Withholding taxes on cross-border payments A conundrum? Ernst & Young Webcast Held on 10 February 5.00 p.m. (IST)
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1 Withholding taxes on cross-border payments A conundrum? Ernst & Young Webcast Held on 10 February 5.00 p.m. (IST)
2 Contents Background Key issues/ challenges Karnataka High Court ruling Technical analysis Way forward Generally asked questions (GAQs)
3 Background
4 Background Withholding tax (WHT) on cross-border payments a significant issue in international taxation Availability of foreign tax credit in home country? Double taxation concerns Real time taxes Difficult/impossible to retrieve the horse after it has bolted Need to control the gates at points of actual or deemed payment Tax Authorities like WHTs it puts them in control of cash flows Page 4
5 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 Page 5
6 Overview of non-resident WHT provisions 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 Page 6
7 Overview of non-resident WHT provisions 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 Page 7
8 Key issues/ challenges
9 Key issues/ challenges Payments subject to WHT Any sums chargeable to tax in India Issues in determining sums chargeable to tax in India A substantive question of law and fact Determining character and source of income Determining appropriate amount where taxation is on net income Characterization of income Royalty/ fees for technical service (FTS) v business profits Broader definition of FTS in domestic tax law v narrower definition in some tax treaties Payments for purchase of computer software, communication services and e-commerce / technology transactions Source of income Services rendered from outside India? Page 9
10 Key issues/ challenges Persons responsible for WHT Any person responsible for making any payment to a NR Any person includes individual, firm, company etc., whether resident or not Extra-territorial application as even NR s (not having any territorial nexus with India) subject to WHT compliance Recent controversy on extra-territorial application of the provision Persons subject to WHT WHT applicable on payments to NR Branch office or PE of a foreign company subject to WHT on all chargeable sums Possibility of payer applying WHT on gross amount Provision for seeking a nil WHT certificate from the tax authorities Page 10
11 Key issues/ challenges Period of limitation for passing AID order Finance (No 2) Act, 2009 amendment provides time limit in case of payments to residents for orders passed after April 1, 2010 No specific time limit provided in tax law for payments to NR Case laws suggest the need to apply a reasonable time limit Mumbai Tribunal (Special Bench) in the case of Mahindra & Mahindra Ltd [2009-TIOL-255-ITAT-MUM-SB] should be at par with the time limit for initiating and completing assessment on NR Delhi High Court in NHK Japan Broadcasting Corporation [305 ITR 137] 4 years from the end of the financial year in which tax was deductible Page 11
12 Key issues/ challenges Mandatory requirement for Permanent Account No (PAN) Section 206AA introduced with effect from April 1, 2010 Recipients of payments on which tax is deductible need to provide PAN WHT at higher of rates in force or 20% in the absence of PAN Application for lower WHT certificate cannot be made without PAN Can Section 206AA operate to override tax treaties that provide for lower WHT rate? Page 12
13 Karnataka High Court Ruling
14 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 Page 14
15 Karnataka HC Ruling in the case of Samsung & Others [2010] 320 ITR 209 (Kar HC) 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 Page 15
16 Karnataka HC Ruling in the case of Samsung & Others [2010] 320 ITR 209 (Kar HC) 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 before it 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 Page 16
17 Karnataka HC Ruling in the case of Samsung & Others [2010] 320 ITR 209 (Kar HC) Likely 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 Page 17
18 Karnataka HC Ruling in the case of Samsung & Others [2010] 320 ITR 209 (Kar HC) Current status of litigation Number taxpayers have filed or in process of filing special leave petition to SC Interim order in case of some taxpayers Stay on recovery of taxes Similar issue also under consideration by Special Bench of Chennai ITAT Page 18
19 Technical analysis
20 Technical analysis: scope of Section 195 Scope of section 195(1) WHT required if a sum is chargeable to tax as per the provisions of the ITL Where payment is not taxable in India (either exempt under the ITL or applicable tax treaty), Section 195 (1) should not have application To be read with Section 4(2) of the ITL In respect of the income chargeable under sub-section (1), income-tax shall be deducted at the source or paid in advance, where it is so deductible or payable under any provision of the Act Page 20
21 Technical analysis: scope of Section 195 Scope of section 195(2) Taxpayer may make an application to the Tax Authority to determine the appropriate portion of such sum so chargeable Taxpayer will have to file an application only when the sum is taxable The term such indicates that income has to be chargeable to tax. The term may indicates that it is not obligatory to approach the Tax Authority for an order. Reliance can be placed on the following: Circular No 152 dated 27 November 1974 Procedure for making remittance to NR on submission of CA certificate in Form No 15CB provided in Circular No 4 dated 29 June 2009 HC decision in Czechoslavak Ocean Shipping [1970] 81 ITR 162 ITAT Special Bench decision in Mahindra & Mahindra Ltd (Supra) Page 21
22 Technical analysis: scope of Section 195 Inappropriate reliance on SC decision in Transmission Corporation by KHC SC observed that any..sum chargeable under the provisions of this Act would mean sum on which tax is leviable Tax is required to be withheld when amount is taxable When some portion is taxable, taxpayer should approach the tax authority for WHT order under section 195(2)/197 Page 22
23 Technical analysis: scope of Section 195 Decisions not given due consideration by KHC Eli Lilly and Co. (India) P. Ltd [2009] 312 ITR 225 (SC) Machinery provisions are not independent of charging provisions ITL is an integrated code in which one cannot segregate the computation machinery from the collection and recovery machinery". Vijay Ship Breaking Corporation [2009] 314 ITR 309 (SC) No WHT obligation in respect of exempt income under the ITL as the liability to withhold tax arises only if tax is assessable in India Jindal Thermal Power Company [2009] 225 CTR 220 (KHC) SC decision in Transmission did not lay down that person making payment has no right to question the tax liability of payee State Bank of India [2008] 13 DTR 294 (Raj HC) Referred to the SC decision in case of Transmission and held that WHT obligation would not apply as the interest was exempt Page 23
24 Technical analysis: binding nature of ruling Legal principles on binding nature of court decisions Law declared by the SC binding on all Courts in India HC decisions binding on subordinate Courts/tribunals/authorities under its jurisdiction Could be considered by non-jurisdictional Courts/ Tribunals/ Authorities as having persuasive value Conflicting decisions of various HC s other than the jurisdictional HC Tribunal may follow that decision that seems to it to lay down the better view Special Bench decision binds the division bench of the Tribunal unless a contrary view is expressed by jurisdictional HC or SC Kanel Oil and Exports Industries Ltd. v. JCIT [2009] 126 TTJ 158 (Ahd) Page 24
25 Technical analysis: binding nature of ruling Taxpayers not subject to jurisdiction of KHC Does not establish a binding precedent Taxpayers can continue to rely on other SC/ HC decisions as well as Special Bench Decision Recent decision of Mumbai ITAT in the case of Anchor Health [ TIOL-767-ITAT-Mum] SB ruling in the case of Mahindra not referred Arguably decided per incuriam, case incorrectly decided Page 25
26 Technical analysis: binding nature of ruling Taxpayers subject to jurisdiction of KHC Possibility of decision setting a binding precedent for jurisdictional ITAT/ Tax Authorities Taxpayers taking contrary position would need to argue their case before larger bench of HC or before SC Is there a case for diluting the binding nature of the decision? Should taxpayers WHT on all NR payments or seek certificate from Tax Authorities? What is the status of CA certificate for NR payments? What is the impact on past transactions? Page 26
27 Way forward
28 Way forward WHT on NR payments has been an area of focus KHC ruling likely to strengthen enforcement efforts of Tax Authorities Consider reviewing current WHT practices and develop strategy for future payments 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 Page 28
29 GAQs on WHT
30 GAQs on WHT 1. What is the impact of stay granted by the SC pursuant to SLP filed against Samsung decision? Has the decision of the KHC been stayed? 2. What are the potential risks if the Tax Authority wins at the SC level? 3. Since the provisions of Forms 15CA and15cb have not been highlighted in the Samsung judgement, does the decision in Samsung be considered as being decided per incuriam? If so, what is the impact of the decision in Samsung? 4. Are WHT provisions applicable in respect of any payment made to NR pursuant to any commercial transaction (supply of goods/provision of services) with the NR? If not, then what is the impact of the contrary ruling passed in Samsung s case? Page 30
31 GAQs on WHT 5. Does the applicability of WHT depend on the Country or does it depend on the type of service or business? 6. In case of payments made for software subscription to software resellers, where such subscription charges are liable to service tax, would such payments be treated as FTS and be subject to WHT in India? 7. What would be the WHT rate applicable in case of payments made for professional fees overseas? How would it differ if the payment is made to a person resident in a country which a treaty partner of India e.g. US or UK? What would be the rate applied in such a case? 8. Is payment made by an Indian company to a US company for transfer of technology (pursuant to a technology transfer agreement entered with its US based parent company), subject to withholding of taxes in India? The US company does not have a PE in India, but the US parent has a PE in India. The Indian company does not have any relation/transaction with the PE in India. Page 31
32 GAQs on WHT 9. Is it mandatory to make an application under section 195(2) even if there is a business income payment and no PE in India? What if a PE does exist? 10. Is there any difference in WHT provisions which are applicable for the foreign company as against those applicable to a NR Individual that provides services in India? 11. A NR supplier or service provider would always want to recover from an Indian buyer, the taxes withheld in India. The amount recovered is the difference in the tax rates applied by the two countries whose authentic calculation is always a big question. What are the possible ways through which an authentic calculation can be ensured? 12. Is WHT dependent on the currency in which the payment is made? 13. At present, is it right that an Indian individual need not to pay any WHT to the Government of India if that Individual provides services in other countries and gets the payment in foreign currency. What are the points which one needs to take care of while providing service? Page 32
33 GAQs on WHT 14. With effect from 1 April 2010, non-residents are required to obtain a Permanent Account Number (PAN) to avoid withholding of tax at 20%. If a payment is not liable to withholding of tax, is the non-resident required to apply for PAN? 15. Update on the India-Mauritius tax treaty and litigation in the Vodafone case? Page 33
34 Ernst & Young Presenter Rajendra Nayak, Partner, Tax Knowledge & Solutions Recorded version of the webcast will be accessible till 12 March 2010 at: For enquiries, please write to: This Presentation provides certain general information existing as at the time of production. This Presentation does not purport to identify all the issues or developments pursuant to the transaction. Accordingly, this presentation should neither be regarded as comprehensive nor sufficient for the purposes of decision-making. Ernst & Young does not undertake any legal liability for any of the contents in this presentation. The information provided is not, nor is it intended to be an advice on any matter and should not be relied on as such. Professional advice should be sought before taking action on any of the information contained in it. Without prior permission of Ernst & Young, this document may not be quoted in whole or in part or otherwise referred to in any documents. Page 34
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