Presentation on theme: "CA. Divakar Vijayasarathy"— Presentation transcript:
1 CA. Divakar Vijayasarathy Recent Trends in AAR – Cost Reimbursements and Permanent EstablishmentsCA. Divakar Vijayasarathy
2 Presentation Schema Permanent Establishment Cost Reimbursements Attribution of ProfitsMethods of Attribution of Profits
3 PE…………? OECD Model Convention: Fixed place of Business Through which Business is “wholly or partly” carried onPE includes:Place of ManagementBranchOfficeFactory / work shopMine, oil or gas well, quarry or similar locations
4 PE…………? PE also includes: Construction PE: A building site, construction assembly or installation project or supervisory activities in connection therewith – exceeding a specified periodService PE: Furnishing of services – employees or other persons engaged - exceeding a specified periodDependant Agent PE: Operated through a Dependant agent who:Habitually concludes contractsMaintains stock for delivery
5 PE…………? PE Excludes a fixed place used for: Storage or display facilitiesMaintenance of stock for storage / display/ processing by another enterprisePurchase or collection of informationAny activity of a preparatory or auxiliary characterIndependent Agent
6 Relevance of PE UN MC Article 7 Clause (1) Business profits from the Country of Source are taxable “only” if the enterprise has a PE in the Source CountryAustralian Company earning Business income from IndiaSource Country - IndiaResident Country - AustraliaIncome of the Australian Company is taxable in India- only if the company has a PE in India.
7 Scope of Total Income – Sec 5 Source of IncomeResident and Ordinarily residentResident and Not Ordinarily residentNon ResidentIndian Income:TaxabilityIncome earned and received or deemed to be earned and received in IndiaYesIncome earned or deemed to be earned outside India but received in IndiaIncome earned or deemed to be earned in India but received outside IndiaForeign Income:Income earned and received or deemed to be earned and received outside India from a business controlled from IndiaNoIncome earned and received or deemed to be earned and received outside India from a business controlled from outside India
8 Income Deemed to Accrue or Arise in India – Sec 9 Nature of IncomeConditionBusiness IncomeWhen there is business connection in India(Please refer to the definition of the term Business Connection- discussed below)Property incomeProperty or asset source is in IndiaIncome from transfer of a capital assetWhen the capital asset is in IndiaIncome from SalariesWhere services are rendered in IndiaIndian citizen, working for the Government of India rendering services outside IndiaDividend IncomeDividend payable/paid by an Indian CompanyInterest, Royalty and Fees for Technical ServicesIf the income is received from:Government of IndiaA resident assessee except where such payment is for business outside IndiaA non resident assessee where the payment pertains to business in India
9 Business ConnectionBusiness Connection – Sec 9(1)(i)explanation includes any person:Habitually concludes contractRegularly maintains stock in IndiaRegularly secures orders in IndiaExcludes activity through an independent agent in the ordinary course of his business.
10 Case Study – Cost Allocation Agreement The assessee is a US Company (USCO) engaged inManufacturing of “Process Control InstrumentsProviding engineering, research and technology based and allied servicesThe company enters into a cost allocation agreement with one of its group company (ICO) for providing certain specific services.
11 Case Study – Cost Allocation Agreement According to agreement USCO shall provide:Guidelines for relevant safety, health and security support to employees on travelAssistance in relation to environmental policiesOverall operations assistance and HR supportAssistance on key projectsFinance, internal audit, treasury and taxCorporate secretarial and legal support
12 Case Study – Cost Allocation Agreement Issues for Consideration:Would the income of USCO be liable for taxation in IndiaIf yes- what would be the nature of the incomeWhat would be the rate of TDS u/s 195- in case such income is taxable in India
14 Case Study – Cost Allocation Agreement No income can be taxed in India if services are rendered abroad.There is no PE for USCO- hence Article 7 does not applyThere is no service which “makes available” the technical knowledge within the meaning of Article 12 (FTS)Therefore the assessee is not liable for tax in India and no withholding tax shall apply on the transactionInvensys Systems Inc vs DIT Chennai – AAR 6th August 2009
15 Database Access Services….. Assessee is a US company engaged in maintained comprehensive financial and regulatory databases of publicly listed companiesThe database is located at the USA client from anywhere in the world is required to download a client interface software to access the databaseSubscription fees are paid online or through wire transfer
16 Database Access Services….. An Indian company intends to use the facilities of accessing the database of the US CoThe USCO does not have a branch or an agent in India
17 Database Access Services….. Issues for ConsiderationWhat would be the nature of the income received from Indian clients- Royalty vs Business IncomeDoes any income of the US Co accrue or arise in IndiaIs the Indian client required to deduct TDS at the time of paymentIf yes- what would be the rate of TDS
19 Database Access Services….. The right that a customer gets is a right to use copy- righted database and not copy-right in the database. Hence income cannot be considered as Royalty.The USCO is engaged in the business of sharing databases for a consideration. Hence income of the company is taxable under Article 7 (business income).The company does not have a PE in India hence business income is not taxable.No withholding tax need to be deducted and the assessee is not required to file his returns in IndiaFACTSET RESEARACH SYSTEMS INC. Vs DIT DelhiAAR dated 30th June 2009
21 Statutory Provisions Income Tax Act – Sec 44C: For a non resident assessee “head office expenses” cannot exceed the lower of:5% of adjusted total income orAmount of expenditure attributable to Indian Operations
22 Statutory Provisions DTAA – Article 7 clause (3): In determination of profits of a PEExpenses incurred for the purposes of PE shall be allowedSuch expenses can be incurred either in the Country of Source or elsewhere
23 Issues in Cost Reimbursement Does Sec 44C apply only to Head Office ExpensesCan expenses incurred by other branches be fully allowedWhere DTAA applies would be provisions of Sec 44C be valid – Sec 90(2)Can the non resident take shelter under Article 24
24 Applicability of 44C to Branch Expenses .US – Head OfficeSingapore BranchExpenses incurred for Indian PEIndian Branch - PE
25 Applicability of 44C to Branch Expenses Explanation (iv) to Sec 44C defines Head Office expenses. Accordingly it means:Rent, rates, repairs or insurance of “ANY PREMISES OUTSIDE INDIA”Salary, perquisites or travelling expense of any employee of “ANY OFFICE OUTSIDE INDIA”
26 Applicability of 44C to Branch Expenses Sec 44C applies to branch expenses incurred outside India and such expenses shall fall within the ceiling of 5%
27 Beneficial Provisions Clause – Sec 90(2) Where there is a DTAA the provisions of this Act shall apply to the extent they are more beneficial to that assessee.Does it mean Sec 44C does not have any relevance in case of non residents from Countries with which India has a DTAA ?May be Yes
28 Article 7 (3)- India Specific DTAAs India – Italy Treaty:In the determination of the profits of a permanent establishment, there shall be allowed as deduction expenses which are incurred for the purposes of the business of the permanent establishment including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere
29 Article 7 (3)- India Specific DTAAs Indo – Brazil Treaty:In determining the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the permanent establishment, including executive and general administrative expenses so incurred, in accordance with the provisions of and subject to the limitations of the taxation laws of the Contracting State concerned.
30 India Specific Treaties – Factual Update TreatyPrima Facie Applicability of- Sec 44CIndia – BrazilYesIndia – AustraliaIndia – ChinaIndia – GermanyIndia – South AfricaIndia – USIndia – UKIndia – CanadaIndia – MauritiusNoIndia – ItalyIndia – Japan
31 Article 24 (2) – Non Discrimination The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities.Is it possible to take shelter under Article 24(2) against Sec 44C -
32 Case Study Assessee is a Canadian Resident Has a Construction PE in IndiaHead Office has apportioned Rs 100 lacs as attributable expenses to the PEAdjusted Gross Total Income (AGTI) of the PE is Rs 500 lacsAO restricts the expenses to 5% of AGTI ie Rs 25 lacsAssessee claims shelter under Article 24 – non discrimination. Discuss
33 Indo – Canada Treaty – Article 7(3) Reasonable allocation of expenses permittedSubject to the limitations of Domestic LawExcludes the following payments to Head Office:Royalties, fees for usage of patents, know-how, copyrights etc,Management fees or fees for specific servicesInterest (other than banking enterprises)The above, if received by the PE, shall also not be included as Income of the PE
34 Indo – Canada Treaty – Article 7(4) Profits to be attributed to a permanent establishment shall be determined on the basis of an apportionment of the total profits of the enterprise to its various parts,Nothing in paragraph 2 shall preclude that Contracting State from determining the profits to be taxed by such an apportionment as may be customary;The method of apportionment adopted shall, however, be such that the result shall be in accordance with the principles contained in this Article.
35 Indo – Canada Treaty – Article 24(2) The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities.
37 Conclusion – Mumbai ITAT Article 24(2) is a specific provisionArticle 7 is a general provisionRestriction on allowability of Head Office u/s 44C is to be ignored in the light of Article 24(2)Revenue appeal dismissedMetchem Canada Inc vs DCIT – Mumbai ITATDated 30th September 2005
38 Group Company Referral Payout Applicant is a Singapore based real estate group company (Sco)One of its group companies is located in India (Ico)Sco identifies overseas clients who intend to purchase property in India.These prospective clients are referred to Ico
39 Group Company Referral Payout Ico earns its commission (agency ) from selling properties to overseas clientsIco pays a flat fee of 30% of the commission earned to Sco – as referral fees
40 Group Company Referral Payout Issues for Consideration:What is the nature of income earned by ScoWould there be any withholding tax on the remittance to S CoIf yes what is the rate of the Withholding tax
41 Group Company Referral Payout Assessee’s argument:Nature of Income – Business IncomeNo PE in IndiaServices Rendered outside IndiaHence no income arises in IndiaDepartment’s contention:30% payout is very highIncome in the nature of Royalty as well as FTS
43 Group Company Referral Payout Conclusion:For income to be taxed as royalty – it should be received for imparting technical knowhow or IPRFor the purpose of FTS- the “make available” condition is not fulfilled. It also does not meet the description of management and consultancy services
44 Group Company Referral Payout Income to be considered as Business IncomeNo PE in IndiaHence no income arises in India and therefore no withholding tax apply on the transactionCushman and Wakefield (S) PTE Ltd AAR dtd 4th July 2008
46 Why Attribution ?? Explanation 3 to Sec 9(1)(i) Where a business is carried on in India through a business connectionOnly so much of income as is attributable to the operations carried out in IndiaShall be deemed to accrue or arise in India
47 Why Attribution ?? Article 7(1) of DTAA: If the enterprise carries on business in the Other Contracting State through a PEThe profits of the enterprise may be taxed in the other State butOnly so much of them as is attributable to that PE.
48 Steps in Attribution?Identifying the overall operations of the non residentAssigning weightage to each of the activities /operationsIdentifying the operations carried out by the Indian PEApportioning profits based on proportionate weightage to the extent of business carried on by the PE
49 Case Study – Online Booking Revenues USP Provides Ticketing and Booking Software and training.US Based Service Provider - USPIndian Intermediary Service Provider - IIPIIP Provides Hardware and access facilities to TAsTransaction CycleTravel Agents in India (TA)Airlines and Hotels (AH)
50 Case Study – Online Booking Revenues USP pays commission to IIP based on Indian Bookings.US Based Service Provider - USPIndian Intermediary Service Provider - IIPAH pays commission to USP based on bookingsPayment CycleTravel Agents in India (TA)Airlines and Hotels (AH)
51 Case Study – Online Booking Revenues Issues for Consideration:Does the USP have a business connection in IndiaIs the income of the USP arising in IndiaDoes the facility of IIP constitute a PE in IndiaIf yes, what portion of the revenues are attributable to India
52 Case Study – Online Booking Revenues Analysis:The hardware and facilities provided by IIP constitute a “Computer PE”Income of USP accrues in India since:Bookings are done in India andFinal subscribers were located in IndiaIncome accrues to the extent of collection of information and receipt of confirmation
53 Case Study – Online Booking Revenues Attribution of Profits:Majority of assets being the main frame computers located outside IndiaThe Computerised Reservation System was located outside IndiaTransaction was processed outside IndiaThe entire risk of the transaction is with the USPTherefore only 15% of the revenues were attributable to India
54 Case Study – Online Booking Revenues USP was already paying more than 15% of its revenues to IIP.Hence no further income is attributable to Indian OperationsGalileo International Inc vs DCIT New Delhi - Delhi ITAT (2007)
55 Attribution of Profits – Decided Case Laws TransactionCitationAs per RevenueAs per CourtContract of Purchasing Agent made in IndiaAnnamalai Timber Trust and Company vs CIT -Madras HC - 41 ITR 78175%10%Negotiation, Procurement of Order and arranging LCsIngersoll Rand Ltd vs ITO – Bombay ITAT- 4 ITD 654Lending arrangement concluded in India – all other activities outside IndiaC.G.Krishnaswami Naidu vs CIT – Madras HC – 62 ITR 686100%NilConclusion of Purchase contracts in IndiaAnglo French Textile Company Limited vs CIT – Supreme Court 23 ITR 101Canvassing orders and securing import/ export licenses by subsidiaryCIT vs Gulf Oil (Great Britain) Ltd – Bombay HC- 108 ITR 8747.5%
57 Income Tax – Rule 10 Where the AO is of the opinion that Income cannot be definitely ascertainedThe amount of income may be calculated using:Percentage / Presumptive MethodProportionate Turnover MethodAny other suitable manner – Discretionary Method
58 Presumptive Method A manufacturer in Germany has a branch in India. The Indian branch does the marketing and distribution for the German company.During the previous year the German company made a total profit of Rs 100 lacs (computed as per ITA) from sale of its products in India.No commission is paid to its branch.
59 Presumptive MethodIn this case the AO may chose to avail the rights under Rule 10.Based on the overall activities of the Germany Company- the AO decides that the activities in India contribute to 20% of the total operations of the German CompanyConsequently proportionate profits of the German Company shall be taxable for the PE ie 20% of Rs 100 lacs = Rs 20 lacs
60 Proportionate MethodWalmart US has branches across 10 countries including IndiaDuring the previous year the company made a total profit of Rs 500 lacs (as per ITA) across all its global operationsThe company has made a total turnover, across all its branches, of Rs 5000 crores.The Indian branch of the company made a turnover of Rs 1000 crores.
61 Proportionate Method Profits taxable = Total Profits* Indian turnover in India Total Turnover= Rs 500 crores*1000 croresRs 5000 crores= Rs 100 crores
62 Discretionary MethodAssessee is a steamer agent – resident of Netherlands having a branch in IndiaThe assessee had not provided details of its worldwide transactionsHowever details of voyage in and out of India were provided as follows:Indian Port Receipts : Rs 100 lacsTotal Port receipts : Rs 400 lacs(in and out of India)Indian Trade Profits : Rs 80 lacs
63 Discretionary MethodIn this case, the AO came up with a unique formula (similar to proportionate method):Profits taxable = Total Indian Trade Profits* Indian Port Receiptsin India Total Indian Port Receipts= Rs 80 lacs * Rs 100 lacsRs 400 lacs= Rs 20 lacsSupreme Court in Netherlands Steam Navigation Co Ltd vs CIT74 ITR 72 (AY based on ITA 1922 Rule 33)
64 Challenges in Rule 10 Choice of Methods to be adopted Calculating world income as per Income Tax ActTreatment of extraordinary incomes and expenses of foreign branches and head officeAccounts maintained in other languagesDifferent methods of accounting adopted by the Indian PE and Head Office
65 Thank You Divakar Vijayasarathy & Associates Chartered Accountants No 3 Vathiar Thottam 1st Street Rangarajapuram Kodambakam ChennaiDivakar Vijayasarathy & Associates