SEPTEMBER 01,2014

By Lukose Joseph,CA & Anil P Nair,CA

INCOME Tax Act,1961 requires tax to be deducted at source from payments to a non resident. What if payments are made to related companies abroad? It is interesting to see the position of law regarding holding and subsidiary companies while either is foreign.

The pertinent question was whether tax is to be deducted under the Income Tax Act,1961 (the Act) on payments made from India by ABC Ltd,a Company Incorporated under the Companies Act engaged in software development to ABC Inc; a company registered in the USA. The payment is for commission on account of services rendered to collect payments from customers of ABC Ltd in the United States and both ABC Ltd & ABC Inc.has identical share holders.

Any sum

By virtue of Section 195 of the Act,any person responsible for paying to a non-resident,not being a company,or to a foreign company,any interest (not being interest referred to in section 194LB or section 194LC) or any sum chargeable under this Act (other than salary) 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.

It is clear that payment unless otherwise expressly exempt is liable to Tax deducted at Source (TDS). The matter was further examined through a reference to related case laws.

G. E. India Technology Centre P. Ltd. v. CIT,2009-TIOL-131-SC-IT-LB.

Let us examine the Honorable Supreme Court of India's decision in G. E. India v CIT. At the outset,the Apex Court noted that the short question which arises for determination in this case,is as follows:

“Whether the High Court was right in holding that the moment there is remittance the obligation to deduct tax at source arise. Whether merely on account of such remittance to the non-resident abroad by an Indian company per se,could it be said that income chargeable to tax under the Act arises in India?”

To decide the issue on hand,the Court referred and explained the provisions of S. 195. The Court,then,stated that the most important expression contained in S. 195 (1) is 'chargeable under the provisions of the Act'. Therefore,a person making payment to a non-resident is not obliged to deduct tax if,such sum is not chargeable to tax under the Act.

In view of the above judgment of the Apex Court,it is settled law that if the payment is made to a non-resident,which is not a taxable income in India,then no tax,is required to be deducted u/s195.

For the above purpose,it is open to the Payer to decide whether such payment is at all chargeable to tax in India as the income of the Payee. The Payer can take into account the relevant provisions of the Act as well as applicable Double Tax Avoidance Agreement (DTAA). If,in the process,the payer is fairly certain about the non-taxability,he need not deduct tax.

Priyadarshini Spinning Mills (P.) Ltd . IT Appeal No. 1776 (Hyd.) of 2011 2012-TII-153-ITAT-HYD-INTL.

Let us also examine a decision of Hyderabad Bench of Appellate Tribunal in the case of Assistant Commissioner of Income-tax,Circle-16(3) v Priyadarshini Spinning Mills (P.) Ltd . IT Appeal No. 1776 (Hyd.) of 2011.

The assessee was engaged in manufacture and sale of cotton and synthetic yarn. In the course of the assessment proceedings,the Assessing Officer (AO) found that the assessee has paid an amount of Rs.80 ,50,703 /- to non-resident agents without deducting tax at source.

The bench observed that non-resident agents did not carry out any business operations within the taxable territory of India. They acted as selling agents outside India. Therefore,neither income accrues or arose in India in view of the judgment of the Supreme Court in the case of Toshoku Ltd.

CIT v. Toshoku Ltd (2002-TIOL-580-SC-IT).

Japanese Company appointed as an exclusive sales agent in Japan and was entitled to commission. Sale price for sale in Japan were wholly received by a statutory agent in India who debited the commission account and credited the amount of commission payable to the Japanese Company. Held,entries made in books of account of the statutory agent could not amount to receipt,actual or constructive as the amounts credited in favor of Japanese Company was not at their disposal.The non-resident assessees did not carry on any business operations in the taxable territories. They acted as selling agents outside India. The receipt in India of the sale proceeds of tobacco remitted or caused to be remitted by the purchasers from abroad does not amount to an operation carried out by the assessees in India as contemplated by cl. (a) of the Explanation to s. 9(1)(i) of the Act. The commission amounts which were earned by the non-resident assessees for services rendered outside India cannot,therefore,be deemed to be incomes which have either accrued or arisen in India.

Hence,Appellate Tribunal observed that there is nothing on record to show that the non-resident agents received the commission in India. Merely because the assessee has made entries in his books of accounts crediting commission in the name of non resident agent,it cannot be deemed to have received in India by the agent or on his behalf as per Sec. 5(2) (a).

Whether chargeable under the Act?

Going by the above,the first condition required to be fulfilled is that the payment must be chargeable under the Act; only thereafter the question of deducting income tax shall arise. Section 195(1) of the Act also prescribes that tax has to be deducted while making payment to nonresident which is chargeable under the provisions of the Act. Therefore,the condition precedent for deduction of tax is that the income must be chargeable under the provisions of the Act. In the given case,the agreement entered into by the assessee with foreign agents revealed that they have been appointed to act as sales agents outside India in their respective countries.

Permanent Establishment or Business Connection

There is also no finding by the AO that the non-resident agents have a permanent establishment (PE) in India or have any business connection in India,by virtue of which the payment of commission would have accrued or arose in India. The facts available on record clearly suggest that the non-resident agents did not carry out any business operations in India and has acted as selling agents of the assessee outside India. Therefore,the commission earned by them for services rendered by them outside India cannot be considered as income chargeable to tax in India.

That apart,the submission of the learned Authorized Representative that DTAA between India and concerned countries stipulates that the income of an enterprise of contracting state shall be taxable in that state unless enterprise carries on business in the other contracting state through permanent establishments also requires consideration.

Double Taxation Avoidance Agreement

Vide article 7 of agreement by India for avoidance of double taxation of income with USA,Business profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein.

The matter to be examined is whether American Company has any Permanent Establishment in India on the basis of India US Double Taxation Avoidance Treaty.

How do India US DTAA define Permanent establishment? It says,

For the purposes of this Convention,the term “Permanent Establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on [(Article 5(1)]

Vide article 5(2). The term “permanent establishment” includes especially:

(a) A place of management;

(b) A branch;

(c) An office;

(d) A factory;

(e) A workshop; etc……….

Vide article 5(5),an enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker,general commission agent,or any other agent of an independent status,provided that such persons are acting in the ordinary course of their business. However,when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm's length conditions,he shall not be considered an agent of independent status within the meaning of this paragraph.

The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State,or which carries on business in that other State (whether through a permanent establishment or otherwise),shall not of itself constitute either company a permanent establishment of the other. [Article (5(6)]

To conclude this exciting exploration,let us refer a Delhi High Court decision which went into the core concepts in DTAA.

e-Funds IT Solutions/ e-Funds Corp vs. DIT 2014-TII-05-HC-DEL-INTL.

Delhi High Court examined entire law on taxability of Permanent establishment under DTAA in the said case. Court examined various elements on an appeal against the decision of AO that the assessee had a Permanent Establishment (“PE”) in India in respect of back office operation and software development services being carried out by its subsidiary e-Fund India Limited(an agent). It was also held by AO that the income was liable to tax in India in respect of operations performed by subsidiary company on its behalf.

The Court considered;

(a) Whether a subsidiary can be a Permanent Establishment?

(b) Location or fixed place PE under Article 5(1) and (2) of DTAA

(c) What constitutes a “Service PE” under Article 5(2) (l) of the DTAA?

(d) Impact of Article 5(3) and its over-riding effect and consequences,

(e) What is “Agency PE” under Article 5(4) and (5) of DTAA?

(f) Relevance of Mutual Agreement Procedure,

(g) Computation,apportionment or accumulation of income/profit,

The Court held,‘on facts,there is no material to hold that the two assessees had a fixed place of business in India through which the business of the enterprise was wholly or partly carried on. It has not been stated that the premises of e-Fund India were at the disposal,legally or otherwise,of the two assessees. The “right to use test” or “disposal test” has not been or applied nor is there any finding to the said aspect. In the absence of any such finding Article 5(1) cannot be applied.

The fact that e-Fund India provides various services to the assessee and was dependent for its earning upon the two assessees is not the relevant test to determine and decide location PE. The fact that the subsidiary company was carrying on core activities as performed by the foreign assessee does not create a fixed place PE. The allegation that e-Fund India did not bear sufficient risk is irrelevant when deciding whether location PE exists. The other circumstances such as reimbursement of costs etc were also irrelevant.

Regarding Taxability of ABC Inc

We have seen the relevant points to be considered. They are:

i. Whether ABC Inc has any permanent establishment in India on the basis of India US Double Taxation Avoidance Treaty,

ii. The transactions between ABC Inc and ABC Ltd are made under arm's length price and

iii. Whether income of ABC Inc is chargeable under the provisions of the Act.

By virtue of article 5(6) mere facts that both ABC Ltd and ABC Inc have the same shareholders and directors of ABC are in management of ABC Inc shall not itself constitute that ABC Inc has a Permanent Establishment in India. If Transactions are at arm's length conditions as specified in article 5(5) above,income of ABC Inc is not taxable in India.

We may,therefore,conclude that ABC Ltd can make the payments to ABC Inc without any deduction of income tax.