Tax Deduction at Source on payments to Non Residents Contents

K Subramanian

Deloitte Haskins & Sells

September 2010

Tax Deduction at Source

on payments to

Non Residents

Contents

2

Section 195 & Objective

Issues

Capital Gains

Quantum

Chargeability

Rate – 112 vs. rates in force – anomaly

Cross Border M&A

Reimbursements

Inter Corporate Loans

Payments to partnership firms / pass thru entities

Permanent Account Number

Others

CA Certificate

Payments to Branches / Head Office

E-Commerce Transactions

Gross Sum vs. Income element

Determining residential status

Other issues

Section 195 & Objective of Tax Deduction at Source (TDS)

Regular inflow of revenue for Government

Checking of tax evasion

Widening of tax base

• To ensure that the tax due from non-resident is secured at the earliest point of time

• To avoid difficulty in collection of tax subsequently at the time of regular assessment

• Failure to deduct tax at source may result in loss of revenue as the non-resident may not

have assets in India from which tax could be collected at a later stage

- Circular No. 152 dated 27 November 1974

3

Issues

Capital Gains

TDS on what amount

• Cost of acquisition = Rs 5000

• Sale consideration = Rs 8000

• At the time of remittance by Y Co India,

section 195 comes into play

6

Capital Gains – Quantum – Case Study 1(a)

X Co

Ind Co

USA

India

10 shares

Y Co

Transfer of

shares in

Ind Co

ISSUE: TDS on what amount?

Rs 8000 (sale consideration) OR Rs 3000 (capital gain)

Determination of cost of acquisition

• Capital Gains = Sale Consideration less

Cost of acquisition

• How does Y Co India determine the cost of

acquisition of shares in the hands of X Co

US?

• Does Y Co obtain FIRCs or other supporting

documents from X Co?

• What if the supporting documents are not

available?

7

Capital Gains – Quantum – Case Study 1(b)

X Co

Ind Co

USA

India

10 shares

Y Co

Transfer of

shares in

Ind Co

Brought forward losses

• Ind Co – 100% subsidiary of X Co US

• Ind Co buys back part of its shares from X

Co – resulting in capital loss to X Co

• Next year, Ind Co again buys back a part

of its shares from X Co – this time, X Co

has a gain

• Overall, if capital gain is set off against the

brought forward capital loss, net position

is a loss

• Can Ind Co set off the brought forward

capital loss against the current capital

gains to determine withholding tax

liability?

8

X Co

Ind Co

USA

India100%

Capital Gains – Quantum – Case Study 1(c)

Brought forward losses – Contd.

Section 197

• Application by payee

• To AO

• For grant of certificate for receipt of

income without deduction of tax at source

or for deduction at lower rates

Issues

• In the previous example, can X Co make

an application to AO u/s 197 on the

ground of brought forward losses?

• 197 application only to determine rate of

tax

9

X Co

Ind Co

USA

India100%

Capital Gains – Quantum – Case Study 1(c) – Contd.

197 Application – Alternatives

Section 195 (2)

• Application by payer

• To A.O.

• To determine the appropriate portion of the sum

chargeable to tax

Section 195(3)

• Application by payee

• To A.O.

• For the grant of a certificate for receipt of

income without deduction of tax at source

• Subject to certain conditions – Rule 29B

Alternative

In the previous example,

• Can Ind Co make an application u/s 195(2)?

• Can X Co make an application u/s 195(3)?

10

X Co

Ind Co

USA

India100%


Rule 29B – Conditions for 195(3) application

• Has been regularly assessed to Income-tax in India

• Has furnished the returns of income for all

assessments years

• Not in default or deemed to be in default in respect of

any tax, interest, fine or any sum payable under the

Act

• Has not been subjected to penalty for concealment of

particulars of income

• Where not a banking company:

Has been carrying on business or profession in

India continuously for at least 5 years

Value of Fixed Assets in India > Rs. 50 Lacs

• Certificate issued by the AO valid only for the Financial

Year mentioned therein

11

X Co

Ind Co

USA

India100%


Non resident to non resident transfer

• Shares in an Indian Company – chargeable to

capital gains tax in India

• Triniti Corporation –165 Taxman 272 (AAR)

• Satellite Television Asian Region Ltd. v. DCIT –

99 ITD 91 (ITAT, Mum)

12

Capital Gains – Chargeability – Case Study 2(a)

X Co

Ind Co

USA

India

10 shares

Y Co

Transfer of shares

in Ind Co

ISSUE: Whether Y Co (non resident) to withhold taxes on payment made to X Co

(another non resident)?

Proviso to Section 112

• In the previous example, Y Co has to withhold

taxes on payments made to X Co

• Non resident eligible to benefit of proviso to

Section112

• Proviso to Sec 112

20% if indexation benefit availed i.e. on Sale

Consideration less Indexed Cost of acquisition

10% of indexation benefit not availed i.e. on

Sale Consideration less Cost of acquisition

(without indexation)

13

Capital Gains – Rate – Case Study 2(b)

X Co

Ind Co

USA

India

10 shares

Y Co

Transfer of shares

in Ind Co

ISSUE: At what rates should Y Co withhold taxes?

Can it apply proviso to Section 112?

• Vodafone ruling

14

Capital Gains – Cross Border M&A – Case Study 3

X Co

Ind Co

USA

India

Y Co

ISSUE: Transfer of X Co’s shares to Y Co whether taxable in India?

A Co Transfer of

shares in X Co

Reimbursements

• Reimbursement of actual expenses – Not in the nature of income

CIT v. Industrial Engineering Projects Pvt. Ltd. – 202 ITR 1014 (HC, Del)

Decta – 237 ITR 190 (AAR)

CIT v. Fortis Health Care Ltd – 181 Taxman 257 (HC, Del)

Bangalore International Airport Ltd v. ITO – 307 ITR 295 (ITAT, Bang)

CIT v. Dunlop Rubber Co Ltd – 142 ITR 493 (HC, Cal)

• Should be backed up with supporting documentation and evidence of such expenses

• Technical services availed. Reimbursement of incidental expenses also held as fees for

technical services

Cochin Refineries Ltd. v. CIT – 222 ITR 354 (HC, Ker)

Steffen, Robertson and Kirsten Consulting Engineers And Scientists v. CIT – 230 ITR

206 (AAR)

Hindalco Industries Ltd v. ACIT – 278 ITR 125 (ITAT, Mum)

16

Reimbursements

• Employees on the payrolls of X Co

• Seconded to Ind Co (subsidiary of X Co)

• Salary cost of seconded employees cross

charged by X Co to Ind Co – no mark up

• DCIT v. HCL Infosystems Ltd. – 211 Taxation

29 (ITAT, Del)

• AT and S India (P) Ltd. v. CIT – 287 ITR 421

(AAR)

• IDS Software Solutions India (P) Ltd. v. ITO –

122 TTJ 410 (ITAT, Bang)

17

Reimbursements – Case Study 1

X Co

Ind Co

USA

IndiaSecondment

of employees

ISSUE: Whether taxes are to be withheld on such reimbursement of salary costs?

• Ind Co sends its employees to X Co for a

training

• X Co incurs expenditure on travel,

accommodation etc of such employees

• X Co cross charges the expenditure at cost to

Ind Co

18


X Co

Ind Co

USA

IndiaEmployees

sent for

training

ISSUE: Whether taxes are to be withheld on such reimbursement of expenses

incurred by X Co?

• X Co acts as a global procurement center for

all subsidiaries

• X Co enters into agreements with service

providers centrally

• Invoice raised by service providers on X Co

• X Co, in turn, allocates the cost to the

subsidiaries in ratio of the utilization of

services and raises debit notes on subsidiaries

for cross charge of such cost – no mark up

19


X Co

Ind Co 1

USA

India

ISSUES: Will payments by subsidiaries to X Co attract TDS?

Will X Co be the deemed service provider to its subsidiaries?

Will the payments to X Co be classified as Royalty / Fees for technical services?

Service provider

Ind Co 2

Invoice raised for all

services rendered to

various subsidiaries

Y Co

Debit notes raised

20


X Co

(R&D centre)

Ind Co 1

USA

India

Ind Co 2

Y Co

Debit notes raised for

services rendered

• X Co has a centralized research and

development (R&D) unit

• The research done at the unit benefits all the

subsidiaries

• Cost contribution agreement between X Co

and subsidiaries – entire costs shared

between the entities

• X Co cross charges proportionate costs to all

the group companies who benefit from such

research


incurred by X Co?

• X Co renders services to Ind Co in USA

• No services rendered in India

• X Co recovers the expenses incurred at

actuals from Ind Co – no markup

Timken India Ltd – 143 Taxman 257 (AAR)

Danfoss Industries – 268 ITR 1 (AAR)

21


X Co

Ind Co

USA

India


incurred by X Co?

Services

rendered in

USA

Inter Corporate Loans

• Ind Co 1 gives loan to Ind Co 2 (resident group

company) in which non resident shareholder

(X Co) has substantial interest

• Deemed dividend u/s 2(22)(e)

• Does not attract dividend distribution tax

• Taxable in the hands of non resident

shareholder

• No payment / credit to the account of non

resident shareholder

23

Inter Corporate Loan – Case Study

X Co

Ind Co 1

USA

India

ISSUE: Whether taxes are to be withheld u/s 195 at the time of remitting the loan to

Ind Co 2?

Loan

Ind Co 2

100%

Pass thru entities

Payments to partnership firms / pass thru entities

• Partnership firm – fiscally transparent entities –

not liable to tax – profits taxed in the hands of

the partners

• Entitlement to the benefits of DTAA – whether

included in the definition of “resident” as given

in DTAA

• Indo-UK DTAA – Resident defined to mean

“any person who, under the law of that State, is

liable to taxation therein by reason of his …”.

25

X Co

(Partnership Firm)

Ind Co

UK

India

ISSUE: Whether the partnership firm is eligible to avail the benefit of Indo UK

DTAA?

Services

rendered

Payments to partnership firms / pass thru entities – Contd.

• Partnership firm eligible to treaty benefits even

when the firm is taxable in respect of its profits

not in its own right but in the hands of the

partners – Linklaters LLP v. ITO – 132 TTJ 20

(ITAT, Mum)

Issues

• What if the partners are residents of different

contracting states? – Which DTAA would

apply?

• Can the partners take credit of such taxes

withheld?

26

X Co

(Partnership Firm)

Ind Co

UK

IndiaServices

rendered

Permanent Account Number

Permanent Account Number (PAN)

• Recent provisions introduced by the Finance Act, 2009 with regard to furnishing of PAN by

the deductee to the tax deductor also applies to tax deducted u/s 195

• As per the new provisions, w.e.f. FY beginning 1 April 2010, where the deductee of the tax

fails to furnish its PAN, the deductor of tax will be required to withhold taxes at higher of

the following rates:

‒ At the rate specified under the Income-tax Act; or

‒ At the rates in force; or

‒ At the rate of 20%

• PAN to be indicated in all correspondence, bills, vouchers and other documents

exchanged between the deductor and deductee

• No certificate for lower rate of withholding taxes u/s 197 shall be issued by the Revenue

authorities to the deductee, unless the PAN of the deductee is furnished

28

PAN – Issues

Particulars Rate under the

Income Tax

Act, 1961

Rate under the

DTAA

Applicable rate

w.e. is

beneficial

In absence of

PAN, will

higher rate of

20% u/s 206AA

get attracted?

Situation 1 X Greater than X Act i.e. X Yes

Situation 2 X X X Yes

Situation 3 X Less than X DTAA i.e. less

than X

Yes

Situation 4 X Not taxable i.e.

Nil

DTAA i.e. Nil ?

Situation 5 No TDS

required

X Act i.e. Nil No

29

PAN – Issues – Contd.

• Would Section 206AA apply where taxes are to be borne by payer?

• Whether 206AA rates to be increased by surcharge and cess?

• Tax deducted at the higher rates u/s 206AA – Can payee claim refund of the tax in excess

of his actual liability?

• Foreign tax credit for higher taxes deducted by virtue of Section 206AA?

• PAN not available at the time of deduction but furnished subsequently

• Difficulties in obtaining PAN for non residents

30

Others

Others – C.A Certificate

• Alternative mechanism – Certificate of a Chartered Accountant certifying the tax withholding amount

• CBDT Circular No. 759 dated 18 November 1997; Circular No. 767 dated 22 May 1998 and Circular

No. 10/2002 dated 9 October 2002

Issues regarding Certificate by CA

• Understanding the nature of payments

• How to determine residential status – Tax Residency Certificate issued by overseas tax authorities

Difficulties in obtaining Residency Certificate (TRC)

What if TRC not available?

Dual residency issues

• To examine PE issues – Determination of PE – is PE certificate sufficient?

• Applicability of DTAA – Eligibility to treaty benefits

• Which Article of DTAA to apply

• Name & address of beneficiary – meaning – “Beneficial Owner” or “Recipient”?

32

Despite amendment by Circular No. 10/2002 permitting Managing Director or any

person authorized by him in writing to sign the verification in Form 15CA, no

corresponding amendment to the Form facilitating the same

Payment by Indian Branch to HO

• Branch – separate entity – Interest payment to HO liable to TDS – Circular 740 dated 17

April 1996

Dresdner Bank – 105 TTJ 149 (ITAT, Mum)

Legal validity of circular questioned since Branch is not a separate entity under law

ABN Amro Bank – 280 ITR 117 (SB, Kol)

• Fees for Technical services to HO liable to TDS – Circular 649 dated 31 March 1993

Payment to Indian branch of foreign company in India (e.g. Branches of foreign banks)

• Circular 20 (II-4) dated 3 August 1961 – Since branch of NR will be NR, deductible

• Foreign branches could obtain „Nil‟ TDS certificates u/s 195(3)

33

Others – Payments to Branches / Head Office (HO)

a) Software

‒ Copyright v. Copyrighted article

‒ Samsung

‒ Sonata Software

‒ Recent Karnataka HC decision – overruled by SC

b) Subscription charges for standard service/data

c) Bandwidth charges

d) Advertisement procurement and revenue share

e) Royalty / Fees for technical services

Services utilized OR rendered in India OR both

Make available

If “make available” not satisfied, should Article on “Business Profits” be analyzed?

Business profits not taxable in absence of Permanent Establishment – In such a case,

should Article on “Other Income” be analyzed?

34

Others – E-Commerce transactions

• Base to be adopted for TDS – Gross amount or net amount which may represent income

• “Any sum chargeable to tax” means “sum” chargeable to tax and it not only applies to the

amount paid which wholly bears an “income” character but the gross sum, the whole of

which may not be income or profits.

• Transmission Corporation – 239 ITR 587 (SC)

• The obligation of the assessee to deduct tax u/s 195 limited only to the appropriate

proportion of the income chargeable under the Act forming part of the gross sums of

money paid to the non-residents – CIT vs. Superintending Engineer, Upper Sileru – 152

ITR 753 (HC, AP)

• Payments to non-residents would be subject to withholding tax only if the income is

chargeable to tax – No TDS if there is no income element at all in payments – GE India

Technology Centre Private Ltd. Civil Appeal Nos.7541-7542 of 2010 (SC)

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Others – Gross sum vs. Income element

Others – Determining residential status

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Case Study

‒ X Co incorporated in UK

‒ Control and management situated wholly in India

‒ Residential status = Resident

‒ Payment by Ind Co (resident in India) to X Co – whether section 195 applies ?

Payee Definition

Non-resident, not being a company Defined in section 6 of the Act

Foreign company Defined in section 2(23A) of the Act

ISSUE: Indian partnership firm – control and management wholly outside India –

How does the payer come to know ?

Payments in kind

• The assessee is liable to deduct tax at source u/s 195 on the payment made to the non-

resident even though the payment is not made in cash but made in kind

Kanchanganga Sea Foods Ltd. v. CIT – 325 ITR 540 (SC)

Net payment received

• The assessee is liable to deduct tax at source u/s 195, even under an arrangement where

he receives only net payment from other party after deducting commission/ management

fees etc.

Raymond Ltd. v. DCIT – 86 ITD 791 (HC, Mum)

Mahindra and Mahindra Ltd. V. DCIT – 30 SOT 374 (ITAT, Mum)

37

Other issues

Thank you

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