ca. divakar vijayasarathy. permanent establishment cost reimbursements attribution of profits...

Recent Trends in AAR – Cost Reimbursements and Permanent Establishments

CA. Divakar Vijayasarathy

Permanent Establishment

Cost Reimbursements

Attribution of Profits

Methods of Attribution of Profits

Presentation Schema

OECD Model Convention: Fixed place of Business Through which Business is “wholly or partly” carried on

PE includes: Place of Management Branch Office Factory / work shop Mine, oil or gas well, quarry or similar locations

PE…………?

PE also includes: Construction PE: A building site, construction

assembly or installation project or supervisory activities in connection therewith – exceeding a specified period

Service PE: Furnishing of services – employees or other persons engaged - exceeding a specified period

Dependant Agent PE: Operated through a Dependant agent who:◦ Habitually concludes contracts◦ Maintains stock for delivery

PE…………?

PE Excludes a fixed place used for: Storage or display facilities Maintenance of stock for storage / display/

processing by another enterprise Purchase or collection of information Any activity of a preparatory or auxiliary

character Independent Agent

PE…………?

UN MC Article 7 Clause (1) Business profits from the Country of Source

are taxable “only” if the enterprise has a PE in the Source Country

Relevance of PE

Source Country -

India

Resident Country - Australia

Australian Company earning Business

income from India

Income of the Australian Company is taxable in India- only if the company has a PE in India.

Source of Income Resident and

Ordinarily

resident

Resident and

Not

Ordinarily

resident

Non

Resident

Indian Income: Taxability

Income earned and received or deemed to

be earned and received in India

Yes Yes Yes

Income earned or deemed to be earned

outside India but received in India

Yes Yes Yes

Income earned or deemed to be earned in

India but received outside India

Yes Yes Yes

Foreign Income: Taxability


be earned and received outside India from a

business controlled from India

Yes Yes No


be earned and received outside India from a

business controlled from outside India

Yes No No

Scope of Total Income – Sec 5

Nature of Income Condition

Business Income When there is business connection in India

(Please refer to the definition of the term Business Connection-

discussed below)

Property income Property or asset source is in India

Income from

transfer of a capital

asset

When the capital asset is in India

Income from

Salaries

Where services are rendered in India

Indian citizen, working for the Government of India rendering

services outside India

Dividend Income Dividend payable/paid by an Indian Company

Interest, Royalty

and Fees for

Technical Services

If the income is received from:

- Government of India

- A resident assessee except where such payment is for business

outside India

- A non resident assessee where the payment pertains to

business in India

Income Deemed to Accrue or Arise in India – Sec 9

Business Connection – Sec 9(1)(i)explanation includes any person:

Habitually concludes contract Regularly maintains stock in India Regularly secures orders in India

Excludes activity through an independent agent in the ordinary course of his business.

Business Connection

The assessee is a US Company (USCO) engaged in ◦ Manufacturing of “Process Control Instruments◦ Providing engineering, research and technology

based and allied services

The company enters into a cost allocation agreement with one of its group company (ICO) for providing certain specific services.

Case Study – Cost Allocation Agreement

According to agreement USCO shall provide:

◦ Guidelines for relevant safety, health and security support to employees on travel

◦ Assistance in relation to environmental policies

◦ Overall operations assistance and HR support

◦ Assistance on key projects

◦ Finance, internal audit, treasury and tax

◦ Corporate secretarial and legal support


Issues for Consideration:

Would the income of USCO be liable for taxation in India

If yes- what would be the nature of the income

What would be the rate of TDS u/s 195- in case such income is taxable in India


Thoughts …..

No income can be taxed in India if services are rendered abroad.

There is no PE for USCO- hence Article 7 does not apply

There is no service which “makes available” the technical knowledge within the meaning of Article 12 (FTS)

Therefore the assessee is not liable for tax in India and no withholding tax shall apply on the transaction


Invensys Systems Inc vs DIT Chennai – AAR 6th August 2009

Assessee is a US company engaged in maintained comprehensive financial and regulatory databases of publicly listed companies

The database is located at the US A client from anywhere in the world is

required to download a client interface software to access the database

Subscription fees are paid online or through wire transfer

Database Access Services…..

An Indian company intends to use the facilities of accessing the database of the US Co

The USCO does not have a branch or an agent in India


Issues for Consideration What would be the nature of the income

received from Indian clients- Royalty vs Business Income

Does any income of the US Co accrue or arise in India

Is the Indian client required to deduct TDS at the time of payment

If yes- what would be the rate of TDS


Thoughts …..

The right that a customer gets is a right to use copy-righted database and not copy-right in the database. Hence income cannot be considered as Royalty.

The USCO is engaged in the business of sharing databases for a consideration. Hence income of the company is taxable under Article 7 (business income).

The company does not have a PE in India hence business income is not taxable.

No withholding tax need to be deducted and the assessee is not required to file his returns in India


FACTSET RESEARACH SYSTEMS INC. Vs DIT Delhi AAR dated 30th June 2009

Cost Reimbursements.

Income Tax Act – Sec 44C:

For a non resident assessee “head office expenses” cannot exceed the lower of:◦ 5% of adjusted total income or◦ Amount of expenditure attributable to Indian

Operations

Statutory Provisions

DTAA – Article 7 clause (3): In determination of profits of a PE

Expenses incurred for the purposes of PE shall be allowed

Such expenses can be incurred either in the Country of Source or elsewhere

Statutory Provisions

Does Sec 44C apply only to Head Office Expenses

Can expenses incurred by other branches be fully allowed

Where DTAA applies would be provisions of Sec 44C be valid – Sec 90(2)

Can the non resident take shelter under Article 24

Issues in Cost Reimbursement

.

Applicability of 44C to Branch Expenses

US – Head Office

Indian Branch - PE

Singapore Branch

Expenses incurred

for Indian PE

Explanation (iv) to Sec 44C defines Head Office expenses. Accordingly it means:

Rent, rates, repairs or insurance of “ANY PREMISES OUTSIDE INDIA”

Salary, perquisites or travelling expense of any employee of “ANY OFFICE OUTSIDE INDIA”



Sec 44C applies to branch expenses incurred outside India and such expenses shall fall within the ceiling of

5%

Where there is a DTAA the provisions of this Act shall apply to the extent they are more beneficial to that assessee.

Beneficial Provisions Clause – Sec 90(2)

Does it mean Sec 44C does not have any relevance in case of non residents from Countries with which India

has a DTAA ?

May be Yes

India – Italy Treaty: In the determination of the profits of a

permanent establishment, there shall be allowed as deduction expenses which are incurred for the purposes of the business of the permanent establishment including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere

Article 7 (3)- India Specific DTAAs

Indo – Brazil Treaty: In determining the profits of a permanent

establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the permanent establishment, including executive and general administrative expenses so incurred, in accordance with the provisions of and subject to the limitations of the taxation laws of the Contracting State concerned.

Article 7 (3)- India Specific DTAAs

Treaty Prima Facie Applicability of - Sec 44C

India – Brazil Yes

India – Australia Yes

India – China Yes

India – Germany Yes

India – South Africa Yes

India – US Yes

India – UK Yes

India – Canada Yes

India – Mauritius No

India – Italy No

India – Japan No

India Specific Treaties – Factual Update

The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities.

Article 24 (2) – Non Discrimination

Is it possible to take shelter under Article 24(2) against Sec 44C -

Assessee is a Canadian Resident Has a Construction PE in India Head Office has apportioned Rs 100 lacs as

attributable expenses to the PE Adjusted Gross Total Income (AGTI) of the PE

is Rs 500 lacs AO restricts the expenses to 5% of AGTI ie

Rs 25 lacs Assessee claims shelter under Article 24 –

non discrimination. Discuss

Case Study

Reasonable allocation of expenses permitted

Subject to the limitations of Domestic Law

Excludes the following payments to Head Office:◦ Royalties, fees for usage of patents, know-how,

copyrights etc, ◦ Management fees or fees for specific services◦ Interest (other than banking enterprises)

The above, if received by the PE, shall also not be included as Income of the PE

Indo – Canada Treaty – Article 7(3)

Profits to be attributed to a permanent establishment shall be determined on the basis of an apportionment of the total profits of the enterprise to its various parts,

Nothing in paragraph 2 shall preclude that Contracting State from determining the profits to be taxed by such an apportionment as may be customary;

The method of apportionment adopted shall, however, be such that the result shall be in accordance with the principles contained in this Article.


The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities.


Thoughts …..

Article 24(2) is a specific provision Article 7 is a general provision Restriction on allowability of Head Office u/s

44C is to be ignored in the light of Article 24(2)

Revenue appeal dismissed

Conclusion – Mumbai ITAT

Metchem Canada Inc vs DCIT – Mumbai ITAT Dated 30th September 2005

Applicant is a Singapore based real estate group company (Sco)

One of its group companies is located in India (Ico)

Sco identifies overseas clients who intend to purchase property in India.

These prospective clients are referred to Ico

Group Company Referral Payout

Ico earns its commission (agency ) from selling properties to overseas clients

Ico pays a flat fee of 30% of the commission earned to Sco – as referral fees


Issues for Consideration: What is the nature of income earned by Sco

Would there be any withholding tax on the remittance to S Co

If yes what is the rate of the Withholding tax


Assessee’s argument:◦ Nature of Income – Business Income◦ No PE in India◦ Services Rendered outside India◦ Hence no income arises in India

Department’s contention:◦ 30% payout is very high◦ Income in the nature of Royalty as well as FTS


Thoughts …..

Conclusion: For income to be taxed as royalty – it should

be received for imparting technical knowhow or IPR

For the purpose of FTS- the “make available” condition is not fulfilled. It also does not meet the description of management and consultancy services


Income to be considered as Business Income

No PE in India

Hence no income arises in India and therefore no withholding tax apply on the transaction


Cushman and Wakefield (S) PTE Ltd AAR dtd 4th July 2008

Attribution of Profits.

Explanation 3 to Sec 9(1)(i) Where a business is carried on in India

through a business connection Only so much of income as is attributable

to the operations carried out in India

Shall be deemed to accrue or arise in India

Why Attribution ??

Article 7(1) of DTAA:

If the enterprise carries on business in the Other Contracting State through a PE

The profits of the enterprise may be taxed in the other State but

Only so much of them as is attributable to that PE.

Why Attribution ??

Identifying the overall operations of the non resident

Assigning weightage to each of the activities /operations

Identifying the operations carried out by the Indian PE

Apportioning profits based on proportionate weightage to the extent of business carried on by the PE

Steps in Attribution?

.

Case Study – Online Booking Revenues

US Based Service

Provider - USP

Indian Intermediary

Service Provider - IIP

Airlines and Hotels (AH)

Travel Agents in India (TA)

USP Provides Ticketing and

Booking Software and training

IIP Provides Hardware

and access

facilities to TAs

Transaction Cycle

.


US Based Service

Provider - USP

Indian Intermediary

Service Provider - IIP

Airlines and Hotels (AH)

Travel Agents in India (TA)

USP pays commission to IIP based on Indian

Bookings

AH pays commission

to USP based on bookings

Payment Cycle

Issues for Consideration:

Does the USP have a business connection in India

Is the income of the USP arising in India

Does the facility of IIP constitute a PE in India

If yes, what portion of the revenues are attributable to India


Analysis:

The hardware and facilities provided by IIP constitute a “Computer PE”

Income of USP accrues in India since:◦ Bookings are done in India and◦ Final subscribers were located in India

Income accrues to the extent of collection of information and receipt of confirmation


Attribution of Profits:

Majority of assets being the main frame computers located outside India

The Computerised Reservation System was located outside India

Transaction was processed outside India

The entire risk of the transaction is with the USP

Therefore only 15% of the revenues were attributable to India


USP was already paying more than 15% of its revenues to IIP.

Hence no further income is attributable to Indian Operations


Galileo International Inc vs DCIT New Delhi - Delhi ITAT (2007)

Transaction Citation As per Revenue

As per Court

Contract of Purchasing Agent made in India

Annamalai Timber Trust and Company vs CIT -Madras HC - 41 ITR 781

75% 10%

Negotiation, Procurement of Order and arranging LCs

Ingersoll Rand Ltd vs ITO – Bombay ITAT- 4 ITD 654

10% 10%

Lending arrangement concluded in India – all other activities outside India

C.G.Krishnaswami Naidu vs CIT – Madras HC – 62 ITR 686

100% Nil

Conclusion of Purchase contracts in India

Anglo French Textile Company Limited vs CIT – Supreme Court 23 ITR 101

10% 10%

Canvassing orders and securing import/ export licenses by subsidiary

CIT vs Gulf Oil (Great Britain) Ltd – Bombay HC- 108 ITR 874

7.5% Nil

Attribution of Profits – Decided Case Laws

Methods of AttributionGuess Work….??

Where the AO is of the opinion that Income cannot be definitely ascertained The amount of income may be calculated

using:◦ Percentage / Presumptive Method◦ Proportionate Turnover Method◦ Any other suitable manner – Discretionary Method

Income Tax – Rule 10

A manufacturer in Germany has a branch in India.

The Indian branch does the marketing and distribution for the German company.

During the previous year the German company made a total profit of Rs 100 lacs (computed as per ITA) from sale of its products in India.

No commission is paid to its branch.

Presumptive Method

In this case the AO may chose to avail the rights under Rule 10.

Based on the overall activities of the Germany Company- the AO decides that the activities in India contribute to 20% of the total operations of the German Company

Consequently proportionate profits of the German Company shall be taxable for the PE ie 20% of Rs 100 lacs = Rs 20 lacs

Presumptive Method

Walmart US has branches across 10 countries including India

During the previous year the company made a total profit of Rs 500 lacs (as per ITA) across all its global operations

The company has made a total turnover, across all its branches, of Rs 5000 crores.

The Indian branch of the company made a turnover of Rs 1000 crores.

Proportionate Method

Profits taxable = Total Profits* Indian turnoverin India Total Turnover

= Rs 500 crores*1000 crores Rs 5000 crores

= Rs 100 crores

Proportionate Method

Assessee is a steamer agent – resident of Netherlands having a branch in India

The assessee had not provided details of its worldwide transactions

However details of voyage in and out of India were provided as follows:◦ Indian Port Receipts : Rs 100 lacs◦ Total Port receipts : Rs 400 lacs

(in and out of India)◦ Indian Trade Profits : Rs 80 lacs

Discretionary Method

In this case, the AO came up with a unique formula (similar to proportionate method):

Profits taxable = Total Indian Trade Profits* Indian Port Receipts

in India Total Indian Port Receipts = Rs 80 lacs * Rs 100 lacs

Rs 400 lacs

= Rs 20 lacs

Discretionary Method

Supreme Court in Netherlands Steam Navigation Co Ltd vs CIT 74 ITR 72 (AY 1952-33 based on ITA 1922 Rule 33)

Choice of Methods to be adopted

Calculating world income as per Income Tax Act

Treatment of extraordinary incomes and expenses of foreign branches and head office

Accounts maintained in other languages

Different methods of accounting adopted by the Indian PE and Head Office

Challenges in Rule 10

Thank You

Divakar Vijayasarathy & AssociatesChartered Accountants

No 3 Vathiar Thottam 1st Street Rangarajapuram KodambakamChennai 600024

[email protected] www.dvsca.com

Divakar Vijayasarathy & Associates

ca. divakar vijayasarathy. permanent establishment cost reimbursements attribution of profits...

Documents