Of late, it has been observed that with the growth of the economy of the country the number of transactions of the tax-payers in India with non-residents have been increasing. Such transactions may relate to supply of plant and machinery from abroad, technology transfers, provision of technical and consultancy services by non-residents, etc. In respect of all the sums payable to non-residents, for the purpose of the aforesaid transactions, tax is required to be deducted at source under Chapter XVII-B of the Income-Tax Act, 1961 (the Act).
Section 195 (S., for short) of the Act, which falls under Chapter XVII-B, casts a duty upon a person to deduct tax at source on payments to non-residents or foreign companies, but such payments must be chargeable to tax under the provisions of the Act. In this context, therefore, it becomes an important issue as to what types of payments fall within the purview of the provisions of S.195 of the Act. There may be certain payments which are not liable to tax in India on the basis of the relevant provisions of the Act, viz. sections 5(2), 9(1), 115A, etc. If the aforesaid payments are not liable to tax under the provisions of the Act, the matter ends there and no tax is required to be deducted at source in respect of such payments. However, if such payments are liable to tax under the Act, then one has to examine the provisions of the Double Taxation Avoidance Agreement (DTAA) between India and the country of residence of the non-resident. There may be a number of payments which may not be liable to tax in India in view of the provisions of the relevant tax-treaty between India and the country of residence of the non-resident.
A tax-payer making payments to non-residents, faces a number of difficulties and ambiguities while deciding whether tax is to be withheld in respect of such payments under the provisions of S.195 of the Act. The scope of this article is only to deal with the issue as to whether such payments are liable to tax in India. In order to ascertain whether such payments are liable to tax in India, we will have to deal with the relevant provisions of the Act. The same are discussed as follows:-
I] Section 195 – TDS from other sums
For our purpose S.195(1) is relevant and the same is reproduced as follows:-
Other sums
195. (1) Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest or any other sum chargeable under the provisions of this Act (not being income chargeable under the head “Salaries”) shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force :
Provided that in the case of interest payable by the Government or a public sector bank within the meaning of clause (23D) of section 10 or a public financial institution within the meaning of that clause, deduction of tax shall be made only at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode :
Provided further that no such deduction shall be made in respect of any dividends referred to in section 115-O.
From the aforesaid provisions of S.195(1), it may be seen that any person responsible for paying to a non-resident, including a foreign company, any interest or any other sum chargeable under the provisions of the Act, except income from ‘Salaries’, shall deduct income-tax thereon, at the rates in force.
In other words, deduction of tax at source, is required to be made only if the payment is chargeable to tax in India.
In order to examine whether a certain payment to a non-resident entity is chargeable to tax in India, we will have to examine the provisions of S.5(2) of the Act.
II] Section 5 – Scope of total income
For our purpose, provisions of S.5(2) of the Act are relevant. The same are reproduced as follows:-
5. (1) ..
(2) Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which—
(a) is received or is deemed to be received in India in such year by or on behalf of such person ; or
(b) accrues or arises or is deemed to accrue or arise to him in India during such year.
Explanation 1.—Income accruing or arising outside India shall not be deemed to be received in India within the meaning of this section by reason only of the fact that it is taken into account in a balance sheet prepared in India.
Explanation 2.—For the removal of doubts, it is hereby declared that income which has been included in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to him shall not again be so included on the basis that it is received or deemed to be received by him in India.
From the aforesaid provisions of S.5(2), it may be seen that the income of a person who is a non-resident, includes income from whatever source derived, which- (a)is received or deemed to be received in India in such year by or on behalf of such person; or (b)accrues or arises or is deemed to accrue or arise in India during such year. As regards receipt of income, it has to be contrasted with remittance. It may be understood here that all direct first receipt of income in India will be taxable in respect of all the tax-payers whether resident or non-resident in India. Even for non-residents, it will be treated as Indian income liable to tax, if received in India, though accrued outside India. However, the income first received abroad but remitted to India, cannot be taxable on receipt basis, unless it is otherwise taxable. For example, foreign pension directly received in India will be taxed as a receipt in India; but a sum credited to a bank account abroad and remitted to India thereafter, does not amount to income received in India.
As regards deemed receipt, this charge is applicable to all assessees irrespective of their residential status, even as charge on ‘actual receipt’ basis is applicable to both residents and non-residents. It is by virtue of fictional deeming that the sums in question are treated as income or treated as receipts in India. One of the examples of such fictional receipt is S.7(i) – annual accretions in the previous year to the balance of an employee in a recognized provident fund. The other example may be any sum received or benefit obtained under section 41(1) of the Act.
As regards receipt of income, such income will naturally be received by a non-resident in a place outside India. Therefore, any such payment to a non-resident outside India will not fall under clause (a) of S.5(2) of the Act.
We will now deal with the provisions of clause (b) of Section 5(2) of the Act.
The first limb of the aforesaid clause (b) relates to accrual or arisal of income. The place of accrual or arisal of income is the place where the right to receive that income accrues or arises in respect of any payment made to a non-resident. Ordinarily the right to receive the same by a non-resident accrues or arises outside India. Therefore, the same will not be liable to tax in India.
Now we will have to deal with ‘Income deemed to accrue or arise in India’. For this purpose, we will have to examine the provisions of s.9 of the Act.
III] Section 9 – Income deemed to accrue or arise in India
In the light of the discussion in the preceding para (II), the most relevant aspect in the present context will be to understand the meaning assigned to the term, ‘Income deemed to accrue or arise in India’.
As for deemed income for non-residents, this has lead to considerable controversy where a part of the activities are in India and other part of the activities extends to some foreign country.
The actual accrual of income is different from deemed accrual. The concept of actual accrual or arisal of income in the taxable territories, although not dependent upon the receipt of the income in the taxable territories, is quite distinct and apart from the notion of deemed accrual or arisal of the income – Carborundum Co. Vs. CIT [1977] 108 ITR 335 (S.C.).
The term ‘deemed’ involves a number of concepts like place, person and year. It brings within the net of chargeability of income not actually accruing but which is supposed notionally to have accrued. It involves a number of concepts. By statutory fiction, income which can in no sense be said to accrue, at all, may be considered as so accruing. Similarly, the fiction may relate to the place, person or be in respect of the year of taxability – CIT / CEPT Vs. Bhogilal Laherchand [1954] 25 ITR 50 (S.C.).
Under section 9, a number of incomes are deemed to accrue or arise in India. The same may be enumerated as follows:-
- Income accruing or arising through business connection, etc.- S.9(1)(i).
- Income which falls under the head salaries, if it is earned in India- S.9(1)(ii).
- Income chargeable under the head ‘Salaries’ payable by the Government-S.9(1)(iii).
- Dividends paid by an Indian Company outside India – S.9(1)(iv).
- Income by way of interest- S.9(1)(v).
- Income by way of royalty – S.9(1)(vi), and
- Income by way of fees for technical services – S.9(1)(vii).
Thus, whether an income is deemed to accrue or arise in India, is to be examined in the light of the provisions of clauses (i) to (vii) of section 9(1) of the Act.
In the present context, the following items of income are relevant:-
(a) Income accruing or arising through business connection, etc. – S.9(1)(i)
(b) Income by way of royalty – S.9(1)(vi), and
(c) Income by way of fees for technical services – S.9 (1)(vii).
The aforesaid items of income are discussed in little more detail, as follows:-
- Income accruing or arising through business connection, etc. – Section 9(1)(i)
The instances of such deemed income as per S.9(1)(i), are as follows:-
- Income arising directly or indirectly from business connection;
- Income from property
- Income from any asset or source of income in India, and
- Transfer of capital asset situated in India.
‘Business connection’, is a concept which has given rise to considerable litigation. Mutual interest, rather than mere common interest may constitute business connection. However, transactions between principal to principal and those at arm’s length would not constitute business connection. Besides, mere continuous dealing without relationship, creating obligation on each other, would not constitute business relationship. In this context, the following two judgements are very relevant.
(a) CIT Vs. R.D. Agarwal & Co. [1965] 56 ITR 20 (S.C.), and
(b) Carborundum Co. Vs. CIT [1977] 108 ITR 335 (S.C.)
Recently, the Apex Court has rendered a landmark judgement in the case of Ishikawajima-Harima Heavy Industries Ltd. Vs. DIT [2007] 288 ITR 408 (S.C.). It has been, inter alia, held in this case that S.9 of the Income-Tax Act, 1961, raises a legal fiction and while dealing with a taxation statue, the legal fiction must be construed having regard to the object it seeks to achieve. Further, the legal fiction created under S.9 must also be read having regarding to the other provisions of the Act.
2. Income by way of royalty – S.9(1)(vi)
S.9(1)(vi) would assume that all payments of royalty accrue or arise in India. Such assumption, when treated as a statutory stipulation does not permit the non-resident to argue that no part of the services is rendered in India and that, therefore, nothing should be taxable in India. Such an argument in respect of royalty would not even otherwise be tenable as the very concept of royalty assumes the nature of rent for use of the property.
Under clause (vi) of S.9(1), income by way of royalty payable by Government or a person who is a ‘Resident’, except where the royalty is payable by the Government in respect of any right, property or information used for services utilized for the purposes of a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India, shall be deemed to accrue or arise in India. This clause in its main part deals with the circumstances in which income by way of royalty can be deemed to accrue or arise in India.
As per Explanation 2 to S.9(1)(vi), for the purposes of this particular clause ‘royalty’, means consideration including any lumpsum consideration [but excluding any consideration which would be income of the recipient chargeable under the head ‘Capital gains’,] for- (i) the transfer of all or any rights (including the granting of licence) in respect of a patent, invention, model, design, secret formula or process or trademark or similar property; (ii) the imparting of any information concerning the working of or the use of, a patent, invention, model, design, secret formula or process or trademark or similar property etc. When the right of exploitation is given by the owner of the secret processes, patents, special inventions, etc. to a third party instead of outright sale, then, for the right to exploit these inventions, secret processes, etc. some amount may be paid and the amount paid may be co-related to the extent of the exploitation. Such payments are royalties, even though termed something else and would be deemed to accrue or arise in India. As an example lease rent payable for the use of a transponder located abroad for relay of programmes in Indian channels should give rise to royalty taxable in India.
3. Income by way of fees for technical services – Section 9(1)(vii)
Under clause (vii) of S.9(1), income by way of fees for technical services payable by the Government or a person who is a resident, except where the fees are payable in respect of services utilized in a business or profession carried on by such person outside India, or for the purposes of making or earning any income from any source outside India, is deemed to accrue or arise in India. Explanation 2 to S.9(1)(vii) provides that for the purpose of clause (vii), ‘fees for technical services’ means any consideration (including any lumpsum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient on consideration which would be income of the recipient chargeable under the head ‘salaries’. The question whether the payment would come within the aforesaid exclusion or not would have to be established by the person who claims such exclusion.
Besides, fees paid for the mere rendering of technical or consultancy services is not sufficient to attract the definition and it is further necessary that the rendering of such services should result in the ‘making available’, to the resident assessee, technical knowledge, experience, etc., which it can use in its business – Lufthansa Cargo India Pvt. Ltd. Vs. Dy.CIT [2004] 91 ITD 133 (Del.):[2005] 92 TTJ 837(Del.).
So far, it is a well understood position as regards the provisions of S.9(1)(vii) that if the technical services are utilized in India, then the fees payable for the same, would be liable to tax in India irrespective of the fact that such services are rendered outside India.
However, in a recent landmark judgement in the case of Ishikawajima-Harima Heavy Industries Ltd. Vs. DIT [2007] 288 ITR 408 (S.C.), the Hon.Supreme Court has totally reversed the aforesaid legal position in relation to the provisions of S.9(1)(vii) of the Act. It has been clearly held by the Apex Court that S.9(1)(vii) envisages the fulfilment of two conditions in respect of the services which are the source of income sought to be taxed in India, viz.:- (i) such services are utilized in India, and (ii) such services are also rendered in India. In other words, both these conditions have to be satisfied simultaneously.
The aforesaid judgement of the Apex Court has changed a number of normally accepted views about the ‘Income deemed to accrue or arise in India’, as provided under S.9 of the Act.
IV] A landmark judgement of the Apex Court relating to the provisions of Section 9 of the Income-Tax Act, 1961
Recently, the Supreme Court has rendered a landmark judgement, dated 4.1.2007, in the case of Ishikawajima-Harima Heavy Industries Ltd. Vs. DIT [2007] 288 ITR 408 (S.C.).
The Supreme Court has thrown new light in respect of the meanings of the terms ‘Business connection’ and ‘Permanent establishment’. The Apex Court has provided a totally different interpretation regarding the tax-treatment of fees for technical services, as per the provisions of S.9 (1)(vii) of the Act. The Apex Court has also provided some other valuable insights as regards the provisions of Double Taxation Avoidance Agreement (DTAA), particularly the DTAA between India and Japan.
The aforesaid company provided services to persons resident in India. It is a non-resident company incorporated in Japan. It formed a consortium along with five other enterprises. The consortium was awarded by Petronet a turnkey project for setting-up a liquefied natural gas (LNG) receiving, storage and re-gasification facility in Gujarat. The aforesaid company was to develop, design, engineer, procure equipment, materials and supplies to erect and construct storage tank including marine facility (jetty and island breakwater) for transmission and supply of LNG to purchasers, to test and commission the facilities, etc. The contract involved: (i) off-shore supply, (ii) off-shore services, (iii) on-shore supply, (iv) on-shore services and (v) construction and erection.
In the aforesaid judgement, the Supreme Court has considered in detail the provisions of Ss.5(2) and 9(1) of the Act and also the provisions of DTAA between India and Japan. The significant part of the aforesaid judgement may be briefly summarized as follows:-
1. The provisions of S.9(1)(vii) of the Act, relating to fees for technical services, must be read with S.5, thereof, which takes within its purview the territorial nexus on the basis whereof tax is required to be levied, namely (a) resident; and (b) receipt or accrual of income.
What is relevant is receipt or accrual of income as would be evident from a plain reading of S.5(2) of the Act. In a case of this nature, interpretation with reference to the nexus to tax territories will assume significance. Territorial nexus for the purpose of determining the tax liability is an internationally accepted principle. It may, therefore, not be possible to give an extended meaning to the words, ‘Income deemed to accrue or arise in India’, as expressed in S.9 of the Act.
Whatever is payable by a resident to a non-resident by way of fees for technical services, thus, would not always come within the purview of S.9(1)(vii) of the Act. It must have sufficient territorial nexus with India so as to furnish a basis for imposition of tax. Whereas a resident would come within the purview of S.9(1)(vii) of the Act, a non-resident would not, as services of a non-resident to a resident utilized in India may not have much relevance in determining whether the income of the non-resident accrues or arises in India. It must have a direct live link between the services rendered in India. When such a link is established, the same may again be subjected to any relief under the DTAA. A distinction may also be made between rendition of services and utilization thereof.
It is evident that S.9(1)(vii), read in its plain language, envisages the fulfilment of two conditions: services which are source of income sought to be taxed in India must be (i) utilized in India, and (ii) rendered in India. In the present case, both these conditions have not been satisfied simultaneously.
So far, the normally accepted view in this regard has been that if the technical or consultancy services in the context of S.9(1)(vii) of the Act, are utilized in India, then the same are liable to tax in India, irrespective of the place where such services are rendered. Thus, such services are considered to be liable to tax in India, even if they are rendered outside India.
The Apex Court has totally reversed the aforesaid view and has clearly held that in the context of S.9(1)(vii), fulfilment of two conditions is envisaged. The services which are source of income sought to be taxed in India must be utilized in India and also rendered in India. Both the aforesaid conditions must be satisfied simultaneously.
Therefore, if the technical or consultancy services, though utilized in India, are rendered outside India, the same will not be liable to tax in India within the provisions of S.9(1)(vii) of the Act.
2. The fact that the contract was signed in India is of no material consequence, since all the activities in connection with the off-shore supply were outside India and therefore, cannot be deemed to accrue or arise in India. So far, the Income-Tax Department has been clinging to the view that if a contract is signed in India, then the income generated in India as a result thereof, will be liable to tax in India.
3. There exists a distinction between a business connection and a permanent establishment. As the permanent establishment cannot be said to be involved in the transaction, the aforementioned provision will have no application. The permanent establishment cannot be equated to a business connection, since the former is for the purpose of assessment of income of a non-resident under a Double Taxation Avoidance Agreement, and the latter is for the application of S.9 of the Income-Tax Act.
4. Once a transaction is excluded from the scope of taxation under the Income-Tax Act, application of the provisions of DTAA would not arise.
5. Sufficient territorial nexus between the rendition of services and territorial limits of India is necessary to make the income taxable in India.
6. The location of the source of income within India would not render sufficient nexus to tax the income from that source.
7. The existence of permanent establishment would not constitute sufficient ‘Business connection’ and the permanent establishment would be the taxable entity. The fiscal jurisdiction of a country would not extend to taxing the entire income attributable to the permanent establishment. There exists a difference between the existence of a business connection and the income accruing or arising out of such business connection.
8. A legal fiction in a taxing statute should be construed on the basis of the object sought to be achieved.
The aforesaid judgement also covers a number of other issues connected with the issue of tax-liability of non-residents in India. Therefore, the same will always prove useful while ascertaining a tax-liability of a non-resident in India.
V] Agreement with foreign countries – Section 90 of the Income-Tax Act, 1961
In order to ascertain as to whether a certain sum payable to a non-resident entity is chargeable to tax in India, we have to examine the provisions of Ss.5(2), 9 and 115A of the Act. If such sum is not chargeable to tax in India, matter ends there and accordingly, no tax will be required to be deducted at source under section 195 of the Act in respect of the payment of such sum. However, if such a sum is found to be chargeable to tax in India, then it has to be examined whether the same is entitled to any relief under the provisions of the relevant DTAA between India and the country of residence of the non-resident entity.
In this context, we have to refer to the provisions of S.90 of the Act.
For our purpose sections 90 (1) and 90 (2) are relevant and the same are reproduced as follows:-
Agreement with foreign countries.
90.
(1) The Central Government may enter into an agreement with the Government of any country outside India—
(a) for the granting of relief in respect of—
(i) income on which have been paid both income-tax under this Act and income-tax in that country; or
(ii)income-tax chargeable under this Act and under the corresponding law in force in that country to promote mutual economic relations, trade and investment, or]
(b) for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country, or
(c) for exchange of information for the prevention of evasion or avoidance of income-tax chargeable under this Act or under the corresponding law in force in that country, or investigation of cases of such evasion or avoidance, or
(d) for recovery of income-tax under this Act and under the corresponding law in force in that country, and may, by notification in the Official Gazette, make such provisions as may be necessary for implementing the agreement.
(2) Where the Central Government has entered into an agreement with the Government of any country outside India under sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee.
From the provisions of aforesaid section 90 (2), it may be seen that an assessee to whom a Double Taxation Avoidance Agreement (DTAA) applies, has got a choice to be assessed in respect of his income, either under the provisions of the Act or the provisions of the DTAA.
In this regard, we may refer to Circular No.728, dated 30.10.1995 of the CBDT. The same is reproduced as follows:-
It is hereby clarified that in view of the provisions of sub-section (2) of section 90 of the Act, in the case of a remittance to a country with which a Double Taxation Avoidance Agreement is in force the tax should be deducted at the rate provided in the Finance Act of the relevant year or the rate provided in the DTAA, whichever is more beneficial to the assessee.
VI] Reimbursement of expenses to a non-resident entity
At times, an Indian entity reimburses a foreign entity in respect of certain expenses incurred by the foreign entity on behalf of the Indian entity.
It is a general impression that no tax is required to be deducted at source in respect of such reimbursements. However, this impression is not correct.
In this regard, the best criterion is to presume as if the payment to the ultimate party has been made by the Indian entity itself and then examine whether tax is required to be deducted at source in respect of such payments. If the answer is Yes, then tax is required to be deducted at source from the reimbursement also.
VII] Other provisions of S.195 of the Act
In the present context, it may be appropriate to discuss some of the relevant provisions relating to S.195 of the Act. The same are discussed as follows:-
1. Section 195(2)
Under the provisions of S.195(2), where the person responsible for paying any such sum chargeable under the Act to a non-resident, considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make an application to the AO to determine the appropriate proportion of such sum so chargeable and upon such determination he shall deduct the tax at source, accordingly.
2. Section 195(3)
Under the provisions of S.195(3),any person entitled to receive any interest or other sum on which income-tax has to be deducted under section 195(1), may make an application in the prescribed form to the AO for the grant of a certificate authorizing him to receive such interest or other sum without deduction of tax at source and where any such certificate is granted, every person responsible for paying such interest or other sum to such person, may make the payment of the same without deduction of tax thereon, under S.195(1) of the Act.
3. Grossing-up of the sum where tax is to be borne by the payer
Where the amount payable to a non-resident is net tax or in other words where the tax payable by the non-resident is borne by the person making the payment, the income chargeable to tax in the hands of the recipient is determined by grossing-up the net tax payment to such an amount as would after deducting the tax on such gross amount leave the stipulated net amount of income.
Accordingly, the sum chargeable to tax in the hands of the non-resident would be the grossed-up amount and it is with reference to this grossed-up amount that tax has to be deducted under the provisions of S.195 of the Act.
In this connection, Board’s Circular No.155, dated, 21.12.1974: [1975] 98 ITR (St.) 110, may be referred to.
4. Refund of tax to the payer in case of excess or erroneous deduction of tax at source under section 195 of the Act
There may be cases where after deduction of tax at source under S.195:
- The contract is cancelled or no remittance is required to be made to a foreign entity.
- The remittance is duly made to the foreign entity, but the contract is cancelled and the foreign entity returns such remittance to the tax-deductor.
- The tax deducted at source is found to be in excess of the tax deductible for any other reason
Or
The tax is deducted at source under S.195 and paid in one assessment year and remittance to the foreign entity is made and / or returned to the Indian entity following cancellation of the contract in another assessment year.
In all the aforesaid cases, where either the income does not accrue to the non-resident entity or excess tax has been deducted, thereby resulting in a refund being due to the Indian entity / enterprise which deposited the tax, a refund can be issued, if a valid claim is made by filing a return.
In this regard, Circular No.769, dated 6.8.1999 issued by the Central Board of Direct Taxes (CBDT) may be referred to.
VIII] Conclusion
All the relevant provisions of the Income-Tax Act, 1961, including the relevant Circulars of the CBDT and legal precedents have been discussed in the preceding pars in detail.
An Indian entity responsible for paying any interest or any other sum to a foreign entity, may refer to the aforesaid discussion in order to ascertain whether the interest or other sum payable to the foreign entity is chargeable to tax in India. If such interest or other sum is not chargeable to tax in India, then the matter ends there and accordingly, no tax would be required to be deducted at source from the aforesaid payments.
However, if the aforesaid payment is chargeable to tax in India, then we should examine the provisions of the DTAA between India and the country of residence of the non-resident, in order to ascertain whether any relief is available to the foreign entity under the DTAA and then the tax is to be deducted at source, accordingly.
In this context, the provisions of S.90(2) of the Act, are to be kept in view, as the same provide a choice to a non-resident either to be assessed under the provisions of Indian Income-Tax Act or the relevant DTAA, whichever is more beneficial to him. An Indian entity responsible for deduction of tax at source under S.195(1) of the Act, may refer to the aforesaid discussion, while ascertaining the deductibility of the tax at source thereunder.
Author Details-
Mr. S. K. TYAGI, M.Sc., LL.B., Advocate, Ex-Indian Revenue Service and Income-Tax Advisor
Office Address– Flat No.2, (First Floor), Gurudatta Avenue, Popular Heights Road, Koregaon Park, PUNE – 411 001, Phone Office: 0212-633012, Residence Phone -0212-682032, 0212-682444
