WeWork Management Fee ALP Cannot Be NIL When Services Proven: ITAT Bangalore

WeWork India Management Private Ltd Vs DCIT (TP) (ITAT Bangalore)

The Income Tax Appellate Tribunal (ITAT), Bangalore Bench, in WeWork India Management Private Ltd Vs DCIT (TP), allowed the assessee’s appeal for Assessment Year 2018-19, deleting transfer pricing adjustments aggregating to ₹8,94,53,562, comprising ₹7,09,23,425 towards management fees and ₹1,85,30,137 towards interest on Compulsorily Convertible Debentures (CCDs). The assessee, engaged in operating shared workspaces, had entered into an Operations and Management Agreement with WeWork Netherlands, subsequently assigned to WeWork UK, for access to intellectual property, trademarks, proprietary software, business systems and operational support. Management fees were paid at 12.5% of gross revenue and benchmarked under the Comparable Uncontrolled Price (CUP) method against comparable agreements indicating rates between 8% and 16%. However, the Transfer Pricing Officer determined the arm’s length price at NIL, alleging inadequate evidence of services and commercial benefits. The Tribunal observed that the assessee’s business depended substantially on the technology, franchise rights, branding, design, marketing and operational assistance provided by WeWork Global. It further noted that the parties were treated as deemed associated enterprises under Section 92A(2)(g) precisely because the assessee’s business depended on the intellectual property and franchise rights of WeWork Global. Therefore, the TPO could not simultaneously dispute the receipt of those services and determine their arm’s length price at NIL. Following judicial precedents including Toyota Kirloskar Motors Pvt. Ltd., EKL Appliances Ltd. and Cushman and Wakefield India Pvt. Ltd., the Tribunal deleted the management fee adjustment.

Regarding the ₹1.85 crore adjustment on CCD interest, the assessee had issued 33,75,000 CCDs of ₹100 each, aggregating to ₹33.75 crore, to WeWork Netherlands under a debenture subscription agreement dated 26 April 2017. The CCDs carried interest at 6% annually and a maximum conversion period of 20 years. The assessee benchmarked the interest payment against comparable CCD transactions indicating an arm’s length range of approximately 10.11% to 11%. Nevertheless, the TPO recharacterised the CCDs as equity and determined the arm’s length price of interest at NIL. Following the coordinate bench decision in Summit Developments Pvt. Ltd., the Tribunal held that CCDs constitute debt until their conversion into equity, and their classification as equity under RBI regulations for foreign investment purposes could not determine their treatment under income tax law. The Tribunal also distinguished the transfer pricing provisions under Sections 92 to 92F from Section 94B, which separately regulates interest deductibility in thin-capitalisation situations. Since the assessee had already made the applicable disallowance under Section 94B in its return, the TPO could not justify a NIL arm’s length price merely on thin-capitalisation grounds without proper benchmarking. Accordingly, the Tribunal deleted the entire CCD interest adjustment along with the management fee adjustment, allowing the assessee’s appeal. The order was pronounced on 24 February 2023.

Cases Discussed

• Summit Developments Pvt. Ltd. Vs DCIT (ITAT Bangalore), IT(TP)A No. 794/Bang/2022, order dated 10.11.2022 — Held that compulsorily convertible debentures constitute debt until conversion into equity and that interest deductibility under Section 94B is distinct from transfer pricing benchmarking.
• Royal Canin India Pvt. Ltd. (ITAT Mumbai), TS-687-ITAT-2022-Mum-TP — Cited regarding the determination of arm’s length price of management services received from associated enterprises.
• TE Connectivity Services Pvt. Ltd. (ITAT Bangalore), IT(TP)A No. 191/Bang/2022 — Cited in support of the treatment of interest on compulsorily convertible debentures under transfer pricing provisions.
• Embassy One Developers Pvt. Ltd. (ITAT Bangalore), (2020) 12 TMI 110 — Considered regarding the characterisation of CCDs and deductibility of interest before conversion.
• IMS Health Analytics Services Pvt. Ltd. (ITAT Bangalore), (2020) 6 TMI 505 — Cited in support of treating CCDs as debt for income-tax purposes until conversion.
• CAE Flight Training India Pvt. Ltd. (ITAT Bangalore), (2019) 8 TMI 554 — Cited regarding the allowability of interest on compulsorily convertible debentures.
• US Technology Resources Pvt. Ltd. (ITAT Cochin), TS-1229-ITAT-2018-Coch-TP — Relied upon concerning the arm’s length determination of payments for services received from associated enterprises.
• Toyota Kirloskar Motors Pvt. Ltd. (Karnataka High Court), (2018) 7 TMI 477 — Relied upon in examining the TPO’s determination of the arm’s length price of management fees at NIL.
• Inteva Products India Automotive Pvt. Ltd. (ITAT Bangalore), TS-565-ITAT-2016-Bang-TP — Cited concerning transfer pricing adjustments relating to services received from associated enterprises.
• Cushman and Wakefield India Pvt. Ltd. (Delhi High Court), 367 ITR 730 — Considered regarding the distinction between determining the arm’s length price of an international transaction and examining the commercial necessity of expenditure.
• EKL Appliances Ltd. Vs CIT (Delhi High Court), 345 ITR 241 — Held that the TPO cannot ordinarily question the commercial expediency of expenditure merely because the associated enterprise transaction is considered commercially unnecessary.
• Besix Kier Dabhol SA (Bombay High Court), 26 taxmann.com 169 — Cited in the discussion of thin-capitalisation principles and the tax treatment of interest payments.
• Enzen Global Solutions Pvt. Ltd. (ITAT Bangalore), 14 taxmann.com 2 — Cited concerning the tax treatment of interest on convertible debentures.
• Amanora Future Pvt. Ltd. (ITAT Pune), ITA No. 772/Pun/2018 — Cited in support of the assessee’s position concerning CCD interest and transfer pricing adjustments.

FULL TEXT OF THE ORDER OF ITAT BANGALORE

This appeal at the instance of the assessee is directed against the final assessment order dated 15.07.2022 passed under Section 143(3) r.w.s. 144C(13) r.w.s. 144B of the Income Tax Act, 1961 (the Act). The relevant assessment year is 2018-19.

2.The brief facts of the case are as follow:-

The assessee is a private limited company which was incorporated on 13.05.2016. The assessee is a subsidiary of Embassy Buildcon LLP and is primarily engaged in leasing of a network of shared workspaces of fully or partly equipped premises. For AY 2018-19 return of income was filed disclosing total loss of Rs.78,77,80,649/- under the normal provisions of the Act. The case was selected for scrutiny and notice under Section 143(2) of the Act dated 22.09.2019 was issued. During the course of assessment proceedings reference was made under Section 92CA of the Act to the Transfer Pricing Officer (TPO) for determination of arm’s length price (ALP) with reference to all the international transactions reported by the assessee. The TPO, vide order dated 31.07.2021 passed an order under Section 92CA of the Act proposing an aggregate adjustment of Rs.8,94,53,562/-. The TP adjustment proposed are detailed below: –

3.The Assessing Officer (AO) thereafter passed draft assessment order on 23.09.2021 incorporating the said TP adjustments. The AO did not propose any other adjustments.

4.Aggrieved by the draft assessment order the assessee filed objections before the Dispute Resolution Panel (DRP) on 22.10.2021. The DRP, vide its directions dated 29.06.2022, disposed off the objections of the assessee. The DRP rejected the objections raised by the assessee. Pursuant to the DRP directions the impugned final assessment order dated 15.07.2022 was passed.

5.Aggrieved by the final assessment order the assessee has filed the present appeal before the Tribunal. The assessee has raised three main grounds and several sub-grounds. Ground No 1 and its sub-grounds are general in nature and no specific adjudication is called for, hence the same are rejected. Ground Nos. 2 & 3 and its sub-grounds relates two transfer pricing adjustments, namely: –

(i) Transfer Pricing adjustment in respect of management fee (Ground No. 2 with 5 sub-grounds)

(ii) Transfer Pricing adjustment in respect of interest on Compulsorily Convertible Debentures (Ground No. 3 with 6 sub-grounds)

6.We shall adjudicate the above issues as under: –

TP adjustment in respect of management fee (Ground 2 and sub-grounds)

7. The brief facts in relation to the above issue are that the assessee company is primarily engaged in the business of leasing of network of shared work spaces of fully or partly equipped premises. The assessee commenced its operations during the impugned assessment year, by executing Operations and Management Agreement (OMA) dated 17.11.2016 with WeWork, Netherlands. The rights under the said OMA were subsequently assigned to WeWork, UK. In consideration of the above, the assessee is required to pay “management fee” as per the terms agreed upon in the OMA. During the impugned assessment year the assessee paid management fee under the OMA at an effective rate of 12.50% of gross revenue amounting to Rs.7.09 crores, to WeWork Netherlands (Rs.3.42 crores) and to WeWork UK (Rs.3.67 crores). These payments were made after deducting taxes prescribed under the relevant Double Taxation Avoidance Act (DTAA).

8.For the relevant assessment year the assessee reported that WeWork Netherlands and WeWork UK (hereinafter together referred to as “WeWork Global”) constituted Deemed Associated Enterprises by virtue of clause (g) of subsection (2) of Section 92A of the Act. The assessee company in its TP study adopted CUP method using external comparable data, as the most appropriate method (MAM) for determining the ALP of its management fee payments. For this purpose the assessee undertook the search of comparable agreements on Power K Database. The search was conducted by selected ‘intangible product type’, under which the agreement classified under ‘process technology’, ‘trademark’ and ‘franchise’ were selected. The ALP was finally determined based on the rate prescribed for the 8 comparable agreements. The arm’s length range of the management fee in comparable transactions was determined at 8% to 16%. Since the assessee’s transaction was undertaken at 12.5% the assessee in its TP study concluded the said transaction to be at ALP.

9.The TPO, however, held that the ALP of the said transaction of payment of management fee was to be taken at ‘NIL’. The TPO ignored the benchmark analysis undertaken by the assessee. Following is the summary of the TPO’s conclusions (refer pages 7 & 8 of the TP order): –

“- Alleged failure of the assessee to prove the actual receipt of the said services; and –Alleged non-satisfaction of need/benefit test – Under controlled circumstances any independent enterprise having skilled & sufficiently trained manpower would not have been willing to pay any third party to provide the above said services.”

10.Aggrieved, assessee filed objections before the DRP. The assessee filed sample copies of emails between WeWork Global and the assessee to demonstrate that the assessee was in receipt of services under the OMA. The assessee also furnished details of the software application provided to it by WeWork Global in terms of the OMA. The DRP however, upheld the order of the TPO and rejected the objections of the assessee.

11.Aggrieved, assessee has raised this issue before the Tribunal. The assessee has filed two sets of paper books: one enclosing the case laws relied on and the other enclosing therein the audited financial statements, statement of accounts, accountant’s report in Form 3CEB, TP study, the OMA dated 17.11.2016, show cause notices issued during the proceedings before the TPO and DRP, submission made before the authorities below, etc. The learned A.R. submitted that under the terms of OMA, the assessee is enabled to carry out its business under the trade name “WeWork”, is granted the right to use intellectual property rights owned by WeWork Global and the rights to use its software (both in-house and third party application) which enabled it to perform the day to day functions such as IP, seat reservations, managing community events, managing room reservations, reservation of conference rooms and work stations, billing and invoicing, etc. The learned A.R. submitted that WeWork Global does not hold any share in assessee company and has been determined only as a deemed AE by virtue of Section 92A subsection (2) clause (g) of the Act. The learned A.R. stated that going by the two parties having become AEs in the present case on account of Section 92A(2)(g) of the Act which is satisfied only when one AE provides services to the other AE by allowing it to use the know-how, patents, trademarks franchise, etc. and when TPO doubts receipt of service/use of IP/franchise, thus the very foundational condition for treating assessee and WeWork Global as deemed AE would be lost. Thereby TPO would be without jurisdiction to determine the ALP of the management fee. The learned A.R. relied on various case law in support of his contention that once the transaction is proved the ALP of management fee paid cannot be determined at NIL by the TPO.

12.The learned D.R. strongly supported the orders of the TPO and DRP.

13.We have heard the rival contentions and perused the material on record. WeWork is a world leader in the business of co-working spaces. It operates as an office space leasing company that offers flexible work space worldwide. It provides flexible leasing options to the tenants on short term basis. Its work space included dedicated desk in shared office spaces, standard office, office suites with private amenities and full floor offices. WeWork work spaces are used by businesses and organisations of various size, freelancers and small start-ups to fortune 500 companies. In India the assessee company has taken franchise from WeWork Global based on OMA entered into between the assessee and WeWork Netherlands. The nature of services and the related benefits, the test of determination of management fee along with relevant agreement are placed on record which depicts the entire business model of the assessee is dependent on foreign AE, which has provided the concept, support, the acquisition and design of property, trademark and trade name, proprietary and third party software for the day to day operations of the assessee in India. In other words, the assessee is dependent on AE to provide all the necessary support, to design and construct of the premises, sell the concept in the market and also operationalisation of business which will require similar look and feel, connected by common software for booking desk etc. The assessee most importantly is allowed to use the trademark/brand of WeWork. The benefit and the services that are provided to the assessee by the WeWork International in brief are narrated below: –

a. Digital Services:

i. WeWork International allows access to its proprietary digital member network, application and suite of operational digital support tools to WeWork India. ii. WeWork India has access to the digital platforms developed by the AEs which provides services like selection of premises, designing the premises, marketing and sales etc.

b. Real Estate Services:

i. The AEs provide strategical site selection services for WeWork India. The site selection process is a methodical search for the site that best meets established criteria, including size, location, proximity to services and price factors that will help ensure the project fulfils the needs of future tenants.

c. Design Services:

i. The right office design is powerful, and WeWork designs the interiors and exteriors of the workspace premises which is undertaken. The AEs provide design development services through and including systematic design phase. d. Corporate Services: i. The AEs provide centralized support functions like branding, marketing enterprise solutions and design/development services for assisting in its business operations.

e. Implementation Services:

i. The AEs monitor and advice in connection with the implementation of the operating principles. ii. The implementation services include operations support, marketing, events and other community building initiatives, digital services, maintenance services and other operational matters.

f. Training Services:

i. They provide training for the community and hospitality team members. ii. The community team is a team of personnel, who manage the operations, coordination, assisting and handling of tenants/members on workspace floors. iii. All expenses (except for travel, accommodation and compensation expenses of such personnel) relating to such trainings are borne by AEs.

g. Billing Services:

i. AEs provide billing services to WeWork India by allowing access to their software systems for global reservation, space management, and member billing platform.

ii. All billings, tracking of collections, overdue etc. are undertaken through the aforesaid platforms of AEs. h. Access to WeWork Brand / Trademarks i. AEs provide access to the intellectual property in the nature of patents, copyrights, business names, domain names (registered or unregistered) including the trademarks owned by them, essential to WeWork India for operating its business.

14. The above benefit derived from the foreign AE have a direct link in increasing the trade and number of desk sold in each of the financial year which is evident from the tabulation below: –

From the above table it is evident that the involvement of AE is directly proportional to the increase in the number of desk sold and corresponding increase in revenue year after year. Moreover, the company has maintained a scientific and reasonable formula to compute management fees and sample copy of the management fee computation is placed on record.

15.More importantly as mentioned above WeWork Global does not hold any share in assessee company. The assessee company and WeWork Global has been treated as deemed AEs by virtue of Section 92A(2)(g) of the Act. The relevant abstracts of the said provision is reproduced below: –

“…. (g) the manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent on the use of know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights; or….”

A reading of the above provision makes it clear that the said section get attracted only when one AE provides service to the other AE by allowing the AE to use the know-how, patents, trademark, franchise, etc. and the business of the assessee is wholly dependent on such IP/franchise. Once the foundational condition is receipt of IP/franchise of which the assessee company’s business is wholly dependent and only on that basis, the AE relationship was established, consequently TP provisions were applicable, it is unsustainable then to turn around and hold that the assessee did not receive the IP/franchise from its deemed AE. By this logic when the TPO alleges that the assessee has not received any of the above services, it would indicate that the very relationship based on which the assessee company and WeWork Global have been established as AE would be nonexistent. The very fact that the entire business model of the assessee is dependent on foreign AE which has provided the concept, design, trademark, software, etc. for the assessee’s day to day operation clearly establishes that services were rendered by the foreign AE to the assessee (independent of the legal point that the AE relationship itself has been established only due the existence of the services and in absence thereof, AE relationship would fail, and consequently, the jurisdiction of the TPO itself would also fail.) Therefore on the facts on record, it is beyond doubt that the assessee is wholly dependent on the use of know-how, patents, copyright, trademark, licences, franchise and other services of WeWork Global, for its day to day operation in India. Therefore once the above fact is established, the ALP of management fee paid by the assessee company to WeWork Global cannot be determined at ‘NIL’ by the TPO. In this context we rely on the following judicial pronouncements: –

i)Toyota Kirloskar Motors Pvt. Ltd. (2018) 7 TMI 477 (Kar.)

ii)EKL Appliance Ltd. 345 ITR 241 (Del.)

iii)Cushman and Wakefield India Pvt. Ltd. 367 ITR 730 (Del)

iv)Inteva Products India Automotive Pvt. Ltd. TS-565-ITAT-2016 Bang-TP (Bangalore Trib.)

v)Royal Canin India Pvt. Ltd. TS-687-ITAT-2022 Mum-TP (Mumbai Trib) vi)US Technology Resources Pvt. Ltd. TS-1229-ITAT-2018 COCH-TP (Cochin Trib)

16.In view of the above said reasoning and the judicial pronouncements cited supra we hold that the TPO is not justified in treating the ALP of management fee paid by assessee to WeWork Global at ‘NIL’. It is ordered accordingly.

17.In the result, ground No. 2 and its sub-grounds are allowed.

Interest on CCDs issued by the assessee

18.During the relevant assessment year 2018-19 the assessee had issued 33,75,000 Compulsory Convertible Debentures (CCD) of Rs, 100/- each amounting to Rs.33.75 crores to WeWork Netherlands under the Debenture Subscription Agreement dated 26.04.2017. As per the terms of the issue specified in the said agreement, interest on the said CCDs was to be paid at 6% per annum and carry a maximum term of 20 years for conversion. During the relevant assessment year the assessee paid an interest of Rs.1.85 crores to WeWork Netherlands. WeWork Netherlands was determined to be a deemed AE of the assessee for the impugned assessment year by virtue of Section 92A(2)(g) of the Act. Therefore the interest paid to WeWork Netherlands on CCDs allotted to it was considered as international transaction in the assessee’s TP study. The assessee in the TP study determined the arm’s length of the interest on CCD under CUP method using external comparable transactions. The assessee undertook search for comparable transactions of companies paying interest on CCDS that carry similar terms of issue, as that of the assessee. Pursuant to the said search, 14 companies containing 22 CCDs allotment transactions with related interest payments were identified as being comparable to that of the assessee. The arm’s length range of the CCDs was accordingly determined at 10.11 to 11% in the assessee’s TP study. Since the assessee’s payment to WeWork Netherlands is at 6% on the CCDs, the said international transaction was concluded to be at ALP in its TP study.

19.The TPO recharacterised the CCDs issued by the assessee to WeWork Netherlands as equity and held that the ALP of the said interest is NIL. The TPO further alleged that an uncontrolled party would not have subscribed to assessee’s CCDs given its skewed financials (refer pages 7 & 8 of TPO’s order). The view taken by the TPO was confirmed by the DRP.

20.Aggrieved, assessee has raised this issue before the Tribunal. The learned A.R. submitted that the TPO has exceeded his jurisdiction in recharacterising CCDs as equity. Further the learned A.R. submitted that when thin capitalisation rules are inserted under Section 94B of the Act w.e.f. 01.04.2018 to address the issue of base erosion posed by thin capitalisation, the same shall take precedence and no adjustment in this regard can be made under the TP provisions which is limited to the determination of ALP. The learned A.R. submitted that the proposition of CCDS are in the nature of debt and cannot be recharactrised as equity by the TPO and the same is within the scope of Section 94B of the Act was also upheld by the coordinate bench order of the Tribunal in Summit Development Pvt. Ltd. in IT(TP)A No. 794/Bang/2022 (order dated 10.11.2022).

21.The learned D.R., on the other hand, supported the orders of the AO and TPO.

22.We have heard the rival contentions and perused the material on record. The Bangalore coordinate bench of the Tribunal in the case Summit Development Pvt. Ltd. (supra) had held that CCD are in the nature of debt and cannot be recharacterised as equity till the time the same is converted into equity. The relevant extract of the said order is reproduced below: –

7.3 It is well settled by judicial proposition that CCDs constitute debt and interest payable thereon is a deductible expenditure till the time the same are converted into equity. The definition of convertible debentures given by RBI is in the context of FDI policy to exercise control on future re-payment obligations in convertible foreign currency and since CCDs does not have any repayment obligation, the same was considered by RBI as equity for FDI policy. Such definition of the term convertible debentures cannot be applied in other context such as allowability of interest on such debentures during pre-conversion period or regarding payment of dividend on such convertible debentures during pre- conversion period or regarding granting of voting rights to the holders of such convertible debentures before the date of conversion. Hence the disallowance of Interest expenditure on CCD cannot be sustained on the basis that CCDs are in the nature of equity. …………….

7.4 …………………………

7.5 In light of the aforesaid judicial pronouncements, we delete the TP adjustment with respect to interest on CCD, contending CCD is equity.

7.6 ……………………………

7.7 The new section 94B of the I.T.Act is applicable with effect from 01.04.2018, and hence is applicable for the impugned assessment year, namely, A.Y. 2018-2019. Section 94B of the I.T.Act is different from transfer pricing provisions contained in sections 92 to 92F of the I.T.Act. The transfer pricing provisions deal with the determining the arm’s length rate of interest payable on a debt-claim from an AE. In contrast, section 94B of the I.T.Act places a blanket threshold on the deductibility of interest paid, based on the profitability of the Assessee and not based on the debt-claim itself. ………….. In the light of the aforesaid reasoning and the judicial pronouncements, cited supra, the impugned TP adjustment with respect to payment of interest on CCD is deleted. However, the disallowance is liable to be made under section 94B of the I.T.Act. It is ordered accordingly.”

(emphasis supplied)

23.In the instant case the assessee had duly made disallowance under Section 94B of the Act in its return of income for the relevant assessment year. The said disallowance therefore address the issue of thin capitalisation in the manner envisaged by the Legislature. Hence, it cannot be disallowed under TP provisions on the same basis. It is submitted that the assessee is not arguing that the TP provisions ought not to apply where a disallowance is made under Section 94B of the Act but only is contending that thin capitalisation cannot be the basis for such TP disallowance and the same may be tested for arm’s length compliance and held to be excessive based on benchmarking exercises. In such an event, the excessive interest of ALP will account for permanent disallowance, while balance interest would be subject to Section 94B of the Act which would be in the nature of a temporary disallowance permitted to be carry forward. However, in the instant case this is not what has been done by the TPO. The above preposition finds support from various judicial pronouncements as detailed below: – i)Besix Kier Dabhol SA 26 taxmann.com 169 (Bom) ii)Summit Developments Pvt. Ltd. IT(TP)A No. 794/Bang/2022 iii)CAE Flight Training India Pvt. Ltd. (2019) (8) TMI 554 Bangalore Trib. iv)Embassy One Developers Pvt. Ltd. (2-020) (12) TMI 110 Bangalore Trib. v)IMS Health Analytics Services Pvt. Ltd. (2020) (6) TMI 505 Bangalore Trib. vi)TE Connectivity Services Pvt. Ld. IT(TP)A No. 191/Bang.2022 vii)Enzen Global Solutions Pvt. Ltd. 14 taxmann.com 2 (Bang. Tirb.) viii)Amanora Future Pvt. Ltd. ITA 772/Pun/2018

24.In the light of the aforesaid reasoning and judicial pronouncements cited supra, the impugned TP adjustment with reference to payment of interest on CCD is deleted. It is ordered accordingly.

25.In the result, the appeal filed by the assessee is allowed.

Order pronounced in the open Court on 24th February, 2023.