Seminar on NRI Taxation Section 9(1) and Treaty Provisions PP Anand April 2017
Income deemed to accrue or arise in India [Section 9]
Income deemed to accrue or arise in India Section 9 Following categories of income shall be deemed to accrue or arise in India: 1. Income from any business connection in India 2. Income from any property in India 3. Income from any asset or source of income in India 4. Income from transfer of a capital asset situated in India 5. Dividend from an Indian company 6. Income from Interest 7. Royalty and Fees for Technical Services ( FTS ) 15
Business connection Section 9(1)(i) CIT Vs RD Aggarwal (SC) The expression business connection means something more than a business. It presupposes an element of continuity between the business of the non resident and the activity in the taxable territory, a stray or isolated transaction is normally not to be a business connection. Business connection may take several forms: it may include carrying on a part of the main business or activity incidental to the main business of the non-resident through an agent, or it may merely be a relation between the business of the non resident and the activity in the taxable territories which facilitates or assists the carrying on of that business. In each case the question whether a business connection from or through which income, profits or gains arise or accrue to a non-resident must be determined upon the fact and circumstances of the case. A relation to be a business connection must be real and intimate, and through or from which income must accrue or arise whether directly or indirectly to the non-resident. 16
Business connection Section 9(1)(i) In the case of business for which all the operations are not carried out in India: Income reasonably attributable to operations carried out in India shall be chargeable to tax in India Purchase of goods for export not included in income deemed to accrue/ arise in India Business connection includes any business activity carried out through a person, who habitually: Exercises in India authority to conclude contracts on behalf of nonresident (unless activities limited to purchase of goods for the nonresident); Maintains in India stock of goods from which he regularly delivers goods on behalf of non resident; or Secures orders in India mainly or wholly for the non-resident/ other non-residents subject to common control as the former non-resident Business connection does not include any business activity carried out by a person having an independent status acting in the ordinary course of his business 17
Salary Income earned in India Section 9(1)(ii) Income which falls under the head Salaries shall be regarded as income earned in India, if the income is payable for: Services rendered in India; and The rest period or leave period, which is preceded and succeeded by services rendered in India and forms part of the service contract of employment. However, certain exemptions are provided under Section 10(6) in respect of salary earned by foreign nationals under certain circumstances and subject to certain conditions. 17
Salary paid by Government of India Section 9(1)(iii) Salary Income payable by the Government of India to an Indian Citizen for services rendered outside India shall be chargeable to tax. The residential status of the individual and the place of receipt of the salary are not relevant for the purpose of this sub section. The following four conditions are to be satisfied: Income should be chargeable under the head Salaries Salary is paid / payable by the Government of India Services rendered outside India; and Recipient should be an Indian Citizen 17
Dividend Section 9(1)(iv) Dividend paid by an Indian Company outside India is deemed to accrue or arise in India by virtue of the provisions of this sub section. For the purpose of this sub section, the residential status of the recipient of the dividend income is not relevant. Similarly, dividend declared by a foreign company and paid in India will be taxed in India on receipt basis. The place of accrual of dividend should be decided on the basis of the place of registered office of the company. Dividend declared and paid by a domestic company is exempt u/s 10(34). 17
Interest Section 9(1)(v) Interest is deemed to accrue or arise in India where the interest is payable by Central or State Government Resident of India (exception provided to debt used for a source of income generated outside India) Non- Resident of India where the interest pertains to debt incurred for the business carried out in India. Explanation to Section 9(1)(v): Where the non-resident is engaged in the business of banking, any interest payable by a PE in India to the following entities outside India shall be deemed to accrue or arise in India: Head Office; Any PE; Any other part of such non-resident The definition of PE has been provided in Section 92F. The deeming fiction mentioned above is in addition to any profit attribution to the PE in India. 17
Royalty Section 9(1)(vi) Section 9(1)((vi) - Royalty payable in respect of any right, property or information used or services for business / profession as stipulated Explanation 2 to Section 9(1)(vi): Royalty means consideration for (includes lump sum consideration but excludes income chargeable under the head Capital Gains ) for: b)imparting of any Information concerning: patent, invention, model, design, secret formula or process or trademark or similar property copyright, literary, artistic or scientific work including films or video tapes but excludes consideration for sale, distribution and exhibition of cinematographic films Knowledge of IPR law very relevant.. working of or use of patent, model, design, secret formula, process, trademark or similar property technical, industrial, commercial or scientific knowledge, experience or skill c) Use or right to use: a)use of or Transfer of all or any rights in including granting of any license: industrial, commercial or scientific equipment (excluding those covered under Section 44BB) [Introduced from AY 2002-03] d)rendering of any services in connection with activities constituting Royalty Explanation 3 to Section 9(1)(vi): Computer software means any computer program recorded on any disc, tape, perforated media or other information storage device and includes any such programme or customized electronic data [from AY 2001-02]
Widening ambit of Royalty Computer Software The Finance Act 2012 - Expansion of Royalty definition retrospectively w.e.f. 1 June 1976 Explanation 4 added to s. 9(1)(vi) - For the removal of doubts, it is hereby clarified that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a license) irrespective of the medium through which such right is transferred As per Memorandum to Finance Bill - Some judicial decisions have interpreted this definition in a manner which has raised doubts as to whether consideration for use of computer software is royalty or not. Considering the conflicting decisions of various courts in respect of income in the nature of royalty and to restate the legislative intent, it is further proposed to amend the Income-tax Act. India in its comment on the UN MC 2011 has recommended The use of and right to use computer software irrespective of the medium through which such right is transferred is to be construed as Royalty (Article 12) As an observer member, India has reserved its positions on several paragraph of the OECD MC cases of reservations which extend to software, ICS experience, undersea cables, payments for roaming calls, spectrum allocation, etc.
Widening ambit of Royalty Use / Possession and Process The Finance Act 2012 - Expansion of Royalty definition retrospectively w.e.f. AY 1977-78 Explanation 5 added to s. 9(1)(vi) - For the removal of doubts, it is hereby clarified that the royalty includes and has always included consideration in respect of any right, property or information, whether or not (a) the possession or control of such right, property or information is with the payer; (b) such right, property or information is used directly by the payer; (c)the location of such right, property or information is in India Use of Process : Explanation 6 added to s. 9(1)(vi) - For the removal of doubts, it is hereby clarified that the expression process includes and shall be deemed to have always included transmission by satellite (including up-linking, amplification, conversion for down-linking of any signal), cable, optic fibre or by any other similar technology, whether or not such process is secret Inserted primarily to overturn Delhi High Court s decision in the Asia Sat case The term Transmission not defined
Software Taxability Income Tax Authorities Characterisation of receipts from software supply by foreign companies / entities / persons Supply of software involves use / right to use of following: copyright, patent, Whether Royalty? Software of supply Invention, process, or scientific work Taxable in India as royalty on gross basis Issue under litigation in a number of cases pre and post introduction of Explanation 4 to Section 9(1)(vi) Whether Business Income? Taxpayers Supply of software does not involve any use / right to use of copyright, patent, invention or process It is for use of a copyrighted product / article and thus, business income, not taxable in India in the absence of any PE in India Reliance placed on OECD and International commentaries Question currently pending before the Supreme Court primarily from series of negative decisions of Karnataka HC and controversy extends to online database access and similar other items as well
FTS Section 9(1)(vii) Explanation 2 to Section 9(1)(vii). FTS means any consideration (includes lump sum consideration) for rendering any: Managerial Technical Consultancy Services Includes Provision of services of technical / other personnel Excludes: Construction; Assembly; Mining; Any like project; Income chargeable as Salary The Supreme Court in Ishikawajima (2007) 288 ITR 408(SC) held that offshore services not only must be utilized in India but also be rendered in India as part of its business or have sufficient territorial nexus live link with India to become taxable The FA 2007 inserted an Explanation to Section 9 w.r.e.f. 1 June 1976 to indicate that Interest, Royalty and FTS would be included in total income of NR irrespective of their place of resident or place of business or business connection in India or rendering of services in India (introduced subsequently by FA 2010)
Meaning of FTS under ITA Managerial Services - R. Dalmia v. CIT (1977) 106 ITR 895 (SC) Technical Services - Bharti Cellular Ltd (2010) 330 ITR 239 (SC) / Kotak Securities [2016] 383 ITR 1 (SC) The words "person concerned in the management of the business" mean a person not only directly participates or engages in the management of the business but also one who indirectly controls its management through the managerial staff, from behind the scenes. Management includes the act of managing by direction, or regulation or administration or control or superintendence of the business. Technical Services Human intervention to be involved in technical services as the term technical is between Managerial & Consultancy Services [Bharti Cellular (SC) and other decisions] Consultancy Services GVK Industries Ltd (2015) 371 ITR 453 (SC) read with Bharti Cellular (Del HC) The term "consultancy" has been defined in the Dictionary as "the work or position of a consultant; a department of consultants." "Consultant" itself has been defined, inter alia, as "a person who gives professional advice or services in a specialized field." The word "consultant" is a derivative of the word "consult" which entails deliberations, consideration, conferring with someone, conferring about or upon a matter. Consult has also been defined in the said Dictionary as "ask advice for, seek counsel or a professional opinion from; refer to (a source of information); seek permission or approval from for a proposed action". It is obvious that the service of consultancy also necessarily entails human intervention. The consultant, who provides the consultancy service, has to be a human being. A machine cannot be regarded as a consultant. Professional Services are also covered per judicial precedents and Technical Services need not be confined to technology relating to engineering, manufacturing or applied science
Taxation of Royalty / FTS under the ITA Taxation on Gross basis under Section 115A Stipulated conditions for agreements with Indian Concern (Payer) Agreement with Government, or Agreement to be approved by the Government; or Where it relates to a matter included in the Industrial Policy (Currently, FEMA) Cases of NR to NR not fully covered as payer envisaged as the Government or an Indian Concern Indian Branch of Foreign Company Indian Concern (CBDT Circular 740 dated 17.4.96 / Bank of Credit & Commerce Mum AT) Prior to AY 2004-05, Gross basis of taxation applied only to R/ FTS income of Foreign Companies Position till AY 2013-14 For agreements made on or after 1 June 1997 till 31 May 2005 Taxation on gross basis under Section 115A read with Section 44D at 20% (+SC and EC) For agreements entered on or after 1 June 2005 - Basic rate of 10% on gross basis (+SC and EC)
Taxation of Royalty / FTS under the ITA Position from AY 2014-15 Taxation on gross basis under Section 115A and net basis under Section 44DA as above Basic rate of tax modified to 10% on gross basis (+SC and EC) Provisions of Section 206AA at 20% on gross basis not relevant unless DTAA stipulates lower rate, TRC available but no PAN of the payee available Deduction under Section 206AA is initial withholding of tax and not a charging Section Thus, excess withholding tax over DTAA rate can be claimed refund in tax return post PAN and TRC If grossing up applies then the grossed up rate is to be compared with 20% This view is now supported by judicial precedents No Surcharge or cess to be applied and 20% is the absolute gross withholding tax rate Section 94A: Cyprus highest rate of withholding at 30% on gross basis from 1 November 2013 till (now de-notified and renegotiated)
Taxation of Royalty / FTS under the ITA Taxation on net basis - Section 44DA position from AY 2004-05 For R/ FTS effectively connected with PE of business / fixed place of profession of NR in India PE As per Section 92F(iiia) of the Act The Supreme Court in Morgan Stanley (292 ITR 416) has held that PE definition in the Act is inclusive and would cover all types of PEs as per DTAA as well Prior to AY 2004-05 / Section 44DA: R/ FTS were held to be taxable on gross basis even when attributable to PE This was due to gross basis taxation only under the ITA; and Where DTAA obliged computation of income in accordance with and subject to limitations of the ITA Several old Advance Rulings have upheld this position
Position of Royalty / FTS under Model Convention (MC) Royalty Royalty US MC OECD MC Exclusive taxation in State of Residence unless attributable to PE of NR in the Source State Royalty = consideration for use / right to use of any copy right of literary, artistic or scientific work including cinematograph films, any patent, trademark, design or model, plan secret formula or process or for information concerning industrial, commercial or scientific experience UN MC Right to State of Source to tax on gross basis as well as net basis when attributable to PE / Fixed Base of Non-Resident Notable inclusions of Films / Tapes used for radio / TV broadcasting Notable inclusions of industrial / commercial / scientific equipment Similar to OECD MC but no exclusive right to tax for State of Residence Notable exclusion of cinematographic films Notable inclusion for gains derived from alienation which is contingent on the productivity or use or disposition of the property FTS There is no specific article on FTS in either OECD / UN / US MC On par with Business Income i.e. Taxable in State of Source only if attributable to PE of NR therein
Agreement with foreign countries or specified territories [Section 90]
Section 90 Central Government may enter into an agreement with: Government of any country outside India; or Specified territory outside India. The agreement may be entered for: Granting relief in respect of "income on which income tax has been paid / "income tax chargeable in India and in country/ specified territory outside India; For avoidance of double taxation of income in India and in country/ specified territory outside India; For exchange of information for prevention/ investigation of evasion/ avoidance of income tax chargeable in India or in country/ specified territory outside India; or For recovery of income tax in India and in country/ specified territory outside India. For taxpayer to whom such agreement applies, the beneficial provisions of the Indian Income-tax Act or such agreement (i.e. tax treaty), as the case may be, shall apply. For foreign company, charge of tax at a higher rate than the Indian company shall not be regarded as less favourable charge.
Meaning of Double Taxation DOUBLE TAXATION Imposition of comparable taxes in 2 or more states on the same / different tax-payer on same subject matter for identical periods Double Taxation arises due to tussle between Residence vs. Source Rule 22
Tax Treaty An Introduction Section 90 of the Income Tax Act, 1961 Empowers Government of India to enter into a Tax Treaty (DTAA) for avoidance of double taxation Statutory objective Relief on doubly taxed income Promotion of mutual economic relations, trade and investment Avoidance of Double Taxation Exchange of information Recovery of tax Parties to tax treaties Countries outside India Specified territories outside India Treaty Override Section 90 of the Income-tax Act, 1961 provides that Domestic tax law will apply to the extent it is more beneficial than the DTAA Tax Residency Certificate (TRC) in prescribed form mandatory for claiming Treaty benefits 23
Structure of DTAA SCOPE DEFINITION SUBSTANTIVE Article 1: Scope Article 3: Definitions Articles 6-22: Article 2: Taxes Covered Article 4: Residence (Business Profits, Dividends, Capital Gains, Interest, Royalty, Other Income, etc.) Article 29/30: Entry into Force Article 5: PE Article 30 /31: Termination ELIMINATION OF DOUBLE TAX ANTI-AVOIDANCE Article 23: Article 26: Elimination of Double Taxation Exchange of information Article 25: Mutual Agreement Procedure Limitation of Benefit MISCELLANEOUS Article 24: Non- Discrimination Article 27: Diplomats Article 28: Territorial Extension 24
Article 1 & 2 : Applicability ARTICLE 1 Persons Covered ARTICLE 2 Taxes Covered DTAA applies to persons who are residents of one or both of the Contracting States Covers income tax and surcharge DTAAs signed recently cover wealth tax Does not cover indirect taxes 25
Article 4 : Residence ARTICLE 4 Residence Lays down criteria for determining residence of person General Rule Resident is a person who is liable to tax by reason of domicile, residence, place of management or other similar criterion [Article 4 (1)] Residence clause should be examined before proceeding to other clauses
Article 7 : Business Profits Article 7(1) Charging provision The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. Charge of tax: Normally, business profits are taxable only in the home county Conditions for taxability: Taxation in the host country only if: the enterprise carries on business in the other State (i.e. host country) through a permanent establishment there are profits attributable to that permanent establishment
Article 5 : Permanent Establishment Article Particulars Type of PE General Rule Article 5 (1) of OECD 5(1) 5(2) Basic rule Illustrative list of PE Fixed place PE Inclusions to fixed base PE For the purpose of this Convention, the term permanent establishment means a fixed place of business through which the business of an enterprise is wholly or 5(3) 5(4) 5(5) & 5(6) PE in relation to projects Construction / Installation / Service PE List of exclusions Exclusions to PE Dependent / Independent agent Agency PE partly carried on. Tests for Fixed place PE - The place of business test - The permanence test - The business activity test
Article 8 : Operation of ships or aircraft Profits from operation of ships or aircraft in international traffic taxable in contracting state in which PEM / (country R)situated Whether Article 8 takes precedence over Article 7 (Business Profit)? Yes -if Article 8 does not apply, Article 7 applies Profits taxable in India if PE exists Article 8 applies notwithstanding existence of PE No specific paragraph in Article 8 regarding effective connection with PE
Article 6 : Immovable Property Income is taxable in the source state if: Income is derived by the non-resident from immovable property (including income from agriculture or forestry) situated in the source state It covers income derived from: Direct use; Letting; or Use in any other form of the immovable property Profits on alienation of immovable property would result in Capital Gains and shall be covered under Article relating to Capital gains, i.e. Article 13
Article 10 : Dividends Article10(1) Principle Dividends paid by a company which is a resident of a X to a resident of Y may be taxed in Y. Article10(2) Right to tax Article10(3) Defines Dividend Article10(4) Holding effectively connected with PE However, such dividends may also be taxed in X of which the company paying the dividends is a resident and according to the laws of X, but if the beneficial owner of the dividends is a resident of the Y, the tax so charged shall not exceed (10) percent
Article 11 : Interest Article11(1) Principle Article11(2) Right to tax Article 11(3) - Meaning of interest Article 11(4) Debt-claim effectively connected with PE Interest arising in X and paid to a resident of the Y may be taxed in Y However, such interest may also be taxed in X in which it arises and according to the laws of X, but if the beneficial owner of the interest is a resident of the Y, the tax so charged shall not exceed (10) percent of the gross amount of the interest.
Article 12 : Royalties/ Fees for Technical Services Royalties and FTS arising in X and paid to Article 12(1) Distribution of rights of a resident of Y may be taxed in Y. the Contracting States Article 12(2) Ceiling of Gross taxation by the State of Source However, such royalties and FTS may also be taxed in X [the State in which they arise] and according to the law of X; but if the Article 12(3) Meaning of the term beneficial owner of the royalties/ FTS is a Royalty/ FTS resident of Y, the tax so charged shall not Article 12(4) Taxation of Royalty / exceed (15) per cent of the gross amount FTS if effectively connected with PE / of such royalties. Fixed Base of Non-Residents in the State of Source
Article 13 Capital Gains Capital Gains realized from Immovable Property Where taxed Situs of IP Base Source base Movable Property Assets of PE Situs of PE/FB Source base Ship, Aircraft Boat etc Place of Eff. Management Eff. Mangmt. Shares of / interest in Property Co / Entity Situs of IP Source base Substantial share holding Residence of Co. Source base Other Assets Residence of Alienator Resi. base
Article 14 Independent Personal Services Article 14(1) - Apart from Resident State, taxation of income derived from professional services or other activities of an independent character in the Source State if: If he has a fixed base regularly available in the Source State for performing activities If his stay in Source State exceeds 183 days in any twelve-months period Article 14(2) - The term "professional services" includes especially independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists and accountants. General attributes of Professional - An advanced level of knowledge acquired through formal training in the chosen practice area - Specialised skill sets and experience acquired through dedicated practice in the chosen and
Article 15 Dependent Personal Services General Rule Salaries, Exception in case employment income Wages remuneration, and taxable other the similar State of received as: Article 16 - Director s Fees Residence State of Source also has the right to tax if employment is exercised there Article 18 - Pensions Article 19 - Government Service
Article 17 Artistes and Sportspersons Notwithstanding the provisions of Article Paragraph 1 : 7 and 15 (ncome derived by a resident of a - Source State has right to tax Contracting State as an entertainer, such - Simplistic and effective method of taxation as a theater, motion picture, radio or television artiste, or a musician, or as a - overrides Article 7 (Business Profits), sportsman (sportsperson in case of UN Article 14 (Independent personal services) Model Convention), from his personal and activities as such exercised in the other services) of the Model Conventions Contracting State, may be taxed in that other State Article 15 (Dependent personal
Article 20 Students Article applies to: students / business trainee, thus Article applicable only to individuals is or was immediately before his visit, resident of the other Contracting State is present solely for the purpose of education / training receives payments for maintenance, education and training from sources outside the host state Article not to cover: a student, who was at one point of time, a resident of a Contracting State but had subsequently become a resident of a third State before he visited the host State. a visitor, who comes to the host State, primarily to work, but also is a part-time student The Individual shall not be taxed in that State, provided that such payments arise from sources outside that State. Remuneration for dependent (Article 15) or independent (Article 14) personal services rendered by student, not covered
Article 21 Other Income Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State. Article 21 is a residuary Article In order to apply Article 21, there should be an element of income Para 1 covers: income not covered in the foregoing Articles wherever arising taxable in the state of residence Article applies irrespective of whether right to tax is in fact exercised by the state of residence Article covers: Non-compete receipts Income from gambling / lottery
Article 22 Taxation of Capital Article 22(1) Immovable property referred to in Article 6: taxable in the State in which property is located Article 22(2) Movable property, forming part of business property of PE / pertaining to fixed base for performing independent personal services: taxable in the State where PE / fixed base is located Article 22(3) Ships and aircrafts operating in international traffic and boats engaged in inland waterways along with movable property pertaining to operation of such ships, aircrafts and boats: taxable in the State in which effective management of the enterprise is situated Article 22(4) All other elements of capital: taxable in the State of residence
Article 23 What are the types of double taxation relief? Unilateral relief Bilateral relief Whether India provides for unilateral relief also? Section 91 of the Income-tax Act, 1961 provides for unilateral relief Example if income accrued outside India (say country A) and tax paid in country A, India does not have a DTAA with such country Relief from Indian tax available on doubly taxed income Indian rate of tax or rate of tax in country A, whichever is lower What are methods of elimination of double taxation? Exemption Method - Looks at income Article 23A - OECD Credit Method Looks at tax Article 23B - OECD
Article 24 Non Discrimination Prevention of discrimination under tax laws of the host country on account of the following four criteria: - Nationality of the taxpayer [Art 24(1)] and [Art 24(2)] - A PE in the host country [Art 24(3)] - Deduction - Payment of interest, royalties, other consideration, etc. to a recipient abroad [Art 24(4)] - Holding of shares in a resident enterprise by non-residents [Art 24(5)] Other provisions: Stateless Persons [Art 24(2)] Inclusion of other taxes [Art 24(6)] Art 24(1) prevents ND of Nationals whereas Art 24(3) to Art 24(5) prevent ND of Residents
Article 25 Mutual Agreement Procedure Where a person considers that the actions of one or both of the Contracting States result or will result for him in taxation not in accordance with the provisions of this Convention, he may, irrespective of the remedies provided by the domestic law of those States, present his case to the competent authority of the Contracting State of which he is a resident or, if his case comes under paragraph 1 of Article 24, to that of the Contracting State of which he is a national. The case must be presented within three years from the first notification of the action resulting in taxation not in accordance with the provisions of the Convention.
Article 26 Exchange of Information The competent authorities of the Contracting State shall exchange such information as is foreseeably relevant for carrying out the provisions of this Convention or to the administration or enforcement of the domestic laws concerning taxes of every kind and description imposed on behalf of the Contracting States, or of their political subdivision or local authorities, insofar as the taxation there under is not contrary to the Convention. The exchange is not restricted by Articles 1 and 2. Covers exchange of all types of information. Information includes instructive knowledge concerning facts and particulars. Not only covers taxpayer-specific information but also general information e.g. tax avoidance/evasion schemes, etc. Foreseeably relevant intended to cover information exchange widely.
Limitation of Benefits LOB clause intends to limit the benefits of the treaty to legitimate residents of the contracting countries. Generally, a LOB clause in a treaty is designed to test the substance of a claimant to the treaty LOB clause is intended to prevent treaty shopping and tax avoidance LOB articles in treaties vary between each treaty in terms of conditions and complexity Generally, the LOB clause denies treaty benefits if the person seeking to obtain treaty benefits is not a qualified person (resident)
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