Nilay Baran Som
Additional Commissioner of Income Tax
International Taxation, Range 1, Kolkata
nilay.b.som@incometax.gov.in
Nilay Baran Som joined the Income Tax Department in the year 1990 as Inspector of Income Tax. He was inducted into the Indian Revenue Service in the year 2005. Presently , he is working as Additional Commissioner of Income Tax ( International Taxation ) Range -1, Kolkata .
Sri Som has worked in various capacities in Assessment , TDS and Head Quarters Charges and spent majority of his tenure in the Training Sector and International Taxation Charges . He has worked in West Bengal & Sikkim and Tamilnadu region. He was on deputation to the Department of Taxes, Government of Botswana , during 2002 to 2005.
Sri Som has contributed to the booklet on Royalty and Fees for Technical Services in the Taxpayer Information Series Booklet brought out by the Directorate of Income Tax (PR, PP&OL) in the year 2013 alongwith Sri SanjayKumar, IRS (Retired ), who was the then Director of International Taxation , Kolkata. He has also contributed to several of the pamphlets developed by the Directorate in the matter of non-resident taxation.
His area of interest are reading, writing and social networking .
| Executive Summary
Executive Summary: By Nilay Baran Som, Addl.CIT: This article tries to develop a working guide to the officers on the issue of payment to non-residents. The fundamental point to be examined by the Assessing Officers in connection with disallowance under section 40(a)(i) of the Income Tax Act of any payment to a non-resident is whether the sum is taxable under the provisions of the Income Tax Act or not. The next point is whether the non-resident is entitled to treaty benefit to escape source-country taxation or not. With quick reference to the relevant sections of the Income Tax Act and the relevant articles of a typical treaty, two particular expenses, viz, software payments and export commission are picked up for further analysis. A check list is also prepared for guidance of the Assessing Officers. The need for co-ordination between the Assessing Unit and the TDS Unit of International Taxation is also highlighted. |
1.1. There are a few books available in the market on the topic, ‘Finance for non-Finance Executives.’ There is also a need for similar literature on the topic, ” international taxation for non- international taxation officers” . The reason is simple, as detailed below.
1.2. The International Taxation Division, even within the Department, still today is looked at, with mixed feeling of awe and nonchalance. Across the board, it is often felt that knowledge and skill in this area of taxation, is necessary for the officers posted in the International Taxation Commissionerates only and those not posted there, can do without an iota of knowledge about International Taxation.
1.3. However, the above deep-rooted prevalent opinion is far from being true, particularly, in the context of today’s globalised world, where there is continuous cross-border flow of labour, capital and technology, almost throughout the year.
1.4. An immediate ramification of the cross-border flow referred to above is that the scrutiny or audit of the cases of resident assessees in India , have more cross border issues than before, apart from the transfer pricing issues. While the Transfer Pricing Officer takes care of transfer pricing issues , other issues, like examination of deductibility of an expenditure claim of a resident taxpayer, claim of a foreign tax credit by a taxpayer, will have to be taken up by the jurisdictional Assessing Officer only. Another recent development is the requirement of enhanced cooperation at the bilateral and multilateral levels, because of several action agenda of the OECD in the context of Base Erosion and Profit Splitting (BEPS). In this scenario, officers willy nilly will require some knowledge about Exchange of Information (EOI) mechanism. Although EOI as such is not a part of international taxation, attending EOI related work requires some idea about the tax treaties and international tax practices. Several information leaks which have come to the public domain also have repercussions on the bucket list of work of a few officers at the operations level.
1.5. This article will focus on the limited issue of allowance /disallowance of expenses under section 40(a) (i) of the Income Tax Act, 1961 ( hereafter, referred to as the Act, wherever considered appropriate ) and how the Assessing Officers may address the issue correctly, which is discussed at length next.
1.6. Payment to Non-residents
1.6.1. The Assessing Officers dealing with the corporate as well as non-corporate business cases often come across cases where payments are made to non-residents without deduction of tax at source. While sometimes, officers do justice to such cases by looking at both the legality of the non-deduction as well as genuineness of such payments, in many cases, these aspects either are not investigated at all or position of the taxpayer accepted without proper examination. Sometimes, the position of the taxpayer is summarily dismissed with much bravado, by simply disallowing such claim u/s 40(a)(i) of the Income Tax Act, 1961, ‘since tax is not deducted at source.’
1.6.2. None of the above positions as mentioned in preceding paragraph is an aid to fair examination of the issue involved. Rather, it is necessary that the Assessing Officer examine the issues from both aspects, factual details as well as legal perspective; so that any addition made in this regard is sustainable. For this, a proper understanding of section 195 and section 40(a)(i) of the Income Tax Act, 1961, is necessary. This apart, it will be of help if the officer develops the confidence to look at relevant provisions of Double Taxation Avoidance Agreement, if any argument is advanced by the taxpayer in support of the remittance/ booking of expenditure without deduction of tax.
1.6.3. In this context, it may be mentioned that section 195 of the Income Tax Act as amended by Finance Act, 2012 makes it obligatory on the part of persons making payment to non residents to deduct tax at source, if such payment constitutes income of the non-resident. To elaborate further, explanation 2 below section 195 of the Act stipulates the obligation to deduct tax at source from any payment comprising sum chargeable under the provisions of the Income Tax Act, 1961, whether or not the non-resident has any residence or place of business or business connection in India or has any other business, in any manner whatsoever in India. While the background for inserting this amendment cannot be discussed within the limited scope of this article, it is necessary to appreciate that the above explanation does not call for deduction of tax at source from each and every payment made to a non-resident. It is important to note that the obligation to deduct tax at source from the payment to a non-resident arises only if the payment is otherwise ‘a sum chargeable to tax under Income Tax Act, 1961’. Interested readers may refer to the ruling of the Honourbale Supreme Court in the case of GE India Technology Centre Private Limited versus CIT [2010] 327ITR 56, to appreciate full implications of the obligation under section195.
1.6.4. At this juncture, it is pertinent to consider the rules of taxation of various categories of income that are generally encountered, as per the provisions of the Act. Generally speaking, out of the various possible payments that a non-resident can receive from a resident taxpayer, i.e., interest, royalty, fees for technical services are tax deductible at source. The applicable rate of deduction is the rate specified by the Act or the Treaty, whichever is beneficial to the non-resident.
1.6.5. Payments on account of transfer of immovable property are generally tax deductible at source at the state where the property is located. However, such payments on capital account will not figure in any claim for deduction under section 40(a) (i) of the Act.
1.6.6. On the other hand, payments in the nature of business income in the hands of non-resident cannot be taxed unless the non-resident assessee has a business connection in India. The idea of business connection appears in section 9(1) (i) of the Income Tax Act. Existence of business connection is a sine qua non for the business of the non-resident to be taxable in India. Further, even if it is possible to establish a business connection, the non-resident may take shelter of the treaty that no business income can be brought to tax in India, since in treaty terms, there is no ‘Permanent Establishment’ of the non-resident in India.
1.6.7. While the above assertions may appear to be aphoristic statements, they are not so really. The basis of the above statement is discussed in the following sub-paragraphs.
1.6.8. Payments in the nature of interest, royalty and fees for technical services are guided by the source rule. Sections 9(1) (v); 9 (1) (vi) and 9(1) (vii) of the Income Tax Act, 1961,respectively provide that interest, royalty and fees from technical services are taxable in India if the payment is made from India ( source country). Generally, the treaties also provide the source country the right to tax such payments albeit at a concessional rate. Interest, Royalty and Fees for technical services generally are covered under Articles 11 and 12 of a typical treaty.
1.6.9. As already stated, for business income the requirement of the section 9(1)(i) of the Act, is that there should be a business connection of the non-resident in India. The treaty requirement as per Article-7 of most of the treaties is that income of the non-resident in the source country can be held as taxable if there is a Permanent Establishment (PE) of the non-resident assessee in that country. The simplest form of PE, as defined in Article 5 of a typical tax treaty, is a fixed place of business in the source country from which the business of the non-resident is carried on.
1.7. The sum and substance of the above discussion is that, it is comparatively easy to deal with cases of interest, royalty and fees from technical services, if the payment can be identified to be of the above category. Even for the purpose of identification or categorisation of income, the Assessing Officer should collect all factual details, such as, particulars of the non -resident parties involved, copies of agreements, if any, copy of invoices etc.
1.8. Even within the boundary of such easier transactions, difficulties may arise sometimes. A typical example may be given in respect of Fees for Technical Services (FTS).The payment to non-resident may be within the realm of the definition of FTS as per the Domestic Act. However, the assessee may advance an argument that the payment is not so as the ‘technology has not been ‘made available’ to it by the non -resident assessee.
1.9. To understand what is meant by ‘technology made available’, as a thumb’s rule , it may be stated that technology is made available when, after the service is provided by the non-resident, the recipient party can in future apply the technology on its own, without external help from the provider. If such a problem is encountered, the Assessing Officer has to carefully examine both the legal and factual aspects of the issue and the judicial precedence, before allowing such claim of the taxpayer. To further appreciate the phrase ‘make available’ interested readers may go through the text of the protocol to the India -USA DTAA, where the concept has been explained with illustrations.
1.10. It is similarly difficult to make a disallowance of a payment to a non-resident if the sum payable is in the nature of business income of the non-resident and the assessee claims that the non -resident does not have a permanent establishment in India . However, it is also imperative on the part of the Assessing Officer to carefully examine the transaction and find out whether it is really business income of the assessee or the income falls within any other category like royalty or FTS. In addition, the Assessing Officer should also examine whether the contention of the assessee is in line with the stated stand of the department in respect of similar transactions.
2.0. With this background, two items of expenditure claims are discussed below which may be of help to the Assessing Officers.
2.1.1. Software related payments: The Income Tax Act, section 9(1) (vi) , Explanation 2 and 4 squarely deal with the issue in as much as any payment by a resident taxpayer to a non resident as software license fee and the like is categorised as royalty. The assessees, on the other hand, claim that such payments are nothing but business income of the non- resident and therefore, not tax deductible in absence of a permanent establishment of the non-resident and further that, the payment does not fit in to the treaty definition of royalty.
2.1.2. Be that may as it, it is first to be acknowledged that the issue is a debatable one. There are a few cases in support of the stand that the payment is nature of royalty while there are contrary rulings also. While the issue is pending before the Honourble Supreme Court for adjudication, a few rulings for and against the department is juxtaposed below.
2.1.3. Therefore, before accepting any submissions based on plethora of judgments in favour of the assessee on the issue of software, the Assessing Officers must take note the views of the Honourable Karnataka High Court in the below cases.
2.1.4. The Assessing Officers should also be on guard before being swayed by the submissions made by the taxpayer quoting from the OECD commentary. The OECD commentary on Article 12 highlights that software license payments have nothing to do with transfer of copyright and it is just a sale of a copyrighted article. It is to be remembered that the concepts of copyright vis a vis copyrighted article is alien to the Income Tax Act, 1961, the
| SI No | Rulings holding such payment as royalty | Rulings holding such payment as not royalty |
| 1 | CIT vs Samsung Electronic Company Ltd & Others [2012] 345 ITR 494(Kar) | Commissioner of Income Tax Vs. Dynamic Vertical Software India (P) ltd. [2011]332 ITR 222 (Del) |
| 2 | Synopsis International Old Ltd. [2012](212 Taxman 454) (Kar) | Director of Income tax vs. Infrasoft Ltd. [2014] 220 Taxman 273 (Del) |
Double Taxation Avoidance Agreements and the Indian Copyright Act, 1957. The above concept has only been floated by the OECD commentary which is not binding on the Indian Tax Authorities. Moreover, India has officially expressed its reservation on many a position on the OECD commentary on royalty including the view on royalty (2017 Update to the OECD Model Tax Convention,pp 639).
2.2.1. Export Commission: This is an area where the Assessing Officer has to tread very carefully.
2.2.2. The Central Board of Direct Taxes, (CBDT) had issued a circular (Circular No 786 dated, the 7th February 2000) regarding taxability of export commission and liability of TDS thereon under section 195 of the Act. In that circular, it was generally held that no tax is required to be deducted from such commission. However, subsequently, the Board has withdrawn the above circular by issuing another Circular, viz, Circular no 7 dated, the 20th July 2009. The reason cited for the withdrawal of the earlier circular was its misuse by some taxpayers.
2.2.3. Now, the question is what is the implication of the withdrawal of the earlier circular of 2000. Does it imply that the Board is of the view that such commission is always tax deductible? The answer is an emphatic ‘no’. One has to remember that in the first place, for tax to be deductible, the sum must be an income of the non-resident accruing/arising in India or deemed to have accruing and arising in India, In many cases , it will be seen that such commission is merely a business income of the export agent and he does not have any Permanent Establishment in India for that business income to be taxable.
2.2.4. In some of the cases however, based on facts and circumstances, the Assessing Officer may find that the commission agent has rendered technical, managerial or consultancy services and the commission is actually in the nature of fees for technical services. However, for arriving at such a conclusion, the Assessing Officer has to gather sufficient evidences such as , the copy of agreement between the exporter and the agent, documentation regarding how the services were rendered, copy of invoices and nature of services mentioned therein, e-mail correspondences etc. If the export agent is a tax resident of a DTAA Country, again it has to be tested, whether the definition of FTS as per the Act also fits in, to the definition of FTS as per the DTAA. The decision of the Delhi High Court in the case of Havel’s India Ltd reported in (2013) 352ITR 376 may be of help to the officers.
2.2.5. The above discussion is made with the presumption that the commission incurred is a genuine one. However, if the finding of fact leads to an inference that the commission is bogus one, the issue of tax deduction under section 40(a) (i) of the Act will take a back seat and the officer will investigate the case from the angle of section 37(1) of the Act.
3.0. Further complications may arise when the taxpayer, in support of non-deduction of tax at source under section 195, may cite existence of ‘Most Favoured Nation (MFN) clause of the treaty and pleads for its automatic application in the case of the assessee. It may also site a few case laws in its support Discussion on such claims based on the MFN Clause is outside the scope of this otherwise basic article. Still in a nutshell, it may be stated that the MFN Clause is present in some of the Double Taxation Avoidance Agreements of India. The MFN Clause tries to ensure that if one of the treaty partners, enters into an agreement with some other state where, in that agreement, under similar circumstances, the other state enjoys some benefits not available in the treaty between the first two states, the other treaty partner of the first treaty, will automatically be eligible to the similar treatment . In this context, it may be mentioned that the revenue favourable ruling of the AAR denying automatic application of the MFN Clause has been reversed by the Honourable Delhi High Court. In other words, decision in the case of Steria (India ) Limited reported in 364 ITR 381 (AAR) has been overruled in the Writ case filed against the ruling. The judgement of the Delhi High Court [Steria India Limited versus DCIT reported in [2016] 386 ITR 390 ( Delhi ) is in favour of the assessee. Many tribunals are following the Delhi High Court Ruling. However, if any Assessing Officer comes across any such claim, alarm bells should ring and he should remember that the issue is pending before the Honourable Apex Court.
4.0. Before winding up this article, it may be reiterated that even after thorough legal and factual analysis of the case, the Assessing Officer may find that the assessee is really entitled to a benefit under the treaty, either on the point of taxability or on the point of rates. For establishing entitlement of treaty benefit, the payer assessee must demonstrate that it is in possession of the tax residency certificate of the non-resident. However, before conferring any benefit the Assessing Officer should be prudent enough to find out how the issue had been dealt with in the earlier years and at what forum the same is pending.
5.0. Further, the Assessing Officer should also check, whether tax can be correctly deducted, where the same has been treated as taxable by the assessee itself. In this connection, it will of help to the Assessing Officer if he prepares a flow -chart based on the following points or tests, as given below :
I. Whether the amount comprise sum chargeable to tax;
ii. If answer is yes, is the non-resident from a state which is a treaty partner?
iii. If yes, whether non-resident has tax residency certificate?
iv. If the answer is yes, whether the non-resident has obtained PAN?
v. If the answer is yes, the tax rate as per the treaty or as per the Act, whichever is less, is the applicable rate.
vi. If the answer to the question no (iv) above is no, whether the sum is in the nature of interest, royalty or FTS?
vii. If the answer is yes, whether the payer is in possession of details as specified Rule 37BC of the Income Tax Rules, 1962?
viii. If the answer is yes, the tax rate as per the treaty or as per the Act, whichever is less, is the applicable rate.
ix. If the answer is no, the maximum marginal rate as per the provisions of section 206AA of the Income Tax Act is the applicable rate.
x. If the answer to the question no (ii) is no, the provisions of the Act will follow and the tax rate will depend on whether the payee has PAN or not.
6.0. To conclude, the Assessing Officers are advised to share any instance of non -deduction of tax where the same was deductible to the notice of the officer in charge of non-resident TDS in the International Taxation Commissionerate. On the basis of such inputs, the Assessing Officer (TDS), International Taxation may initiate proceedings under section 201of the Act. It is expected that in near future, there will be system- driven protocols to share such data between the Assessing Officer and the TDS officer so that appropriate and timely action from all possible angles can be taken by the department timely.
References:
1. Web reference: 2017 Update to the OECD Model Tax Convention [www.oecd.org/ctp/treches/2017-update-model-tax–convention.pdf accessed on 28.04.2019]
2 Taxpayer Information Series Booklet Series 44 :Royalty and Fees for Technical Services, Published by Directorate of Income Tax [PR,PP&OL] Authors : Shri Sanjay Kumar ,Former DIT, International Taxation Kolkata and Shri Nilay Baran Som , Former DDIT(Trg), D.T.R.T.I, Kolkata . [ Sections of the Income Tax Act:9 (1)(i); 9 (1)(v); 9 (1)(vi); 9 (1)(vii); Section 40(a)(i), Section 195, Section 201 and Section 206AA of the Income Tax Act,1961].
Source- CBDT Taxalogue Magazine Jul – Oct 19 | Volume 1 | Issue 1
