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F UNDAMENTALS OF I NTERNATIONAL T AXATION & TDS ON P AYMENT TO N ON -R ESIDENTS U / S 195 Sanjay Jhanwar Advocate B.Com, LLB, FCA 1© Chir Amrit Corporate School24-January-2015
Basis of International Taxation Residence Based Source Based 24-January-20152© Chir Amrit Corporate School
Jurisdictional Clash International Double Taxation Economic Double Taxation 24-January-20153© Chir Amrit Corporate School
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 A resident in 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. 24-January-20154© Chir Amrit Corporate School
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 ($100 Million) 5% p.a. ($ 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-20155© Chir Amrit Corporate School
Aspects of International Taxation Multi country taxation injures flow of cross border transactions 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) Home country is country of residence (COR) Host country is country of source of income (COS) Usual for COR to provide reliefMitigation can result in relief from double taxation, but, no refund by COR/COS 24-January-20156© Chir Amrit Corporate School
Double Tax Avoidance Agreement (DTAA) OECD Model UN Model US Model 24-January-20157© Chir Amrit Corporate School
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, January-20158© Chir Amrit Corporate School
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 24-January-20159© Chir Amrit Corporate School
Comparative Analysis ArticleUN 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 Mostly include supervisory activities Mostly follow UN time threshold Service PE found in one third of treaties Insurance PE occurs in 20 treaties 24-January-2015 © Chir Amrit Corporate School10
| 11 Comparative Analysis ArticleUN model (Source rule) OECD model (Residence rule) Indian Treaties Article 7 Attribution of Profits Force of attraction rule – attribute to PE profits from sale of same / similar goods or same / 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 8 Shipping, 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 make departure from OECD rule Article 11 Taxation 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 24-January-2015© Chir Amrit Corporate School
| 12 Comparative Analysis ArticleUN model (Source rule) OECD model (Residence rule) Indian Treaties Article 12 Royalties 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 followed Exceptions - Belgium, Greece, Israel, Namibia, Netherlands and Sweden Article 13 Capital Gains Capital gains from sale of stock in 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 – no pattern discernible Singapore, Cyprus, Mauritius and Thailand – OECD approach 24-January-2015© Chir Amrit Corporate School
OECD Model ArticleContentTaxation Article 6Income from Immovable Property.Full tax in COS Article 7Business Income.Taxable in COR In case of PECOS to levy full tax Article 8International Shipping & AirlineONLY to country of Place of Effective Management Article 10Dividends TDS in COS Final tax in COR Article 11Interest TDS in COS Final tax in COR Article 12.RoyaltyRight to tax given ONLY to COR Article 13Capital Gains: Immovable PropertyCOS – Full tax PECOS – Full tax 24-January © Chir Amrit Corporate School
OECD Model ArticleContentTaxation Shares in Company primarily having immovable Property Full tax by COS Other PropertiesCOR Article 15Salary Primarily taxable in COR If services are exercised COS COS Article 16Director’s feesCountry where the Company is resident Article 17Artists & SportsmanCOS Article 18PensionsOnly COR Article 21Other incomeOnly COR Article 22Capital tax or Wealth tax COR 24-January © Chir Amrit Corporate School
Indian Perspective Taxability of Non-resident in IndiaIndian Resident’s income taxed outside IndiaAvoidance of Double taxation 24-January © Chir Amrit Corporate School
Indian Law Charging Provision Sec. 4, 5, 6 R & ORR but NORNR Indian Income: Accrued / sourced in IndiaTaxable Received in IndiaTaxable Foreign Income : Accrued outside India but deemed to accrue in India by virtue of Section 9 Taxable Accrued outside India - First receipt in India Taxable Any other income accruing outside India and received outside India TaxableNot taxable (Taxable if from business controlled in India) Not taxable 24-January © Chir Amrit Corporate School
Double Taxation relief provisions in Indian Tax Law Chapter IX 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 90 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 taxes Section January © Chir Amrit Corporate School
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 24-January © Chir Amrit Corporate School
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 24-January © Chir Amrit Corporate School
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. 24-January-2015© Chir Amrit Corporate School20
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 24-January © Chir Amrit Corporate School
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 24-January © Chir Amrit Corporate School
Article 4 : Residence Permanent Home Vital Personal & Economic Interest Habitual AbodeNationality Mutual Agreement 24-January © Chir Amrit Corporate School 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 BranchFactoryOfficeWorkshop Mine, Oil, Gas well etc. 24-January © Chir Amrit Corporate School
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 24-January © Chir Amrit Corporate School
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. 24-January © Chir Amrit Corporate School
Methods of Eliminating Double Taxation 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. Exemption 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. Credit Method 24-January-2015© Chir Amrit Corporate School27
Methods of Eliminating Double Taxation 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 Tax Sparing 24-January-2015© Chir Amrit Corporate School28
TDS on Payments to Non Resident u/s January-2015© Chir Amrit Corporate School29
Facets of the Section… 195(1) Liability for deduction from payment 195(2) Application by Payer for lower/ NIL withholding 195(3) Application by Payee for lower/NIL withholding 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 24-January-2015© Chir Amrit Corporate School30
How is it different? Difference between 195 and other TDS sections How?Section 195Other TDS provisions Nature Income Chargeable under Income Tax Act Specific Payments, Whether Income or not. SumAny Sum Above prescribed threshold Applicability Any personsSpecified persons in the sections Certification for remittance MandatoryNot required 24-January-2015© Chir Amrit Corporate School31
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, January-2015© Chir Amrit Corporate School32
An Overview 24-January-2015© Chir Amrit Corporate School33 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 No Deduct tax at the rates prescribed under IT Act Deduct tax at the rates prescribed under DTAA Yes
Sum Chargeable to Tax Chargeability governed by provisions of IT Act and DTAA 24-January-2015© Chir Amrit Corporate School34 Nature of IncomeIT ActDTAA Business/ProfessionS. 9(1)(i)Article 7, 14 r.w. 5 SalaryS. 9(1)(ii)Article 15 DividendS. 9(1)(iv), S. 115AArticle 10 InterestS. 9(1)(v), S. 115AArticle 11 RoyaltiesS. 9(1)(vi), S. 115AArticle 12 Fees for Technical ServicesS. 9(1)(vii), S. 115AArticle 12 Capital GainsS. 9(1)(i), S. 45Article 13
Sum Chargeable to Tax 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 Amount not chargeable to tax in India 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  90ITD793 When income is exempt under DTAA 24-January-2015© Chir Amrit Corporate School35
Section 195 : How to deal with different aspects? S.No.Nature of TransactionApplicabilityReason 1.Payment by branch office of a foreign company YesBranch of a foreign co. /concern in India is separate entity. Circular No. 740, dated April 17, Payment in kindYesKanchanganga Sea Food Ltd. v. CIT  325 ITR 540 (SC) 3.Agent of NR making payment to NRNoCIT v. Premier Tyres Ltd.  134 ITR 17 (Bom.) 4.Payment to an Indian Agent of NRYesNarsee Nagsee & Co. v. CIT (1959) 35 ITR 134 (Bom.) 5.Payment made to NORNoPayee should be NR 6.Payee is NR at the time of tax deduction but Resident at the time of payment YesUnited Breweries Ltd. v. Asstt. CIT  83 Taxman 263 (Kar.) 7.Money paid into Court under decree obtained by NR YesLalta Prasad Goenka v. Biratnagar Juice Mills Ltd.  48 ITR 653 (Cal.) 8.Regular Trading OperationsYesCIT v. Superintending Engineer  19 Taxman 356 (AP) 24-January-2015© Chir Amrit Corporate School36
Refund of tax deducted under Section 195 (CIRCULAR NO. 7/2007, DATED AND CIRCULAR NO. 07/2011 dated ) S.No.SituationCriteria 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 partial execution and remittance related to non-executed part is made to the nonresident Amount refunded to the payer or no remittance was made but tax was deducted and deposited when amount was credited to the account of the nonresident 24-January-2015© Chir Amrit Corporate School37
Refund of tax deducted under Section 195 (CIRCULAR NO. 7/2007, DATED & CIRCULAR NO. 07/2011 dated ) S.No.SituationCriteria 5.Amendment in law or by notification under the Act There occurs exemption of the remitted amount from tax 6.Order passed u/s 154 0r 248 0r 264Tax deduction liability of the payer is reduced 7.Double deduction of tax amountSame amount deducted twice by mistake 8.Other than discussed abovePayment of tax at higher rate under domestic law while a lower rate is prescribed under DTAA 24-January-2015© Chir Amrit Corporate School38
Furnishing information relating to payments S. 195(6) r.w. R. 37BB FormThreshold LimitRequirements 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) 24-January-2015© Chir Amrit Corporate School39
THANK YOU 24-January-2015© Chir Amrit Corporate School40
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