tax deduction on remittances abroad (section 195 and others) page 1 tax deduction on remittances...

Tax deduction on remittances abroad (Section 195 and others)


27th August 2010

by Dhinal Shah, Chartered Accountant

Section 195 - Payments to Non-residents


Presentation Outline

Payments to Non-residents – Section 195

Overview

Certain recent controversies


Withholding Tax

Why TDSWhy TDS??

Ensure regular flow of income for the Revenue

Collect tax in advance

Minimizes cases of tax evasion or avoidance

Minimizes incidence of interest costs for the recipient

Place responsibility on the persons other than payees

Circular of RBI for certificate of C.A. for all trade payments.

OverviewOverview

Pay as you earn scheme

Deduction at the time of payment or credit whichever earlier

Deposit within one week from end of month of deduction

Income credited/ paid on last day of financial year, tax

withheld deposited within period of two months from last

day

Default attracts

─ Disallowance of expenses

─ Penal Interest

─ Penalty

─ Prosecution

4


Section 195 – Overview

Section Provisions

195(1) Scope and conditions for applicability

195(2) Application by the ‘Payer’ for lower or Nil withholding

195(3) Application by the ‘Payee’ for lower or Nil withholding

195(4) Validity of certificate issued by the AO u/s 195(3)

195(5) CBDT empowered to make Rules in respect of sec 195(3)

195(6) CBDT empowered to provide forms in which information to be furnished - Rule


Section 195 – scope and conditions for applicability Any person responsible for paying to a non-resident, any interest

or any other sum chargeable under the provisions of 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, whichever is earlier, deduct income-tax thereon at the rates in force

Proviso 1:In case of interest payable by Government or public sector bank or public financial institution, deduction of tax only on payment basis

Proviso 2:No deduction in respect of dividend under section 115O

Explanation:Credit to Interest payable account or Suspense account deemed as credit of such income to payee’s account


Overview of non-resident WHT provisions

WHT provision (Sec 195) applicable on: any sums payable by any person to a non-resident (NR) which is chargeable to tax in India at rates in force

Arises at the time of credit or payment, whichever is earlier Certificate for tax authority for appropriate rate or appropriate amount

of WHT Possible to seek advance ruling Procedural rules require the payer to obtain an Accountant’s

certification before making remittance



Final tax liability (where tax liability is on gross amount) or could be a collection on account of the final tax liability

Tentative in nature, subject to determination of final tax liability Recipient can file tax return and claim refund for excess WHT

Typical payments subject to WHT Any sums which are chargeable to tax in India

Interest Royalty Service Fees (managerial, technical or consultancy services) Capital gains Business profits attributable to a PE/ business connection in India Any other income accruing or arising in India



Consequences of WHT default: Payer treated as “assessee in default (AID)” under Section 201 Recovery of taxes not withheld from payer Payer subject to interest and possibly penalties Expense disallowance

“Net of taxes” clauses in contracts Common but may be expensive Section 195A requires gross up of taxes borne by payer


Comparative analysis of 195(2), 195(3) and 197

Particulars 195(2) 195(3) 197

Application by Payer Payee under Rule 29B

Payee

Purpose To determine the appropriate proportion of sum chargeable

No deduction of tax No deduction/ deduction at lower rate

Whether appealable?

A revision petition under section 264 would lie against such orders

Appeal u/s 248 denying liability to deduct tax after payment of tax

No appeal No appeal


Alternate option – (I) CA certificate

Form 15CA (format of undertaking) and Form 15CB (CA Certificate) notified

Circular also issued by CBDT (Circular No 4 dated June 29, 2009)

Points to be factored

Examination of PE and related issues

Beneficial ownership/ Tax residency evaluation

Declaration that payer continues to be liable for taxes, interest and penalty

Declaration that payer will submit all requisite documents


Documentation to be maintained

Agreement and Invoices

Tax Residency Certificate

Certificate from payee for – no PE, tax residency, beneficial owner, treaty entitlement, etc and Indemnification from payee

Payment details

Correspondences

Technical Advice – prove bonafides

Proof of services being rendered in case of Group Company transactions

E-mails etc regarding pricing in case of Group Company transactions


Alternate option – (II) Advance Ruling under Chapter XIX-B Mechanism for upfront determination of taxability of transactions

undertaken by/ with non-residents

Ruling by quasi-judicial authority on reference by payer/payee

Ruling binding on applicant as well as the tax authorities unless change in facts/ law

Usual 4-tier appeal mechanism not available/ applicable

Upfront determination of the taxability; certainty of tax treatment even at lower levels of income tax authorities

Fast track mechanism; protracted litigation on a year on year basis can be avoided

Certain Recent Controversies

Issue 1- Is it obligatory to approach AO for non-withholding of taxes?


Scope of Section 195

“(1) Any person responsible for paying to a non-resident, any sum chargeable under the provisions of this Act shall deduct income-tax thereon at the rates in force .”

“(2) Where the person responsible for paying any such sum chargeable under this Act to a non-resident considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make an application to the Assessing Officer to determine, the appropriate proportion of such sum so chargeable, and upon such determination, tax shall be deducted under sub-section (1) only on that proportion of the sum which is so chargeable.”


Scope of section 195(1)

The provisions of Section 195 of the Act require withholding of tax on “any…sum chargeable under the provisions of this Act".

A plain reading of the provision would suggest that in a case where there is no sum chargeable to tax in India, the payer is not liable to withhold taxes on the payments made.

Hence, where a transaction is not taxable in India, either on account of an exemption in the Act or on account of provisions in the relevant tax treaty, Section 195 should, as such have no application.


Karnataka HC Ruling in the case of Samsung & Others [2010] 320 ITR 209 (Kar HC) Background

Tax Authority on appeal before Karnataka High Court (KHC) against order of Bangalore Income-tax Appellate Tribunal (ITAT) in a case involving several taxpayers

Principal issue before HC - whether payment for purchase of computer software should be subject to royalty WHT?

Tax Authority argued that payment is in the nature of royalty, subject to WHT

The first appellate authority ruled in favor of the Tax Authority while the ITAT ruled in favor of the Taxpayer


Samsung Ruling

KHC decision

Taxes have to be withheld on any payment made to a NR which is in the nature of income

Reliance placed on certain observations of Supreme Court (SC) decision in Transmission Corporation [1999] 239 ITR 587 (SC)

As the Taxpayers had not obtained certificate for lower WHT from Tax Authority contention that there is no liability to WHT cannot be sustained

Charging provisions under the ITL are independent of the provisions governing withholding of taxes

WHT provisions seek to withhold a tentative amount as taxes before determination of actual tax liability of the NR


Samsung Ruling

KHC decision (Cont’d)

Tax Authority not required to assess the income of the NR for the purpose of WHT when an application is filed

For failure to withhold taxes, Tax Authority can initiate proceedings for recovery of taxes and interest

NR can contest its tax liability in India by filing a tax return under the ITL Principal question of characterization of payment for purchase of computer

software not addressed


Samsung Ruling

Implications

Payments made to NR for all commercial transactions subject matter of WHT, irrespective of taxability

Taxpayers would need to follow the process of seeking certificate under Section 195(2)/ 197 in each and every case

Significant increase in number of such applications Adverse implications on international trade in case of delay/ reluctance in

processing certificates Indiscriminate application of ruling can result in denial of deduction for

most payments to NR Possibility of tax authorities seeking to re-open past matters

Current status of litigation - The SC has heard the matter on August 19, 2010 and the order has been reserved


Van Oord & Prasad Productions rulings

Van Oord Payer obligated to withhold tax only if payment is chargeable to tax

Delhi HC expressed is disagreement with ‘some of the observations of Karantaka HC’

Certain observations in the concluding paras – disturbing?

Prasad Productions – comprehensive and well reasoned ruling If assessee under bonafide belief that income is not chargeable, then he

is not under statutory obligation to withhold tax

Various situations summarised by Prasad Productions in the ensuing slide


Is it obligatory to approach AO for non-withholding of taxes? – Prasad Production summarised

Various situations arising under Section 195

Implications under Section 195

How interest of Revenue protected

Bonafide belief that no part of payment has any portion chargeable to tax

Section 195 inapplicable Revenue has recourse to Section 201 proceedings

Payer believes that whole of payment is chargeable to tax

Deduct tax under Section 195(1)

Tax already deducted

Payer believes only part of payment is chargeable to tax

Application under Section 195(2)

AO to determine the appropriate rate

Payer believes only part of payment is chargeable to tax and does not make an application under Section 195(2)

Deduct tax from entire payment

Tax already deducted, following Transmission Corporation (supra)

Payer believes that entire or part of the payment is chargeable to tax and fails to deduct tax

Face all consequences under the Act

Revenue has recourse to Section 201 proceedings, Section 40(a)(i) disallowance

Payer believes that he has to deduct tax and expresses this duty to payee

Payee to apply under Section 195(3) to receive payment without tax deduction

AO to determine the appropriate rate

Under sl.no. (f), if payee fails to obtain certificate under Section 195(3)

Payer to withhold tax based on his belief

Tax already deducted


Way forward

WHT on NR payments has been an area of focus KHC ruling likely to strengthen enforcement efforts of Tax Authorities

– though ratio diluted by decision of Van Oord / Prasad Productions Consider reviewing current WHT practices and develop strategy for

future payments. Attribution restricted to amount “reasonably attributable” to operations in India. [Refer Explanation (a) to Section 9]

Undertake a risk assessment for past transactions Evaluate options for mitigating risks (e.g. Advance Ruling, Sec 195/

197 certificates) where appropriate Assess legal remedies that may be available in case of adverse

action by Tax Authorities Need to monitor future judicial and legislative developments

Issue 2 – Withdrawal of Circular no. 23 : Impact analysis


Withdrawal of Circular No. 23 : Background

Circular 23 has now been withdrawn by the CBDT vide Circular No.7 dated October 22, 2009 with immediate effect

The above Circular 23 has been withdrawn only from 22 October 2009 and would not have any impact in earlier years [Mumbai ITAT in the case of Siemens (2010-TIOL-102-ITAT-MUM)]

2 other circulars also withdrawn along with Circular 23

Circular No. 163 dated May 29, 1975

Activity restricted to purchase of goods through an agent for export out of India – No tax liability in India for non-resident [clarified the scope of Para 3(7) of Circular 23]

Circular No. 786 dated 7 February 2000

Services rendered by the agent outside India - No taxability in India of commission paid to non-resident agent on export of goods from India (Reiterated the clarification provided in Circular 23, in response to CAG objection)

Reason for withdrawal as provided by the CBDT

The interpretation not in accordance with the provisions of the Act /

intention behind the circulars


Circular 23 – Key clarifications

Situations Clarifications provided by Circular 23

Sale of goods by a non -resident from outside India

No tax liability on non-resident where the transactions are on principal-to-principal basis

Sale of goods by a non -resident from outside India to Indian subsidiary

No tax liability on non-resident where the transactions are on principal-to-principal basis & at arm’s length

Business connection arising out of parent – subsidiary relationship or the fact that parent might exercise control over the affairs of the subsidiary is immaterial

Sale of plant and machinery by a non-resident on installment basis

No tax liability if the transaction is on a principal to principal basis and no other business connection exists between the non-resident supplier and the Indian buyer


Circular 23 - Key clarifications

Situations Clarifications provided by Circular 23

Foreign agents receiving commission from Indian exporters

No tax liability if foreign agent operates in its own country and receives commission outside India from an Indian exporter

Circular No. 786 further clarified that there should be no withholding tax on such commission

Non-resident purchasing goods in India

No tax liability on income attributable to operations confined to purchase of goods in India for export, even if the non-resident has an office or agency in India

Circular 163 further clarified that mere existence of an agent in

India, will not be sufficient to charge the non-resident to tax, if the sole function of the agent is to purchase for export.

Issue 3 – Fees for Technical services – Amendment in section 9(1)(vii)


Section 9(1)(vii)

9(1) The following incomes shall be deemed to accrue or arise in India

……………………………..

(vii) Income by way of fees for technical services payable by: The Government; or

A person who is a resident, except, where the fees are payable in respect of services utilised in a 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; or

A person who is a non-resident, where the fees are payable in respect of services utilised in 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


…Section 9(1)(vii)

FTS deemed to accrue or arise in India if payable by: The Government

Resident of India except for business / source outside India

Non resident for business / source in India

Excludes consideration for construction, assembly, mining or like project


Analysis – Pre amendment

Landmark SC ruling in Ishikawajima Harima Heavy Industries (288 ITR 408): Taxation rights to India only if twin conditions met:Rendition of services in India

Utilization of services in India.

‘Live Link’ and ‘Territorial nexus’ essential.

As services not rendered in India, NOT TAXABLE


Analysis – Post amendment

Explanation to section 9(1) inserted with retrospective effect

Source Rule widened for FTS, Royalty, Interest

Deemed accrual whether or not: NR has a residence / place of business / business connection in India;

NR has rendered services in India

Clear intent to overrule following precedents Ishikawajima’s Ruling (SC) (288 ITR 408)

Jindal Thermal Power Co Ltd (Kar) (225 CTR 220)

Clifford Chance vs DCIT (Bom) (221 CTR 1)


Analysis - Ashapura Minechem Ltd - Impact

Law now states that utilization of services in India is enough to attract its taxability in India

Territorial nexus for determining tax liability is relevant only for a territorial tax system in which taxability is confined to the income earned within its borders

Apart from tax havens, only prominent countries following territorial tax systems are France, Belgium, Hong Kong and Netherlands

In other major tax systems, source and residence rules are concurrently followed

Issue 4 – Supply of Software


Supply of software as part of hardware

Lucent Technologies (ITAT Bangalore):

Facts

Assessee is a limited company engaged in the business of manufacture and sale of electronic

switching systems required for telecommunication industry.

During the relevant financial years, assessee imported certain hardware and software from its non-

resident group companies without deduction of tax at source.

Consequently, assessee was treated as assessee in default for failure to comply with the provisions

of section 195 of the Act

Decision

Acquisition of software was inextricably linked to acquisition of hardware and one cannot function

without the other - thus this is purchase of an integrated equipment

Assessee had purchased a copyrighted article and not copyright of the rights; therefore, it is wrong

on part of Revenue to treat purchase of software as an independent transaction, therefore payments

cannot be regarded as royalty

Therefore no TDS under section 195 of the Act is required to be deducted

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Sale of shrinked wrapped software

Sonata Information Tech Ltd. – 103 ITD 324 (Bangalore)

Facts:

Payments made for purchase of software for distribution .

Stand of Revenue Authorities - Sale of shrinked wrapped software is ‘Royalty’

Computer software is licensed and not sold

Computer programme is a secret process and consideration for the same is ‘Royalty’

Software could also be considered as ‘information concerning scientific experience’

the consideration of which would be in the nature of Royalty

Software can also be treated as Invention the consideration of which would be in the

nature of Royalty

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Sale of shrinked wrapped software

Revenues from distribution of shrink wrapped software are ‘business profits’ and cannot be considered as ‘royalty’ under the Act or DTAA for reasons as under

End user of software does not get any license to duplicate software and there is no transfer of

intellectual property rights in the software to the end users. The original knowledge in the software

(used in developing the software) remains protected and is not transferred to the end users .

Sale of computer software cannot be considered as transfer of copyright in secret formula, process,

information containing scientific experience as in this case the end user does not get access to

knowledge to develop or manufacture the software (OECD Commentaries relied).

Payments for acquisition of software products and not for acquisition of IPR in the products.

Section 14 of Copy Right Act

Exclusive rights in a work i.e. reproduction rights, distribution rights, rental or landing right –

not transferred.

The property contained in the copy right material and the property contain in the copy right to

software are two different rights

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Royalty & FTS: Sec. 9(1)(vi) & Section 9(1)(vii):

Favorable : Samsung Electronics (94 ITD 91 (Banglore)) Lucent Technologies (82 TTJ 163) TCS (271 ITR 401) Sonata Information Technologies (103 ITD 324 (Bang)) Motorola Inc (95 ITD 269 (Delhi – SB)) GeoQuest Systems B.V. (A.A.R. No. 774 of 2008)

Against : Head Start (285 ITR 530 (AAR)) IMT Labs (287 ITR 450 (AAR)) Air Port Authority of India – 218 CTR 321 (AAR) CIT and Anr. vs Sonata Information Technology Ltd. (232 CTR 20) (Kar)

Payments to agent of shipping Company : Circular 723 dated 19/09/1995

39

Issue 5 – Fees for Technical services – Make available concept


Fees for Technical services – Make available concept Broadly, most of tax treaties signed by India deal with the FTS claise

in following mannder :

No FTS clause in the tax treaty eg. India – Mauritius, India – UAE

FTS clause in line with the Indian domestic law – comprehensive to tax ny managerial, technical or consultancy service

FTS clause with make available concept


Whether services involve technical knowledge, etc?

Payment for services

Whether ‘technical or consultancy services’?

Yes No

Whether make available?

Whether development & transfer of technical plan or design

Yes No

Taxable as FIS

Not taxable as FIS

YesNo

Article 12(4)(b) applies

Not taxable as FIS

‘Make Available’ under India-US DTAA

Concept of ‘make available’…

YesNo Not taxable as

FIS

Issue 6 – Reimbursement of expenses


Reimbursement of expenses

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

Wallace Pharmaceuticals P. Ltd. (278 ITR 97) (AAR) – TDS required

Reimbursement of allocated cost (ie costs-sharing arrangements)

No TDS

Dunlop Rubber Co (142 ITR 493) (Cal)

TDS required

Danfoss Industries (India) Ltd (268 ITR 1) (AAR)

Payments for services rendered at cost

Timkin India Ltd (273 ITR 67) (AAR) – TDS required


Reimbursement of expenses

Reimbursement of incidental expenses in addition to payments of FTS/ Royalty

No TDS

Siemens (310 ITR 320) (Bom)

Krupp Udhe Gmbh (38 DTR 251)

Telco Ltd (245 ITR 823) (Bom)

Industrial Engg. Project (202 ITR 1014) (Del HC)

Clifford Chance (82 ITD 106) (Mum)

Mahindra & Mahindra Ltd (1 SOT 896) (Mum)

TDS required

Cochin Refineries Ltd (222 ITR 354) (Ker)

SRK Consulting (230 ITR 206) (AAR)

Hindalco Industries Ltd [278 ITR (AT) 125] (Mum)

Issue 7 – Section 206AA – Draconian?


Provision in brief

Section 206AA overrides all the provisions of the Act Recipient who is entitled to receive any sum or income or amount which is

subject to TDS is expected to furnish his PAN to the payer. Non-furnishing of PAN by the recipient requires payer to deduct tax at higher

of the following rates: Rate specified in the relevant provisions of the Act Rate or rates in force as defined in Section 2(37A) 20%

PAN required for declaration in form 15G/H and certificate u/s 197 If PAN is invalid or false - Higher of above rates would apply. Payer and recipient will need to indicate PAN of the recipient in all

correspondence, bills, vouchers and other documents exchanged between them.


Implications

For Payer Failure to withhold tax at 20% - Payer may be treated as Assessee in

default (AID) under section 201. Disallowance under section 40(a)(i)/(ia). Problem of recovering excess TDS paid from the recipient.

For Recipient TDS at a higher rate of 20% is expected to act as a deterrent for the

recipient. No specific implication provided. If recipient has an obligation to obtain PAN under section 139A,

failure to do so would attract penalty under section 272B r/w section 139A(5A).


Implications for non-resident

NR is covered even if the NR is not otherwise obliged to apply for and obtain PAN under the Act.

Application of tax treaty rates in preference to rate of 20% ?

Grossing up of TDS at the higher rate of 20% results in increased cost for the payer

Whether 20% rate to be increased by surcharge and education cess?

Whether higher taxes under Section 206AA creditable in overseas country


Thank you

tax deduction on remittances abroad (section 195 and others) page 1 tax deduction on remittances...

Documents

tax deduction

payment of tax

withholding tax

tax return

tax authority

deduction income

nonresidents section

cases of tax evasion