in the interim budget yesterday, FM promised recapitalization of PSU banks to the tune of Rs 112 bn. Needless to say that the incremental capital will just be fraction of the total NPA burden in banks' books. And without any stringent measures to arrest further slippage in asset quality, India is staring at a full blown banking crisis. One that could not just erode shareholder wealth but also endanger depositor money. But FM Chidambaram seems oblivious to these consequences. That India's largest bank had to be bailed out by the LIC for its QIP offer should have been indicative enough of investor sentiments. The RBI has already sounded warnings about the health of the sector. However, without government support to bring the PSU banks in order, 70% of India's financial sector is at the realm of crisis.

PBOC drains $7.9B from financial system.

The People's Bank of China has drained $7.9B from the country's financial system by selling 48B yuan in repurchase contracts, the first such transaction since June. The PBOC made the tightening move after weekend data showed that aggregate financing soared to a record 2.58T yuan ($425B) in January from 1.23T yuan in December despite the bank's attempts to rein in lending.

Sunday, February 16, 2014

Indian WPI eases, adding to slowing CPI.

India's wholesale-price index slowed to +5.05% on year in January from +6.2% in December. The data adds to a reading which showed that CPI eased to +8.8% last month from +9.9% in December. The falling inflation comes as the Reserve Bank of India focuses on reducing consumer prices, with the RBI hiking interest rates three times since September.

Eurozone recovery firms up.

A veritable feast of eurozone GDP data has shown that the bloc's nascent recovery strengthened a bit in Q4. The eurozone's growth accelerated to 0.3% on quarter from 0.1% in Q3 and topped forecasts of +0.2%, while German GDP increased to +0.4% from +0.3%. Even in France, where data has been variable lately, the economy recovered from a fall of 0.1% in Q3 to expand 0.3% last quarter. The GDP figures have helped boost European stocks.

Thursday, February 13, 2014

German CPI in deflation territory.

As expected, German CPI fell 0.6% on month in January following an increase of 0.4% in December. The drop in prices comes amid increasing concern that the eurozone faces the threat of deflation, although European Central Bank chief Mario Draghi has so far been sanguine about the prospect. Still, Barclays says the risks "are significant," far greater than markets or policy makers have acknowledged.

Wednesday, February 12, 2014

BOE raises growth forecasts, changes forward guidance.

The Bank of England has increased its outlook for the U.K. economy, predicting that 2014 GDP will grow 3.4% vs a previous forecast of 2.8%. However, Governor Mark Carney indicated that the recovery is neither balanced nor sustainable, and with spare capacity high and inflation benign, the degree of stimulus will need to remain "exceptional" for some time. The BOE had said it would keep interest rates low until unemployment falls to at least 7%.

Global stocks lifted by Yellen, the House and Chinese exports.

Janet Yellen has pledged to retain the Fed's super easy money policies, a GOP-led House has agreed to suspend the U.S. debt ceiling by a whole year with barely a whimper, and China's exports blew past expectations - the sun is shining, the sky is blue and equities the world over were green at the time of writing.

Tuesday, February 11, 2014

Japan's current-account gap hits record.

Japan's current-account deficit widened to a record ¥638.6B ($6.2B) in December from ¥592.8B in November, partly due to surging imports - particularly of energy - and the weak yen. Consensus was for ¥685.4B. The fear is that the deficit will become permanent and hurt investor confidence in Japan - which would be rather dangerous given the country's massive debt.

BOF: France returned to growth in Q4; however, recovery weak.

The Bank of France has estimated that the country's GDP rose 0.2% in Q4 after a fall of 0.1% in Q3. However, industrial output contracted 0.3% on month in December after rising 1.2% in November and missed consensus that production would show no change.

PBOC to tolerate "reasonable interest-rate volatility."

The People's Bank of China is prepared to tolerate "reasonable" volatility in money-market interest rates as it attempts to rein in soaring debt in the country. While the PBOC will ensure "appropriate liquidity," it won't fund growth that is dependent on investment and debt. The PBOC's remarks come after repurchase rates spiked to high levels at various points over the past several months, causing ructions in stock markets.

S. 41(1): Unclaimed liabilities (of earlier years), which are shown as payable in the accounts, are not taxable as income even if creditors untraceable & liabilities are non-genuine

CIT vs. Bhogilal Ramjibhai Atara (Gujarat High Court)

In AY 2007-08 the assessee showed an amount of Rs. 37.52 lakhs as being due to various creditors. The AO issued summons to the creditors. Some of the creditors were not found at the given address and some stated that they had no concern with the assessee. The AO took the view that there was a “cessation” of the liabilities and assessed the said liabilities to tax u/s 41(1). The CIT(A) confirmed the addition though the Tribunal deleted it on the basis that as the liabilities had not been written back in the accounts, s. 41(1) did not apply. On appeal by the department to the High Court HELD dismissing the appeal:
 
S. 41(1) would apply in a case where there has been remission or cessation of liability during the year under consideration. In the present case, there was nothing on record to suggest there was remission or cessation of liability in the AY 2007-08. It is undoubtedly a curious case. Even the liability itself seems under serious doubt. The AO undertook the exercise to verify the records of the so-called creditors. Many of them were not found at all in the given address. Some of them stated that they had no dealing with the assessee. In one or two cases, the response was that they had no dealing with the assessee nor did they know him. Of course, these inquiries were made ex parte and in that view of the matter, the assessee would be allowed to contest such findings. Nevertheless, even if such facts were established through bi-parte inquiries, the liability as it stands perhaps holds that there was no cessation or remission of liability and that therefore, the amount in question cannot be added back as a deemed income u/s 41(1) of the Act. This is one of the strange cases where even if the debt itself is found to be non-genuine from the very inception, at least in terms of s. 41(1) of the Act there is no cure for it.

Monday, February 10, 2014

Movement of emerging market currencies over the past year.

The US Fed's excessive money printing may have done the damage to the economy's debt burden. However, as the US central bank unwinds its QE policy and cuts down its bond buying programme, the recipients of the cheap liquidity supply are left to panic. The major currencies across emerging markets, with the exception of China, saw massive correction over the past year. Countries with high current account deficits have been the worst hit. Argentina, which is running out of forex reserves to protect its currency, has seen the Peso fall by as much as 37.9%. And as the US continues to taper the QE in a slow but steady manner the damage to these currencies is far from done! 

Entire law on taxability of Permanent Establishment under DTAA, impact of Mutual Agreement Procedure (MAP) and computation of profits attributable to PE explained

e-Funds IT Solutions/ e-Funds Corp vs. DIT (Delhi High Court)

eFunds Corporation, USA and eFunds IT Solutions Group Inc, USA entered into contracts with their clients for providing certain IT enabled services. The same contract was either assigned or sub-contracted to eFunds India for execution. The AO, CIT(A) & Tribunal (42 SOT 165) held that from the Function performed, Assets used and Risks assumed (FAR analysis) by assessee and eFunds India, it was clear that eFunds India was not having requisite software and database needed for providing IT enabled services independently and that they were made available by the assessee to eFunds India free of any charges. It was also held that eFunds India did not bear any significant risk as the ultimate responsibility lay with the assessee. It was also noted that the sales team of the assessee undertook marketing efforts for its affiliates including eFunds India. It was accordingly held that the entire activities of the assessee in India were carried out by eFunds India Ltd (an agent) and said agent had not been remunerated on arm’s length price basis, it was to be held that the assessee had a Permanent Establishment (“PE”) in India in respect of back office operation and software development services being carried out by its subsidiary. It was also held that the assessee’s income was liable to tax in India in respect of operations performed by subsidiary company on its behalf. On appeal by the assessee to the High Court HELD allowing the appeal:
 
(i) Re Whether a subsidiary can be a Permanent Establishment: While under Article 5(6), a holding or a subsidiary company by themselves would not become PE of each other, a subsidiary can become a PE of the holding company if it satisfies the requirements of Article 5. Accordingly, any premises belonging to the subsidiary that is at the disposal of the parent (the “right-to-use test”) and that constitutes a fixed place of business (the “location test” and the “duration test”) through which the parent carries on its own business (the “business activity test”), gives rise to a PE of the parent under Art. 5(1). In addition under Art. 5(5) of the OECD Model, a subsidiary constitutes an agency PE of its parent if the subsidiary has the authority to conclude contracts in the name of its parent and habitually exercises this authority, unless these activities are limited to those referred to in Art. 5(4) or unless the subsidiary does not act in the ordinary course of its business as an independent agent within the meaning of Art. 5(6);
 
(ii) Re Location or fixed place PE under Article 5(1) and (2) of DTAA: The word “permanent” refers to some degree of permanency and not a mere transitory nature of the business in the other State. The expression “fixed place of business” refers not only to physical location in the form of immovable property or premises but in certain instances can mean machinery and equipment. The word “fixed” refers to a distinct place with some or certain degree of permanence. The carrying on of “business” should be “through” the fixed place of business. The fixed location test may be in form of a legal right or can be inferred from the facts when the foreign establishment and its employees are allowed right to use the place of business belonging to a subsidiary, a third party. The term “through” postulates that the taxpayer should have the power or liberty to control the place and hence the right to determine the conditions according to its needs;
 
(iii) Re What constitutes a “Service PE” under Article 5(2)(l) of the DTAA: Article 5(2)(l) and (k) defines what can be called service PE. Sub-clause (l) requires furnishing of services within the second contracting State by a foreign enterprise through its employees or other personnel. But a PE is created only if activities of that nature continue for a period or periods aggregating more than 90 days in 12 months period or under clause (ii) services are performed within that State for a related enterprise as defined in Article 9 paragraph 1. For application of clause (ii) no time period stipulation is postulated. Sub-clause (l) would apply only if the foreign enterprise or the two assessees had performed services in India through their employees or personnel, i.e., personnel engaged or appointed by the foreign assessee. The employees and other personnel must be of the non-resident assessee to create a service PE. Any other interpretation or treating employees of the Indian entity, i.e., e-Fund India as “other personnel” of the foreign assessee would lead to incongruities and irrational result, for every subsidiary which engages an employee, would always become a PE of the controlling foreign company. This would be contrary to the overriding mandate of Article 5 paragraph 6;
 
(iv) Re Impact of Article 5(3) and its over-riding effect and consequences: Article 5 (3) contains a list of negative activities which are deemed not to create PE. First and foremost, Article 5(1)/(2) should be applicable but then if the activities fall within parameters of paragraph 3, PE is not created for imposing tax in the second state. It does not follow that if activities are not covered in the negative or exclusions set out in paragraph 3, a PE is established or deemed to be established under paragraphs 1 or 2 of Article 5;
 
(v) Re What is “Agency PE” under Article 5(4) and (5) of DTAA: A dependent agency is one which is bound to follow instructions and is personally dependent on the enterprise he represents. Such dependency must not be isolated or once in a while transaction but should be of comprehensive nature. The “dependency test” requires examination and answer whether the business interest of the principal and the agency have merged. When there is evidence of merging of interest, then power to instruct the agent exceeds a certain level. In such cases the Principal regularly participates in the process of settling current business problems or exercises discretionary power in the said respects. The OECD Commentary does not accept dependency based on financial support, supply of patents etc. as itself creating agency PE. Interdependence must exist in both legal and economic respects but the independence is the main criteria;
 
(vi) Re Relevance of Mutual Agreement Procedure: The MAP procedure and agreement is no doubt relevant but cannot be determinative or the primary basis to decide whether the assessee had PE in India. Whether or not PE exists is a matter of law and fact and there has to be determination of the said issue on merits. A decision on merits will normally be “persuasively” conclusive for subsequent or other assessment years, unless there are good and sufficient reasons to take a contrary or divergent view. However, a concession on point of law, is not binding for other assessment years or a different assessee. It is always open to the competent authorities of the two countries to enter into an agreement for avoidance of double taxation and bring a litigation/dispute to an end.
 
(vii) Re Facts: On facts, there is no material to hold that the two assessees had a fixed place of business in India through which the business of the enterprise was wholly or partly carried on. It has not been stated that the premises of e-Fund India were at the disposal, legally or otherwise, of the two assessees. The “right to use test” or “disposal test” has not been or applied nor is there any finding to the said aspect. In the absence of any such finding Article 5(1) cannot be applied. The fact that e-Fund India provides various services to the assessee and was dependent for its earning upon the two assessees is not the relevant test to determine and decide location PE. The fact that the subsidiary company was carrying on core activities as performed by the foreign assessee does not create a fixed place PE. The allegation that e-Fund India did not bear sufficient risk is irrelevant when deciding whether location PE exists. The other circumstances such as reimbursement of costs etc were also irrelevant;
 
(viii) Re Computation, apportionment or accumulation of income/profit: Article 7(5) states that the profits attributed to the PE in Article 7(1)(a) shall only include profits derived from assets and activities of the PE. The determination should be by the same method from year to year unless there are good and sufficient reasons. Only the assets and activities of the PE i.e. “e-Fund India” can be taken into consideration for attribution of profits to the two assessees, if it is assumed that e-Fund India was PE of the assessee. The activities, which were not undertaken by e-Fund India and the assets of the two assesses outside India, cannot be taken into account or attributed for earning/income of the two assessees. This is subject to the limited force of attraction principle, which in the present case is not applicable. The method of apportionment has to be fair, rational and logical. If the transfer pricing analysis includes and takes into account risk taking functions of the PE enterprise, nothing further would be attributable to the foreign or non-resident enterprise. However, if the transfer pricing computation does not adequately reflect the functions performed and risk assumed by the Indian enterprise, there is need to attribute profits for those functions or risks which have not been considered. Data placed by the taxpayer which is examined and considered in transfer pricing analysis is, therefore, of importance and has to be examined in each case (Morgan Stanley 292 ITR 416 (SC) & commentaries by OECD, Klaus Vogel, Phillip Baker &Arvid A. Skaar referred)
 
 

India scores poor on innovation.

As per R&D spending data for 2011 (the latest available), the US maintained its status as the leader of innovation. This is because the country's R&D spend remained the highest - at just below 30% - of the global R&D spend. This is hardly surprising given that the rise in status and power of the US in the global economy in the past several decades has been a result of its focus on innovation. What is more interesting, however, is that while the US still leads the field as compared to others, its R&D share since 2001 has declined. This has been due to increasing investments being made by other countries. And also due to the fact that the US itself is not innovating as much as it once used to. In the meanwhile, China has been making rapid strides in innovation, while India still lags far 
behind.
 
 

German imports, exports surprisingly drop.

Germany's trade surplus slipped to €18.5B in December from €18.9B in November but came in above consensus of €17.3B. Exports surprisingly fell 0.9% on month after four gains in a row, while imports dropped 0.6%. "With these numbers, the secret hope that fourth-quarter growth was actually better than suggested by the Statistic Office's first estimates are fading away," says ING's Carsten Brzeski. The preliminary estimate for German Q4 GDP is +0.25%.

ArcelorMittal core profit rises 23% to $1.91B.

ArcelorMittal's (MT) Q4 EBITDA climbed 23% to $1.91B, topping analyst forecasts of $1.8B, as revenue increased 2.8% to $19.85B. Profits were boosted by a 4.4% rise in steel shipments to 21M tons, a 56% increase in marketable iron-ore shipments, cost savings and asset restructuring. ArcelorMittal is cautiously optimistic about its prospects, and forecasts that 2014 EBITDA will grow to $8B from $6.89B in 2013. Consensus is for $8.1B. Shares were +2.35% premarket.

Thursday, February 6, 2014

S. 14A disallowance has to be applied while computing book profits under clause (f) of Explanation to s. 115JA

CIT vs. Goetze (India) Ltd (Delhi High Court)

In AY 2000-01 the assessee offered income on the basis of book profits u/s 115JA. The assessee had credited the P&L A/c with dividend income of Rs. 1.57 crore. It claimed that the said dividend had to be excluded while computing the book profits, which was accepted by the AO. The CIT thereafter passed an order u/s 263 in which she claimed that the expenditure incurred to earn the said dividend had to be disallowed under clause (f) of the Explanation to section 115JA while computing the book profits. She estimated the said expenditure at Rs. 1.83 crore. Before the Tribunal the assessee claimed that s. 14A did not apply to AY 2000-01 in view of the Proviso thereof and that in any event s. 14A disallowance could not be made on facts. The Tribunal accepted the contentions and held that (a) two views were possible as to whether s. 14A can apply to AY 2000-01 in view of the Proviso thereof and as the AO’s view is a possible view, the CIT cannot revise u/s 263, (b) clause (f ) of the Explanation to s. 115JA uses the words ‘expenditure relatable to any income’, while s. 14A uses the words ‘expenditure incurred by the assessee in relation to income’. These words have the same meaning. However, sub-sections (2) & (3) of s. 14A do not find a place in clause (f) and cannot be imported into clause (f) of the Explanation to s. 115JA, (c) the funds of the assessee were mixed. The investments were made in the past and there were no fresh investments during the year, (d) as the capital and free reserve far exceeded the investments, the prima facie presumption was that investment was made out of own funds, (e) the CIT did not bring any material evidence on record to show that the borrowed funds were deployed in the tax-free investments & (f) as no expenditure was incurred for earning dividend income, the same could not be estimated by working out certain formula. On appeal by the department to the High Court HELD reversing the Tribunal:
 
The assessee’s contention that in view of the Proviso to s. 14A, the said provision could not have been invoked for AY 2000-01 in a revision u/s 263 is not acceptable because the assessment order was passed after section 14A was enacted (Honda Siel Power Products 340 ITR 53 (Del) (approved by SC) followed). The failure of the AO to invoke s. 14A had resulted in the order being erroneous and prejudicial to the interests of the Revenue. On the question of quantum of deduction to be made u/s 14A, the Tribunal has not gone into the said question of quantum. The deduction or quantum has to be decided in light of Maxopp Investment 347 ITR 272 (Delhi)
Note: The argument that sub-secs (2) & (3) of s. 14A (which enact Rule 8D) do not apply to s. 115JB and that no disallowance can be made if the assessee has own funds & no fresh investments are made during the year was not specifically rejected. For the contra view that s. 14A does not apply to s. 115JB see Spray Engg 53 SOT 70 (Chd)
 
 

Wednesday, February 5, 2014

S&P cuts Puerto Rico to junk status.

S&P has reduced Puerto Rico's rating to BB+ and maintained a negative outlook for the debt-laden commonwealth, citing a reduced capacity to access liquidity to fund its operating deficit. Even though Puerto Rico is planning to issue debt, it "will remain constrained in the medium term," S&P says. Moody's and Fitch are threatening to drop Puerto Rico to junk status as well.

Eurozone retail sales tumble.

Putting a dampener on any optimism that the encouraging eurozone PMI data may have engendered, Eurostat reports that retail sales volumes in the bloc slumped a greater-than-expected 1.6% on month in December after rising 0.9% in November. Consensus was for a drop of 0.5%.

Asian, EU stocks mostly up, U.S. futures slip.

Asian and European shares have mostly risen as markets enjoy a break from a global sell-off that has been going on for about two weeks. The Nikkei increased following strong earnings reports, while encouraging PMI data has helped keep much of Europe higher. However, there are doubts about the sustainability of today's gains. "Opinions remain divided on whether this week's rally is anything more than a 'dead cat bounce'," say analysts at BNP Paribas. Perhaps reflecting those doubts, U.S. stock futures were lower premarket.

Eurozone business activity strengthens again, Spain charges higher.

Eurozone composite PMI rose to 52.9 in January from 52.1 in December as the services print edged up to 51.6 from 51. Of particular note, Spain's composite PMI hit a 6 1/2 year peak of 54.8. "Spain and Ireland are now seeing robust growth, undergoing their strongest phases of expansion since 2007, while Italy is also returning to growth and France's business sector is also showing signs of stabilizing."

Tuesday, February 4, 2014

Spanish unemployment rises but at low pace for January.

The number of unemployed people in Spain unexpectedly rose by 113,100 in January to 4.81M after a fall of 107,600 in December. Consensus was for a drop of 21,300. However, the seasonally adjusted unemployment fell by 3,907 people, while the non-SA figure was the smallest in January since 2007. Although many European stock indices were down at the time of writing, Spain's IBEX 35 was +0.1%.

RBA leaves rates at 2.5%, signals end of easing cycle.

As expected, the Reserve Bank of Australia has held its key cash rate at 2.5% and it has indicated the end of a two-year easing cycle. "The most prudent course is likely to be a period of stability in interest rates," RBA Governor Glenn Stevens said in a statement. The Australian dollar's decline "will assist in achieving balanced growth," Stevens also said. The S&P/ASX 200 closed -1.75%, although the Aussie was +1.5% at $0.888 at the time of writing.

European, Asian stocks hit by U.S. data.

European and Asian shares were mostly lower at the time of writing following sharp losses on Wall Street yesterday after poor U.S. manufacturing numbers added to disappointing Chinese PMI data and the turmoil in emerging markets to further hurt sentiment. However, U.S. stock futures were enjoying a bit of a rebound. The Nikkei fell 4.2% for its biggest one-day drop since June, although it's worth remembering that the index soared 57% last year.

Retail inflation* remains high in India

Emerging markets are in the midst of a meltdown as a combination of various factors has resulted in foreign investors pulling out money. Of course, many of the problems are country specific. And yet there are some economic indicators which point out to the same trend. One such indicator is the rise in consumer prices. As today's chart of the day shows, barring China, all the other BRIC nations have been seeing higher consumer prices. India leads the pack by a wide margin with consumer prices being just below the 10% mark. In India's case, the RBI's policy of gradually hiking interest rates has not really worked. And the Indian government has not done its bit in eliminating supply side bottlenecks.


Employees’ PF/ ESI Contribution is also covered by s. 43B & allowable as a deduction if paid by “due date” of filing ROI. ITC Ltd 112 ITD 57 (Kol) (SB) impliedly reversed

CIT vs. Vijay Shree Ltd (Calcutta High Court)

The assessee collected ESI & PF from its employees but did not pay the sum to the respective funds within the due date prescribed in relevant legislation. The amount was, however, paid before the due date u/s 139(1) for filing the ROI. The AO & CIT(A) disallowed the payment u/s 36(1)(va) read with s. 2(24)(x). Before the Tribunal, the department justified the disallowance by relying on Ashika Stock Broking Ltd 139 TTJ 192 (Kol) (which in turn relied on ITC Ltd 112 ITD 57 (Kol) (SB) where it was held that s. 43B does not apply to employees’ contribution). However, the Tribunal declined to follow that law and allowed the appeal by relying on Sabari Enterprises 298 ITR 141 (Kar) and P.M. Electronics Ltd 220 CTR 635 (Del) where it was held that s. 43B applied also to employees’ contribution to ESI and PF and that if a payment was made within the due date u/s 139(1) of filing the ROI, the disallowance cannot be made. On appeal by the department to the High Court HELD dismissing the appeal:
 
The only issue involved in this appeal is as to whether the deletion of the addition by the AO on account of employees’ contribution to ESI and PF by invoking the provision of s. 36(1)(va) read with s. 2(24)(x) of the Act was correct or not. In CIT vs. Alom Extrusion Ltd 390 ITR 306 the Supreme Court has held that the amendment to the second proviso to s. 43(B) as introduced by Finance Act, 2003, was curative in nature and is required to be applied retrospectively with effect from 1st April, 1988. Such being the position, the deletion of the amount paid by the Employees’ Contribution beyond due date was deductible by invoking the aforesaid amended provisions of s. 43(B) of the Act. We, therefore, find that no substantial question of law is involved in this appeal and consequently, we dismiss this appeal
Note: Though the judgement is old it does not appear to have been reported so far. This impliedly reverses the Special Bench verdict in ITC Ltd 112 ITD 57 (Kol) and impliedly affirms the Special Bench verdict in Bharati Shipyard 132 ITD 53 (SB)(Mum).

Monday, February 3, 2014

Eurozone manufacturing PMI rises, Greece returns to growth.

Eurozone manufacturing PMI increased to a 32-month high of 54 in January from 52.7 in December. Germany led the expansion and Greek PMI returned to growth for the first time since August 2009, while Spain hit a 45-month high and France showed signs of stabilization. The data is consistent with GDP growth of 0.4-0.5% in Q1. The euro was +0.2% at $1.3516 at the time of writing.

Chinese official PMIs show growth slowdown.

China's official manufacturing PMI fell to a six-month low of 50.5 in January from 51 in December, while the non-manufacturing print slipped to the lowest level since December 2008, falling to 53.4 from 54.6. The readings add to other data that indicate slowing growth in China, although at least the latest manufacturing figure shows expansion - HSBC's PMI gauge indicated contraction. The trends have partly been attributed to the Lunar New Year as people travelled home for the holiday.

German retail sales suffer shock fall.

German retail sales plunged 2.5% on month in December after rising 0.9% in November and badly missed consensus for an increase of 0.2%. The drop in sales is in marked contrast to surveys showing that consumer confidence is high and getting stronger, as well as to other positive economic data.

Eurozone CPI falls, reviving deflation fear

Eurozone inflation edged down to 0.7% on year in January from 0.8% in December, brought down by a sharp fall in energy costs. Consensus was for a rise to 0.9%. Overall CPI is now under half that of Japan. A question for policy makers in the eurozone is whether deflation is a major threat. ECB President Mario Draghi has indicated that he isn't too concerned, saying at the end of last month that "We don't have a situation as in Japan."

Japanese inflation edges closer to BOJ 2% target.

Japanese core inflation, which excludes food prices, edged up to a fresh five-year high of 1.3% on year in December from +1.2% in November and topped consensus of 1.2%. Overall inflation increased to 1.6% from 1.5%. While CPI is heading towards the Bank of Japan's target of 2%, the government wants businesses to increase wages in order to solidify the rise in inflation, the test of which will come in Spring wage negotiations. There are also concerns about the impact of an increase in sales tax in April.

Japan's unemployment rate dropped to the lowest since December 2007, falling to 3.7% last month from 4% in November and vs forecasts of 3.9%. The number of positions for every person looking for a job rose to 1.03, passing one for the first time since October 2007. Industrial production recovered with a rise of 1.1% on month vs -0.1% previously.

Microsoft to name Nadella CEO, mulls replacing Gates - Bloomberg.

Microsoft (MSFT) is preparing to name server/cloud product chief Satya Nadella as its next CEO, Bloomberg reports. Microsoft is also thinking of replacing Bill Gates as Chairman with lead independent director John Thompson. Nadella is head of a product group that has arguably represented Microsoft's biggest success story over the last decade.