credit of taxes and withholding taxes-cross border issues sushil lakhani

CREDIT OF TAXES AND WITHHOLDING TAXES-CROSS BORDER ISSUES

SUSHIL LAKHANI

PROFESSOR KLAUS VOGEL APPRECIATES THE INDIAN JUDICIARY FOR DECISIONS ON INTERNATIONAL TAXATION - ESPECIALLY THE DELHI SPECIAL BENCH DECISION IN THE CASE OF NOKIA, ERICCSON AND MOTOROLA

– ECONOMIC TIMES OF 7TH APRIL 2006

IFA-RRC - April, 2006

Cross Border Payments Withholding Tax Issues- Cross Border Issues 3Sushil Lakhani

Cross Border Payments-Withholding Tax Issues



any person responsible for paying to a non-resident or a foreign company• Non resident to non resident covered.• Payment by Branch to HO (ABN Amro Bank (280 ITR

(AT) 117)(Kol – SB)) “sum chargeable to tax (other than Salaries)”

• Capital Gains – NR to NR trf of shares??• Sec 195 vs Sec 196D?? (Int to FIIs)• Interest – whether all interest or only interest chargeable to tax

covered??• Gift??• Gross Sum vs Income element

• FTS, Royalty etc•Other than Sec 44D

Section 195 (1) – Scope of the section



Treaty vs Act

• meaning of “Liable to Tax” – Recent

developments- Abdul Razak Meman (276 ITR 306)(AAR)

- GE Pension Trust (280 ITR 425) (AAR)

- Green Emirates Shipping and Travel (99 TTJ 988)

(Mum)

• Surcharge and Education Cess not to be included

when treaty applied .

Section 195 (1) – Scope of the section



Deductibility of TDS borne by payer--S.40(a)(ii)??

Section 195A – Grossing up of tax

Sec 40(a) (ii)

“any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains”

Incidental issuesExpenses whether disallowed u/s 40(a)(i), if TDS

partly deducted??



Certificate by a CA for remittance:

Clause 1 – “name & address of beneficiary”

• “Beneficiary” – meaning of – “Beneficial Owner” or “Recipient”?

Clause 7– determination of a PE and profits of PE:

• Whether CA duty bound to ascertain the existence of PE?

• Determination of “attributable to PE” ?




Some Issues: Consequence of difference of opinion between a CA and AO Consequence of change in the view due to an amendment or

a judicial decision or circular subsequent to issue of certificate.

Determination of any “special relation” between payer and payee.

Tax residency certificate – if not available? Tax residency certificate—not sufficient -- dual residency? Validity period of tax residency certificate / undertaking /

declaration from the payee – for a year or for single payment?




Some Issues (Cont…): Whether CA certificate is an alternative to Order u/s 195(2)? “Non resident” status of the receiver – at what point of time

to be considered?• at the time of signing of agreement or• the prior financial year or• making of remittance

In absence of address in the agreement is the payer obliged to determine the status of purchaser for purchase of capital gains?



SECTION 9(1)(i)--BUSINESS CONNECTION

Taxable only if :• relates to a source of income or asset in India; or• if “business connection” under IT Act and “PE” under

the treaty exists. Taxable only to the extent “reasonably attributable”

to operations in India. Specific exclusions – Explanation 1(b); 1(c) & 1(d) of

Section 9(1)(i) Specific inclusions – Explanation 2 to Section 9(1)(i)

• treaty concept of dependent agent introduced in Act• agent need not be in India but must Act in India.



CIT Vs. R.D. Aggarwal & Co. (56 ITR 20) & Circular 23 and 786 lay down certain tests.

Business in India Vs. Business with India

Difference between a BC and a PE• BC is wider in scope than PE.

Section 9(1)(i) – Business Connection – Judicial Interpretations

SECTION 9(1)(i)--BUSINESS CONNECTION



Source of Income outside India• “Source” – meaning of (91 ITD 133(Del); 85 ITD 478(Del))• Whether “Export” – a source outside India ??(262 ITR 513(Mad))

“Service utilised” is where the income accrues (250 ITR 164(AP))

Query?• Fees to Investment Advisor of non- resident FII--both are outside :

- No presence of adviser in India (250 ITR 194(AAR); 271 ITR 1 (AAR); 272

ITR 416 (AAR))- Presence of adviser in India – Service PE clause

Payment of commission to foreign agents (Circular 23 of 1969; 125

ITR 525(SC); contrary - 278 ITR 97(AAR))

SECTION 9(1)(i)--BUSINESS CONNECTION - Issues



Payments for supply and installation of equipment• Payment of design and drawings alongwith equipment (259 ITR 248)(Del)-

Mitsui);• Payment for installation and supervision of machinery supplied—not

taxable --as part of supply(262 ITR 110(AP)-Sundwiger) ;Contrary Decisions:• Proportionate amount relating to provision of certain subsidiary services in

course of supply taxable as PE existed.– Protocol of India – Japan Treaty (271 ITR 193)(AAR)-IHH)

• Where consideration for supply and installation separately stated (279 ITR 165)(AAR)-Rotem)

• Finalisation and signing of deal by country manager in India amounts to PE (268 ITR 156)(AAR)-Sutron)

SECTION 9(1)(i)--BUSINESS CONNECTION - Issues



ROYALTIESRoyalty and FTS deemed to accrue or arise in India if payable by:

GovernmentGovernment

ResidentResident

Non-residentNon-resident

In all cases, except where payable for any right, property etc. or services utilized for the purpose of / in 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

In all cases without exception

Only in cases where it is payable for any right, property etc. or services utilized for the purpose of a business or profession carried on by such person in India, or for the purposes of making or earning any income from any source in India



For Agreements on or after 1 April 2003 • No PE in India

Section 115A of the Act

- Taxed on gross basis

- Lower rate for Central Government approved Agreements or those

relating to matter included in Industrial Policy

20% for agreements entered before 1 June 2005

10% for agreements entered on or after 1 June 2005

- Provisions earlier applicable only to foreign companies extended to all

non-resident entities w.e.f. AY 2004-05

ROYALTIES



For Agreements on or after 1 April 2003 • PE in India and Royalty / FTS effectively connected with

such PESection 44DA of the Act w.e.f. AY 2004-05

- Taxed on net basis at the rate applicable to Non Residents

- Amounts paid to Head Office / Other Offices not deductible (except

reimbursement of actual expenses)

• PE as defined in Section 92F(iiia) of the Act – fixed place

PE

ROYALTIES



Difference in definition of Royalty under Act and Treaties

ACT TREATY(UN Model)

• Consideration for transfer Consideration for use or of “all” of any rights right to use

• “Cinematographic films” “Cinematographic specifically excluded films” included

• Services in relation to Services in relation totransfer of any rights transfer if incidental willcovered get covered here else not

• Use of equipment in No Such exclusion. Use of connection with exploration all sorts of equipment of mineral Oil excluded covered.

ROYALTIES



Payment for Software

Off- the -shelf Software ; (94 ITD 91 (Bang.-Samsung));

( TCS-SC-271 ITR 401)

Customised Software; ( 88 ITD 134(Mum)—ISBC)

Software along with Hardware (82 TTJ 163-Bang-Lucent)

ROYALTIES



Payment for following whether “Royalty” ?• Consideration for design and drawings (Indian Hotels

(Unreported)

• Payment for “Know how” and “Information”

• Payment for access to info base-not royalty (94 ITD 9 (Bang)-

Wipro)

• Payment for the use of satellite (78 TTJ 498 (Del)-Asiasat)

ROYALTIES



Analysis of some treaties signed by India

Excludes Ships and Aircrafts • UK USA

Exclude ICS equipment from ambit of Royalties• Belgium / France / Greece / Israel / Netherlands / Sweden

Excludes payment for use of Aircraft• Ireland Includes proceeds from outright sale of copyrights etc. that are

contingent on its use by purchaser

• USA

ROYALTIES



Fees For Technical Services (FTS)

FTS receipt taxable in India regardless of situs and

mode of services – other than FTS utilised in a

business or source outside India. Consideration (includes lump sum consideration) for

rendering any:• Managerial, technical or consultancy services

Thrust is on ‘Services’ Technical Services vs Technology driven services



Excludes:

• Construction,

• Assembly,

• Mining,

• Any like project,

• Income chargeable as salaries,




SOME ISSUES IN FTS

Connectivity payments –standard facilities (80 TTJ 191 (Bang)-

Wipro)

Payment for use of telephone, electricity etc i.e. standardised

products is not FTS (251 ITR 53)(Mad)-Skycell

Payment for repairs

• Hardware (273 ITR 437)(AAR)-Airport Authority-Not FIS

• Software – Clause 12 (4) (a) of India USA Treaty – Ancillary and

subsidiary to royalty (273 ITR 437)(AAR)-Airport Authority

• Specialised repairs –FTS (79 TTJ 268) (Del)-Sahara

• General repairs-Not FTS (91 ITD 133)(Del)-Lufthansa



Absence of specific Article on FTS

• Bangladesh, Brazil, Greece, Indonesia, Libya, Mauritius,

Nepal, Philippines, Sri Lanka, Syria, Thailand, UAE, UAR

Concurrent Coverage under Independent Personal Services

(IPS)

• Japan, New Zealand




Fees for Included Services (FIS) – “Make Available”

Deals with Technical Services - but coverage is very

narrow.

Services under FIS should be technical (Mckinsey (99 TTJ

857)); and

Services should satisfy further conditions as per the MOU

of India –US Treaty



Fees for Included Services (FIS) – “Make Available” (Cont…) Associated with Service PE

The words “make available” held to have the same meaning as in India-USA Treaty even in absence of the MOU (Raymonds Ltd. (80 TTJ 120))

Caution! These treaties also have “Service PE” clause.



Case Laws• Advisory service –not FIS (80 TTJ 806) (Cal)-Raymonds

• Preparation of project report-FIS?? (85 TTJ 794)(Del)-Sinar Mas

• Payment for strategic consultancy services-Not FIS (99 TTJ 857)(Mum) Mckinsey

• Payment for testing charges-FIS (278 ITR 233)(AAR); (278 ITR 97)(AAR)

Analysis of few Treaties signed by India (FIS)• Directly - Australia, Canada, Cyprus, Malta, Portugal, Finland,

Singapore, USA, UK

• Due to MFN Clause - Belgium, France, Israel, Kazakhstan, Spain, Sweden—(Service PE missing)

Fees for Included Services (FIS) – “Make Available” (Cont…)



Reimbursement of expenses

Reimbursement of incidental expenses in addition to payments of Fees for

Technical Services (FTS) / Royalty

Reimbursement of cost of services of a third party engaged by the non-resident.

(278 ITR 97)(AAR) -Wallace

Reimbursement of allocated cost (i.e. costs- sharing arrangements) (268 ITR 1)

(AAR)-Danfoss

Payments for services rendered at cost. (273 ITR 67)(AAR)-Timkin

Reimbursement of living allowance, etc of a person deputed to India by the non-

resident. (274 ITR 261)(Del)

Direct payments by the non-resident of expenses and salaries of foreign

technicians. (233 ITR 751)(All)



Reimbursement of expenses (Cont…)

GREY AREAS

Reimbursement of expenses incurred by group company outside India on behalf of

Indian company

• If the services are taxable in India and

• If the services are not taxable in India

Reimbursement of pre joint venture expenses like incorporation, registration fees

etc. incurred by a foreign joint venture partner.



Analysis of some treaties signed by India:• “interest on deferred payment sales” included in the

definition – Indonesia, Philippines• Penalty charges for later payment excluded – Singapore,

Indonesia

Payment of usance interest is not a part of purchase price (261 ITR 113) (Guj)

INTEREST AND SHIPPING INCOME



Payments for Shipping:• Freight

• Payment to Shipping Agent (Circuar 742)

• Bare Boat lease (113 ITR 307)(SC)

• Wet Lease – is same as bare boat lease – sec 44B does not apply (4

SOT 18)

Analysis of Treaties signed by India• Profits taxable only in residence country – USA, Singapore

• Profits taxable where effective management is situated –

• Profits taxable in India for specified no of years – Netherland, Japan

• Profits taxable in Indian but at concessional rates -

INTEREST AND SHIPPING INCOME



Cross Border Payments – Credit of Taxes



EXEMPTION METHOD Full Exemption Exemption with progression – taken into account for rate

purposesCREDIT METHOD Full credit – No restriction Ordinary credit – restricted to the extent of tax payable –

qua “Income” Underlying tax credit – except Mauritius & Singapore

Treaty only one way in Indian Treaties Tax sparing

Sparing w.r.f. certain income Sparing w.r.f. tax payable (e.g. Mauritius)



Directly Via Mauritius

UK Parent / Home Company

Income (Grossed up)

Tax @ 30%

Underlying Tax Credit (633)

1,633

(490)

Income (Grossed up)

Tax @ 30%

Underlying Tax Credit

1,633

(490)

1,143

490

1,143

245

1,633 1,388

Offshore Intermediary Company

Income (Grossed up)

Tax @ 15%

Underlying Tax Credit (633)

Withholding Tax

1,633

(245)

1,388

245

1,633

NIL

1,633

Indian Host Company

Tax @ 30%

DDT @ 12.5%

Withholding Tax

1,633

(490)

1,143

(143)

1,000

NIL

1,000

Tax @ 30%

DDT @ 12.5%

Withholding Tax

1,633

(490)

1,143

(143)

1,000

NIL

1,000

Underlying Tax Credit



General Principles Whenever exemption method is followed – the

expenses are also not deductible. Grossing up of Underlying Tax & Dividend

Distribution Tax. No Grossing up of Tax Sparing as no tax has

been paid.



Case Study (a)

Facts:“X” (Parent Company in India)

“Z” (100% Subsidiary in Mauritius)

“A” (50% Subsidiary in BVI)

Case Studies for Group Discussion:



“Mauritius tax payable” shall be deemed to include any amount which would have been payable as Mauritius tax for any year but for an exemption or reduction of tax granted for that year or any part thereof under:

(i) section 33, 34, 34A and 34B of the Mauritius Income – tax Act, 1974 (41 of 1974)

(ii) any other provision which may be subsequently be made granting

an exemption or reduction of tax which the competent authorities of the contracting states agree to be for the purposes of economic development.

Case Study (a) Contd.(i) What is the “Mauritius Tax payable” ??

As per (Article 23(3) of the India - Mauritius Treaty)



(ii) Will ‘X’ be entitled to a foreign tax credit in India for the taxes payable (before Tax Sparing) in Mauritius ??

Article 23(3)(i) of India Mauritius Treaty – Section 33, 34, 34A and 34B of the Mauritius Income Tax Act, 1974 have been deleted – Article 2(2) has ambulatory approach – Similar taxes which are imposed after the date of conventions are also covered.

Therefore ‘X’ Should be entitled to credit of taxes payable in Mauritius though the taxes are not paid because of Tax Sparing Clause in Article 23(3).

Case Study (a) Contd.



(iii)Whether change in the character of income makes a difference for credit??

The Residence State is obliged to give credit / exempt on income so long as the source state has taxed that item “in accordance with provision of the convention.”

(Para 32 of OECD Commentary on

Article 23)

Case Study (a) Contd.



Case Study (b)

Whether Exchange Rate fluctuation should be considered for giving credit ??Rate of exchange for conversion into rupees of income expressed in foreign currency. (Rule 115 of the Income Tax Rules 1962)

Telegraphic Transfer buying Rate of such currency as on the specified date. (31 ITR 538 (Ch. D))



Case Study (c)Whether foreign tax credit can be denied on the ground that the taxes are not paid by the foreign deductor to the Govt. of foreign country ??

No ?? (104 ITR 233(Guj))



Case studies on withholding of taxes



1. Whether PH can claim refund or US Co will have to claim refund?

• Circular 790 dated 20.04.2000• Whether the two instances in the Circular are only

illustrative?• 83 TTJ 458 (mum)(TELCO) – if assessee was not liable

to deduct tax it can claim refund if TDS certificate not issued

2. Will the answer be different if the TDS certificate is issued?• Yes. Not entitled to claim refund (82 TTJ 325(Del))

3. If the tax was borne by PH, whether that would make a difference?

• No if certificate has been issued??

Case Study 1:



4 What is the obligation of PH for issue of TDS Certificate.• Certificate has to be issued within 30 days of credit of

deduction of tax (Rule 31)

5 Whether excess deduction u/s 195 in one quarter can be adjusted against short deduction u/s 195 in next quarter?• Yes• Quarterly return to be filed in Form 27

6 Whether excess deduction u/s 195 can be adjusted against payment of TDS u/s 194A to 194D?• Yes• No restrictions under the Act

Case Study 1: (Cont…)



1. Whether payments for business information will amount to FTS in India and hence liability to TDS?• Non Technical Services – not FIS (99 TTJ 857-Mckinsey)

2. Whether application u/s. 195(2) mandatory?• No• Payer should apply only when he is unable to determine

the sum chargeable to tax

Case Study 2:



3 Whether the AO was justified in disallowing the payments u/s. 40(a)(i)?• Yes?, if he is of the view that TDS was deductible (Sol

Pharma (83 ITD 72 (Hyd))• Appeal can be filed against such an addition

- Fact that in the assessment of Exotic USA the income was not taxable can of help in getting a favourable order but that by itself not enough.

Case Study 2:



1 Whether payment by a non resident to another non resident in respect of shares in Indian company is chargeable to TDS?

• Yes; Difficult for the Department to enforce .

2 If Yes, Whether Canada Ltd. should consider the details of different shareholders before deducting tax?

• Yes• Indexation not available (Section 48)

3 What is the rate of tax applicable to :• Resident Shareholders – No TDS • Ismail (UAE) – (Green Emirates Vs.Meman) Not deductible- As per India UAE Treaty gains taxable only in

UAE, hence not deductible.

Case Study 3:



• Charlie (Mauritius) – Not deductible. As per India Mauritius Treaty gains taxable only in Mauritius, hence not deductible.

• Dinanath (NRI)• Section 115E

•TDS on LTCG – 10%•TDS on STCG – 10%

• Other non-residents (Assumed to be resident of USA)- TDS on LTCG – 10%- TDS on STCG – 10 %

• Sub account of foreign FII• No TDS – Sec 196D (2)

Case Study 3: (Cont…)



Case Study 4:

1. Whether tax is deductible on payment for purchase of software?• No --as purchase of software not royalty if copyrights not

transferred.2. Assuming payment for purchase of software is royalty,

whether TDS is deductible when:(a) Payment of Rs 5 Cr is made to Software Ltd – Yes(b)Payment of Rs. 5 Cr is made to Singapore Ltd –Yes?(c) Payment of Rs. 5 Cr is made by Singapore Ltd to

Software Ltd – Yes??• Sec 9(1)(vi)(c) – “a person who is a non resident …for the

purpose of business or profession carried on by such person in India”



Case Study 5:

Project of ‘A’ Ltd.

‘A’ Ltd. ‘B’ Ltd. - HR Agency

‘C’ Inc. – Wholly owned subsidiary

Contract to supply Personnels

Appointment of qualified persons

In India

Outside India

Con

trac

t to

ap

poi

nt

per

son

s at

Pro

ject

Cos

t of

per

son

s +

10

% o

f fe

es



Case Study 5:

1 Is TDS u/s 195 deductible on payments made by B

Ltd. to C Inc in respect of Cost of the person

employed and 10% fees? • TDS deductible on both cost of the person and 10% fees

charged

• 278 ITR 97 (AAR)-Wallace and Timkin( 273 ITR 67

AAR)



1 What will be the tax to be deducted at source for

payment of “Professional Fees” paid to Individual?• Covered under S 9(1)(vii)

• Treaty--Specific Provision (IPS) overrides general

provision (FIS)

• Covered under IPS of India- USA Treaty

- Fixed base or

- 60 days in the source state

• If does not fit in “Professional Services” of IPS Article –

Article 5 (PE) applies.

• No TDS

Case Study 6:



Whether payment for roaming charges is “royalty”? –

No Service (E-Commerce report of OECD) vs use of

equipment

Technical Services vs Technology driven services

(Wipro (80 TTJ 191 Bang); Skycell (251 ITR 53 Mad))

Case Study 7:

credit of taxes and withholding taxes-cross border issues sushil lakhani

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