PAYMENTS TO NON RESIDENTS&

TAX AUDIT

P.M.Veeramani FCAveeramani@rgnprice.com

Section 40(a)(i) & Section 195

Section 40 (a) (i) : Interest, Royalty, Fee for technical services or other sum chargeable to tax under this Act which is payable –

A) Outside India orB) In India to a non resident Unless TDS is made as required under the Act - not allowable as expenditure

Section 195 : Any person responsible for paying to a non-resident, not being a

company, or to a foreign company, any interest or any other sum chargeable to

tax under the provisions of this Act (not being income chargeable under the head

‘salaries’) shall, at the time of credit of such income to the account of the payee or

at the time of payment thereof shall deduct income tax there on at the rates in

force.

LIABILITY FOR DEDUCTION OF TAX AT SOURCE

• In the case of :

• Fee for technical services - Amendment to explanation 2 under section 9(1) by Finance Act 2007 and Finance Act 2010

• Royalty – Samsung Electronics Ltd decision• Business Profits –• Other Sums chargeable to tax

Fee for Technical Services

INCOME DEEMED TO ACCRUE OR ARISE IN INDIA – Sec.9(1)(v), (vi) & (vii)

Nature of Income INTEREST ROYALTY FEE FOR TECHNICAL SERVICES

Section 9(1)(v) 9(1)(vi) 9(1)(vii)

PayerSub-section (a)

GovernmentSub- section (b)

ResidentSub-section (c )

Non Resident

Receipts from Government -

Taxability

Taxable Taxable Taxable

INCOME DEEMED TO ACCRUE OR ARISE IN INDIA – Exceptions

Nature of Income INTEREST ROYALTY FEE FOR TECHNICAL SERVICES

ResidentBorrowings outside India;Used in business outside India;Used for earning income outside India

Right, property or information used outside India;Services used in business outside India;For earning income outside India

In respect of services used in a business outside India;Used for earning income outside India

Non - residentBorrowings in India;Used in business in India;Used for earning income in India

Right, property or information used in India;Services used in business in India;For earning income in India

In respect of services used in a business in India;Used for earning income in India

SUPREME COURT DECISION IN JAN 2007 CHANGES SCENARIO

• Ishikawajima-Harima Heavy Industries Ltd vs Director of Income tax – 288 ITR 408 SC

• Turkey project awarded by Petronet LNG , Indian Company to the Japanese Company

• Project consisted of : Offshore supply of equipments Offshore supply of services like designs, drawings and other

services to rendered from outside India Onshore supply of equipments Onshore supply of services

• Company had a PE in India but contended that the project was not executed by the said PE

ISHIKAWAJIMA decision……..

• Offshore supply: Transfer of property in goods as well as payment were carried outside India, transaction not taxable in India

• Only that part of the operations carried out by the PE in India is taxable . Since no part of the activity is carried out by PE in India, transaction not taxable in India

• Offshore services : In order for the services to taxable, it is necessary that services are not only be utilized in India , but such services are rendered in India

• The services are inextricably linked to the supply of goods and hence, it must be considered in the same manner

Amendment by Finance Act 2007

• Explanation to section 9(2) inserted with retrospective effect from 1.6.1976

“ For the purpose of this section, where income is deemed to accrue or arise in India under clause (v), (vi) or (vii) of sub section 1, such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India”

DECISION OF KARNATAKA HC – 321 ITR 31 – 16.3.2009

• Decision in the case of JINDAL THERMAL POWER CO LTD vs DCIT

• “ The criteria of rendering the service in India and utlisation of service in India to attract tax liability to attract tax liability under section 9(1)(vii) remains unaffected by the explanation to section 9(2) and therefore, remuneration paid by the assessee to non-resident company for rendering technical services for commissioning of a power plant in India did not attract tax liability and assessee was not liable for TDS from said payments as the technical services were in the nature of theoretical formulations which could be rendered wholly offshore and outside India “

Amendment by Finance Act 2010

• For the removal of doubts, it is hereby declared that for the purposes of this section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of sub-section (1) and shall be included in the total income of the non-resident, whether or not,—

(i) the non-resident has a residence or place of business or business connection in India; or

(ii) the non-resident has rendered services in India.

Recent Tribunal Decision

As per explanation to section 9(1) as amended retrospectively by Finance

Act 2010 , income of non resident shall be deemed to accrue or arise in

India where, it has rendered services which are utilized in India. In order to

attract taxability in India, it is no longer necessary that the services must

also be rendered in India. The entire fees for professional services earned

by the assessee, UK based partnership firm, in connection with projects in

India is taxable in India under the domestic law. - Linklaters LLP vs ITO

(International Taxation) 42 DTR Mum Trib 233 – 16.7.2010

ITO (International Taxation) vs Prasad Production Ltd – 3 ITR Trib 58 SB (9.4.2010)

Person making payment to non-resident liable for TDS only if the payment

is chargeable to tax in India. If the payer is under bonafide belief no part

of the payment has an income character, section 195(1) would not apply

and he shall also not be required to go through the procedure of 195 (2)

Payment of technology transfer fee to a foreign company towards

services of installation of equipment and training of personnel under an

agreement for supply, maintenance and installation of theatre equipment

is part of price of equipment and said payment is not chargeable to tax in

India and assessee is justified in not deducting tax at source.

Where FTS clause is absent in tax treaties

• Where ever, the Article on Fees for Technical Services is absent in a tax treaty, such a payment is classifiable as ‘Business Profit’ under Article 7 of the relevant tax treaty and if the payee does not have a permanent establishment in India in terms of Article 5 of the tax treaty, the same will not be liable to tax in India

Royalty

Samsung Electronics Ltd – 320 ITR 209 Kar – 24.9.2009

Departmental appeal before High Court against the decision

of ITAT that assessees were not liable for TDS on payments

made by them to non-resident suppliers as consideration for

purchase of software for the purposes of their business by

holding that subject payments were not royalty within the

meaning of section 9(1)(vi) and not an income chargeable to

tax in India

Samsung Electronics Ltd – 320 ITR 209 Kar – 24.9.2009

Under section 195(1) , there is an obligation on the part of the

person responsible for paying to the non-resident to make TDS , if

the payment partakes the character of income. The impugned

payment to non-residents being consideration for acquiring ‘ready

to sell, off the shelf ‘ packaged software product, tax was deductible

at source;

For non-deduction or deduction at lower rate, the resident tax

payer has to go through the procedure envisaged under 195(2) –

same decision followed in CIT vs Sonata Information Technology Ltd

38 DTR 350 Kar 25.9.09

Transmission Corporation of AP Ltd - 239 ITR 587 SC

The answers given by the High Court that:

(i) The assessee who made payments to the three non-

residents was under obligation to make TDS under section 195

in respect of the sum paid to them under the contracts entered

into and

(ii) The obligation of the assessee to make TDS is limited only

to the appropriate proportion of the income chargeable under

the act,

are correct

DDIT vs SET Satellite (Singapore) – ITAT Mumbai

The assessee, a Singaporean company with a PE in India,

obtained rights from the Global Cricket Council, Singapore,

for telecast of cricket matches in India. The AO took the view

that the payment for the said rights constituted “royalty” in

the hands of GCC u/s 9(1)(vi) & Article 12(7) of the India-

Singapore DTAA and that it had arisen in India on the ground

that the payer had a PE in India and there was a direct nexus

between collection of advertisement revenue in India and

payment for the rights

DDIT vs SET Satellite (Singapore) – ITAT Mumbai

Mere existence of a PE in India does not mean that royalties

arise in India. In addition to the existence of PE, it is essential

that liability to pay such royalties has been “incurred in

connection with” and is “borne by” the PE of the payer in

India. There must be an “economic link” between the

liability for payment of such royalties and PE. As there was

no economic link between the payment of royalties and the

PE of the assessee in India, the payments to GCC are not

incurred “in connection” with the PE in India – Not yet

reported

Business Profits

CBDT Circular 786 of 2000

The deduction of tax at source under section 195 would arise if the payment of commission to the non-resident agent is chargeable to tax in India. In this regard attention to CBDT Circular No. 23 dated 23rd July, 1969 is drawn where the taxability of Foreign Agents of Indian Exporters was considered along with certain other specific situations. It had been clarified then that where the non-resident agent operates outside the country, no part of his income arises in India.

CBDT Circular 786 of 2000

The relevant sections, namely section 5(2) and section 9 of the Income-tax Act, 1961 not having undergone any change in this regard, the clarification in Circular No. 23 still prevails. No tax is therefore deductible under section 195 and consequently, the expenditure on export commission and other related charges payable to a non-resident for services rendered outside India becomes allowable expenditure.

CBDT Circular 723 of 1995 – Shipping Business of non-residents

Section 172 deals with shipping business of non-residents.

Said section shall apply notwithstanding anything contained

in any other provisions of the Act. There fore in such cases,

the provisions of section 195 relating to TDS are not

applicable. There would be cases where payments are made

to shipping agents on non-resident ship owners, in India.

Since the agent acts on behalf of the non-resident ship owner,

he steps into the shoes of the principal . In such cases also,

provisions of section 172 shall apply . Section 195 shall not be

applicable - 128 CTR St.6 – 19.9.1995

Other sums chargeable to tax

Van Oord ACZ India Private Ltd – 323 ITR 130 – Delhi HC – 15.3.10

Facts: Van Oord reimbursed certain expenses to its parent

Dutch company and claimed the same as business

expenditure. TDS was made at the rates stipulated by AO

based on application under 195 (2). In the assessment under

143(3), AO disallowed the expenditure invoking section 40(a)

(i). The parent company filed its return of income and

claimed the receipt as exempt and this return was accepted

under 143(1)(a) and TDS was refunded.

Van Oord ACZ India Private Ltd – 323 ITR 130 – Delhi HC – 15.3.10

Held, Obligation for TDS under section 195 is attracted only

when the payment is chargeable to tax in India; IT authorities

having accepted that non-resident recipient is not liable to

tax , the assessee was not liable for TDS under section 195 in

respect of costs reimbursed to the foreign company.

Decision of Jindal Thermal Power Co relied on;

Decision of Samsung Electronics dissented from ;

Mahindra & Mahindra Ltd vs DCIT 30 SOT 374 Mum SB

• Services rendered by non-resident lead manager to the assessee

company for bringing out an FCCB issue;

• Underwriting commission was not fee for ‘technical services’

within meaning of section 9(1)(vii), but management fee is taxable

• UC not a business profit in the absence of PE of the non-resident

in India

• Reimbursement of expenses not being in the nature of income,

was not taxable

• Obligation for tax deduction at source restricted to management

fee

DDIT vs TISCO 34 SOT 83

• Services rendered by non-resident lead manager to the assessee

company for bringing out an Euro and GDR issue;

• Fee paid included payment for legal services rendered in

Hongkong and hence claimed as not taxable

• As per sec.9(1)(vii)(b) , if payer is resident ,FTS is taxable in India,

irrespective of status of payee and the place where services are

rendered / utilised

• Reimbursement of expenses not being in the nature of income,

was not taxable

• TDS was applicable in respect of FTS

Review of recent decisions

• No disallowance of depreciation when capital asset is purchased without TDS – SMS Demag Pvt Ltd vs DCIT 37 DTR Del Trib 78

• Unpaid installments of purchase price of goods supplied by non-resident supplier not being loan, there was no requirement of TDS from interest paid on unpaid installments and disallowance under 40(a)(i) not attracted – CIT vs India Pistons Ltd 282 ITR 632 Madras

• Payment to non-resident companies on account of rentals for hosting websites on servers in USA were not in the nature of royalty or fee for technical services and hence there was no liability for TDS - Millenium Infocom Technologies Ltd vs ACIT 117 TTJ 456 Delhi

• Payment by way of training fees to foreign company to train its personnel to explain the intending buyers the salient features of the products imported and to impart training to the customers for the use of the products is not fee for technical services - DCIT vs PIC Ltd 15 DTR Del Trib 215

• Malaysian company having no business place in India, making payment to a Dutch company for supply of personnel for executing contracts in India was not taxable in India and provisions of section 195 not attracted - DDIT (International Taxation vs Stock Engineers and Contractors BV 122 ITD 49 Mumbai

• Purchase of property from Non resident by an individual .Section 195 is attracted and TDS should be made - Mrs.Meena.S.Patil vs ACIT 113 TTJ 863 Bangalore

• Charter hire paid to foreign ships were in the nature of simple payments for chartering ships on hire and not royalty within the meaning of section 9(1)(vi) – ACIT vs Kinship Services India Private Ltd 2 ITR Trib 392 Cochin

• Section 172 shall have no application in the case of demurrage charges paid to foreign company. Reliance placed on CBDT circular 723 is misplaced. Non deduction of TDS on demurrage charges results in disallowance under section 40(a)(i) - CIT vs Orient Goa Private Ltd 325 ITR 554 Bombay (Goa bench)

• Assessee availed bandwidth services and other infrastructure for providing internet access to customers. These were standard facilities availed of by the assessee. The payment made for such services were not technical services within the meaning of section 9(1)(vii) - CIT vs Estel Communications Pvt Ltd – 318 ITR 185 (Del); Pacific Internet (India) Pvt Ltd vs ITO – 318 ITR AT 179 (Mum)

Tax audit report - Clause 17 (f) vs 27

• Clause 17 (f) – covers only payments in the nature of expenditure debited to profit and loss account to which disallowance under section 40a apply

• Clause 27 – covers not only items covered under 17 (f) but also other payments to which TDS is attracted – eg: Payment to Non resident other than those covered under 40(a)(i)

• Audit report to bring out case laws , if any , relied on for non deduction of TDS

• Brief of judicial decisions - regular updates in Newsletter at www.kochiicai.org

• You can reach me veeramani@rgnprice.com

Thank you