International Tax Update: India
Foreign Remittance: TDS u/s 195: Case Law Analysis 2015: Series 1
Some of the important case laws published during 2015 pertaining to TDS u/s 195 and/or taxability of foreign companies/non-resident entities in respect of source of income in India. Discussion and analysis (given in italics) pertain to relevance of judgement in future proceedings, subsequent developments, other relevant case laws on the same aspect, judicial decisions which are no longer relevant.
1. Interest by Indian branch to foreign Head office-TDS u/s 195- (Antwerp Diamond Bank NV vs. ADIT [2015] 152 ITD 446 (Mumbai - Trib.))
Interest was paid by assessee Indian branch of a Belgian bank to its head Office on subordinate debts and term borrowing. HELD, in view of domestic law as well as treaty same would not be chargeable to tax in India and thus, TDS provision of section 195 would not be attracted and, hence, question of disallowance under section 40(a)(i) did not arise.
1.1. Comments: However, the above judgement shall not hold good in respect of interest payments w.e.f. 1.4.2015 by Indian branch to foreign head office due to amendment in Finance Bill 2015 whereby interest paid by Indian branch to foreign head office has specifically been made chargeable to income tax in India. Concept of ‘Non-taxability of Income on grounds of mutuality/payment to self’ no longer holds validity after 1.4.2015 in respect of interest payment by Indian branch to foreign head office.
2. Royalty-Sale of Software – (Halliburton Export Inc. vs. ADIT [2015] 152 ITD 803 (Delhi - Trib.))
Assessee, a US company, entered into agreements with various customers in India for rendering software services - Assessing Officer held that payments received by assessee from sale of software and provision of maintenance and other support services to customers in India, were taxable as 'royalty' and accordingly made additions. HELD, in view of decision of Jurisdictional High Court in case of DIT v. Infrasoft Ltd. [2014] 220 Taxman 273/[2013] 39 taxmann.com 88 (Delhi), payment received by assessee from sale of software and provisions of maintenance and other supports services to customers in India were not taxable as 'royalty', in terms of article 12 of India US Double Taxation Avoidance Agreement.
2.1) Comments: There were two issues involved –taxability of sale of software and taxability of support services
2.1.1) Sale of Software: The tribunal rightly concluded that sale of software is not royalty. The decision again underlies that sale of prepackaged software is not a sale of copyright and hence not royalty. The judgement could have been different but for the Delhi High Court decision in the case of Infrasoft Limited (supra) as the earlier Karnataka HC Decision held that sale of licensed software amount to royalty. The decision of Infrasoft Ltd. (supra) has now become an authority being the latest high court decision as regards taxability of software is concerned. It overruled the earlier Karnataka HC decision of Samsung Electronics on the ground that ‘The license granted to the licensee permitting him to download the computer programme and storing it in the computer for his own use was only incidental to the facility extended to the licensee to make use of the copyrighted product for his internal business purpose’
Though there was another decision of Delhi High Court (subsequent to Samsung Decision) in the case of DIT v. Nokia Networks OY [2013] 212 Taxman 68/[2012] 25 taxman.com 225 (Delhi) wherein taxability of software sale was not held as royalty but on different grounds. HC held that the software that was loaded on the hardware did not have any independent existence and no separate payment was agreed for it. On these facts it was held by the High Court that the payment for software was not royalty. Hence decision of Nokia has no application in the instant case of independent sale of software.
2.1.1a) Decisions on longer relevant: Important decisions (which held software as copyright and hence taxable as royalty and were relied upon by revenue) which are no longer relevant after Infrasoft decision of Delhi high court include: CIT v. Sunray Computers (P.) Ltd. [2012] 348 ITR 196 (Kar. HC); Citrix Systems Asia Pacific (P.) Ltd., In re [2012] 343 ITR 1 (AAR - New Delhi); CIT v. Samsung Electronics Co. Ltd. [2012] 345 ITR 494 (Kar.HC).
2.1.2) Software Support/Maintenance Services: Maintenance / other software support services to the customers in India were held as non-taxable. However, no detailed reasoning for the same was given in the judgement. The taxability of the same were also not discussed in Delhi HC decision of Infrasoft Ltd.(supra). However there was another decision viz. Infrasoft Ltd. v. Asstt. DIT (International Taxation) [2009] 28 SOT 179 (Delhi) wherein it was held that “The other receipts on account of maintenance charges and training fees, being incidental to the software receipts would assume the same character as that of software receipts and the same were liable to be taxed accordingly”. However, there is no High Court or Supreme Court judgement on the matter. It may be regarded as fees for technical services or royalty depending on the facts of the case. The issue needs further clarification as regards taxability of charges for software updates/support services/maintenance charges.
3. Royalty-Subscription Charges: (CIT vs. Infosys Technologies Ltd. [2015] 229 Taxman 335 (Karnataka))
Subscription charges paid to non-resident would amount to royalty liable to TDS
3.1) Comments: The judgement of High Court relied on its earlier judgement CIT v. Infosys Technologies Ltd. [2012] 204 Taxman 311 (Kar.) which relied on judgement of CIT (IT) v. Wipro Ltd. [2011] 203 Taxman 621 (Kar. HC) and held that subscription charges paid to non-resident would amount to royalty. However, it is pertinent to note that Karnataka HC in the case of Wipro Ltd had not given any detailed reasoning as to why subscription charges would amount to royalty and how online access to database is different from subscription made to a journal or magazine. It relied on the reasoning given in its earlier decision as regards taxability of shrink-wrapped software in CIT v. Samsung Electronics Co. Ltd. [2012] 345 ITR 494 (Kar.HC) which has since been distinguished by the subsequent decision of DIT v. Infrasoft Ltd. [2014] 220 Taxman 273/[2013] 39 taxmann.com 88 (Delhi). Hence, the reasoning given in Karnataka HC decision of Wipro ltd for taxing the subscription charges does not seem to hold good in the present scenario and subscription charges can be argued to be not representing fees for use of copyright and hence not taxable as royalty.
However, there are other decisions where subscription charges/database access fees have been held to be taxable as royalty on the ground of imparting information concerning industrial and commercial knowledge, experience and skill. The judgements include: Cargo Community Network (P.) Ltd., In re [2007] 289 ITR 355 (AAR), ONGC Videsh Ltd. v. ITO [2013] 141 ITD 556 (Delhi-Trib.), ThoughtBuzz (P.) Ltd. [2012] 346 ITR 345.
4. Movie/Film Satellite rights as royalty: (S. P. Alaguvel vs. DCIT [2015] 228 Taxman 202 (Madras)(MAG.))
Transfer of Movie/Film satellite rights to assessee under an agreement for a period of 99 years is a sale and, therefore, excluded from definition of 'royalty' under clause (5) of Explanation 2 to section 9(1)(vi).
4.1) Comments: Tribunal relied on the decision of High Court in Mrs. K. Bhagyalakshmi v. Dy. CIT [2014] 221 Taxman 225/[2013] 40 taxmann.com 350 which has considered elaborately the perpectual transfer of rights for a period of 99 years in terms of section 26 of Copyright Act and also the definition under clause (5) to Explanation 2 of section 9(1)(vi) in relation to royalty and had come to conclusion that transfer in favour of assessee is a sale and, therefore, excluded from definition of royalty under section 9(1)(vi). Explanation 2.
5. Fees for Technical Services for Business Outside India: (DCIT vs. Hofincons Infotech & Industrial Services (P.) Ltd. [2015] 152 ITD 249 (Chennai - Trib.))
Assessee, providing consultancy services, made payment pertaining to some support services rendered by non-resident in Qatar qua its Nigerian projects. HELD, since fees was paid to non-resident abroad for services utilized in business carried outside India, same was not liable for any deduction of tax at source.
5.1) Comments: The decision once again outlines the non-taxability of payment to a non-resident if it is for the purpose of business conducted outside India covered by exclusion clause under section 9(1)(vii)(b). Other important decisions which have dealt with exclusion clause under section 9(1)(vii)(b) are as under:
5.1. a) Selling commission to foreign agents-Non-Taxable: assessee made payment of selling commission to its agent located abroad for mobilising its sales in foreign countries, since said services were not in nature of managerial services, payment in question was not taxable in India as 'fee for technical services' under section 9(1)(vii)(b) (ACIT vs. Lohia Starlinger Ltd. [2014] 65 SOT 155 (Lucknow - Trib.)(URO))
5.1.b) Testing services for export- Taxable: Assessee-company was engaged in manufacture of switch gears, energy meters, cables and wires, electrical fans, compact florescent lamp and related components - It paid certain amount to US company for purpose of obtaining witness testing of AC contractor as part of CB report and KEMA certification and did not deduct TDS therefrom on ground that since it was making exports to other countries, fees were paid for purpose of making or earning income from a source outside India and, hence, payment was not chargeable to tax in India in view of second exception in section 9(1)(vii)(b). HELD, in order to fall within second exception provided in section 9(1)(vii)(b), source of income and not source of receipt, should be situated outside India. Since, in instant case export activity having taken place or having been fulfilled in India, source of income was located in India and not outside and mere fact that export proceeds emanated from persons situated outside India did not constitute them as source of income. Therefore, fees for technical services was taxable in hands of US company in India and assessee was liable to deduct tax at source while making payment thereof. (Commissioner of Income-tax vs. Havells India Ltd. [2012] 253 CTR 271 (Delhi))
5.1.c) FTS for running aircrafts in international routes only: Non-Taxable: Income can be said to have been earned from a ‘source of income’ outside India if source from which income is derived is situated outside India and in context of an international transaction, source can be said to be ‘outside India’ if - (i) payer is a non-resident, or (ii) contract with non-resident is made outside India, or (iii) activity yielding income takes place outside India.
In this case, Assessee, a domestic company, had acquired four Boeing Cargo Aircrafts from a foreign company and obtained license from licensing authority to operate those aircrafts on international routes only. Assessee periodically made payments to a non-resident company on account of overhaul, repairs of its aircrafts, engines sub-assemblies and rotables (components) in workshops abroad. HELD, even assuming that payments for such maintenance repairs were in nature of fees for technical services, they would not be chargeable to tax as they were made for earning income for sources outside India and, therefore, would fall within purview of exclusionary clause of section 9(1)(vii)(b).(Lufthansa Cargo India (P.) Ltd. vs. DCIT [2005] 92 TTJ 837 (Delhi))
5.1.d) FTS for acquiring business outside India- Existence of source of Income is not relevant: Non-Taxable: Assessee-sugar manufacturer engaged a Brazilian company to advice and assist in acquisition of sugar mills and distilleries in Brazil and paid them fees for technical services - Whether since assessee was contemplating to create a source for earning income outside India, though source of income had not yet come into existence, assessee would still get benefit of exceptional clause (b) of section 9(1)(vii) as there is nothing in section 9(1)(vii), clause (b) to show that source of income should have come into existence so as to except payment of fees for technical services. (ITO vs. Bajaj Hindustan Ltd. [2011] 47 SOT 74 (Mumbai)(URO))
5.1.e) FTS for rendering consultancy outside India: Non-Taxable: Assessee paid consultancy fee to consultants for carrying out consultancy services in Nigeria. HELD, consultants were used in business of assessee abroad, and, therefore, section 9(1)(vii)(b) would apply and income of such non-residents could not be deemed to accrue or arise in India. (DCIT vs. Ajapa Integrated Project Management Consultants (P.) Ltd. [2012] 49 SOT 37 (Chennai)(URO))
Exclusion clause under section 9(1)(vii)(b) is the most underutilised clause for arguing non-taxability of income of non-residents for the purpose of business outside India. It offers a great tax planning opportunity for reducing tax liability on foreign remittance.
6. Capital gains/Resident: (DIT vs. ICICI Bank Ltd. [2015] 370 ITR 17 (Bombay)) Where capital gain accrued to residents of UAE from sale of Government securities in India carried out through respondent bank, was not taxable in UAE, said income generated in India could not be subjected to tax in India and, therefore, respondent bank was not liable to deduct tax at source while remitting amount in question to non-residents.
6.1) Comments: The dispute arose from the fact that the DTAA with UAE requires that capital gain be taxable in UAE, however there is no taxation of individuals in UAE and hence it lead to double non-taxation. However, the treaty provisions prevail and also the judgement of Asstt. DIT v. Green Emirate Shipping & Travels [2006] 100 ITD 203 (Mum.) clearly laid out that taxability in one country is not a sine qua non for availing relief under treaty from taxability in other country and being ‘liable to tax’ in Contracting State does not necessarily imply that person should actually be liable to tax in that State by virtue of an existing legal provision but would also cover cases where other Contracting State has right to tax such persons irrespective of whether or not such a right is exercised by Contracting State.
6.1.a) Subsequent developments: Transactions in the ICICI case pertained to financial year 2005-06. However, there is subsequently revision in DTAA with UAE w.e.f. 1/4/2008 - wherein the capital gains tax protection available to the UAE residents in respect shares of Indian companies has been done away with. Also, it is now provided that the capital gain would be liable to tax in India in the hands of UAE resident, if underlying immovable property of the company is situated in India.
Also, the definition of resident of UAE has been revised to ‘in the case of the United Arab Emirates: an individual who is present in the UAE for a period or periods totalling in the aggregate at least 183 days in the calendar year concerned, and a company which is incorporated in the UAE and which is managed and controlled wholly in UAE.’ Hence dispute as regards concept of ‘liable to tax’ for determining residential status and hence applicability of treaty have been put to rest.
Hence the above decision will not hold good for transaction in shares of Indian companies and hence transaction of sale of shares in Indian company shall be liable to TDS u/s 195 even if seller is a resident of UAE.
7. Business Profits/Attribution of Profits: (Galileo Nederland BV vs. ADIT [2015] 228 Taxman 11 (Delhi HC)) Assessee Dutch company engaged in providing electronic distribution services to travel industry through Computerized Reservation System (CRS) appointed Indian distributor which only negotiated and entered into contracts with various travel agents who wished to be connected to assessee's CRS - Major functioning of collecting data bases with various airlines, hotels, etc. and their analysis and development took place and all data were stored in huge capacity computers in Denver, USA. Indian agent merely provided connectivity to agents enabling them for booking function. HELD, the 15 per cent formula, which was applied for assessment years 1995-96 to 1998-99 has been followed up to assessment year 2002-03. Hence, attribution of 15 per cent of assessee's profit to India was just and proper for subsequent assessment years as well.
7.1) Comments: It is to be noted that 15% of profits and not revenue are to be attributed to India as has been rightly held. Also, such attributed profit is subject to further deduction of expenditure by PE in India. The Tribunal has rightly observed that estimation of profits would be ideally based upon number of bookings originating from India in comparison with the bookings in a particular year and on consideration of global accounts. However, HC did not agree with the submission as the Assessing Officer had mentioned in the assessment orders that the facts and circumstances of the case remain the same and no such Foundation and basis had been first made in the assessment order.
Also, the HC relied on FAR analysis to determine the 15% rate of attribution of profits to India. The major functioning, i.e., collecting data bases with various airlines, hotels etc. and entering or feeding them into the computer took place outside India. The role performed by the computers in India or the Indian agents was to merely get connected or be configured so that the travel agents could perform the booking function. The computers in India were not capable of processing data, which was processed abroad. Thus, it was looking at the nature and the character of the functions undertaken in India viz., the functions and assets outside India, 15 per cent was attributed to India.
However, the concept of customers as asset was not brought up during the proceedings. If revenue generating assets viz. Customers are more in India, more profits be ideally allocated to India.
8. Usance Charges as Interest: (ACIT vs. Bhavani Enterprises [2015] 152 ITD 339 (Panaji - Trib.)): Usance charges paid to non-resident on import purchase by assessee would be considered as 'interest' income and hence liable for TDS u/s 195.
8.1) Comments: The tribunal relied on the Gujarat HC decision of Vijay Ship Breaking Corpn. [2003] 261 ITR 113/129 Taxman 120 (Guj.) wherein it was held that usance charges are interest within the provisions of Sec. 2(28A) of the Income Tax Act. However, arguments presented in another judgement of Gujarat High Court viz. CIT v. Saurashtra Cement & Chemical Industries Ltd. [1975] 101 ITR 502 (GUJ.)) was not discussed before the tribunal wherein it was held that unpaid purchase price cannot be regarded as loan since non-resident company could not be said to have lent amount of unpaid purchase price to assessee-company either in cash or in kind, there was no question of interest payable assessee-company to non-resident company being deemed to be ‘income’ accruing or arising from any money lent at interest and brought into India in kind.
9. Telecom Services as Fees for Technical Services: (ITO vs. Clear Water Technology Services (P.) Ltd. [2015] 67 SOT 15 (Bangalore - Trib.)(URO)) Payment made by assessee, an Indian company to a US company for utilizing telecom services in USA did not constitute fee for technical services as said payments were for use of bandwidth provided for down linking signals in US; and said payments were not in nature of managerial, consultancy or technical services nor was it for use of or right to use industrial, commercial or a scientific equipment.
9.1) Comments: This decision by the Bangalore tribunal is in line with the latest decision of Karnataka High Court in the case of CIT vs. Infosys Technologies Ltd. [2015] 229 Taxman 335 (Karnataka)) wherein it was held that Down linking charges paid to foreign party could not be treated as royalty.
Also, with regard to telecom services, The Madras High Court in the case of Sky Cell Communication Services Ltd. v. DCIT [2001] 251 ITR 53 (Mad.) has held that payment for use of mobile phone services would not constitute royalties or fees for technical services. Payments made for bandwidth are akin to the payments for use of mobile phone services.
The Bangalore Bench of the ITAT in the case of Wipro Ltd. v. ITO 80 TTJ 191 has held that payment for bandwidth would constitute neither royalties nor fees for technical services either under the Act or under the agreement for Avoidance of Double Taxation with USA.
10. Capital Gains and Compensation: (ITO vs. Vinay P. Karve [2015] 152 ITD 58 (Mumbai - Trib.)) Income earned by assessee, a French resident, from sale of shares of Indian companies, could not be taxed under head 'capital gain' due to benefit conferred in terms of article 14(6) of India-France DTAA
Where assessee, a non-resident, received certain amount of compensation from his power of attorney holder towards damages for breach of trust in respect of sale of shares of Indian companies, said amount being in nature of capital receipt, could not be brought to tax.
10.1) Comments: The DTAA with France provides that capital gains realised by French resident on sale of shares in Indian Company would be taxable in France (i.e. country of residence) only if shares do not represent more than 10% of capital of company.
France has a progressive tax regime wherein tax rates vary from 0% to 45% depending on income levels. However, capital gain on sale of shares is subject to 65% reduction in income tax if period of holding is 8 years or more. However, India exempts income tax on capital gains on listed shares if period of holding is more than 1 year only. Also, for unlisted shares maximum rate is 20% if period of holding is more than 1 year. Hence, the provision of taxability of capital gain from sale of shares in Indian company by French resident in state of residence i.e. France is more of a disadvantage and should be planned properly.
Further decision points out that damage for breach of trust as capital receipt and not taxable in India. There are other recent judicial precedents pertaining to treatment of damages/compensation as capital receipt:
10.1.a) Bernstein Litowitz Berger And Grossmann LLP v. UOI: [2015] 228 Taxman 334 (Delhi HC)(Mag.) - Certain shareholders of American Depository shares filed suit against Indian company and others, claiming damages on account of alleged fraud - A settlement amount was arrived between them and same was transferred to beneficiaries - Authority of Advance Ruling(AAR) determined that said amount was taxable in India and deducted tax at source prior to payment to beneficiaries. In this case, HC did not outrighly held the compensation as capital receipt rather remanded the matter back to AAR to determine whether the settlement amount is capital receipt or revenue receipt.
10.1.b) Spaco Carburetors (I) (P.) Ltd. V. ACIT: [2010] 127 ITD 153 (MUM.): Assessee was a manufacturer of different types of carburetors required for automobile and two wheeler industries - It entered into a technical collaboration agreement (TCA) with a Japanese company ‘K’ Ltd.. ‘K’ refused to provide any technology advice as regards newly developed carburetor - As there was no amicable settlement, matter was referred to Arbitration Tribunal before Internation Court of Arbitration. HELD, compensation awarded by Arbitration Tribunal is a capital receipt.
10.1.c) Upaid Systems Ltd., In re [2011] 338 ITR 517 (AAR): Satyam, Indian Company agreed to pay to applicant an amount of $ 70 million under Settlement deed for extinguishment of all rights and obligations between parties, for severing their business relationship arising out of prior agreements, towards compensation for deficiency in its patent found to exist by applicant, for grant of perpetual worldwide royalty-free licence by applicant on all its patents to Satyam, subject to Satyam not having a right to assign licence. HELD, compensation of $ 70 million paid to applicant would be capital receipt in hands of applicant.
Payment of amount as settlement represents a tax loophole as it is held as capital receipt and not liable to tax in India. The non-taxability of settlement/compensation where such amount is paid on order of tribunal or appropriate authority is understandable. However, treatment of out of court settlement as capital receipt is a matter of concern and can be misused to avoid taxation in India.
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CA Rohit Gupta
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