In a landmark ruling on cross-border taxation, the Delhi High Court has quashed Section 148 notices for AYs 2012-13 to 2014-15 and directed refund of approximately Rs. 783 crores in TDS to Teva Israel, subject to a corporate guarantee from Teva USA. The High Court held that the mere fact that an Indian resident is the payer of a cross-border payment does not, by itself, constitute income ‘accruing or arising’ in India within the meaning of Section 5(2)(b) of the Income Tax Act. The Revenue must establish a sufficient nexus between India and the income-producing right or activity or bring the receipt within one of the specific deeming provisions under Section 9 of the Income Tax Act.
The High Court set aside the AAR’s order dated 25 October 2019 which had declined to rule on the taxability of the Rs. 1,851 crore payment received by Teva Israel from Ranbaxy India, holding that the AAR exceeded its jurisdiction by recording findings on the tax liability of Teva USA, a third party who was not before it, and by conflating the distinct statutory stages of admission under Section 245R(2) and pronouncement of ruling under Section 245R(4).
The Court quashed the Section 148 reassessment notices issued to Teva USA for AYs 2012-13 and 2013-14, holding that the underlying contractual rights, the Abbreviated New Drug Applications (ANDA) regime, the disputed Ready Date Notice, the US litigation and the market whose exploitation generated the economic return were all substantially situated outside India, and that the Revenue had failed to demonstrate any real and substantive nexus between the impugned receipt and the territory of India.
For AY 2014-15, the High Court quashed the Section 148 notice as being hopelessly time-barred, holding that the Assessing Officer could not invoke the extended ten-year limitation under Section 149(1)(b) by treating a deposit in Teva Israel’s bank account as an ‘asset’ of Teva USA, and that the original notice issued on the last date under TOLA left no surviving period for further proceedings. The High Court also directed refund of approximately Rs. 783 crores in TDS to Teva Israel along with applicable interest within two months, holding that while protective assessment is permissible in law, there is no concept of ‘protective recovery’, and the Revenue cannot withhold the refund of one assessee merely because proceedings are pending against another. The refund was made conditional upon Teva USA furnishing a corporate guarantee and Teva Israel furnishing a back-up surety.
The Division Bench comprising Justice Dinesh Mehta and Justice Vinod Kumar observed that the specific deeming provisions in Section 9(1)(v), (vi) and (vii), relating to interest, royalty and fees for technical services, represent an exhaustive and not merely illustrative codification of the source rule for cross-border payments. The legislative history of the 1976 amendments does not support the existence of a universal ‘default source rule’ based solely on the location of the payer.
On the question of taxability, the Court observed that the situs of accrual must be determined having regard to the true juridical and commercial source of the income. The underlying contractual rights, the ANDA regime, the disputed Ready Date Notice, the litigation and the market whose exploitation generated the economic return were all substantially situated outside India. The mere fact that Ranbaxy India was the payer and remitted the amount from India did not, by itself, constitute income accruing or arising in India.
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On the AY 2014-15 notice, the Court observed that the Assessing Officer had sought to invoke the extended ten-year limitation under Section 149(1)(b) by treating the bank receipt of Teva Israel as an ‘asset’ of Teva USA. The Court held that a deposit in a third party’s bank account could not be treated as an ‘asset’ of the assessee, and that the existence of a qualifying asset was a jurisdictional fact that could not be assumed by presuming the answer to the very question sought to be examined. The Court further held that the fresh ground for invoking the extended limitation was raised for the first time in the order under Section 148A(d), without affording the assessee an opportunity to respond, contrary to the scheme of the Act.
The Court also observed that the AY 2014-15 notice was hopelessly time-barred even on the ordinary three-year limitation under Section 149(1)(a). The original notice was issued on June 30, 2021, which was the last date under the Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act, 2020 (TOLA). Since no surviving period remained after the exclusion period, the order under Section 148A(d) passed on July 28, 2022, and the notice under Section 148 issued on July 29, 2022, were void.
On the refund claim, the Court observed that while protective assessment is recognised in law, there is no concept of ‘protective recovery’. The Revenue could not withhold the refund of Teva Israel merely because proceedings had been initiated against Teva USA, particularly when those proceedings had been stayed by the Court. Withholding the refund for over 10-15 years was, in the Court’s view, arbitrary and to the extent of being confiscatory.
On the AAR’s jurisdiction, the Court observed that the AAR had travelled beyond the contours of Chapter XIX-B of the Act. The AAR’s finding that the income belonged to Teva USA was recorded behind the back of Teva USA, which was not a party to the proceedings, and was therefore a nullity. The AAR could not determine the tax liability of a third party in proceedings that were applicant-specific and transaction-specific under Section 245S.
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The Court further observed that the AAR conflated the distinct statutory stages contemplated by sub-sections (2) and (4) of Section 245R. Once the application had been admitted in July 2015 and the AAR had, by order dated Sep 11, 2019, declined to reconsider the question of admission, the AAR could not thereafter invoke clause (iii) of the proviso to Section 245R(2) to refuse to answer the question. The AAR was required to pronounce a ruling on the question specified in the application under sub-section (4).
On the merits, the Court observed that the AAR had embarked upon a roving inquiry into the commercial wisdom of the parties, the validity of the Ready Date Notice, and the underlying US contractual controversy, matters that were beyond its expertise and jurisdiction. The AAR’s reliance on the OAG’s opinion was misplaced, as the OAG’s observations were merely an opinion expressed in the course of anti-trust proceedings and could not be elevated to a judicial finding of illegality, particularly since the parties had not admitted liability.
Briefly, the batch of petitions arises out of payments aggregating approximately Rs. 1,851 crores made by Ranbaxy Laboratories Limited (India) to Teva Pharmaceutical Industries Limited (Israel) under a settlement arrangement connected with the commercial exploitation of the generic drug Atorvastatin in the United States. The genesis of the dispute lies in two parallel Abbreviated New Drug Applications (ANDAs) filed before the US FDA. Ranbaxy USA filed first on Aug 19, 2002, and Teva USA filed later on Feb 21, 2003. Under US law, the first filer is entitled to a 180-day ‘Sole First to File Exclusivity’ (SFFE).
In 2008, the US FDA imposed an import ban on Ranbaxy’s Indian facilities on account of quality-control deficiencies, placing Ranbaxy’s pending ANDA in jeopardy. On Dec 07, 2010, Ranbaxy India, Ranbaxy USA and Teva USA entered into an agreement under which, if Ranbaxy failed to obtain FDA approval, Teva USA would step in, share 50% of its profits with Ranbaxy, and pay a USD 15 million upfront commitment fee. On Nov 23, 2011, Teva USA issued a ‘Ready Date Notice’ to Ranbaxy. Ranbaxy disputed the validity of the notice and, on Nov 30, 2011, obtained its own ANDA approval. Teva USA immediately filed a suit in the US District Court seeking specific performance. Within twenty-four hours, the parties settled the dispute and executed an Amended and Restated Agreement dated Dec 07, 2011, under which the commercial structure was flipped. Ranbaxy would now manufacture and sell the drug and pay Teva 50% of the contract margin.
Teva USA thereafter assigned its rights under the agreement to Teva Israel by a Letter of Assignment dated March 22, 2012, and Ranbaxy India remitted the payments directly from India to Teva Israel, deducting tax at source at approximately 42% under Section 195 of the Income Tax Act. The total TDS amounted to Rs. 783,83,11,687 across AYs 2012-13, 2013-14 and 2014-15.
Teva Israel filed returns in India declaring ‘Nil’ income and claimed refund of the TDS. It also moved an application before the Authority for Advance Rulings (AAR) under Section 245Q seeking a ruling that the receipt was not taxable in India. The Revenue opposed the application principally on the ground that the income belonged to Teva USA and not to Teva Israel, and that the arrangement was prima facie designed for tax avoidance. Separately, the Office of the Attorney General of the State of New York (OAG) initiated an anti-trust inquiry in 2014 into a ‘No Challenge Provision’ in the agreement, under which the parties had agreed not to challenge each other’s first-to-file exclusivity rights across multiple drugs. The OAG characterised the clause as ‘per se unlawful’ under US anti-trust law. The parties settled the OAG inquiry by paying USD 150,000 each and agreeing to drop the offending clause, without admitting liability.
The AAR, by order dated Oct 25, 2019, declined to rule on the taxability of the receipt, holding that the income belonged to Teva USA (and not to Teva Israel) and that the arrangement was prima facie designed for avoidance of income-tax under clause (iii) of the proviso to Section 245R(2). The Assessing Officer then initiated reassessment proceedings under Section 148 of the Act against Teva USA for AYs 2012-13 to 2014-15, while passing a protective assessment order in the hands of Teva Israel. Teva Israel and Teva USA jointly challenged the AAR order, whereas Teva Israel also sought refund of the TDS withheld by Ranbaxy.
