f undamentals of i nternational t axation & tds on p ayment to n on -r esidents u / s 195 sanjay...

© Chir Amrit Corporate School 1

FUNDAMENTALS OF INTERNATIONAL TAXATION& TDS ON PAYMENT TO NON-RESIDENTS U/S 195

Sanjay Jhanwar Advocate B.Com, LLB, FCA

24-January-2015


Basis of International Taxation

Residence

Based

Source Based

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Jurisdictional Clash

International Double TaxationEconomic Double Taxation

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International Double taxation One legal entity is subject to tax, on same income, in 2 countries for same

taxable year. Arise because most countries:

tax residents on global income (i.e. regardless of source); and tax non-residents on domestic-source income.

Company Aresident in Country X

Country X

Branch Country Y

Company A’s branch profits are subject to tax in two countries: in Country X due to residence; and In Country Y, due to source.

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Economic Double Taxation 2 legal entities are subject to tax, on (economically) the same income, in

two (or more) countries. Arises where one country applies its transfer pricing rules

Company B

Taxable profits = US$ 10 million

Company A

Loan ($100Million)

Interest @ 5% p.a.

($ 5 million)

Taxable profits = $ 2 million

Country X

Country Y

If Country Y considers that the arm’s length rate of interest on the loan should be 4% p.a., it will reduce Company B’s interest deduction by $1 million

Company B’s taxable profits increase by $ 1 million to $ 3 million Unless Country X provides some relief for Company A, economic double taxation

will occur in respect of the $ 1 million.24-January-2015


Aspects of International Taxation

Multi country taxation injures flow of cross border transactions

• Home country is country of residence (COR)• Host country is country of source of income (COS)

Double Tax Avoidance Agreement (DTAA) eliminates or mitigates hardship caused by multi country taxation

Home country tax is obligation; host country tax is a cost (if credit not allowed)

Usual for COR to provide relief

Mitigation can result in relief from double taxation, but, no refund by COR/COS

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Double Tax Avoidance Agreement (DTAA)

OECD Model

UN Model

US Model

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Double Tax Avoidance Agreement

Organization for Economic Co-operation & Development (OECD) Model • Emphasis on the Residence Principle• OECD Model Double Taxation Convention [approved by the 30 OECD

member countries]• India not a member, observer status

United Nations Model

• More weight to the Source Principle against the Residence Principle• UN Model Double Taxation Convention

US Model

• No Tax Sparing Clause• US Model Double Taxation Convention,1996

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General Structure of DTAAs

Article 1 to 2

Applicability

Article 3 to 5

Definitions

Article 6 to 22

Categories of Income

Article 23

Elimination of Double

Taxation

Article 24 to 29

Miscellaneous Provisions

Article 30 to 31

Final Provisions

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Comparative Analysis Article UN model

(Source rule)OECD model

(Residence rule)Indian Treaties

Article 5 Permanent Establishment

Installation PE

Service PE

Agency PE

• Includes supervisory activities

• Threshold: 6 months

Rendering of services by employees for over 6 months within 12 month period

• Resulting from habitual maintenance of stock of goods or merchandise for delivery

• Deemed PE in case of insurance enterprise

• Supervisory activities excluded

• Threshold: 12 months

No such provision

No such provision

No such provision

•Mostly include supervisory activities

•Mostly follow UN time threshold

Service PE found in one third of treaties

Insurance PE occurs in 20 treaties

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Article 7 Attribution of Profits

Force of attraction rule – attribute to PE profits from sale of same / similar goods orsame / similar business activity or associated enterprises

No ‘force of attraction rule’

• UN - 15 treaties• OECD - 25 treaties• OECD or UN with

variants - 27 treaties

Article 8Shipping, Inland, Waterways Transport and Air transport

In certain circumstances, profits from operation of ships may be taxed in the source State

Profits taxable only in the state where the place of effective management is situated

Two-third of treaties makedeparture from OECD rule

Article 11Taxation of Interest

Tax rate in source country to be established through bilateral negotiations

Tax rate in the source country not to exceed 10 percent of gross amount

• OECD - 36 treaties• UN - 27 treaties • Libya, Mauritius, Greece

and Egypt -no cap on tax withholding

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Article 12Royalties

• Includes income from use of equipment

• Source state may also tax royalty

• Does not include rental income

• Taxing right exclusively with state of residence

UN convention followedExceptions - Belgium, Greece, Israel, Namibia, Netherlands and Sweden

Article 13Capital Gains

Capital gains from sale of stockin certain circumstances may be taxed in the state where the company issuing shares is resident

Capital gains from sale of stock shall be taxed only in the state where alienator is resident

Diverse approaches – nopattern discernibleSingapore, Cyprus,Mauritius andThailand – OECDapproach

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OECD ModelArticle Content Taxation

Article 6 Income from Immovable Property. Full tax in COS

Article 7 Business Income. Taxable in COR

In case of PE COS to levy full tax

Article 8 International Shipping & Airline ONLY to country of Place of Effective Management

Article 10 Dividends •TDS in COS•Final tax in COR

Article 11 Interest •TDS in COS•Final tax in COR

Article 12. Royalty Right to tax given ONLY to COR

Article 13 Capital Gains:Immovable Property COS – Full tax

PE COS – Full tax

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OECD Model Article Content Taxation

Shares in Company primarily having immovable Property

Full tax by COS

Other Properties COR

Article 15 Salary •Primarily taxable in COR•If services are exercised COS COS

Article 16 Director’s fees Country where the Company is resident

Article 17 Artists & Sportsman COS

Article 18 Pensions Only COR

Article 21 Other income Only COR

Article 22 Capital tax or Wealth tax

COR

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Indian Perspective

Taxability of Non-resident in India

Indian Resident’s income taxed outside India

Avoidance of Double taxation

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Indian Law Charging ProvisionSec. 4, 5, 6

R & OR R but NOR NR Indian Income: Accrued / sourced in India Taxable Taxable Taxable Received in India Taxable Taxable Taxable Foreign Income : Accrued outside India but

deemed to accrue in India by virtue of Section 9

Taxable Taxable Taxable

Accrued outside India - First receipt in India

Taxable Taxable Taxable

Any other income accruing outside India and received outside India

Taxable Not taxable (Taxable if

from business controlled in

India)

Not taxable

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Double Taxation relief provisions in Indian Tax LawChapter IX

Section 90

• Regulates a case where India has a tax treaty• Taxpayer has the option to be taxed as per tax treaty or domestic tax laws, whichever is more

beneficial• Subject thereto, domestic law has full force

Section 91

• Relief from double taxation if India has no tax treaties• Person resident in India is allowed credit of foreign taxes paid against amount of

Indian taxes24-January-2015


Effectiveness of Treaty

If there is no tax liability under domestic law – treaty cannot impose it

Treaty, to the extent it is more beneficial in any respect, can override the domestic law

Payer can consider lower withholding rate in terms of treaty

Treaty need not always be more favourable than the domestic law

Use of treaty by taxpayer is optional

Choice could be qua each source of income

Choice available on year on year basis

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Treaty Interpretation: Vienna Convention on Law of Treaties

Article 26 : Every treaty in force is binding upon the parties to it and must be performed by them in good faith

Article 31(1) : A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose

Article 31(2) : Context is defined to include texts and subsequent agreements/instruments related to the treaty

Article 31(4) : Special meaning only if specifically intended by parties

Article 32 : Supplementary means to be used only to confirm the meaning

Article 34 : A treaty does not create either obligations or rights for a third state without its consent

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Treaty Interpretation: Vienna Convention on Law of Treaties

Ram Jethmalani vs. Union Of India , 4 July, 2011

• While India is not a party to the Vienna Convention, it contains many principles of customary international law, and the principle of interpretation, of Article 31 of the Vienna Convention, provides a broad guideline as to what could be an appropriate manner of interpreting a treaty in the Indian context also.

• The words ( in the treaty) are to be given their general meaning, general to lawyer and layman alike. The meaning of the diplomat rather than the lawyer.

• The fact that such treaties are drafted by diplomats, and not lawyers, leading to sloppiness in drafting also implies that care has to be taken to not render any word, phrase, or sentence redundant would lead to a manifestly absurd situation, particularly from a constitutional perspective. “

• The Government cannot bind India in a manner that derogates from Constitutional provisions, values and imperatives.

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Applicability of DTAA

Article 1

Application of tax treaty to persons resident of one or both the Contracting States

Does not apply to person who is not resident in both the Contracting States

Permanent Establishment (e.g. branch) is not a person

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Article 4: Residence

A person is a resident of a country if it is ‘liable to tax’ in the country by virtue of :

Domicile

Residence

Place of management

Any other criterion of a similar nature

In case a person is resident of both countries

In case of an individual – tie breaker rule determines residency

In any other case – the place of effective management

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Article 4 : Residence

Permanent Home Vital Personal & Economic Interest Habitual Abode

Nationality Mutual Agreement

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Tie Breaker Rule is to be applied in the following order:


Article 5: Permanent Establishment PE means a fixed place of business through which business of an

enterprise is wholly or partly carried on.

Place of Management Branch Factory

Office Workshop Mine, Oil, Gas well etc.

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Article 5 : Permanent Establishment Difference between OECD and UN Model

Duration of presence of non-resident is essential in both models UN Model prescribes conditions for becoming a PE more liberally

so that in more circumstances a business establishment will be treated as a PE

UN Model, duration becomes irrelevant provided large value addition

UN Model had 6 months duration test for building sites OECD Model prescribes 12 month duration test for building sites

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Article 7: Business Profits

The profits of an enterprise of India shall be taxable only in India.

If the enterprise carries on business through a permanent establishment situated in Country A, the profits of the enterprise may be taxed in Country A but only so much of them as is directly or indirectly attributable to that permanent establishment.

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Methods of Eliminating Double Taxation

Exemption Method

• Residence country to altogether exclude foreign income from its tax base. • COS is then given exclusive right to tax such income. • Known as complete exemption method and is generally followed in respect of

profits attributable to foreign permanent establishment or income from Immovable Property.

• Indian tax treaties with Denmark, Sweden and Norway embody the method in respect of certain income.

Credit Method

• Underline concept that resident remains liable in COR on its global income• However, credit of tax paid in COS is given by COR against domestic tax as if foreign

tax were paid to the COR itself.

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Methods of Eliminating Double Taxation

Tax Sparing

• Tax credit sparing is an extension of the normal rule and regular tax credit to taxes that are spared by the source country, i.e. forgiven or reduced due to rebates with the intention of providing incentives to investments.

• Tax credit is allowed by COR, not only in respect of the taxes actually paid by it in India but also in respect of those taxes India forgoes dues to its fiscal incentive provisions under the Indian Income Tax Act.

• Tax sparing clause is generally not included under the OECD model

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TDS on Payments to Non Resident u/s 195

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Facets of the Section…

195(1)Liability for

deduction from payment

195(2)Application by Payer

for lower/ NILwithholding

195(3)Application by Payee

for lower/NILwithholding

195(4)Validity of the

Certificate

195(5)CBDT empowered to

notify rules for 195(3)

195(6)Obligation on Payer

to furnish information as prescribed

195(7)CBDT empowered to notify

class of persons for application to be made to AO for

determination of appropriate sum chargeable

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How is it different?

Difference between 195 and other TDS sections

How? Section 195 Other TDS provisions

Nature Income Chargeable underIncome Tax Act

Specific Payments, WhetherIncome or not.

Sum Any Sum Above prescribed threshold

Applicability Any persons Specified persons in thesections

Certification for remittance

Mandatory Not required

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Birds Eye View : S. 195

Payer •Any person responsible for paying

Payee•Non Resident (not a company) or •Foreign Co.

Amount Payable

•Interest or any other sum (other than Salaries) and• Chargeable under provisions of Act

Time of deduction

•Payment or credit whichever is earlier• Conversion rate to be applied – TT Buying Rate on the date which tax is required to be deducted (R.26)

Rate of Deduction

• Rates in force• Rates of

income-tax specified in the Finance Act or the rates specified in the DTAA, whichever is applicable by virtue of Section 90 or Section 90A - Circular No. 728 of October 30, 1995

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An Overview

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Payment to NR

Taxable under IT Act

Whether DTAA exists with the Contracting State

Income Taxable under DTAA

Rates under DTAA beneficial

Yes

No No deduction of tax at source

As per IT Act

No Tax liability

Yes

Yes

No

No

NoDeduct tax at

the rates prescribed

under IT ActDeduct tax at the rates prescribed under DTAA

Yes


Sum Chargeable to Tax

• Chargeability governed by provisions of IT Act and DTAA

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Nature of Income IT Act DTAA

Business/Profession S. 9(1)(i) Article 7, 14 r.w. 5

Salary S. 9(1)(ii) Article 15

Dividend S. 9(1)(iv), S. 115A Article 10

Interest S. 9(1)(v), S. 115A Article 11

Royalties S. 9(1)(vi), S. 115A Article 12

Fees for Technical Services S. 9(1)(vii), S. 115A Article 12

Capital Gains S. 9(1)(i), S. 45 Article 13


Sum Chargeable to Tax

Amount not chargeable to

tax in India

•Where payment, made by resident to non-resident, was an amount not chargeable to tax in India, no tax is deductible at source even though assessee has not made an application before the AO. GE India Technology Centre Pvt. Ltd (327 ITR 456) SC

When income is exempt

under DTAA

• The expression chargeable under the provisions of the Act cannot include an income which in terms of the specific provisions of the applicable DTAA, is not exigible to tax in India. Maharasthra State Electricity Board v. CIT [2004] 90ITD793

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Section 195 : How to deal with different aspects?

S.No.

Nature of Transaction Applicability Reason

1. Payment by branch office of a foreign company

Yes Branch of a foreign co. /concern in India is separate entity. Circular No. 740, dated April 17, 1996

2. Payment in kind Yes Kanchanganga Sea Food Ltd. v. CIT [2010] 325 ITR 540 (SC)

3. Agent of NR making payment to NR No CIT v. Premier Tyres Ltd. [1982] 134 ITR 17 (Bom.)

4. Payment to an Indian Agent of NR Yes Narsee Nagsee & Co. v. CIT (1959) 35 ITR 134 (Bom.)

5. Payment made to NOR No Payee should be NR

6. Payee is NR at the time of tax deduction but Resident at the time of payment

Yes United Breweries Ltd. v. Asstt. CIT [1995] 83 Taxman 263 (Kar.)

7. Money paid into Court under decree obtained by NR

Yes Lalta Prasad Goenka v. Biratnagar Juice Mills Ltd. [1963] 48 ITR 653 (Cal.)

8. Regular Trading Operations Yes CIT v. Superintending Engineer [1984] 19 Taxman 356 (AP)

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Refund of tax deducted under Section 195 (CIRCULAR NO. 7/2007, DATED 23-10-2007 AND CIRCULAR NO. 07/2011 dated 27.09.2011)

S.No.

Situation Criteria

Cancellation/Partial Execution of the Contract

1. The contract is cancelled No remittance is made to the non-resident

2. Contract is cancelled, remittance is duly made

Remitted amount has been returned to the person responsible for deducting tax at source

3. Contract is cancelled after partial execution

No remittance for non executed part

4. The contract is cancelled after partialexecution and remittance related tonon-executed part is made to the nonresident

Amount refunded to the payer or no remittance wasmade but tax was deducted and deposited whenamount was credited to the account of the nonresident

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Refund of tax deducted under Section 195 (CIRCULAR NO. 7/2007, DATED 23-10-2007 & CIRCULAR NO. 07/2011 dated 27.09.2011)

S.No.

Situation Criteria

5. Amendment in law or by notificationunder the Act

There occurs exemption of the remitted amount fromtax

6. Order passed u/s 154 0r 248 0r 264 Tax deduction liability of the payer is reduced

7. Double deduction of tax amount Same amount deducted twice by mistake

8. Other than discussed above Payment of tax at higher rate under domestic law while a lower rate is prescribed under DTAA

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Furnishing information relating to payments S. 195(6) r.w. R. 37BB

Form Threshold Limit Requirements

Part A : Form 15 CA

Amount of payment does not exceed Rs. 50,000 and the aggregate of such payments made during the f.y. does not exceed Rs. 2,50,000;

-

Part B : Form 15 CA

Payments other than referred above Certificate in Form 15 CB from CA or Certificate from A.O. u/s 197 or Order from A.O. u/s 195(2) or 195 (3)

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THANK YOU

24-January-2015

f undamentals of i nternational t axation & tds on p ayment to n on -r esidents u / s 195 sanjay...

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