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Tax Deduction at Source

on payments to
Non Residents

K Subramanian
Deloitte Haskins & Sells

September 2010
Contents

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

• 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

Regular inflow
of revenue for
Government

Widening of Checking of
tax base tax evasion

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Issues
Capital Gains
Capital Gains – Quantum – Case Study 1(a)

TDS on what amount

X Co • Cost of acquisition = Rs 5000


Transfer of
shares in
Ind Co • Sale consideration = Rs 8000
USA
India
• At the time of remittance by Y Co India,
section 195 comes into play

10 shares

Ind Co Y Co

ISSUE: TDS on what amount?


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

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Capital Gains – Quantum – Case Study 1(b)

Determination of cost of acquisition

X Co • Capital Gains = Sale Consideration less


Transfer of
shares in Cost of acquisition
Ind Co
USA
• How does Y Co India determine the cost of
India acquisition of shares in the hands of X Co
US?

10 shares • Does Y Co obtain FIRCs or other supporting


documents from X Co?

• What if the supporting documents are not


Ind Co Y Co available?

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Capital Gains – Quantum – Case Study 1(c)

Brought forward losses

X Co • Ind Co – 100% subsidiary of X Co US

USA • Ind Co buys back part of its shares from X


Co – resulting in capital loss to X Co
India
100%
• 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
Ind Co is a loss

• Can Ind Co set off the brought forward


capital loss against the current capital
gains to determine withholding tax
liability?

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

Brought forward losses – Contd.

X Co Section 197

USA • Application by payee


• To AO
India • For grant of certificate for receipt of
100%
income without deduction of tax at source
or for deduction at lower rates

Issues

Ind Co • 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

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

197 Application – Alternatives

X Co Section 195 (2)


• Application by payer
USA • To A.O.
• To determine the appropriate portion of the sum
India chargeable to tax
100%

Section 195(3)
• Application by payee
• To A.O.
• For the grant of a certificate for receipt of
Ind Co 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)?
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Capital Gains – Quantum – Case Study 1(c) – Contd.

Rule 29B – Conditions for 195(3) application

X Co • Has been regularly assessed to Income-tax in India

• Has furnished the returns of income for all


USA assessments years

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


100% any tax, interest, fine or any sum payable under the
Act

• Has not been subjected to penalty for concealment of


particulars of income

Ind Co • 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

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Capital Gains – Chargeability – Case Study 2(a)

Non resident to non resident transfer


Transfer of shares
in Ind Co
• Shares in an Indian Company – chargeable to
capital gains tax in India

• Triniti Corporation –165 Taxman 272 (AAR)


X Co Y Co
• Satellite Television Asian Region Ltd. v. DCIT –
99 ITD 91 (ITAT, Mum)
USA
India

10 shares

Ind Co

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


(another non resident)?
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Capital Gains – Rate – Case Study 2(b)

Proviso to Section 112


Transfer of shares
in Ind Co
• In the previous example, Y Co has to withhold
taxes on payments made to X Co

• Non resident eligible to benefit of proviso to


X Co Y Co Section112

• Proviso to Sec 112


USA  20% if indexation benefit availed i.e. on Sale
India Consideration less Indexed Cost of acquisition
 10% of indexation benefit not availed i.e. on
Sale Consideration less Cost of acquisition
10 shares (without indexation)

Ind Co

ISSUE: At what rates should Y Co withhold taxes?


Can it apply proviso to Section 112?
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Capital Gains – Cross Border M&A – Case Study 3

• Vodafone ruling
A Co Transfer of
shares in X Co

X Co Y Co

USA
India

Ind Co

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

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Reimbursements
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)

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Reimbursements – Case Study 1

• Employees on the payrolls of X Co

X Co • Seconded to Ind Co (subsidiary of X Co)

USA • Salary cost of seconded employees cross


charged by X Co to Ind Co – no mark up
India
Secondment
of employees
• DCIT v. HCL Infosystems Ltd. – 211 Taxation
29 (ITAT, Del)

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


(AAR)
Ind Co
• IDS Software Solutions India (P) Ltd. v. ITO –
122 TTJ 410 (ITAT, Bang)

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

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Reimbursements – Case Study 2

• Ind Co sends its employees to X Co for a


training
X Co
• X Co incurs expenditure on travel,
accommodation etc of such employees
USA

• X Co cross charges the expenditure at cost to


India
Employees Ind Co
sent for
training

Ind Co

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


incurred by X Co?
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Reimbursements – Case Study 3

Invoice raised for all


services rendered to • X Co acts as a global procurement center for
various subsidiaries all subsidiaries

X Co Service provider
• X Co enters into agreements with service
providers centrally
Debit notes raised
• Invoice raised by service providers on X Co

Y Co
• X Co, in turn, allocates the cost to the
subsidiaries in ratio of the utilization of
USA
services and raises debit notes on subsidiaries
India for cross charge of such cost – no mark up

Ind Co 1 Ind Co 2

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?
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Reimbursements – Case Study 4

• X Co has a centralized research and


development (R&D) unit
X Co
(R&D centre)
• The research done at the unit benefits all the
Debit notes raised for subsidiaries
services rendered

• Cost contribution agreement between X Co


and subsidiaries – entire costs shared
between the entities
Y Co
USA
• X Co cross charges proportionate costs to all
India the group companies who benefit from such
research

Ind Co 1 Ind Co 2

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


incurred by X Co?
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Reimbursements – Case Study 5

• X Co renders services to Ind Co in USA

X Co • No services rendered in India

USA • X Co recovers the expenses incurred at


actuals from Ind Co – no markup
India
Services
rendered in
 Timken India Ltd – 143 Taxman 257 (AAR)
USA  Danfoss Industries – 268 ITR 1 (AAR)

Ind Co

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


incurred by X Co?
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Inter Corporate Loans
Inter Corporate Loan – Case Study

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


company) in which non resident shareholder
X Co (X Co) has substantial interest

USA • Deemed dividend u/s 2(22)(e)

India • Does not attract dividend distribution tax

100% • Taxable in the hands of non resident


shareholder

Ind Co 1 Ind Co 2
• No payment / credit to the account of non
resident shareholder

Loan

ISSUE: Whether taxes are to be withheld u/s 195 at the time of remitting the loan to
Ind Co 2?

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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
X Co the partners
(Partnership Firm)
• Entitlement to the benefits of DTAA – whether
UK
included in the definition of “resident” as given
in DTAA
India
Services
rendered • 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 …”.

Ind Co

ISSUE: Whether the partnership firm is eligible to avail the benefit of Indo UK
DTAA?
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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
X Co not in its own right but in the hands of the
(Partnership Firm) partners – Linklaters LLP v. ITO – 132 TTJ 20
(ITAT, Mum)
UK

Issues
India
Services
rendered • What if the partners are residents of different
contracting states? – Which DTAA would
apply?

• Can the partners take credit of such taxes


Ind Co withheld?

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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

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PAN – Issues

Particulars Rate under the Rate under the Applicable rate In absence of
Income Tax DTAA w.e. is PAN, will
Act, 1961 beneficial 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 Yes
than X
Situation 4 X Not taxable i.e. DTAA i.e. Nil ?
Nil
Situation 5 No TDS X Act i.e. Nil No
required

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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

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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”?

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

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Others – Payments to Branches / Head Office (HO)

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)

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Others – E-Commerce transactions

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?

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Others – Gross sum vs. Income element

• 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 – Determining residential status

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

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 ?

ISSUE: Indian partnership firm – control and management wholly outside India –
How does the payer come to know ?

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Other issues

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)

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Thank you

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